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April 2013

Fiduciaries Must Act Diligently By Thoroughly Investigating All Potential Investment Opportunities for Beneficiaries

On March 21, the U.S. Court of Appeals for the Ninth Circuit heard cross-appeals in a class action suit. The plaintiff-beneficiaries alleged that benefit plan administrator Edison International, a holding company for various electric utilities, acted in an imprudent manner and in a self-interested fashion when it managed their pension plan by offering the beneficiaries a unitized stock fund, money market-style investment, and offering only retail-class mutual funds, and excluding institutional-share mutual funds.  

Although the beneficiaries prevailed only on one claim of Edison acting in an imprudent manner, the Ninth  Circuit made it clear in Glen Tibble, et al. v. Edison International, et al. that fiduciaries must diligently explore, evaluate, and thoroughly investigate all funding options, and the fiduciary cannot simply rely on a consultant’s recommendation.

On appeal, in addition to their respective substantive claims, both parties raised procedural arguments related to statute of limitations and class certification.  The beneficiaries argued that the Ninth Circuit should adopt a “continuing violation” theory making timely all claims (even those beyond the six-year statute of limitations) so long as the underlying investment remained in the plan. Conversely, Edison argued for a three-year statute of limitations under ERISA’s “actual knowledge” provision based on the fact that the fund information was contained in the Summary Plan Description. The Ninth Circuit rejected both arguments and held that imprudence claims have a six-year statute of limitations beginning at the time of the designation of the investment.  

Edison also tried to invoke the “safe harbor” provision of ERISA §404(c). The safe harbor provides that a fiduciary cannot be liable for any loss or breach that results from the beneficiary’s exercise of control. The Ninth Circuit rejected this argument holding that the safe harbor provision did not apply because the specific act of limiting or designating investment options is a fiduciary function and not a result of a participant’s direction. 

The final procedural issue at stake was Edison’s opposition to the certification of the class. Relying on Seventh Circuit case law, Edison argued that a class representative must have invested in the same funds as the class members. Since one of the three funds litigated at trial was not held by any of the six named plaintiffs, the class should not have been certified. Unfortunately, Edison did not present this argument to the district court so the Ninth Circuit declined to address the issue at this time.

At the center of the appeal was whether Edison sufficiently considered investment opportunities when it decided to select certain funds and exclude others. The Ninth Circuit confirmed that the plan documents vested discretionary authority to Edison’s Benefits Committee to construe and interpret the plan’s terms and provisions, and therefore applied the abuse of discretion standard. Under the abuse of discretion standard, the court considered whether Edison construed the plan in a way that conflicts with its plain language. To determine prudence, the Ninth Circuit looked at whether Edison employed the appropriate methods to thoroughly investigate the merits and structure of the transaction by ensuring that it explored all potential investment opportunities, including reviewing the data provided by the consultant, assessing its significance, and supplementing where necessary. The Ninth Circuit cautioned that a fiduciary cannot satisfy its duty of prudence simply by engaging a well-qualified and impartial consultant.   

By applying this standard, the Ninth Circuit found that Edison did not violate its duty of prudence when it chose to include mutual funds in the plan because of the regulatory and transparency features strictly governed by the Securities Act of 1933 and the Investment Company Act of 1940. The Ninth Circuit also did not share the beneficiaries’ concern that the mutual funds charged excessive fees because retail-class mutual funds generally have higher expense ratios than their institutional-class counterparts, and this revenue-sharing does  not violate the terms of the plan or ERISA §406(b)(3). 

The Ninth Circuit also found that Edison did not act imprudently when it offered a stable value fund rather than a short-term investment fund option. The appeals court described both funds as conservative with an emphasis on capital preservation rather than maximized returns.  More importantly, the Ninth Circuit found that Edison produced sufficient evidence that it reviewed all options and made a measured decision based on the pros and cons of both funds. 

However, the Ninth Circuit found that Edison acted imprudently when it failed to investigate the possibility of including institutional-share class alternatives.  Edison argued that it relied on financial experts for investment consulting advice and to help design and manage the plan’s menu.  Nevertheless, the Ninth Circuit pointed out that the service provider was a consultant and not a fiduciary. As a fiduciary, it was Edison’s responsibility to ensure that it explored all potential investment opportunities, including reviewing the data provided by the consultant, assessing its significance, and supplementing where necessary. There was no evidence that Edison considered the possibility of institutional classes and sought advice from the consultant on specific recommendations of retail versus institutional mutual funds. There also was no evidence on what steps Edison took to evaluate the consultant’s recommendations. 

The overwhelming absence of evidence established that Edison did not conduct a thorough investigation when selecting retail mutual funds over the institutional-share class alternative. On this basis, the appeals court upheld the district court’s finding that Edison did not exercise the due diligence required under ERISA.

Tibble illustrates that even when a fiduciary has good intentions and consults on a regular basis with an expert in the respective area, the fiduciary cannot simply rely on the consultant’s opinion. The fiduciary must engage in its own investigation into the alternative options and confirm that all available share classes and the relative costs have been explored and evaluated before offering them to a plan. 

To view the opinion in Glen Tibble, et al. v. Edison International, et al., 2013 U.S. App. LEXIS 5598 (9th Cir.) (March 21, 2013), click here.

This decision may be cited now as persuasive nonprecedential authority. The decision may be modified by further proceedings in the district court or on appeal.

This and other case bulletins, as well as other publications of Gordon & Rees LLP, may be found at www.gordonrees.com.
 

ERISA

Ronald K. Alberts
Sarah N. Turner



ERISA
Insurance
Life, Health & Disability