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Schlichter Wins One, Loses Several in Excessive Fee Suit

Litigation

The defendants in an excessive fee suit managed to prevail on most – but not all – of their motions for summary judgment, and exclusion of expert witness testimony.

The plaintiffs in this case (Marshall v. Northrop Grumman Corp., C.D. Cal., No. 2:16-cv-06794, complaint filed 9/9/16), seven former employees of Northrop Grumman Corp. represented by Schlichter Bogard & Denton, alleged that the $19 billion, 110,000-participant Northrup Grumman plan paid nearly $10 million (between $1.7 million and $2.1 million/year) in administrative fees associated with the company’s retirement plan – even though the plan was already paying millions of dollars in fees to a third-party recordkeeper, Hewitt Associates (effective April 1, 2016, Fidelity Investments replaced Hewitt as the plan’s recordkeeper). The suit claims that Northrop executives had “unfettered control” over the amounts taken from the retirement plan, allowing the company to receive plan assets “in the guise of compensation” that wasn’t reasonable or necessary for the plan’s administration. 

The suit also challenges the decision by the plan to retain as an active equity investment option the Emerging Markets Equity Fund, while during 2010 the plan fiduciaries “determined that an active investment strategy for the Plan’s equity and fixed income investment options was no longer prudent or in the Plan participants’ best interest” – a fund that was alleged to have “consistently and dramatically underperformed its benchmark index,” while also being the most expensive fund on the plan menu.

Motions Made

Two motions were before Judge André Birotte Jr. of the U.S. District Court for the Central District of California (Marshall v. Northrop Grumman Corp., C.D. Cal., No. 2:16-cv-06794-AB-JC, 8/14/19); a motion for partial summary judgment, and a motion to exclude Plaintiffs’ Experts Dr. Steve Pomerantz and David Witz. Additionally, the Northrup defendants also filed objections to Martin Schmidt’s expert report and testimony. We’ll come back to the expert witness determinations in a minute.

While acknowledging that “Plaintiffs’ theories have shifted significantly over the course of this litigation,” Judge Birotte explained that “the Investment Committee did not have an absolute duty, as a matter of law, to offer an EM Fund operating under passive management. The reasonably prudent fiduciary standard “merely requires that fiduciaries reach a well-reasoned decision after weighing the risks and benefits and considering other alternatives.”

As for that reasoned decision, Birotte noted that “the parties rely on, among other things, reports and presentations” prepared by the investment committee, that “the Court has reviewed the voluminous record in this case,” and that ultimately, “the parties overstate the value of numerous[i] pieces of evidence, and there are significant gaps in the record as to whether the Investment Committee considered, adopted, or rejected most of the ITA’s recommendations and/or presentation materials.” That, in fact, “a trier of fact could reasonably view the ITA’s evaluations and discussions in Investment Committee meetings insufficient to disprove a breach of Defendants’ fiduciary duties because the Investment Committee failed to adequately weigh the costs and benefits of an active management strategy against a passive management strategy.”

Search ‘Mien’?

However, the element in the decision that seems most likely to be draw attention was the decision regarding the review and evaluation of recordkeeping fees. Judge Birotte outlined the two major surviving allegations (an allegation that defendants should have renegotiated fees to be on a per-participant basis was set aside since that had been accomplished): that defendants should have renegotiated recordkeeping fees in a competitive bidding process; and that the defendants failed to account for payments received by Hewitt from Financial Engines.

With regard to the first allegation, Judge Birotte – noting that he was “drawing all inferences in Plaintiffs’ favor,” concluded that “no reasonable trier of fact could find that Defendants breached their fiduciary duty of prudence by failing to monitor and renegotiate recordkeeping fees in a competitive bidding process every three to five years.” Noting that the plaintiffs relied “heavily upon George v. Kraft Foods Glob., Inc.,” this court drew a distinction – mainly that while the Kraft ruling noted that the failure to solicit competitive bids might (emphasis ours) – “where (1) plaintiffs presented concrete evidence about the objective level of fees and why they were unreasonable; and (2) the plan fiduciaries had not renegotiated their recordkeeping arrangement for more than fifteen years” – create a triable issue. 

But judge Birotte then went on to list a number of steps that the defendants had undertaken before hiring Hewitt, including an RFP, benchmarking fees using an external consultant (2010) and renegotiating fees (2011). “Thus, even assuming fiduciaries have a duty to conduct frequent fee reviews and renegotiate fees in a competitive bidding process, Defendants meet the requirement because Defendants benchmarked Hewitt and renegotiated fees starting in 2010 and 2011, and the new RFP for recordkeeping services issued in 2014.”

‘Kickback’ Kicked Back

As for the second issue – that the data connectivity agreement and Master Service Agreement between Hewitt and Financial Engines constituted a “kickback” arrangement – well, Judge Birotte didn’t see it that way. “ERISA does not require, as a matter of law, that fiduciaries leverage the type of third-party fees at issue here in order to reduce recordkeeping fees,” he wrote. Noting that the plaintiffs tried to draw a connection between that connectivity fee and revenue sharing, Judge Birotte found “important differences” between the two. “A plan’s duty to monitor revenue sharing fees makes sense because plan fiduciaries have control over these payments, payments are paid out of plan assets, and payments are for services provided to the plan and its participants. Data connectivity fees, by contrast, are not subject to fiduciary control, the fees are not paid out of plan assets, and are for services Hewitt provides to Financial Engines out of an independent business arrangement.”

Expert ‘Opinion’

With regard to the motions regarding expert witnesses, Judge Birotte denied the objections to the expert testimony of Pomerantz and Witz as “moot” because “the Court did not rely upon” their testimony in resolving Defendants’ Motion for Summary Judgment. As for Schmidt, Birotte wrote that the defendants move to exclude Schmidt’s expert report and testimony on two topics – specifically: (1) how plans should leverage the fees from Financial Engines to a plan recordkeeper for the benefit of plan participants; and (2) a calculation for “expected fees for recordkeeping and administrative services – on the grounds that “he is unqualified and his opinions are unreliable.” 

Basically, Judge Birotte summarized their rationale as follows: that his opinion as to reasonable recordkeeping fees was not based on any relevant experience or reliable methodology, and that his testimony as to fiduciaries leveraging the fees paid between a recordkeeper and a financial advisory service provider was an “experience-based opinion” about “a practice for which he has no experience.” Judge Birotte found their argument (and the apparent lack of a response to the arguments by the plaintiffs) persuasive, and went on to state that “The Court is not aware of any evidence that Schmidt has any expertise with these types of fees.” Moreover, commenting that “while Schmidt contends that he has experience leveraging fees for ‘advisory services’ to negotiate recordkeeping fee adjustments, this experience is not germane to whether prudent fiduciaries have successfully leveraged the type of third-party fees at issue here in order to reduce recordkeeping fees.”

When all is said and done, the court here “GRANTS in part and DENIES in part Defendants’ Motion for Partial Summary Judgment.” Specifically, the court:

  • denied Defendants’ Motion for Summary Judgment with regard to the duty of prudence on Plaintiffs’ EM Fund claim; and
  • granted the Defendants’ Motion for Summary Judgment with regard to Plaintiffs’ duty of loyalty claims, with regard to the duty of prudence for Plaintiffs’ recordkeeping fees claim, for Plaintiffs’ failure to monitor claim; and on Plaintiffs’ prohibited transaction claim.

What This Means

Summary judgment determinations are done with a deference to the interests of the party that isn’t moving to have the case dismissed. Here that’s the plaintiffs, and even with that deference, most of the “calls” here went for the defendant, including a refutation of the notion (widely touted in this kind of litigation) that an RFP is required at all, much less every 3-5 years.[ii]

With regard to the prudence of the selection and retention of the EM fund, while there appears to be a lot of documentation, one senses that Judge Birotte wasn’t willing to make a call on whether all that paper constituted a prudent review and process. 

For that, we’ll have to wait for the next round. 

Footnotes

[i]In an interesting and somewhat amusing footnote, Judge Birotte explains (with the exasperation of teacher who’s inattentive students have failed to pay attention to the specifics of the assignment) that “the parties have literally buried the Court in paper.” He goes on to comment: “Counsel on both sides consistently file motions, oppositions, and reply briefs in excess of the page limit set forth in Local Rule 11-6. Plaintiffs omit spaces between paragraph and section symbols in their opposition; Defendants filed a twenty-six page reply brief; and both parties interpret the Local Rules as excluding signature blocks from the word count. The Court reminds counsel that the page limit excludes only indices and exhibits, not signature blocks or conclusions.”

[ii]For some interesting insights, check out the March 2019 NAPA-Net Reader Poll: Less is More With RFPs 

 

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