DC plan sponsors tread lightly with capital preservation

In providing capital preservation options for investment menus, some defined contribution plan executives have wound up in the crosshairs of participants' lawsuits alleging fiduciary breaches of the Employee Retirement Income Security Act.

Some sponsors have been sued because they offered a money market fund instead of a higher-return stable value fund. Sponsors and providers have been sued for offering a stable value fund whose fees were too high. Or because the funds were too conservative. Or because the funds were too aggressive.

"They can get sued no matter what choice they make," said Patrick DiCarlo, Atlanta-based counsel for the law firm Alston & Bird LLP, which represents sponsors in ERISA cases. "The variations in plaintiffs' complaints are more so than I have ever seen before."

Despite some settlements — such as the preliminary agreement this month by Philips North America LLC to pay $17 million — many defendants have prevailed as federal district court judges and appeals court judges have rejected plaintiffs' arguments.

For example, judges have rebuffed complaints that the CVS Health Corp. stable value fund was too conservative and that Chevron Corp. should have offered a stable value fund instead of a money market fund.

Still, trade groups, ERISA attorneys and DC plan consultants urge executives to be careful in their investment-menu planning to reduce the risk of losing or settling Choosing a capital preservation option "requires a trade-off of risk vs. return," said Brian Netter, a Washington-based partner for Mayer Brown LLP, which represents sponsors in ERISA cases. "You must make reasoned, documented decisions. Find the answer that is most suitable for your company."

Amidst the flurry of ERISA lawsuits, trade organizations have leaped to the defense of plan sponsor defendants by filing friend-of-the-court briefs.

"Judge them by their process — not on hindsight," said Jan Jacobson, senior counsel for retirement policy at the American Benefits Council, Washington, who argued that plaintiffs' lawyers "cherry pick" data in their ERISA complaints.

The council has filed several amicus briefs in capital preservation cases including one in February in White et al. vs. Chevron Corp., now before the federal appeals court in San Francisco. A federal district judge in Oakland, Calif., twice dismissed the complaint, in 2016 and 2017, that alleged six ERISA violations, including the "imprudent" strategy of offering a money market fund instead of a higher-return stable value fund.

The judge rejected the argument, noting ERISA requires plans to offer "some type of low-risk capital preservation option" and doesn't require executives to predict winners. The plaintiffs had failed to provide information supporting allegations that Chevron officials failed to consider the "advantages and disadvantages" of different capital preservation strategies, the judge wrote.

The participants appealed. The council and the U.S. Chamber of Commerce filed a brief saying plaintiffs were asking judges to accept "second-guessing of a fiduciary's discretionary choice among several options." ERISA governs fiduciaries "not for the outcome of their decisions but for the process by which those decisions were made," they wrote.

The Chevron case illustrates that capital preservation complaints are often components of multipronged ERISA lawsuits against sponsors. Also, in Ramsey et al. vs. Philips North America LLC, for example, the preliminary settlement document said 47% of the award was related to the money market/stable value issue. Another 47% was attributed to the allegation of high record-keeping and investment fees, and 6% was based on criticism of a diversified real asset fund. Philips admitted "no wrongdoing or liability with respect to any of the allegations or claims," the document said.

Another key legal hurdle for defendants is whether a court certifies a complaint as a class action, thus adding thousands or tens of thousands of plaintiffs to a complaint. "If the court denies the class, it's not as economical (for a plaintiff's attorney) to pursue the case," said James P. McElligott Jr., the Richmond, Va.-based counsel for McguireWoods, which represents defendants in ERISA cases. "Any time you have a large number of participants, it's big numbers for class-action lawsuits."

Class-action status can put pressure on stable value providers, which have defended a series of ERISA lawsuits targeting the style, management and investment choices of their funds. In December 2017, eight months after a judge granted class-action status, J.P. Morgan Chase & Co.agreed to settle a stable-value complaint for $75 million, ending nearly six years of litigation.

The case represented the consolidation of suits from participants in nine 401(k) plans. They alleged that J.P. Morgan violated its ERISA duties of prudence by including highly leveraged and risky underlying investments in its stable value fund. The company admitted no wrongdoing and added the settlement was made to "avoid the ongoing cost of litigation."

Although J.P. Morgan settled, other stable value providers have prevailed recently, including Fidelity Management Trust, Voya Retirement Insurance & Annuity Co. and Galliard Capital Management, which was a co-defendant in the CVS Health Corp. case.

Litigation isn't driving clients' capital preservation decisions, DC consultants said. Sponsors cannot prevent being sued, but they can practice good governance such as monitoring fees and conducting benchmark studies, said Robyn Credico, Arlington, Va.-based defined contribution consulting leader for Willis Towers Watson PLC. "Just show good process and hope the suit will be dismissed."

ERISA lawsuits attacking the offering of money market funds instead of stable value funds allege the latter produce higher returns than the former, especially in recent years of low interest rates. However, DC consultants said stable value might not be appropriate or desirable for some plans.

Stable value is harder to explain to participants, more difficult to administer than money market funds and might have multiple restrictions imposed by the provider and, especially, the wrap provider, which offers insurance to maintain book value for investors in the underlying bonds.

Wrap contracts can restrict a plan's offering so-called competing investments such as money market funds and short-term bond funds. Wrap providers can impose penalties and restrictions based on employer-generated events, which can be a merger, a spinoff, bankruptcy, a re-enrollment or the adding of a self-directed brokerage account depending on the contract.

"You need to know what you are buying and what are the provisions of the contract," said Preet Prashar, associate director, Pavilion Advisory Group, Chicago. "Chasing yields is not the highest priority. You must know the risks before making an informed choice."

Among the questions executives should ask, he said, are:

• Is the stable value investment portable if a participant moves to another DC plan?


• What happens if the sponsor decides to terminate the investment?


• What events can trigger penalties?

"Make sure you pick a strategy that you are comfortable with and that's appropriate for your participants," said Benjamin Taylor, a San Francisco-based senior vice president at Callan LLC. They may select money market funds due to their ease of use, participants' familiarity with the option, simplicity and conservatism. But sponsors must document why this was the best choice, he said.

His clients who offer stable funds are comfortable with their strategies. "I haven't seen sponsors express concern as long as their process is prudently diligent," Mr. Taylor added.