United States: ERISA Newsletter - Third Quarter 2017


As we have observed on other occasions, the ERISA class action plaintiffs' bar has, for several years now, honed in on 401(k) plan fiduciaries and their decisions to select and retain investment options that they allege, in hindsight, underperformed and/or were too expensive. More recently, they have done the same for 403(b) plans sponsored by non-profit institutions. Our featured article this quarter reviews current developments in these lawsuits and urges, as a means to stem this tide and the associated costs, judicial enforcement of heightened pleading standards established by the U.S. Supreme Court.

We also cover developments concerning the DOL fiduciary rule, disaster relief, wellness programs, disability benefits retiree benefits, exhaustion of administrative remedies, and health care reform.


By Russell Hirschhorn

Over the past decade, there have been scores of lawsuits filed against ERISA plan fiduciaries charging them with breaches of fiduciary duty and prohibited transactions in connection with their selection and retention of the investment options made available to previous hit401(knext hit) and 403(b) plan participants. Plaintiffs have advanced several theories against these plan fiduciaries, including that the available investment funds underperformed alleged comparable investments, charged excessive fees, and/or were unsuitable investments for plan participants. They also have argued that plan fiduciaries engaged in self-dealing by selecting and maintaining affiliated funds (also referred to as proprietary funds or in-house funds) as plan investment options. Litigation also has expanded to include challenges to fee arrangements with service providers. Most recently, plaintiffs have launched attacks on 403(b) plans sponsored by universities, which, in an interesting twist, include allegations that plan fiduciaries offered participants too many investment options.

Depending on one's point of view, the proliferation of these lawsuits may be seen as a sincere effort to insure that ERISA plan fiduciaries act prudently and loyally in fulfilling their obligations to the plan, or simply the product of entrepreneurial ingenuity on the part of a growing and opportunistic ERISA plaintiffs' bar, which is well aware that these lawsuits can generate handsome settlements and concomitant attorneys' fees awards. A recent survey revealed that there may be cause for the more skeptical approach: from 2009 through 2016, ERISA plan sponsors and fiduciaries paid nearly $700 million in fines, penalties and settlements in connection with breach of fiduciary duty lawsuits, while plaintiffs' counsel collected more than $200 million and the average plan participant award was $116. See Tom Kmak, Fiduciary Benchmarks: Protect Yourself at All Times, DC DIMENSIONS (Summer 2016).

The most logical remedy for these alarming developments is judicial enforcement of heightened pleading standards. In this article, we review the standards established by the U.S. Supreme Court that plan participants must meet in order for their complaints to survive a motion to dismiss. We then survey some of the recent case law to illustrate how courts have, with less than complete consistency, applied these pleading standards to previous hit401(knext hit) and 403(b) plan investment challenges. Lastly, we comment on the going-forward implications for plan sponsors and fiduciaries.

Requirements for Pleading ERISA Fiduciary Breach Claims

The Federal Rules of Civil Procedure govern (with some exception) the procedure in all civil actions and proceedings in the United States district courts. Rule 8(a)(2) requires that, to state a claim for relief, a plaintiff file a pleading that contains a "short and plain statement of the claim showing that the pleader is entitled to relief."

For decades, this Rule had been broadly construed to require only "notice pleading" such that a plaintiff's allegations were presumed to be true, facts were construed in a manner most favorable to a plaintiff, and, importantly, a court could not dismiss a complaint unless a plaintiff could prove "no set of facts" in support of his or her claim for relief. Conley v. Gibson, 355 U.S. 41 (1957). In 2007, however, the U.S. Supreme Court changed the existing interpretation of Rule 8(a)(2). In Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the Court adopted a more strict, "plausibility" standard. In Ashcroft v. Iqbal, 556 U.S. 662 (2009), the Supreme Court provided guidance as to how lower courts should apply the Twombly test: "First, the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions...Second, only a complaint that states a plausible claim for relief survives a motion to dismiss. Determining whether a complaint states a plausible claim for relief will...be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Id. at 679 (citations omitted).

The Second Circuit translated this standard into a heightened one for participants advancing ERISA fiduciary breach claims based on investment losses. The court required participants to either: (i) allege facts referring directly to a fiduciary's deficient investigation of the investment in question; or (ii) if the complaint relies on inferences from circumstantial factual allegations to show a breach, "allege facts, accepted as true, showing that a prudent fiduciary in like circumstances would have acted differently." Pension Benefit Guar. Corp. v. Morgan Stanley Inv. Mgmt. Inc., 712 F.3d 705, 718-20 (2d Cir. 2013). While the court did not specify what facts would suffice to meet this standard—since each case is "context-specific"—it explained that neither poor performance of an investment nor the availability of "better investment opportunities" would show that a prudent fiduciary would have made different choices. Id. at 718. The court also stated that the cost of defending fiduciary breach claims in discovery, and the risk that these prospective costs will be used to extort settlements, require that participants include in their complaints "a factual predicate concrete enough to warrant further proceedings." Id. at 719 (quotation omitted).

The Supreme Court subsequently endorsed that view in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014), when it devised a rigorous pleading standard for fiduciary breach claims, and stated that a motion to dismiss is an "important mechanism for weeding out meritless" ERISA claims—or, as the Court expressed it, to "divide the plausible sheep from the meritless goats." Id. at 2470. That standard also furthers ERISA's twin policies of (i) defraying litigation expenses that might otherwise discourage employers from offering benefit plans in the first place; and (ii) affording deference to the decision-making of plan fiduciaries, and not transforming courts into de facto plan administrators.

Application of Pleading Standards to Defined Contribution Plan Investment Litigation

The plaintiffs' bar has, for many years now, launched a multi-prong attack on plan fiduciaries' decisions to select and maintain various investment options in 401(k) plans and, more recently, in 403(b) plans. These lawsuits generally fall into one of the following categories:

Underperformance and Excessive Fees. Plan participants claim that the investment options charge higher fees than alleged comparables. A corollary claim is that it was imprudent to offer actively managed funds because these funds have not outperformed index funds that charge lower fees. Often times, these claims are combined with the assertion that the performance of the challenged funds, net of the fees charged, trails the net performance of the comparable investments alleged in the complaint. Although scores of lawsuits have been filed, to date, there are but a few bright lines that have evolved in evaluating whether plaintiffs' claims should be permitted to proceed into discovery. For example, courts have held that an investment's poor performance, standing alone, does not create an inference that a prudent fiduciary would have chosen different investment products because investments cannot be evaluated based on hindsight and periods of underperformance are not uncommon. White v. Chevron Corp., No. 16-cv-0793-PJH (N.D. Cal. Aug. 29, 2016). And, the fact that an investment option may charge higher fees than other investments does not create an inference of imprudence because "nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund." Hecker v. Deere & Co., 556 F.3d 575, 586 (7th Cir. 2009).

Affiliated Funds. In recent years, the claims for underperformance and/or excessive fees have increasingly targeted affiliated funds. Plaintiffs' argument is that the plan fiduciaries breached their duty of prudence and loyalty by offering these funds, in lieu of supposedly superior funds, to generate profits for the plan sponsor or to "seed" these funds with investment money that will make them more attractive to other investors. Because of the added disloyalty allegations, these cases have generally been more successful in withstanding motions to dismiss. See Cryer v. Franklin Templeton Res., No. C 16-4265 CW (N.D. Cal. Jan. 17, 2017); Urakhchin v. Allianz Asset Mgmt. of Am., L.P., No. SACV 15-1614-JLS (JCGx) (C.D. Cal. Aug. 5, 2016). The reasoning of these rulings seemingly ignores the fact that both Congress and the U.S. Department of Labor have created exemptions to permit the use of affiliated funds as investment options in a 401(k) plan. See, e.g., 29 U.S.C. § 1108(b)(8); 42 Fed. Reg. 18,734 (Mar. 31, 1977). Thus, one can argue that a claim that is otherwise implausible does not become plausible just because an affiliated fund is involved. After all, zero plus zero still equals zero.

Alternative Investments. Plan participants also have targeted alternative investments, such as hedge funds, as being unsuitable for 401(k) plans, either as stand-alone investment options or as a significant component of an investment vehicle such as a target date fund or default investment vehicle. See Johnson v. Fujitsu Tech. & Bus. of Am., Inc., No. 16-cv-03698 NC (N.D. Cal. Apr. 11, 2017) (denying motion to dismiss complaint challenging a plan's custom target date funds invested in "speculative assets classes" that are allegedly not common and underperformed their benchmarks and other established target date funds).

403(b) Plans. With respect to the more recent spate of lawsuits against the fiduciaries of university sponsored 403(b) plans, the few courts that have issued opinions evaluating motions to dismiss have permitted many of the claims to proceed to discovery. They generally have reasoned that the complaints pled specific enough allegations about better performing or cheaper alleged comparables to create issues of fact that should not be resolved on a motion to dismiss. For example, plaintiffs survived dismissal in a case challenging a 403(b) plan's decision to offer: (i) the retail share class version of many of the plan's investment options, which allegedly charged excessive fees and performed poorly when compared to identical, lower-cost share classes of the same funds; and (ii) actively managed funds when passively managed funds in the same investment style were available with lower fees and better performance.

Proskauer's Perspective

The results thus far on motions to dismiss have been mixed at best. Notwithstanding the Supreme Court's endorsement of stricter pleading requirements, many complaints have withstood motions to dismiss, particularly—but not exclusively—those challenging the use of affiliated funds. The courts' failure to apply these standards consistently is significant for plan sponsors and fiduciaries: Plaintiffs who survive a motion to dismiss are permitted to engage in costly class action discovery, which often causes plan fiduciaries to think about settlement despite the fact that the claims, if taken to summary judgment or trial, would be successfully refuted. According to a recent study, defending a breach of fiduciary duty lawsuit through the motion to dismiss stage can cost up to $750,000 and discovery can cost affected companies between $2.5 million and $5 million. See LOCKTON COMPANIES, Fiduciary Liability Claim Trends (February 2017). Moreover, as discussed above, these lawsuits rarely inure to the benefit of plan participants in any meaningful way.

Given the high stakes associated with the outcome of the motion to dismiss, and the obstacles they face to prevailing using the heightened pleading standards, it is important to think "outside-the-box" when devising a motion to dismiss strategy. For example, conventional arguments about the insufficiency of the pleadings may be coupled with attacks on the plaintiff's standing to bring suit or timeliness of the complaint. It also may be appropriate to consider the prospects of an immediate motion for summary judgment if the court will need to consider documents not embraced by the complaint in order to conclude that the complaint is insufficient.

Although it is always difficult to predict the future, we remain optimistic that the courts will eventually apply the rigorous pleading standards with greater consistency, and thus will separate the plausible sheep from the meritless goats and preclude the plaintiffs' bar from extracting multi-million dollar settlements merely on the threat of costly, class action discovery. Any other result would be harmful to the individual plans targeted and, more broadly, the private retirement system.

To read this Newsletter in full, please click here.

ERISA Newsletter - Third Quarter 2017

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