DYLAN RUDOLPH and JOSEPH FAUCHER, September 29, 2022
Over the past several weeks, a single law firm, Miller Shah, LLP, has filed nearly a dozen lawsuits against fiduciaries of defined contribution plans that offer the BlackRock LifePath Index target date funds (“BlackRock Funds”). The cases represent a shift in approach relative to earlier waves of ERISA litigation. While cases in this area have largely targeted investment options that plaintiffs claimed were overpriced “actively managed” funds, the BlackRock Funds are passively managed funds tied to mutual fund indices, and, as a result, carry lower overall expense ratios relative to their actively managed cousins.
What has become colloquially known as “excessive fee” litigation has proven to be both stubbornly persistent and consistently evolving; in fact, that name itself may need to be revisited now that even low-cost indexed funds are in the plaintiffs’ crosshairs. For almost two decades, these “excessive fee” lawsuits have been filed against fiduciaries of defined contribution plans throughout the country, asserting that plan fiduciaries selected investment options which were both overpriced and poorly performing, among other claims. One frequently repeated theory of liability in those cases was that actively managed investment funds did not perform well enough to justify their higher investment management fees (as compared to passively managed funds) and, therefore, should have been removed from a plan’s investment lineup.
Target Date Investment Options
The BlackRock Funds are target date investment options, which “target” a participant’s anticipated retirement year and adjust the risk/reward strategy of their underlying investments based on a participant’s proximity to that retirement year. Where a target date fund uses an indexed strategy, as the BlackRock Funds do, the underlying investments track market indices based on investment type, such as large cap growth, large cap value, small cap growth, small cap value, etc. These types of funds are designed to track the market generally, rather than attempt to outperform the market based on complex financial assessments — as so-called “actively managed” funds do. The additional complexity associated with active management typically comes at a comparatively higher price.
Under a traditional target date model, a participant’s retirement assets are invested in riskier underlying investments, like equities, the farther away they are from their target retirement year (i.e., early in their career). The thinking is that participants can tolerate more risk when they are younger, which hopefully results in greater returns. Then, as participants approach retirement, the underlying investments in their chosen fund move gradually toward lower risk investments, like fixed income bond funds, because the low-risk investments are safer and in line with the lower risk tolerance of a participant who is near retirement.
The path on which the underlying investments move from riskier to safer investments is called the “glidepath.” Some funds adopt a more conservative “to retirement” glidepath, which runs “to” the target retirement year. Other funds are managed on a “through” glidepath, which runs “through” the retirement year and continues to adjust risk/reward strategies past a participant’s retirement and through the investor’s anticipated lifetime. The thinking with a “through” glidepath is that participants may have some risk tolerance after retirement to look for potential higher returns in the years after they retire (especially since participants are, on average, living longer than in the past).
When these two variations of target date funds are compared based on performance alone, a “through” glidepath fund may generate increased returns over a fixed time period because they will have more high risk/reward funds for a longer time period than a “to” glidepath fund. That is especially possible when both funds have underlying investments that track market indexes, as the BlackRock Funds do, and the time period at issue is a period of positive market performance. That calculus would change during a period of a market downturn.
Recent Cases Targeting the BlackRock Funds
In these recent cases targeting the BlackRock Funds, the plaintiffs claim that plan fiduciaries breached their fiduciary duties by offering the BlackRock Funds as an investment option and, commonly, making the BlackRock Funds the Plan’s “Qualified Default Investment Alternative” (QDIA). A QDIA is an investment in which participants’ assets are invested by “default” if they do not specify how they want their assets invested. The majority of the allegations in these cases are nearly identical.
To support their claims, the plaintiffs allege that the BlackRock Funds performed worse than other mutual fund target date alternatives in the market during the relevant period. In their complaints, the plaintiffs present a host of performance data, which they claim tracks the performance of the BlackRock Funds relative to supposed “comparator” funds for different time periods. They further claim that the BlackRock Funds used risk allocation strategies (i.e., a “to” glidepath) that made the BlackRock Funds perform worse than the other target date investments employing a “through” retirement philosophy during fixed periods of time.
The claims in these cases are atypical of claims usually asserted by ERISA plaintiffs because the allegations in the BlackRock cases are focused on performance alone, and not the funds’ cost. Further, because the primary focus of previous plaintiffs has been on the investment options’ costs, the focal point of litigation has traditionally been actively managed investment options and the claim that the options were overly priced, in addition to being poorly performing. The complaints in the BlackRock cases appear to concede that the passively managed BlackRock Funds were not overpriced.
These claims have not yet been tested through motion practice, and we will need to wait to see whether courts find them plausible. Aside from apparent contradictions between claims targeting low-cost investments vs. the typical claims in this area which attack cost, these cases ask courts to find that the BlackRock Funds were imprudent per se. Such a finding would impact nearly 10% of the market for target date options, by the plaintiffs’ own admissions, and finding that plan fiduciaries breached their duties by merely including such a popular option would be an extreme result.
While it remains to be seen whether cases targeting fiduciaries that selected BlackRock Funds as plan investment options will survive scrutiny, plan committees and other fiduciaries should still take note and guide their decision-making accordingly. What was true before remains true now: the law does not require fiduciaries to be prescient. Rather, it requires them to carry out their duties prudently, and to engage in an appropriate process in deciding what investments to offer their plan participants. Demonstrating a prudent process almost always means asking appropriate questions, getting answers to those questions, and documenting the process along the way. Fiduciaries should not assume that selecting low-cost passively managed investment options will insulate them from liability. Instead, they should assume that any investment decision they make could be challenged in court. Because no fiduciary can control how the markets will behave, they should always take pains to follow — and document — a scrupulous process in selecting and monitoring plan investments.