“Smoke” Signals
Plan sponsors spend a lot of time wondering—and worrying—about the “right” way to do things. They rely on the guidance of experts, the insights of publications like ours, the black—though often gray—letter of the law, and sometimes they must rely on the occasionally contradictory adjudications of the courts.
Those contradictions have been much in evidence in the series of 401(k) revenue-sharing lawsuits, which, IMHO, continue to suffer from what seems to be a confusing “flexibility” in judicial discernment regarding the standards of fiduciary responsibility and application of ERISA’s 404(c) safe harbors. In fact, it is only a matter of time until some plan sponsor somewhere files an injury claim for whiplash incurred from simply trying to keep up with the direction of these decisions.
The most recent example was the case of Gerald George vs. Kraft Foods Global (see Appellate Court Sends Back Kraft Fee Case), a case the 7th U.S. Circuit Court of Appeals remanded (albeit in a split 2-1 decision) for further deliberation to a District Court—which had already determined that there was no issue presented that required a formal adjudication, while granting the employer-defendant’s motion for summary judgment (see Kraft Excessive Fee Case Thrown Out).
That District Court, which relied heavily on the decision of this same federal appellate court ruling in Hecker v. Deere & Co., reasoned that ERISA requires only that fiduciaries use a “reasoned decisionmaking process” that utilizes the appropriate methods to decide on a proper course of action in running a plan, and that in continuing to employ its current recordkeeper (Hewitt Associates) , the Kraft fiduciaries were under no obligation “to scour the market” for the cheapest fund or service provider (see “Reasonable Redoubts”).
However, in the recent appellate decision, we find that, since hiring Hewitt in 1995, the plan’s fiduciaries had not solicited competitive bids from other recordkeepers—a finding that raised my eyebrows, as it doubtless would most retirement professionals. Now, one should always be careful in reading judicial explanations of the facts on which they based their decisions as a complete picture, but this court said that the defendants “…emphasized that they engaged several independent consultants for advice as to the reasonableness of Hewitt’s fee and argued that in doing so they satisfied their duty to ensure that Hewitt’s fees were reasonable”—a statement that the appellate court juxtaposed against a statement that, over a 10-year period, “fees paid to Hewitt ranged between $43 and $65 per participant per year.”
The implication seemed to be that casual conversations with “independent consultants” were no replacement for a full-blown competitive bidding process—and the fee trend, lacking context, was an eye-opener as well. But the District Court outlined a series of plan changes and negotiations over that time period that painted a very different picture and were anything but “casual.” True, one might well wonder why a full RFP wasn’t issued, but the District Court opinion paints a picture of lots of merger-related plan changes; an active discussion, review, and comparison of fees; alongside a pattern of negotiation that both reduced fees and/or expanded services over the period in question. In sum, the picture painted by the lower court’s opinion was the kind of thing you might expect to come from a full competitive bid without the time, pain, and—yes—expense of undertaking it. And, yes, it was documented.
That said, the appellate court found error in the District Court’s dismissal based on a finding that the “defendants satisfied their duty of prudence by relying on the advice of their consultants”, going on to note that “although the fact that defendants engaged consultants and relied on their advice with respect to Hewitt’s fee is certainly evidence of prudence, it is not sufficient to entitle defendants to judgment as a matter of law” (1).
Ultimately, while some commentators have painted this opinion as a reversal of fortunes for employers in these cases, I am disinclined to see it that way. Rather, to my reading, you have a court that sees just enough smoke2 to wonder if there might be a fire; a large plan that went a decade without a formal RFP3. Determining not that not doing so was inherently imprudent4—but that making that determination would require a more complete airing of the facts.
—Nevin E. Adams, JD
1 In explaining its determination, the court cited Donovan v. Cunningham, 716 F.2d 1455, 1474 (5th Cir. 1983) (stating that “[a]n independent appraisal is not a magic wand that fiduciaries may simply waive over a transaction to ensure that their responsibilities are fulfilled”).
2 There were also issues raised about the use of two different accounting structures in two different plans for its company stock funds, and questions about how float was accounted for, in addition to questions about the use of actively managed funds. In fact, considering the volume of the opinion dedicated to it, the company stock accounting may well have been the most compelling triable issue of fact for the appellate court.
3 The appellate court also took issue with the District Court’s dismissal of testimony by an expert witness by the plaintiffs. According to the appellate court, Lawrence R. Johnson reviewed the process that defendants followed when they extended Hewitt’s contract and opined that defendants acted imprudently by extending the contract without first soliciting bids from other recordkeepers. The District Court found his expertise was limited to mid-size plans and dismissed it, while the appellate court said that “defendants have not pointed to any differences between the recordkeeping needs of mid-sized and large plans that would make experience with mid-sized plans an insufficient qualification for rendering an opinion about the recordkeeping needs of a large plan.”
4 In a “spirited” dissent, Judge Richard D. Cudahy, who characterized the lawsuit as an “implausible class action based on nitpicking with respect to perfectly legitimate practices of the fiduciaries,” noted that “[i]f plaintiffs can find one ‘expert’ who will testify that the fee is too high, must there be a trial? Here, the trustees have a relationship with Hewitt going back fifteen years. They have a good sense of the dimensions of the job and Hewitt’s performance in carrying it out. Must they substitute any lower bidder that happens along?”
Those contradictions have been much in evidence in the series of 401(k) revenue-sharing lawsuits, which, IMHO, continue to suffer from what seems to be a confusing “flexibility” in judicial discernment regarding the standards of fiduciary responsibility and application of ERISA’s 404(c) safe harbors. In fact, it is only a matter of time until some plan sponsor somewhere files an injury claim for whiplash incurred from simply trying to keep up with the direction of these decisions.
The most recent example was the case of Gerald George vs. Kraft Foods Global (see Appellate Court Sends Back Kraft Fee Case), a case the 7th U.S. Circuit Court of Appeals remanded (albeit in a split 2-1 decision) for further deliberation to a District Court—which had already determined that there was no issue presented that required a formal adjudication, while granting the employer-defendant’s motion for summary judgment (see Kraft Excessive Fee Case Thrown Out).
That District Court, which relied heavily on the decision of this same federal appellate court ruling in Hecker v. Deere & Co., reasoned that ERISA requires only that fiduciaries use a “reasoned decisionmaking process” that utilizes the appropriate methods to decide on a proper course of action in running a plan, and that in continuing to employ its current recordkeeper (Hewitt Associates) , the Kraft fiduciaries were under no obligation “to scour the market” for the cheapest fund or service provider (see “Reasonable Redoubts”).
However, in the recent appellate decision, we find that, since hiring Hewitt in 1995, the plan’s fiduciaries had not solicited competitive bids from other recordkeepers—a finding that raised my eyebrows, as it doubtless would most retirement professionals. Now, one should always be careful in reading judicial explanations of the facts on which they based their decisions as a complete picture, but this court said that the defendants “…emphasized that they engaged several independent consultants for advice as to the reasonableness of Hewitt’s fee and argued that in doing so they satisfied their duty to ensure that Hewitt’s fees were reasonable”—a statement that the appellate court juxtaposed against a statement that, over a 10-year period, “fees paid to Hewitt ranged between $43 and $65 per participant per year.”
The implication seemed to be that casual conversations with “independent consultants” were no replacement for a full-blown competitive bidding process—and the fee trend, lacking context, was an eye-opener as well. But the District Court outlined a series of plan changes and negotiations over that time period that painted a very different picture and were anything but “casual.” True, one might well wonder why a full RFP wasn’t issued, but the District Court opinion paints a picture of lots of merger-related plan changes; an active discussion, review, and comparison of fees; alongside a pattern of negotiation that both reduced fees and/or expanded services over the period in question. In sum, the picture painted by the lower court’s opinion was the kind of thing you might expect to come from a full competitive bid without the time, pain, and—yes—expense of undertaking it. And, yes, it was documented.
That said, the appellate court found error in the District Court’s dismissal based on a finding that the “defendants satisfied their duty of prudence by relying on the advice of their consultants”, going on to note that “although the fact that defendants engaged consultants and relied on their advice with respect to Hewitt’s fee is certainly evidence of prudence, it is not sufficient to entitle defendants to judgment as a matter of law” (1).
Ultimately, while some commentators have painted this opinion as a reversal of fortunes for employers in these cases, I am disinclined to see it that way. Rather, to my reading, you have a court that sees just enough smoke2 to wonder if there might be a fire; a large plan that went a decade without a formal RFP3. Determining not that not doing so was inherently imprudent4—but that making that determination would require a more complete airing of the facts.
—Nevin E. Adams, JD
1 In explaining its determination, the court cited Donovan v. Cunningham, 716 F.2d 1455, 1474 (5th Cir. 1983) (stating that “[a]n independent appraisal is not a magic wand that fiduciaries may simply waive over a transaction to ensure that their responsibilities are fulfilled”).
2 There were also issues raised about the use of two different accounting structures in two different plans for its company stock funds, and questions about how float was accounted for, in addition to questions about the use of actively managed funds. In fact, considering the volume of the opinion dedicated to it, the company stock accounting may well have been the most compelling triable issue of fact for the appellate court.
3 The appellate court also took issue with the District Court’s dismissal of testimony by an expert witness by the plaintiffs. According to the appellate court, Lawrence R. Johnson reviewed the process that defendants followed when they extended Hewitt’s contract and opined that defendants acted imprudently by extending the contract without first soliciting bids from other recordkeepers. The District Court found his expertise was limited to mid-size plans and dismissed it, while the appellate court said that “defendants have not pointed to any differences between the recordkeeping needs of mid-sized and large plans that would make experience with mid-sized plans an insufficient qualification for rendering an opinion about the recordkeeping needs of a large plan.”
4 In a “spirited” dissent, Judge Richard D. Cudahy, who characterized the lawsuit as an “implausible class action based on nitpicking with respect to perfectly legitimate practices of the fiduciaries,” noted that “[i]f plaintiffs can find one ‘expert’ who will testify that the fee is too high, must there be a trial? Here, the trustees have a relationship with Hewitt going back fifteen years. They have a good sense of the dimensions of the job and Hewitt’s performance in carrying it out. Must they substitute any lower bidder that happens along?”
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