The plaintiffs’ bar is deploying a litigation strategy specific to asset managers who offer proprietary investments to their own employees, according to one law firm.
Large, and in most cases, household name money managers face a unique reputation risk when their 401(k) plans are sued for offering their own investments, says Brian Netter, co-chair of the ERISA litigation practice at Mayer Brown.
In nearly two-dozen lawsuits targeting money managers offering their own products to their own employees, plaintiffs allege the proprietary investments amount to self-dealing, and fail the Employee Retirement Income Security Act’s fiduciary duty of loyalty.
The allegation presents a unique risk for financial institutions relative to other large plan sponsors that have been sued under ERISA.
“The business risk for the financial institution defendants is that there could be a judgment at the end of the day saying that it wasn’t appropriate even to offer the institution’s own employees their financial products,” explained Netter in a recent web conference.
The plaintiffs’ bar is leveraging that specific risk, alleges Netter.
“The view of plaintiffs’ lawyers is creating that risk increases the incentives of financial institutions to liquidate the risks and to settle lawsuits,” said Netter.
With the lawsuits against large plan sponsors that began in 2006, the “financial expectation” of the plaintiffs’ attorneys was that the plans were big enough to expose potential damages to plan participants. Netter says favorable settlements could be negotiated using assets from plan fiduciaries’ insurance policies.
Those large sponsors that did settle claims—Boeing, Lockheed Martin, Cigna, and Caterpillar among them—faced limited reputation risk relative to their core business models.
But asset managers face considerably greater reputation damage, given that it is the quality of their core products—and not just their defined contribution plans—that the lawsuits are calling into question.
Courts reluctant to dismiss self-dealing claims
BlackRock, T. Rowe Price, JP Morgan, TIAA, Charles Schwab, Morgan Stanley, Wells Fargo, and New York Life are among the financial institutions that have been targeted for offering proprietary products through the investment lineups of their own 401(k) plans.
Much of the original body of ERISA claims was brought under the law’s duty of prudence requirements. That obligation is distinct from the duty of loyalty.
In alleging self-dealing under the ERISA’s duty of loyalty, Netter says the plaintiffs are not necessarily trying to prove that participants suffered negative investment outcomes, but only that plan fiduciaries devised investment lineups out of self-interest.
“The theory is that they were trying to bolster the company bottom line instead of acting in the best interest of employees,” said Netter.
So far, courts have been reluctant to grant defendants’ motions to dismiss the claims.
“Opinions permitting cases to proceed have not contained a tremendous amount of reasoning, except to say you are offering products that potentially generate profits for the company and plan participants deserve to explore the facts about those claims,” explained Netter.
While the claims against financial institutions also include allegations that sponsors failed their duty of prudence--more prudent investment options existed in the market place--the lawsuits are generally proceeding under the breach of loyalty claims.
“It’s always easy looking back in hindsight to second guess the decision somebody else made about financial products,” said Netter.
Some asset managers flinching
A handful of financial institutions have settled claims.
The Principal Financial Group, New York Life, and TIAA reached settlements between $3 million and $5 million, substantially smaller amounts than typical ERISA settlements.
Netter says the diminutive settlements suggest that financial institutions perceived reputation risk, and not that they feared their proprietary offerings resulted in bad outcomes for plan participants.
In June, the U.S. District Court for the District of Massachusetts ruled against the plaintiffs in a suit brought by employees of Putman Investments after a seven-day bench trial.
The court found that the suing plan participants failed to prove how Putnam’s use of proprietary funds caused losses to the plan, and failed to prove that plan fiduciaries were acting out of self interest.
Netter says the ruling in favor of Putnam was a reasonable outcome.
Another federal court in Minnesota recently dismissed a claim against Wells Fargo, which alleged its use of proprietary Target Date Funds breached ERISA’s prudence and loyalty duties. That case stands as an exception to the trend of courts allowing claims to proceed to discovery.
Mass Mutual got spooked
Not all self-dealing claims have had clean outcomes for financial firms.
In 2015, Mass Mutual settled a self-dealing claim for more than $30 million.
“Mass Mutual got spooked,” said Nancy Ross, co-chair of Mayer Brown’s ERISA litigation practice. The firm is not currently representing financial institutions in ERISA claims over investment fees.
Participants alleged the plan was “larded” with costly proprietary investments.
According to Ross and Netter, Mass Mutual’s use of retail share classes of mutual funds was a liability accelerator.
Share-class claims are fact intensive, explained Ross. As such, they are not easily dismissed at the early stages of a case.
“That’s why the plaintiffs like it,” she said.