Comparing active and passive investment options, impossible benchmarks—courts have applied inconsistent and often arbitrary pleading standards to the over 350 excessive fee lawsuits in the last five years. So how should they weed out frivolous, yet often expensive, filings, and how can courts provide much-needed clarity on what is, and is not a fiduciary breach?
Fiduciary insurance underwriter Euclid Specialty Managers tackles the topic in a new whitepaper from Managing Principal Daniel Aronowitz that focuses on Hughes v Northwestern University, et al., No. 19-1401, an excessive fee accepted by the Supreme Court.
The Department of Labor filed an amicus brief noting that the case presented an opportunity for the Court to rule on “the question of what ERISA requires of plan fiduciaries to control expenses” – a question that DOL said, “frequently recurs.”
According to Euclid’s whitepaper, “the key issue is what standard or hurdle plaintiffs must satisfy in order to withstand a motion to dismiss.”
The pleading standard is critical, it notes, because if the case proceeds to expensive discovery, it’s more burdensome to the defense and plaintiffs gain the upper hand to drive a substantial settlement against plan sponsors based on a high damages model. The differential model is the difference in what plaintiff lawyers say recordkeeper and investment fees should have been subtracted from what the plan actually paid.
THE FULL WHITEPAPER IS FOUND HERE
Only one-quarter of cases are dismissed at the pleading stage, and Northwestern says it paid $4 million for discovery in just 16 months before its motion to dismiss was decided.
Aronowitz argues that the Supreme Court needs to clarify two principles supported by ERISA fiduciary law, related excessive fee law under the Investment Company Act, and even the briefs of DOL and participant counsel:
(1) that no fiduciary under ERISA fiduciary law should be held liable for breach of fiduciary duty and be forced to spend millions defending their conduct unless the fees are egregious or disproportionately large; and
(2) to properly allege whether fees are egregious, plaintiffs must allege a reliable benchmark of materially identical investments or services, demonstrating that no prudent fiduciary would have made the same decision.
This more rigorous test would weed out the many meritless excessive fees cases currently being filed against plan sponsors, He adds. It would require dismissal of challenges to small fee differentials and would require plaintiffs to substantiate their claims by comparing claims of excessive fees against reliable alternative investments and services that are materially identical.
By contrast, in many cases being allowed to proceed to expensive discovery, plaintiffs are asserting unsubstantiated benchmarks and comparing actively managed funds to passive investments that have completely different investment strategies and cost structures.
Even DOL’s amicus brief requires a higher pleading standard in which fiduciaries are liable for breach of fiduciary duty if lower investment fees are available for “materially identical investments,” Aronowitz concludes.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
