Lawsuits filed against several major corporations asserting violations of ERISA based on claims of excessive fees in 401(k) plan investment options and failure to disclose revenue sharing arrangements have garnered much attention in the benefits community over the past couple of years. One of these lawsuits has recently settled, some are scheduled for trial in upcoming months, and some have been the subject of court rulings at preliminary stages of the proceedings. In a previous article (see our March, 2009 issue), we discussed the decision by the Seventh Circuit Court of Appeals in the case of Hecker v. Deere where the appellate court upheld the dismissal by the district court of the lawsuit in its entirety. In a counterpoint to the Hecker decision, the Eighth Circuit Court of Appeals in Braden v. Wal-Mart Stores, Inc., 2009 WL 4062105 (8th Cir. Nov. 25, 2009) (“Braden”), recently reinstated on appeal a similar lawsuit that had also been dismissed in its entirety by the district court.
At the time of the filing of the lawsuit, the Wal-Mart Stores, Inc. Profit Sharing and 401(k) Plan had more that one million participants and about $10 billion in plan assets. The investment menu options under the self directed plan included 10 mutual funds, a collective trust, Wal-Mart stock and a stable value fund that had all been selected by the Wal-Mart Retirement Plans Committee. Braden filed suit in 2008 against Wal-Mart and several executives who had oversight responsibility for the Retirement Plans Committee.
The allegations in Braden’s complaint were similar to those made in many of the other 401(k) fee lawsuits. The complaint alleged that the Wal-Mart Plan is a large plan, that the 401(k) marketplace is highly competitive, and that retirement plans of the size of the Wal-Mart Plan have the ability to obtain institutional class shares of mutual funds. The complaint further alleged that the Wal-Mart Plan offered only retail class shares of the ten mutual funds included in the Plan, which charge significantly higher fees than institutional shares for the same return on investment, and that the defendants did not change the investment options included in the Plan despite the fact that most of them underperformed the market indices they were designed to track. The complaint also alleged that seven of the Plan’s ten mutual funds charged 12b–1 fees from which the Plan participants allegedly derived no benefit. Finally, the complaint alleged that the funds included in the Plan made revenue sharing payments to the trustee, Merrill Lynch, and that these payments were not made in exchange for services rendered, but rather were “kickbacks” paid by the mutual fund companies for including their funds in the Plan.
Braden’s complaint contained five claims for relief including breach of the fiduciary duty of prudence by including the funds in the Plan’s investment line-up, breach of the fiduciary duty of loyalty by failing to disclose to Plan participants certain information as to the fees charged by the funds in the Plan and the amounts of revenue sharing payments made to Merrill Lynch, and prohibited transactions in the payment of the revenue sharing amounts. The other two claims in the complaint asserted co-fiduciary breaches against the defendants who had oversight responsibility for the Plan Committee.
District Court Rulings
The district court dismissed all of Braden’s claims. It found that he lacked constitutional standing to assert claims for alleged breaches that occurred before he had first contributed to the Plan. The district court dismissed the breach of fiduciary duty claim with respect to the selection of the investment options on the basis that, while Braden stated the expense ratios and fees on the funds were unreasonable and that better alternatives were available, he did not allege any specific deficiencies in the defendants’ conduct in selecting the funds. The district court noted that the Plan fiduciaries could have chosen funds with higher fees for any number of valid reasons and that Braden did not allege any facts showing that the defendant fiduciaries had not properly investigated the available options before making a choice. The district court dismissed the breach of fiduciary duty claim with respect to the alleged failure to disclose information about the fund fees on the basis that the information was not material to the investment decisions of Plan participants. The district court also found that there is no duty to disclose revenue sharing arrangements under current ERISA law. The prohibited transaction claim was also dismissed by the district court because Braden had failed to show that the revenue sharing payments were unreasonable in relation to the services provided.
Again, the district court noted that the mere availability of less expensive options is insufficient to state a claim, because the Plan fiduciaries could have chosen more expensive funds for a variety of legitimate reasons. Finally, the district court dismissed the failure to monitor and co-fiduciary breach claims because these claims were derivative of the underlying claims that had been dismissed.
Court of Appeals Reinstates Complaint
The Eighth Circuit Court of Appeals found that the district court had improperly dismissed Braden’s complaint and remanded the case to the district court for further proceedings. The Eighth Circuit found that Braden had standing under Article III of the U.S. Constitution to bring the claims because he had alleged injury to his own Plan account and a causal connection between the conduct of the defendants, including actions taken by the defendants before his participation in the Plan, and the alleged injury to his account. The court pointed out that an imprudent selection of investment options by the Plan fiduciaries that occurred before Braden’s participation in the Plan could have caused him a subsequent injury when he did begin participating in the Plan, if those investment options were still in place then. Citing the decision by the U.S. Supreme Court in LaRue v. DeWolff, Boberg and Associates (see our March 2008 issue) for the proposition that a claim for fiduciary breach under Section 502(a)(2) of ERISA is brought in a representative capacity on behalf of the Plan as a whole, the Eighth Circuit found that, if Braden succeeded in his claims, relief could be granted for the entire Plan and would not be necessarily limited to the time period in which Braden participated in the Plan.
The district court had dismissed Braden’s complaint pursuant to a motion to dismiss and, in these circumstances, a court assumes that the factual allegations of the complaint are true and grants all reasonable inferences in favor of the party against whom the motion has been filed. Applying these principles, the Eighth Circuit held that Braden had sufficiently stated a claim for breach of fiduciary duty with respect to the selection of the investment options for the Plan. Even though none of the complaint’s allegations specifically addressed the process by which the funds had been selected, the court found it was reasonable to infer from the allegations in the complaint that the process had been flawed. In reaching this conclusion, the court pointed out the limited range of investment options available under the Wal-Mart Plan and distinguished the decision in the Hecker case where participants in the Deere plan had access to over 2500 mutual funds through a brokerage window. The court also noted the remedial purpose of ERISA, and said that purpose would fail if ERISA plaintiffs could not state a claim without pleading facts that “tend systemically to be in the sole possession of defendants,” such as the process used by fiduciaries for the selection of plan investment options. The Eighth Circuit, however, did agree with the Seventh Circuit’s ruling in Hecker that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund” and stated that a bare allegation that cheaper alternative investments exist in the marketplace would not support a claim for breach of fiduciary duty in the selection of plan investment options.
Braden’s claim that the Wal-Mart Plan fiduciaries had breached their fiduciary duty of loyalty by failing to disclose to Plan participants material information about fund fees was found to be sufficient by the Eighth Circuit. The court stated that, in the context of the case, the materiality of information depended on the effect that the information would have on a reasonable participant’s decision about how to allocate his or her investments among the options in the Plan, and that the failure to disclose the information about the allegedly “high” fund fees in the Plan could mislead a reasonable participant in making investment decisions under the Plan. Similarly, Braden’s allegations that there was a failure to disclose information about the revenue sharing payments were found to be sufficient to support a claim for breach of the fiduciary duty of loyalty. The court stated that Braden alleged that the revenue sharing payments had “corrupted the fund selection process” in that the funds were allegedly selected for inclusion in the Plan because they made payments to Merrill Lynch as the trustee and not because they were prudent investments. The Eighth Circuit opined that this information, if true, could influence a reasonable participant in evaluating his or her investment options under the Plan.
Braden’s claim that the revenue sharing payments by the fund companies to Merrill Lynch as the trustee for the Plan constituted prohibited transactions under ERISA was also reinstated. As trustee and a service provider to the Plan, Merrill Lynch was a “party in interest” within the meaning of ERISA and subject to the prohibited transaction restrictions under ERISA section 406(a). ERISA section 408(b)(2) provides an exemption from the prohibited transaction rules for payments to parties in interest for services necessary for the establishment or operation of a plan but only if the compensation is reasonable in amount in relation to the services provided. Braden had alleged that the revenue sharing payments made by the mutual funds in the Plan to Merrill Lynch were “kickbacks” for including the funds in the Plan and were not reasonable compensation for actual services performed by Merrill Lynch for the Plan. The Eighth Circuit found that the district court had erred in dismissing Braden’s prohibited transaction claim on the basis that he had failed to show that the payments were not exempted by ERISA section 408 because the Section 408 exemption is a defense that has to be proven by a defendant and the plaintiff does not bear the burden of pleading facts that show the payments were unreasonable in proportion to the services provided. The court concluded that Braden had stated a claim for prohibited transactions because the complaint alleged that there was an arrangement with Merrill Lynch, as a party in interest, under which Merrill Lynch received revenue sharing payments in exchange for services provided to the Plan and these allegations were sufficient to shift the burden to the defendants to show that that no more than reasonable compensation was being paid for Merrill Lynch’s services.
Finally, the Eighth Circuit reinstated the claims brought by Braden alleging breach of monitoring and co-fiduciary duties because the district court had dismissed these claims as being derivative of the other claims it had dismissed and had not analyzed the merits of these claims. The Eighth Circuit remanded the derivative claims to the district court to determine whether Braden could proceed with them.
The decision by the Eighth Circuit in the Braden case is the first major appellate court ruling in favor of the plaintiffs in the 401(k) fee lawsuits. This victory may well breathe new life into the bringing of such claims by ERISA plaintiff attorneys even though many of the previous court rulings have gone against them. In particular, the ruling by the Braden court on the prohibited transaction claim can be read as making it very easy, at least in the Eighth Circuit, for plaintiffs to survive motions to dismiss on such claims that challenge revenue sharing practices that have been widespread in the 401(k) industry for many years. There have, however, been recent court rulings in 401(k) fee cases in favor of plan sponsors and fiduciaries that serve as a counterweight to the pro-plaintiff nature of the Braden case. The wide ranging victory for the plan sponsor and fiduciaries in Hecker v Deere has been, since the publication of our prior article, upheld when the plaintiff’s Petition for Panel Rehearing and Petition for Rehearing En Banc were denied. The dismissal by the district court of the 401(k) fee case in Taylor v. United Technologies Corporation has been affirmed by the Second Circuit Court of Appeals, although it was done by a summary order without any substantive analysis by the appellate court. Lastly, the District Court for the Northern District of Illinois relied on the Hecker decision in granting a motion to dismiss in Loomis v Exelon Corporation even though the plaintiff had specifically amended the complaint in order to avoid some of the holdings by the Seventh Circuit in Hecker. There are sure to be further developments in the ongoing 401(k) plan fee litigation and we will cover significant ones as they arise in future issues of Benefits Report.