The latest ruling in Tibble vs. Edison comes out of the U.S. District Court for the Central District of California, applying the now-famous “distinct duty to monitor” standard set forth by the U.S. Supreme Court on an appeal of the very same litigation.
By way of background, the pioneering lawsuit has played out over the last full decade, filed first in the California district court and eventually reaching all the way up to the Supreme Court of the United States after an appellate ruling.
Readers of PLANSPONSOR will recall the Supreme Court’s decision was taken to establish clearly that the “ongoing duty to monitor” investments is a fiduciary duty that is separate and distinct from the duty to exercise prudence in the initial choice of an investment. The big practical result was that plan sponsors can no longer rely on ERISA’s statute of limitations to protect themselves from accusations of potentially imprudent investment decisions made in the past when the investment options in question persist on the menu to this day. However the SCOTUS decision declined to apply that determination to the facts of the case at hand, leaving the lower courts to put into practice the standard it had put forth.
Now that a new ruling has emerged it seems that the SCOTUS and appellate court instructions have led the district court to side with the plaintiffs, ruling that defendants breached their fiduciary obligations of prudence and monitoring in the selection of all 17 mutual funds at issue. Damages will be calculated from 2011 to the present, the decision states, “based not on the statutory rate, but by the 401(k) plan’s overall returns in this time period.”
The ruling examines in detail the process surrounding the adoption of 14 mutual funds that the plaintiffs contend should have been switched by the defendants from retail to institutional shares on August 16, 2001, the beginning of the statutory period. An additional three mutual funds in dispute had their institutional-class shares become available later, during the statutory period, and had no statute of limitations questions.
In the previous bench trial, the district court “rejected the contention that the defendant was justified in selecting the retail-class shares because these shares had more public information available, because participants would be confused by proposed changes in the switch from retail to institutional shares, or because the plan did not qualify for the investment minimum required of institutional share classes.” In the current case, the defendants do not revive these same arguments.
“Instead, they concede that they were in the wrong in not considering institutional shares,” the decision states. “They argue, however, that a hypothetical prudent fiduciary who did consider the institutional shares would have still invested in at least some of the retail share classes. Defendants assert that during collective bargaining negotiations between Edison and plan participants in 1999, the parties agreed—or, at least, understood—that Edison would invest in funds with revenue sharing in order to defray some of the recordkeeping costs Edison was paying Hewitt Associates.”
The defendants further contended that “the unions understood and accepted this bargain … Because the unions accepted this bargain, and because for most of the 17 funds at issue, fees charged to plan participants by the ‘retail’ class were the same as the fees charged by the ‘institutional’ class, net of the revenue sharing paid by the funds to defray the plan’s recordkeeping costs, defendants argue that investment in the retail share classes was prudent.”
NEXT: Prudence and investment monitoring
On the duty of prudence, the plan sponsor argued it had a right to invest in the retail-class shares to take advantage of revenue sharing. But the court determined this argument “fails on its merits.”
“Defendants’ argument is that by informing plan participants that revenue sharing is available, the fiduciaries could then choose higher cost retail shares that had revenue sharing instead of the institutional shares that did not,” the decision explains. “This quid-pro-quo is not identified in any of the communications that defendants present to the court. Instead, the understanding seems to be simply that defendants could use revenue sharing it received to defray recordkeeping costs—this is most logically interpreted to mean that if a prudent investment has revenue sharing, then defendants are allowed to use these proceeds to defray recordkeeping costs instead of applying the proceeds to other possible uses (such as reinvesting that money into the plan). There is no indication that this understanding would allow the fiduciaries to choose otherwise imprudent investments specifically to take advantage of revenue sharing.”
The decision continues: “Defendants argue that in fact allowing Edison to take advantage of revenue sharing instead of investing in lower costs institutional-class shares was actually better for the plan participants, since in a hypothetical scenario in which Edison had no revenue sharing to defray recordkeeping costs it would have reallocated plan administrative costs to plan participants. Beyond the fact this argument is both pure speculation and belied by the court’s previous findings that defendants were not motivated by recouping revenue sharing in making investment decisions, the argument also requires the court to accept that a $1.1 million increase in recordkeeping costs would motivate Edison to restructure its Plan. The court is not convinced.”
On the duty to monitor questions, “the court does not suggest that in all duty to monitor cases a fiduciary would breach their duty the day a fund becomes imprudent. Certainly, reasonable fiduciaries are not expected to take a daily accounting of all investments, and thus the reasonable discovery of an imprudent investment may not occur until the systematic consideration of all investments at some regular interval … However, the facts of this particular case present an extreme situation. Defendants have never disputed that a reasonable fiduciary would be knowledgeable of the existence of the institutional shares for the mutual funds at issue. Thus, there is no credible argument that a reasonable fiduciary only would have discovered these share classes during some later annual review. Defendants always knew, or should have known, institutional share classes existed.”
Furthermore, the court says “there may be times when a reasonable fiduciary suspects an imprudent investment, but waits until she engages in a regularly scheduled systematic review to confirm her suspicion and properly reinvest the funds elsewhere. This is also not that sort of case.”
NEXT: District court not persuaded
The plan sponsor's arguments have flatly failed, it seems, to persuade the district court. Following some lengthy analysis of the facts and the previous decisions in the case, the district court “concludes that defendants are liable for breaching their fiduciary obligations and are liable beginning on August 16, 2001—or for three funds the later date institutional share classes become available—for the actual loss in excessive fees paid and for the lost investment opportunity of this breach.”
The decision and the method of calculating damages are further explained: “Defendants argued that once a prudent fiduciary decided to switch share classes, two to five months were necessary for the plan to actually make the switch. Defendant relies on the testimony from Diane Kobashigawa, Manager of Benefits Administration and Compliance for SCE from approximately January 1997 to February 2007. Kobashigawa stated there are several steps she understands Hewitt would take before switching share classes. She concluded that Hewitt would need two to five month to complete these steps, absent unusual circumstances. The court does not find Kobashigawa’s testimony persuasive. Beyond her specific testimony, the court notes there was no evidence that it would be more prudent for Hewitt to complete these tasks before switching share classes, and not after making the switch. As for her specific testimony, the court does not find it comports with other evidence in the record which shows that a change in share class can be accomplished in substantially less time and with the testimony of Dr. Witz that such a change could occur in a day.
“Further, as a breaching fiduciary, defendants would be liable in making plaintiffs whole regardless of how long it takes to cure the breach. Defendants are liable for any profits that the trust would have accrued in the absence of the breach … Absent this breach, the prudent investments would have been made immediately—either on August 16, 2001, or on the day after 2001 that institutional funds became available. Thus, even if defendants successfully showed it would take months to make the switch, they are nonetheless liable for losses on each mutual fund at issue either beginning on August 16, 2001, or on the day after 2001 that institutional funds became available.”
The full decision is available here.