Former employees of Putnam Investments can proceed with an ERISA class action against their former employer and other plan fiduciaries based on allegations that they suffered losses as a result of the investment options selected for their 401(k) plan, the 1st U.S. Circuit Court of Appeals has decided.
U.S. District Court Judge William G. Young granted a defense motion for summary judgment dismissing the plaintiffs’ claim that the defendants engaged in prohibited transactions in violation of ERISA. Young further found that the plaintiffs failed to prove that any lack of care in selecting the plan’s investment options resulted in losses to the plan.
But a unanimous 1st Circuit panel concluded that Young improperly placed the entire burden of proof on the issue of causation on the plaintiffs. Noting a circuit split on the issue, the panel found that such claims are to be analyzed under a burden-shifting framework.
“[W]e align ourselves with the Fourth, Fifth, and Eighth Circuits and hold that 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, that is, to prove that the resulting investment decision was objectively prudent,” Judge William J. Kayatta Jr. wrote on behalf of the court.
In addition, the 1st Circuit concluded that the plaintiffs could go forward with a claim alleging that the defendants violated §1106(b)(3) because Putnam received fees from the funds in which the plan invested.
The 50-page decision is Brotherston, et al. v. Putnam Investments, LLC, et al.
Boston’s James R. Carroll, who represents the defendants, did not respond to requests for comment.
However, Carroll filed a defense motion requesting that the 1st Circuit stay its mandate in Brotherston to allow the defendants to file a petition for a writ of certiorari with the U.S. Supreme Court.
“Appellees’ petition will present a substantial question for the Supreme Court — whether the plaintiff or the defendant bears the burden of proof on loss causation under ERISA §409(a),” Carroll wrote.
Kayatta granted the requested stay on Oct. 29, giving the defendants 90 days to file their petition.
The plaintiffs are represented by James H. Kaster of Minneapolis. Kaster said Brotherston is a significant decision in favor of plan participants on the issue of loss, one that prevents the recognition of a standard that many in the defense bar view as an insurmountable obstacle to recovery.
“The defense would have you believe that what you need to prove is that the decisions they made were ‘objectively’ imprudent,” Kaster said. “The court basically looked to the Restatement [(Second) of Trusts] and said you can prove this in several different ways, one of which is to use index funds as a marker for how you judge the performance of imprudently chosen funds.”
Boston ERISA attorney Jonathan M. Feigenbaum said the 1st Circuit made the right call in following those circuits that have shifted the burden of proof on causation to ERISA fiduciaries.
“The burden shifting follows settled trust law,” Feigenbaum wrote in an email. “A beneficiary in seeking certain equitable remedies under trust law theories does not always bear the burden of proving causation for a loss.”
Meanwhile, Providence ERISA attorney Brooks R. Magratten said that putting that burden on the fiduciary was “not a surprising decision,” nor “particularly consequential.”
“When defending a breach of fiduciary duty action, the fiduciary will almost always come forward with evidence tending to prove the lack of causation between an alleged breach and plaintiffs’ loss,” Magratten explained. “The Brotherston ruling may make it more difficult for fiduciaries to prevail on a motion to dismiss, but for cases that are litigated on the merits I do not think it will have a significant impact.”
Feigenbaum said Brotherston underscores the point that fiduciaries need to vet for “suitability, costs and performance” the retirement investment options offered to employees.
“Also, the fiduciaries must continue to monitor the investment options for performance and costs on a continuous basis against competitive benchmarks,” he wrote.
“The defense would have you believe that … you need to prove the decisions they made were ‘objectively’ imprudent. The court said you can prove this in several different ways, one of which is to use index funds as a marker for how you judge the performance of imprudently chosen funds.”
— James H. Kaster, plaintiffs’ counsel
Putnam 401(k) plan
Putnam is an asset management company in the business of managing and selling mutual funds. Plaintiffs John Brotherston and Joan Glancy participated in Putnam’s defined-contribution 401(k) retirement plan.
Under the 401(k) plan, Putnam employees make contributions to individual accounts and direct those contributions among a menu of investment options. Putnam also contributes to its employees’ accounts.
The plan’s governing documents identify defendant Putnam Benefits Investment Committee as one of the plan’s named fiduciaries. Under the terms of the plan, PBIC is responsible for selecting, monitoring and removing investments from the plan’s investment options, which include Putnam mutual funds.
Between 2009 and 2015, more that 85 percent of the plan’s assets were invested in Putnam funds.
The trial judge found that PBIC did not independently investigate Putnam funds before including them as investment options, nor did the committee independently monitor those funds once in the plan.
In 2015, the plaintiffs filed a class action against Putnam, PBIC and various other Putnam entities. First, the plaintiffs alleged that the fees charged by Putnam subsidiaries to the mutual funds offered in the plan constituted prohibited transactions under ERISA.
In addition, the plaintiffs alleged the defendants breached fiduciary duties by stocking the plan with Putnam investment options.
By agreement of the parties, the plaintiffs’ claims were decided on summary judgment using a “case-stated” procedure. The procedure used in non-jury cases allows the District Court to engage in a certain amount of fact-finding, including the drawing of inferences from facts agreed to by the parties. The judge found against the plaintiffs on all claims after a seven-day bench trial at which only the plaintiffs presented their case.
ERISA claims revived
The plaintiffs’ suit implicated two ERISA provisions prohibiting certain transactions. Subject to certain exceptions, 29 U.S.C. §1106(a)(1)(C) prohibits a fiduciary from causing the plan to engage in a transaction that constitutes a direct or indirect “furnishing of goods, services, or facilities between the plan and a party in interest.”
Section 1106(b)(3) likewise prohibits a fiduciary from receiving “any consideration” from “any party dealing with such plan in connection with a transaction involving the assets of the plan.”
The Putnam 401(k) plan raised a question of liability under §1106(a)(1)(C) because it contracted for services with Putnam subsidiaries. A question of liability under §1106(b)(3) arose because Putnam received service fees charged by Putnam funds in which the plan invested.
Putnam contended and the 1st Circuit agreed that there was no liability under §1106(a)(1)(C) because of a statutory exemption allowing the payment of “reasonable compensation” to parties in interest for services rendered.
The 1st Circuit reached a contrary conclusion as to the plaintiffs’ claim that the defendants were liable under §1106(b)(3).
The defendants claimed a safe harbor under a Department of Labor regulation, PTE 77-3, which provides a prohibited transaction exemption for employee benefit plans that invest in in-house mutual funds so long as certain conditions are met.
The plaintiffs contended that the defendants could not satisfy a condition that “all other dealings” between their 401(k) plan and Putnam were any less favorable to the plan than dealings between Putnam and other shareholders investing in the same Putnam funds.
According to the plaintiffs, their plan did not benefit from an arrangement offered to third-party plans that invested in Putnam funds under which revenue sharing offset the payment of service fees.
However, the trial judge found that Putnam’s discretionary employer contributions to the plaintiffs’ 401(k) meant that their plan was treated more favorably than third-party plans that benefitted from revenue sharing.
The 1st Circuit determined that the trial judge erred in his analysis on that point.
“Putnam cannot point to those contributions to offset funds Putnam charges (or withholds from) the Plan in its capacity as a plan fiduciary,” Kayatta wrote. “To hold otherwise would be to allow employers to claw back with their fiduciary hands compensation granted with their employer hands.”
Finally, the panel addressed the dismissal of the plaintiffs’ claims that Putnam acted imprudently in selecting plan investment options and breached the duty of loyalty by engaging in self-dealing.
The trial judge found that PBIC breached its fiduciary duty in automatically including Putnam funds as investment options for the plan and then failing to independently monitor the performance of those funds.
The defendants argued, and the lower court judge agreed, that the defendants nonetheless had no liability for breaching the fiduciary duty of prudence because the plaintiffs were unable to show they sustained losses as the result of any such breach.
To show loss in the ERISA context, the 1st Circuit turned to well-established trust principles.
“We … hold that an ERISA trustee that imprudently performs its discretionary investment decisions, including the design of a portfolio of funds to offer as investment options in a defined-contribution plan, ‘is chargeable with … the amount required to restore the values of the trust estate and trust distributions to what they would have been if the portion of the trust affected by the breach had been properly administered,’” Kayatta wrote.
The plaintiffs’ expert testified that the 401(k) plan paid a premium of $30 to $35 million to obtain net returns that fell below the returns generated by the passive investment options that could have been offered by PBIC. The 1st Circuit found that evidence sufficient as a matter of law to establish a prima facie case of loss.
The panel observed that the circuits are divided on who bears the burden of proving or disproving causation once a plaintiff has proven a loss in the wake of an imprudent investment decision.
Turning once again to “ordinary trust principles,” the panel concluded that the burden-shifting scheme adopted by the 4th, 5th and 8th circuits was the correct approach, rejecting 6th, 9th, 10th and 11th Circuit decisions placing the burden of proof on the plaintiff.