It appears that laws of fiduciary prudence under ERISA are evolving. A recent district court decision, in Lorenz v. Safeway, demonstrates this point.
"What is good for the goose is good for the gander" is not a common legal maxim, but the District Court in the Northern District of California essentially used it when determining whether certain fees were excessive and resulted in a breach of the duty of prudence.
The court began its analysis by holding that the failure of the defendant, Safeway Inc., to offer the investment option with the lowest expense ratio wasn't sufficient, on its face, to plausibly state a claim for breach of the duty of prudence.
It cited the opinion of the Seventh Circuit in Hecker v. Deere, which said "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)." It explained that there are too many relevant considerations for a fiduciary to rely on a bright-line test to determine if fees are excessive, and that it is inappropriate to compare investment vehicles solely by fees, since their essential features differ so significantly.
Nevertheless, the claim for breach of the duty of prudence was permitted to go forward, because there were other allegations that supported the proposition that the defendant's decision-making process was flawed.
The defendant argued a cost comparison between JPMorgan funds and Vanguard Group funds was inappropriate, because the JPMorgan funds are a mix of actively managed and passive funds, while the Vanguard funds are entirely index funds.
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The court explained that Safeway might ultimately be able to persuade the court that there were legitimate reasons to select the JPMorgan funds, but the plaintiff was not required to rebut all possible lawful explanations for the defendant's conduct at the pleading stage.
Defendants then argued that their challenged expense ratios were within a range that other courts had found to be reasonable as a matter of law. The district court disagreed on several grounds.
First, the court said the defendant's position would effectively establish a presumption of prudence for expense ratios within a certain range, which would be contrary to the Supreme Court's position in Fifth Third Bancorp v. Dudenhoeffer that, in the ERISA pleading context, a "careful, context-sensitive scrutiny of a complaint's allegations was required."
Defendants then got hoisted on their own petard. The court noted that defendants, in their brief, had argued cost should not be dispositive of the prudence inquiry. But defendants, the court said, "cannot have their cake and eat it too. Just as the plaintiff cannot plausibly allege a breach of fiduciary duty by simply pointing to the cost of the challenged investment in isolation, the defendants cannot defeat a claim for breach of fiduciary duty by doing the same thing."
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The district court then distinguished a series of decisions at the circuit-court level regarding the reasonableness of fees. Those cases held that the range of expense ratios offered under the retirement plans in question were reasonable, not that a fiduciary's decision to include an investment option that has an expense ratio within that range is always reasonable as a matter of law.
In other words, where a plaintiff's challenge is not to the prudence of the overall mix of investment options available under the plan, but rather the decision to include the JPMorgan funds in particular, the overall expense-ratio range is of less legal relevance.
The court cited cases for the proposition that the prudence of investments offered by the plan must be judged individually. The DOL's prudence regulations might be based on modern portfolio theory, which requires fiduciaries to give appropriate consideration to the role of an investment or investment action in the context of a plan's investment portfolio, but modern portfolio theory by itself cannot provide a defense to a breach-of-prudence claim.
In other words, the prudence of the portfolio as a whole can't be used as a means of evading the duty of prudence with respect to particular funds.
Thus, it appears that the ERISA laws of fiduciary prudence are evolving to require prudence for all investment options individually and the portfolio in the aggregate.
Marcia S. Wagner, managing and founding partner of The Wagner Law Group, specializes in ERISA and employee benefits.
