In a relatively brief opinion issued by the U.S. Supreme Court on May 18, 2015, the Court unanimously ruled in favor of the plan participants, remanding the case to the lower courts for further proceedings. While the decision largely merely affirms established law, the question arises as to whether the decision may influence DOL rule-making in the months ahead.
As seen above, the Supreme Court noted that mutual fund expenses “can sometimes” significantly reduce the value of investment accounts. This statement can be read several different ways.
The Supreme Court noted these facts in the case: “Petitioners contend that respondents breached the duty of prudence by offering higher priced retail-class mutual funds when the same investments were available as lower priced institutional-class mutual funds.” However, the Supreme Court did not opine on this aspect of the case, nor upon the trial court’s finding that the plan sponsor “had ‘not offered any credible explanation’ for offering retail-class, i.e., higher priced mutual funds that ‘cost the Plan participants wholly unnecessary [administrative] fees,’ and [the trial court] concluded that, with respect to those mutual funds, [the plan sponsor] had failed to exercise ‘the care, skill, prudence and diligence under the circumstances’ that ERISA demands of fiduciaries.”
Nevertheless, given the clear duty of due care of an ERISA fiduciary to justify higher-cost funds, the burden is very heavy upon an ERISA fiduciary to recommend higher-cost investments when lower-cost investments are available which are substantially similar in terms of their composition, risks, and expected returns. One of the key issues for analysis of the "Best Interests Contract Exemption" is whether higher fees and costs incurred - that results in additional compensation to the broker-dealer firm or insurance company - can ever be justified under ERISA, and if so, what this justification would look like. What is the evidentiary standard for such justification to withstand scrutiny? The Supreme Court's decision does not directly address these issues, but it is clear that justification must be credible.
COURT DISCUSSES THE ERISA FIDUCIARY’S DUTY OF DUE CARE. “An ERISA fiduciary must discharge his responsibility ‘with the care, skill, prudence, and diligence’ that a prudent person ‘acting in a like capacity and familiar with such matters’ would use.”
This statement of the ERISA fiduciary’s duty of due care follows many prior decisions.
Note that the U.S. Supreme Court did not discuss the ERISA fiduciary’s duty of loyalty, nor did the Court discuss procedures to be followed under ERISA when a fiduciary possesses a conflict of interest.
COURT DISCUSSES THE ONGOING DUTY OF THE FIDUCIARY TO MONITOR INVESTMENTS. “[U]nder trust law [from which an ERISA fiduciary’s duties are derived] a fiduciary is required to conduct a regular review of its investment with the nature and timing of the review contingent on the circumstances.” The Uniform Prudent Investor Act confirms that “[m]anaging embraces monitoring” and that a trustee has “continuing responsibility for oversight of the suitability of the investments already made.” §2, Comment, 7B U. L. A. 21 (1995) (internal quotation marks omitted). Scott on Trusts implies as much by stating that, “[w]hen the trust estate includes assets that are inappropriate as trust investments, the trustee is ordinarily under a duty to dispose of them within a reasonable time.”
“Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset. The Bogert treatise states that ‘[t]he trustee cannot assume that if investments are legal and proper for retention at the beginning of the trust, or when purchased, they will remain so indefinitely’ … Rather, the trustee must “systematic[ally] conside[r] all the investments of the trust at regular intervals” to ensure that they are appropriate … The Uniform Prudent Investor Act confirms that “[m]anaging embraces monitoring” and that a trustee has “continuing responsibility for oversight of the suitability of the investments already made.” §2, Comment, 7B U. L. A. 21 (1995) (internal quotation marks omitted). Scott on Trusts implies as much by stating that, “[w]hen the trust estate includes assets that are inappropriate as trust investments, the trustee is ordinarily under a duty to dispose of them within a reasonable time.”
This lengthy discussion of the scope of the ERISA fiduciary’s duty to monitor addresses the key, albeit narrow, issue in the Tibble v. Edison case, which involved when action occurs which is actionable (i.e., when action occurs which tolls the statute of limitations, within which time a claim must be brought).
This aspect of the decision reminds us that ERISA fiduciaries – firms and their representatives – possess an ongoing duty to update their due diligence as to investments previously recommended to a client, at least where the client remains a client of the firm.
IN SUMMARY. Only a small amount of guidance can be inferred from the Court's Tibble vs. Edison decision. Yet, the Court's decision can serve as a reminder of the high level of due diligence required in the selection of investments. Moreover, the Court's acknowledgement of the significant role played in mutual fund expenses in a plan participant's retirement account value will likely result in a strong focus on the type of justification required to recommend higher-cost investments, especially where higher cost investments result in greater compensation to the ERISA fiduciary (as proposed to be permitted under BICE).