A federal appellate court has ordered another review of decisions made in a proprietary fund suit – and shifted the burden of proof applied by the lower court.
The case has drawn the interests of a wide-ranging number of organizations in filing friend of the court briefs on behalf of the plaintiffs (AARP, the AARP Foundation and the National Employment Lawyers Association) and the Putnam fiduciary defendants (the Chamber of Commerce of the United States of America, American Benefits Council, the Securities Industry and Financial Markets Association (SIFMA), and the Investment Company Institute).
Interestingly enough, the case – more specifically Putnam’s victory in the district court – has been cited by a number of settlement filings as indicative of the uncertain nature of plaintiffs prevailing in similar cases (see Terms Announced in Proprietary Fund Settlement, Settlement Struck in Excessive Fee Suit and Airline’s Excessive Fee Turbulence Settles).
The case, Brotherston v. Putnam Investments, LLC (2017 BL 208765, D. Mass., No. 1:15-cv-13825-WGY, 6/19/17), was filed against Putnam Investments by participants in that plan, alleging that the defendants “have loaded the Plan exclusively with Putnam’s mutual funds, without investigating whether Plan participants would be better served by investments managed by unaffiliated companies.”
The plaintiffs’ arguments had been dismissed in June 2017, with District Judge William G. Young determining that not only had the plaintiffs failed to identify any specific circumstances in which the company and its 401(k) plan put their own interests ahead of the interests of plan participants, but that the plaintiffs failed to show how Putnam’s allegedly imprudent actions resulted in losses that required compensation. That said, Judge Young had also noted that the Putnam plan fiduciaries “review of the Plan lineup was no paragon of diligence.”
On appeal, the 1st U.S. Circuit Court of Appeals noted (Brotherston v. Putnam Invs., LLC, 1st Cir., No. 17-1711, opinion 10/15/18) that “finding several errors of law in the district court’s rulings, we vacate the district court's judgment in part and remand for further proceedings.”
The appellate court (Judge William J. Kayatta Jr. wrote the decision, joined by Judges Juan R. Torruella and O. Rogeriee Thompson) began by noting that the plaintiffs here alleged two types of claims under ERISA. “First, they claim that the fees charged by Putnam subsidiaries to the mutual funds offered in the Plan constituted prohibited transactions under ERISA. Second, they claim that Putnam, through its committees operating the Plan, breached its fiduciary duties by blindly stocking the Plan with Putnam-affiliated investment options merely because they were proprietary.”
With regard to the alleged prohibited transactions, the appellate court quickly noted that “the design and operation of the Plan implicates both of these prohibitions,” in that it “contracts with parties-in-interest (Putnam subsidiaries) for services, thereby implicating section 1106(a)(1),” and that Putnam, through the service fees it charges the Putnam funds in which the Plan invests, receives a benefit “in connection with a transaction involving the assets of the [P]lan” (that transaction being the Plan’s purchase of shares in the Putnam funds), “thereby implicating section 1106(b),” and that “Putnam therefore runs afoul of each prohibition unless it qualifies for an applicable exemption.”
And, turning to one of those exemptions, the appellate court posed the question, “Were the payments received by these Putnam subsidiaries for their services to Putnam mutual funds reasonable?”
The court looked to the findings of the district court on the issue, and while it noted conclusions that “the Putnam funds were both offered to and acquired by at least some other individuals and entities who had the freedom to invest in other funds in the marketplace,” it saw no reason to displace the district court’s conclusion despite allegations that few plans of Putnam’s size invested in those funds.
However, after citing various documents and assertions from both parties regarding the issue, the court stated that “without guidance from the parties on how to analyze these various documents and without the benefit of the district court’s assessment on the matter, we think it best not to sift through the record to reach our own unaided conclusions,” and instead decided to vacate the district court’s judgment against the plaintiffs on this issue, and send the issue back to that district court “to reconsider whether the requirement of PTE 77-3(d) is satisfied in light of revenue sharing payments Putnam makes to some other plans.”
As for “…the district court’s ruling mid-trial dismissing plaintiffs’ claims that Putnam acted imprudently in selecting the Plan's investment options and that it breached the duty of loyalty by engaging in self-dealing,” the appellate court noted the “district court's tentative finding 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,” and that that court had “correctly observed that such a breach does not mean that the Plan necessarily suffered any loss.” So the question – the appellate court said – “was, did any loss occur?”
After some discussion of the arguments presented by both sides, the appellate court pulled up, noted that the determination of suitable benchmarks, calculation of returns, and/or the applicable time period(s) for comparison were questions of fact – and “the district court never reached these questions…” and then, going on to note that “Correctly recognizing that its resolution of that issue was not clear cut, the district court explicitly invited de novo review on the question of legal sufficiency” – the appellate court provided that, “by determining that plaintiffs' evidence was sufficient to support a finding of loss.”
The court then turned to the issue of causation, noting that, “assuming the Plan suffered a loss, the district court was certainly correct that the lack of prudence in the procedures used to select investments may not have caused the loss” – and then considered the issue of which party bore the burden of proof on the matter. After some discussion about various considerations, the appellate court embraced a “common sense” approach, explaining that “An ERISA fiduciary often – as in this case – has available many options from which to build a portfolio of investments available to beneficiaries. In such circumstances, it makes little sense to have the plaintiff hazard a guess as to what the fiduciary would have done had it not breached its duty in selecting investment vehicles, only to be told ‘guess again.’ It makes much more sense for the fiduciary to say what it claims it would have done and for the plaintiff to then respond to that.”
The appellate court then opted to “…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.”
The appellate court found no fault in the district court’s dismissal of the plaintiffs claim for breach of the duty of loyalty, nor a separate claim for disgorgement of fees.
So, in sum, the appellate court:
- affirmed the district court's dismissal of plaintiffs' prohibited transaction claim under section 1106(a)(1) (C);
- vacated the district court's dismissal of plaintiffs’ prohibited transaction claim under section 1106(b)(3) and remanded that for “further proceedings”;
- affirmed the dismissal of plaintiffs' breach-of-loyalty claim;
- affirmed the dismissal of the disgorgement claim (except to the extent that disgorgement may be a remedy for a prohibited transaction claim);
- vacated the finding that plaintiffs have failed as a matter of law to show loss; and
- remanded for “further consideration” plaintiffs’ prudence claim in light of our holding on the burden-shifting issue.
Costs were awarded to the plaintiffs.
However – the court concluded by noting that “none of this means, we add, that defendants have violated any duties or obligations owed to the Plan or its beneficiaries. Rather, it simply means that we have rejected two reasons for concluding that such a violation necessarily did not occur, and we have otherwise clarified for the district court several principles that should guide its subsequent rulings in this case.”