Morgan Stanley has fended off a participant suit that a federal judge described as “opportunistic Monday-morning quarterbacking on the part of lawyers.”
In Patterson v. Stanley (2019 BL 384508, S.D.N.Y., No. 1:16-cv-06568-RJS, 10/7/19), U.S. Circuit Judge Richard J. Sullivan, sitting by designation, granted Morgan Stanley’s motion to dismiss, finding that the plaintiffs in the case lacked standing to bring many of their claims under ERISA, and made “conclusory,” but ultimately uncompelling arguments in other respects.
The $150 million class action had taken issue with Morgan Stanley’s decision to offer six proprietary funds in its $60 billion plan that the former participants/now-plaintiffs (Ralph J. Peterson & Terri Lo Sasso) claimed charged fees that were improperly high, and that three of those funds (the Small Cap Fund, the Mid Cap Fund and the Global Real Estate Fund) “performed so poorly that any reasonable fiduciary would have removed them from the array of Plan offerings,” noted Judge Sullivan.
The plaintiffs had also claimed that the plan “improperly included seven poorly performing target-date retirement funds offered by BlackRock” – that, they alleged, were either poorly performing or “entirely untested” when they were added to the plan. Moreover, the plaintiffs argued that those funds charged “inordinate fees” and underperformed throughout the period in question – but that Morgan Stanley continued to offer those funds “because they were being paid by BlackRock to do so,” commented Sullivan.
Standing Stymied
The Morgan Stanley defendants challenged the suit on several fronts; first, whether these plaintiffs had standing to bring suit regarding the seven funds in which they weren’t invested. Judge Sullivan agreed with the defendants that they lacked standing, since they suffered no injury. Moreover, he also rejected the notion that, as part of a class action, they were similarly situated enough to attain that standing, explaining that, “Plaintiffs’ claims will undoubtedly require a fund-by-fund analysis for all thirteen funds identified…”.
Sullivan also rejected the plaintiffs’ alternative argument that they were, in fact, “individually harmed” because the inclusion of the funds “undermined the plan as a whole” by robbing them of their “right to choose from superior investment options.” Sullivan noted that they “cite no source in the statute for such a ‘right’ or any other basis for concluding that the derivation of the 'right to choose from superior options' is enough to establish standing under ERISA.”
With regard to the claims about the imprudent inclusion of proprietary funds, Judge Sullivan said that the plaintiffs’ theory “boils down to an allegation that Defendants either did not (1) offer Plan participants the opportunity to invest in ‘separate accounts’ (as other Morgan Stanley clients did) that replicated the strategies of the MS Funds, but with reduced fees, or (2) unilaterally discount the fees associated with the MS funds to equal those charged to its separate account clients” – either of which he held “must be dismissed.”
‘Separate’ Account
Oddly, Judge Sullivan seemed to say the development of a specific separate account solution in which the fiduciary has an interest or receives fees would violate ERISA, but that – even if an exemption to that structure were to be found – “nothing in ERISA requires a Plan to offer separate accounts in lieu of reasonably-priced mutual funds.”
In response to an argument that the Morgan Stanley plan participants were ill served by not receiving the same separate account treatment as that accorded other Morgan Stanley clients, Sullivan noted that nothing in ERISA requires Morgan Stanley to “unilaterally offer Plan participants a discounted fee as to the MS Funds, or to reduce the market-based fees of the MS Funds to equal those charged to the MS Funds to equal those charged to separate account clients simply because those funds are including in an ERISA plan” (though he also acknowledged that nothing prevented them from doing so).
Performance ‘Measurement’
As for continuing to offer the Mid Cap Fund (allegedly imprudent because it underperformed relative to its Russell Midcap Growth Index benchmark and two “alleged comparators”), Sullivan said the plaintiffs had to “allege non-conclusory factual content raising a plausible inference of misconduct and may not rely on the vantage point of hindsight.” Suffice it to say that Sullivan didn’t find the factual content here (a 2016 prospectus – the year the fund was removed from the plan menu) to be sufficient (if not based on hindsight) – nor did he find the allegations “…of the Fund’s alleged underperformance in average returns as compared to certain benchmark indices or alleged insufficient performance history” the requisite plausible inference.
Moreover, he noted that the benchmark difference alleged – “less than one percentage point” – was “such a small disparity in performance relative to its benchmark does not support the inference that Defendants were imprudent to retain the Mid Cap Fund in the set of Plan offerings.” And – Sullivan notes that the yearly benchmark comparisons “fare no better.” In fact, he concludes that “…the mere fact that the Mid Cap Fund did not do as well as other options does not give rise to the inference that Defendants’ decision to retain that investment offering was imprudent.”
“Put simply,” Sullivan writes, “the duty of prudence does not compel ERISA fiduciaries to reflexively jettison investment options in favor of the prior year’s top performers. If that were the case, Plan sponsors would be duty-bound to merely follow the industry rankings for the past year’s results, even though past performance is no guarantee of future success. Clearly, no court has ever suggested the existence of such a duty.”
Rather, he cautioned that fiduciaries are to consider all the circumstances at the time a decision is made. He applied a similar analysis to the allegations regarding the Global Real Estate Fund, rejecting those claims as well.
Fees ‘Able’?
Sullivan also challenged the allegations regarding fees, noting that “the facts alleged in the Complaint do not give rise to a plausible inference that the Mid Cap Fund’s fees were so excessive as to reflect a breach of fiduciary duty.” He found that the fee differential between the Mid Cap Fund (0.61%) and the Vanguard Mid Cap Fund (0.08%) is not insignificant, but that the plaintiffs had “failed to properly allege that the passively-managed Vanguard Mid Cap Fund was in fact comparable to the actively-managed Mid-Cap Fund.” And assuming they were comparable, Sullivan said that a fee differential alone is insufficient to demonstrate disloyalty without allegations that the Defendants acted “‘for the purpose’ of providing themselves or others a benefit.” Concluding his determination here, he wrote, “Absent other evidence demonstrating some improper motivation, Plaintiffs have failed to plead sufficient facts demonstrating the fiduciaries acted disloyally.”
‘Missed’ Targets
As regards the BlackRock target-date funds, only one remained in contention – the 2025 Trust in which plaintiff Lo Sasso invested. In that Judge Sullivan began his analysis noting the similarities between the claims here and the Mid Cap Fund (underperforming benchmarks and “allegedly comparable alternative investment options”), it shouldn’t be surprising that he found these arguments “conclusory” and “insufficient to state a claim,” noting that “backward-looking contentions regarding underperformance are improperly grounded in hindsight.” He also noted that those benchmark comparisons didn’t prove the case, since in some years the fund actually outperformed the funds with which it was compared.
He was similarly unimpressed by the claims regarding fees, finding the comparison with Vanguard’s 2025 fund a “conclusory allegation” of comparability – and determining that, in an event, the fee differential (0.12% versus 0.07%) was “only marginally higher.” Sullivan also failed to see support for claims of imprudence in the Vanguard’s option rated higher by Morningstar than the BlackRock option, nor did he find fault with the decision to go with the BlackRock option even though it was “untested.” Supporting his perception that a prudent process was in place, Sullivan cited the reality that Morgan Stanley ultimately removed the BlackRock fund from the set of plan offerings. “On the whole,” he wrote, “Plaintiffs have failed to plausibly allege that Defendants breached their duty of prudence in connection with their decision to offer, and to continue to offer, the 2025 Trust.”
Judge Sullivan was similarly dismissive of the plaintiffs’ claims of a failure of the duty to monitor, or conducting prohibited transactions in paying investment management fees to itself.
The conclusion of the judgment made Sullivan’s disdain for the arguments presented crystal clear: “Contrary to plaintiffs’ claims, ERISA does not require clairvoyance on the part of plan fiduciaries, nor does it countenance opportunistic Monday-morning quarterbacking on the part of lawyers and plan participants, who, with the benefit of hindsight, have zeroed in on the underperformance of certain investment options. More is required, and Plaintiffs came nowhere close to alleging such a case in their Complaint.”
What This Means
Judges are people too, and sometimes even in the impartial application of the law, reasoned (and reasonable) minds can draw different conclusions. On the surface anyway, Judge Sullivan’s rejection of the plaintiff’s standing to bring suit as class representatives regarding funds they weren’t actually invested in, stands in sharp contrast to what a number of courts in other jurisdictions have allowed. He focused on the individual aspects of a defined contribution plan and the injuries actually suffered by plaintiffs, rather than the class. Not that, considering his take on the arguments presented, he would likely have concluded otherwise.
The bottom line seems to be that Judge Sullivan felt the arguments were presented in a conclusory manner, almost as though the plaintiffs expected their mere presentation of less-expensive, sometimes better-performing alternatives as sufficient to make the case. That is perhaps to be expected after so much similarly positioned litigation charges over more than a decade.
What’s not made as clear in this decision, but seems worth noting, is that the defendants apparently had a review process in place that appears to have been active and effective.
