First Circuit shifts burden of defending a fiduciary 401(k) breach claim

A recent ruling could set the stage for a definitive U.S. Supreme Court opinion regarding retirement plan fiduciaries’ liability on the subject of monitoring plan expenses. The U.S. Court of Appeals for the First Circuit’s ruling in Brotherston v. Putnam Investments shifts a key aspect of the burden of proof of a fiduciary breach from the plaintiff employees to the plan sponsor defendant.

Imprudent actions

In 2015, a class action suit by Putnam employees charged their employer with a fiduciary breach by limiting their 401(k) plan investment choices to actively managed Putnam funds with higher fees than comparable index funds. The trial court (before the case was appealed) found that Putnam “did not independently investigate Putnam funds before including them as investment options under the plan, did not independently monitor them once in the plan, and did not remove a single fund from the plan lineup for underperformance.” (Other allegations, not described here, were also made.)

An imprudent act by plan fiduciaries might not have created a dispute without proof that plan participants had suffered a loss because of the imprudent act. The question of harm was a key piece of this case. An expert witness for plan participants quantified a loss by comparing the impact of the higher fee structure of the funds chosen by the Putnam investment team with those of alternative index funds offered by another prominent fund manager (Vanguard).

The trial court accepted Putnam’s argument that the fact that it lacked a prudent process for monitoring plan investments didn’t necessarily render the entire investment lineup imprudent. ERISA offers some support for the view that the absence of “procedural prudence” doesn’t have to lead to sweeping liability for decisions that even a prudent fiduciary might have made. The lower court also agreed with Putnam’s view that the analyst’s report failed to prove that participants had sustained a loss. However, according to the appellate court, it wasn’t clear why the district court made such a conclusion.

Burden of proof

The most broadly applicable issue in the case is which party bears the burden of proof to show that the fiduciaries’ imprudent procedures resulted in a loss by plan participants: Is it the plaintiffs’ burden to show a breach of fiduciary duty? Or must the plan sponsor prove it shouldn’t be held responsible for any loss?

In a lengthy review of related court decisions and principles of trust law, the appeals court overturned the trial court with this conclusion: “Once an ERISA plaintiff has shown a breach of fiduciary duty and loss to the plan, the burden shifts to the fiduciary to prove that such loss was not caused by its breach.”

The appeals court sought to dispel any conclusion that it was turning the tables on fiduciaries. “Nothing in our opinion places on ERISA fiduciaries any burdens or risks not now faced routinely by financial fiduciaries,” such as investment advisors, it stated.

According to the court, any “plan such as the plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds.” In addition, the court stated that, if a fiduciary believes it can find funds that beat the market, it “will be immune to liability unless a district court finds it imprudent in its method of selecting funds, and finds that a loss occurred as a result.”

The case was sent back to the trial court to reconsider its ruling in light of the principles established by the appeals court.

Looking ahead

The ruling evens the split between eight of the 10 federal appeals courts that have ruled on this issue. The other circuit courts that have already ruled as the First Circuit just did are the Fourth, Fifth and Eighth. Those on the other side of the issue are the Sixth, Ninth, Tenth and Eleventh. Such a scenario often leads to a U.S. Supreme Court ruling to resolve the inconsistent appellate court opinions. But even if your company isn’t based in one of the 19 states whose appeals courts are now aligned with this latest ruling, the issue is one that all plan sponsors should follow closely.

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