Barry’s Pickings Online: Investment Choice and Fee Litigation

Art by Joseph Cardiello“This is the way you make laws for your dog: … [t]hey won’t tell a man beforehand what it is he should not do – they won’t so much as allow of his being told:  they lie by till he has done something which they say he should not have done, and then they hang him for it.” —Jeremy Bentham, “Truth versus Ashhurst” 

Policymakers, retirement plan sponsors and providers all have an ambiguous attitude towards participant choice in defined contribution (DC) plans. In the beginning, giving participants the ability to choose how to invest their retirement savings was, along with giving them the ability to choose how much to save, seen as a key DC plan selling point.

My guess is, however, that if you did a survey, most policymakers, sponsors and providers would say that the overwhelming majority of participants are not good at investing and generally make bad choices. Frankly, that’s what I believe. And so, we have developed tools—participant investment education, investment advice and defaults—that “nudge” participants in (what we believe to be) the right direction.

The law as to what sorts of choices sponsors must provide participants is, likewise, ambiguous. We know that, if you want to qualify for 404(c) protection at least, you have to give a participant a set of choices that (quoting the 404(c) regulation) “in the aggregate enable the participant … by choosing among [funds in the fund menu] to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant.”

One question that, it seems to me, is lurking in the fee litigation weeds is: If you give participants enough good (that is, efficiently-priced) choices, can you include funds in the fund menu that maybe aren’t efficiently priced? Perhaps because participants like those less efficiently priced choices?

We know that the Department of Labor (DOL) would like the answer to that question to be “no.” From what I can tell, its position (in litigation at least) is: The inclusion of any fund in the plan as a designated investment alternative must be prudent. And, it seems, a fundamental element of prudence is that the fund must be … what exactly is the standard here? Reasonably priced? Efficiently priced? Have the lowest price available?

The 7th U.S. Circuit Court of Appeals, in Hecker v. Deere (in 2009), looked at this issue. In its first opinion in this case it said:

“In our view, the undisputed facts leave no room for doubt that the Deere Plans offered a sufficient mix of investments for their participants. … As the district court pointed out, there was a wide range of expense ratios among the twenty Fidelity mutual funds and the 2,500 other funds available through BrokerageLink. At the low end, the expense ratio was .07%; at the high end, it was just over 1%. Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition. The fact that it is possible that some other funds might have had even lower ratios is beside the point; nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems).”

This seemed to be a forthright endorsement of the idea that if you give participants enough good choices, it doesn’t matter if you’ve also included some bad ones. And that the standard for what is a good choice does not depend on it being the “cheapest possible fund.”

The DOL strongly objected to this language, suggesting that it “could be read as a sweeping statement that any Plan fiduciary can insulate itself from liability by the simple expedient of including a very large number of investment alternatives in its portfolio and then shifting to the participants the responsibility for choosing among them.” Famously, the 7th Circuit, in a second opinion purporting to clarify its first opinion, insisted that it was doing nothing of the kind and that its decision in Deere “was tethered closely to the facts before the court.”

To be clear about what is at issue here (and at the risk of repeating myself), there are two questions: 1. If a plan provides enough prudent/efficiently-priced investment choices, does it have to review every choice a participant has with the same scrupulosity? 2. What exactly is the standard – must every fund be the cheapest or is it simply enough to argue that fees are “reasonable” and that other (presumably prudent) investors (“the general public”) is prepared to pay those fees?

The Deere case also raised the issue of the status of brokerage windows in this argument. The questions about brokerage windows here cut two ways. Does the existence of efficiently-priced funds in the brokerage window somehow insulate fiduciaries against complaints targeting inefficiently priced funds in, e.g., the plan’s core fund menu? That appeared to be the issue addressed (and, at first at least, answered affirmatively) in Deere. But, a complaint recently filed against Fidelity (with respect to the same BrokerageLink product referenced in Deere) seemed to be premised on the idea that someone (in this complaint, Fidelity) has a duty to get the best price on every investment inside the brokerage window.

These issues have been around for a long time—like, 40 years. How much choice can you give participants—specifically, if you give them enough good choices, can you give them some choices that might not pass a strict (e.g., “cheapest possible fund”) prudence standard?

Obviously, the DOL wants, in litigation, to preserve its ability to hold fiduciaries to the strictest possible standard. Indeed, the DOL has even toyed with the idea of imposing fee disclosure requirements (if not full fiduciary standards) on some brokerage window investments.

But, really, this is not the way the law should made—no explicit, up-front guidance to fiduciaries, and a plaintiffs bar on the prowl for firms with deep pockets to punish.

That is what Jeremy Bentham called “dog-law.” We have a clear set of questions here. Can we get a clear answer?

Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services­ corporations with the regulatory issues facing their plan sponsor clients. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.