Ninth Circuit Joins Circuit Splits in ERISA Section 404(c) Opinion and Defers to DOL Interpretation of Safe Harbor | Practical Law

Ninth Circuit Joins Circuit Splits in ERISA Section 404(c) Opinion and Defers to DOL Interpretation of Safe Harbor | Practical Law

In Tibble v. Edison Int'l, the US Court of Appeals for the Ninth Circuit held that a company's 401(k) plan fiduciaries did not violate their duty of prudence under ERISA by including certain investments in the plan, but acted imprudently in including retail-class shares of some mutual funds because they failed to investigate the possibility of institutional-share class alternatives. The Ninth Circuit joined one circuit split by deferring to the DOL's interpretation that the safe harbor from fiduciary liability in Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA) does not apply to a fiduciary's selection of investment funds and joined a separate circuit split by applying Firestone deference to breach of fiduciary duty claims (and not just benefit claims).

Ninth Circuit Joins Circuit Splits in ERISA Section 404(c) Opinion and Defers to DOL Interpretation of Safe Harbor

by PLC Employee Benefits & Executive Compensation
Published on 22 Mar 2013 • USA (National/Federal)
In Tibble v. Edison Int'l, the US Court of Appeals for the Ninth Circuit held that a company's 401(k) plan fiduciaries did not violate their duty of prudence under ERISA by including certain investments in the plan, but acted imprudently in including retail-class shares of some mutual funds because they failed to investigate the possibility of institutional-share class alternatives. The Ninth Circuit joined one circuit split by deferring to the DOL's interpretation that the safe harbor from fiduciary liability in Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA) does not apply to a fiduciary's selection of investment funds and joined a separate circuit split by applying Firestone deference to breach of fiduciary duty claims (and not just benefit claims).

Key Litigated Issues

The key litigated issues in Tibble v. Edison Int'l were whether:
  • The fiduciaries of Edison International's 401(k) plan violated ERISA by imprudently selecting investment funds, and specifically selecting "retail" mutual funds for plan investment options without considering similar "wholesale" or "institutional" mutual funds with lower expense ratios.
  • The fiduciaries were insulated from liability under ERISA Section 404(c) for the selection of these investment options because the participants and beneficiaries controlled the investment of their accounts.
  • A deferential abuse of discretion standard should apply to the fiduciaries' decisions under the US Supreme Court's Firestone standard (see Standard Clauses, Plan Language, Firestone Plan Interpretation and SPD Language, Firestone Plan Interpretation), including the decision to include a revenue-sharing arrangement.
  • ERISA's 6-year statute of limitations begins when the initial decision is made to include the challenged investment in the plan or if a "continuing violation" theory should apply.

Background

Current and former employees of Edison International's 401(k) plan sued under ERISA, claiming the plan had been managed imprudently. On behalf of a class representing all of Edison's eligible workforce, the plaintiffs claimed:
  • The inclusion of retail-class mutual funds, a unitized employer stock fund and money market-style investments as investment options was imprudent.
  • The related practice of revenue-sharing, under which certain mutual funds collect fees out of fund assets and disburse them to the plan's service provider as compensation, violated the plan document and ERISA Section 406(b)(3).
The district court granted summary judgment to Edison on most claims, and found that ERISA's limitations period barred recovery for claims arising out of investments included in the plan more than six years before the lawsuit began. However, although the court decided at summary judgment that retail mutual funds were not categorically imprudent, it agreed with the plaintiffs that Edison had been imprudent in failing to investigate the possibility of institutional-class alternatives. The plaintiffs appealed the district court's partial grant of summary judgment to Edison, and Edison cross-appealed the post-trial judgment.

Outcome

On March 21, 2013, the US Court of Appeals for the Ninth Circuit issued an opinion, holding:
  • Edison did not violate its duty of prudence under ERISA by including "retail" mutual funds, a short-term investment fund akin to a money market and a unitized fund for employees' investment in the company's stock in the plan. However, it was imprudent in deciding to include retail-class shares of three specific mutual funds in the plan because it failed to investigate the possibility of institutional-share class alternatives.
  • The safe harbor against fiduciary liability in ERISA Section 404(c) did not apply to the plan fiduciary's selection of these funds, deferring to the Department of Labor's (DOL) final rule interpreting Section 404(c).
  • The Firestone deferential abuse of discretion standard of review applied because the plan granted interpretive authority to the administrator.
The court also rejected the DOL's position on when a claim for fiduciary breach based on imprudent plan design under ERISA Section 413 accrues. The DOL argued that because fiduciary duties are ongoing, such claims are timely under ERISA's statute of limitations as long as the challenged investments remain in the plan (a continuing violation theory). The Ninth Circuit held, however, that the timeliness of these claims is measured from the moment the challenged investments were added to the plan.

Breach of Fiduciary Duty for Selection of Funds

The Ninth Circuit held that Edison did not violate its duty of prudence under ERISA by including in the plan investment menu:

Breach of Fiduciary Duty for Selection of Retail Mutual Funds without Consideration of Lower-cost Alternatives

However, the Ninth Circuit affirmed the district court's holding that Edison was imprudent in including retail-class shares of three specific mutual funds as plan options because it failed to investigate the possibility of similar, institutional-share class alternatives with significant lower expense ratios likely available to the plan. In particular, the Ninth Circuit noted all three funds offered institutional options in which the plan could have participated. Those options were between 24 to 40 basis points cheaper than the retail class options the plan included and there were no salient differences in the investment quality or management between the class profiles.
Edison argued that it reasonably relied on Hewitt Financial Services (HFS) for advice on which mutual fund share classes to select for the plan. However, the district court held, and the Ninth Circuit agreed, that Edison had not demonstrated that its reliance on HFS's advice was reasonably justified under the circumstances. In particular, the trial evidence showed that while an experienced investor would have reviewed all available share classes and the relative costs of each before selecting a mutual fund, Edison had neither:
  • Considered the possibility of institutional classes for the funds litigated.
  • Shown that HFS engaged in a prudent process in considering share classes.
This conclusion is an important reminder that plan fiduciaries are responsible for the careful selection and monitoring of all plan service providers, including investment consultants (see Practice Note, Negotiating ERISA Service Provider Agreements: Selecting a Service Provider and Monitoring the Service Provider).

ERISA Section 404(c) Safe Harbor

Under Section 404(c), a fiduciary's liability for investment losses is limited if plan participants can control the investment of their accounts (see ERISA Section 404(c) Checklist). Edison argued that this safe harbor applied because each beneficiary had exercised control under Section 404(c) by selecting the challenged investments from the available plan options. In its amicus brief, the DOL argued that according to its earlier interpretation of Section 404(c), the breach or loss must be the direct and necessary result of a beneficiary's action for the fiduciary to be insulated from liability. Since the fiduciary is responsible for selecting the funds to include in the plan, it logically precedes and therefore cannot result from a participant's decision to invest in any of those options.
The Ninth Circuit agreed with the DOL's interpretation that the ERISA Section 404(c) safe harbor does not protect plan fiduciaries from liability flowing from their selection of investment funds for a plan, applying Chevron deference to the DOL's interpretation.
Under Chevron, U.S.A., Inc. v. Natural Resources Defense Council Inc., if a court determines that Congress has not directly addressed the precise question at issue, the issue for the court is whether the relevant agency's answer is based on a permissible construction of the statute. Several other circuit courts have applied Chevron deference to the DOL's interpretation of ERISA Section 404(c), including the US Courts of Appeals for the Third Circuit and the Sixth Circuit. However, Edison focused on the US Court of Appeals for the Fifth Circuit's decision in Langbecker v. Electronic Data Systems Corp., in which the court held the DOL's interpretation of Section 404(c) could not receive Chevron deference because it contradicted the governing statutory language.
The Ninth Circuit disagreed, finding the DOL's interpretation was reasonable because:
  • A fiduciary is better situated to prevent plan losses from unsound investment options than plan beneficiaries.
  • Applying Chevron deference promotes the coherent and uniform construction of federal law, as the DOL has adopted a similar interpretation for breaches of fiduciary duty that chronologically follow a participant's decision.

Deferential Firestone Standard Applied to Plan Fiduciaries' Decisions

In actions challenging denials of benefits, the US Supreme Court has held that an ERISA plan administrator that has discretionary authority to interpret the plan is entitled to deference in exercising that discretion (Firestone Tire & Rubber Co. v. Bruch, 489 US 101 (1989)). The Supreme Court decided that if the plan documents give the plan administrator the power to construe disputed or doubtful terms, then the plan administrator's interpretation will not be disturbed if it is reasonable (see Standard Clauses, Plan Language, Firestone Plan Interpretation and SPD Language, Firestone Plan Interpretation).
The US Courts of Appeals for the Third and Sixth Circuits have found that this standard also applies to cases implicating ERISA Section 404 fiduciary duties, while the US Court of Appeals for the Second Circuit has held that the standard is limited to benefit denial cases. The Ninth Circuit agreed with the Third and Sixth Circuits, holding the usual abuse of discretion standard applies. In particular, the court found:
  • That although the US Supreme Court case adopting the abuse of discretion standard was aimed at actions challenging denials of benefits, the principles underlying the decision apply to ERISA generally.
  • That allowing an employer to grant a plan administrator primary interpretive authority over an ERISA plan helps keep administrative and litigation expenses under control, while a contrary decision could discourage employers from offering ERISA plans at all.

Firestone Deference Applied to Decision to Compensate Provider Through Revenue-sharing

Applying Firestone deference to the plan fiduciaries' decision, the Ninth Circuit found that the challenged revenue-sharing arrangement between mutual funds and the administrative service provider did not violate the plan's governing document and was not a conflict of interest under ERISA Section 406(b)(3), because:
  • Revenue-sharing did not explicitly conflict with the plan's plain language.
  • Adding the revenue sharing mutual funds expanded the plan's mutual fund options.
  • Edison and the union negotiators had extensive discussions about how the revenue-sharing from the mutual funds would be used, and participants were specifically advised that the mutual funds were being used to reduce the cost of retaining the plan's administrative service provider.
The court also held that Edison's revenue-sharing arrangement did not violate ERISA Section 406(b)(3), which prohibits fiduciaries from receiving consideration for their own personal accounts for plan transactions, as the DOL's regulations under ERISA Section 408(b)(2) exempt revenue-sharing payments from the definition of consideration (see Practice Note, Service Provider Disclosure Requirements for Pension Plans).

ERISA's 6-year Statute of Limitations Begins When Challenged Investments Initially Chosen

The Ninth Circuit agreed with the district court's conclusion that ERISA's limitations period barred recovery for claims arising out of investments included in the plan more than six years before the lawsuit began. It disagreed with the beneficiaries and the DOL's argument that a continuing violation theory or liability should apply, such that the statute of limitations would remain open so long as the challenged investments were included as part of the plan's menu.
The Court emphasized that it would consider whether changed circumstances should have prompted a review, but that does not change the statute of limitations. Rather, it reasoned that it demonstrates that fiduciaries have an ongoing duty of prudence. However, this rationale does leave open the possibility that future plaintiffs may have a claim beyond this six-year period if they can prove that changed circumstances should have prompted the plan fiduciaries to reconsider the initial selection of investment funds.

Practical Implications

The Tibble decision has several practical implications for future ERISA Section 404(c) cases, including that:
  • A plan fiduciary's selection of retail mutual funds in and of itself is not necessarily deemed an imprudent plan decision in the Ninth Circuit and Seventh Circuit. However, plan fiduciaries should carefully analyze the availability ofsimilar, lesser-cost institutional mutual funds that may be available to the plan at the time they make this decision.
  • Three Circuit Courts of Appeal (the Third, Sixth and Ninth Circuits) have now deferred to the DOL's interpretation that the ERISA Section 404(c)'s safe harbor against fiduciary liability does not protect plan fiduciaries from an imprudent initial selection of investment funds, contrary to the Fifth Circuit's decision in Langbecker.
  • The same three Circuit Courts of Appeal have now agreed that the deferential Firestone abuse of discretion standard of review applies to ERISA fiduciary duty cases, and not just benefit denial cases.
  • ERISA's 6-year statute of limitations is viewed by the Ninth Circuit as beginning when a plan fiduciary makes the initial selection of a challenged investment, absent changed circumstances that would warrant another review.

Court Documents