Lawsuits show risk to managers in offering their own products

A spate of legal settlements involving financial firms' DC plans this year illustrates the potential risk of sponsors offering their own proprietary products due to alleged ERISA violations.

Placing proprietary products, such as mutual funds and collective investment trusts, in defined contribution lineups is perfectly legal, and financial firms often include them in their own plans. However, plaintiffs' lawyers have found enough alleged flaws in some plans' procedures and practices to convince sponsors that settling is cheaper than fighting in court even though sponsors admit no wrongdoing.

"A lot of companies can do everything right and still get sued," said Emily Costin, a Washington-based partner for Alston & Bird LLP who represents sponsors.

She declined to comment on specific cases but said factors influencing a settlement decision could include a sponsor's risk tolerance, the facts of the case, the amount of coverage by the sponsor's insurer, the court where a complaint is filed and even the judge hearing the complaint.

"ERISA cases are expensive to litigate," said Kai Richter, a plaintiffs attorney and partner at Nichols Kaster PLLP, Minneapolis, offering a rare agreement with defense attorneys.

His firm has secured several settlements in proprietary-product ERISA lawsuits, and it is representing plaintiffs in several pending cases.

"The fundamental allegation is: If a non-conflicted fiduciary follows a prudent process, would they choose these funds or retain these funds?" said Mr. Richter, who declined to comment on specific cases. "A settlement reflects the recognition of significant litigation risk."

Based on dates that settlement terms were announced, recent proprietary-product agreements include McKinsey & Co. ($39.5 million) and Huntington Bancshares Inc. ($10.5 million) in August; Fidelity Investments ($28.5 million) and Neuberger Berman Group ($17 million) in June; and J.P. Morgan Chase & Co. ($9 million) in May.

Management consultant McKinsey & Co. isn't a financial services firm. It was sued along with MIO Partners Inc., an affiliate that provided proprietary investments for two McKinsey DC plans.

Other settlements this year include Putnam Investments ($12.5 million) in April; SunTrust Banks Inc. ($29 million) and Invesco Holding Co. (U.S.) Inc. ($3.5 million) in March; and M&T Bank Corp. ($20.9 million) in January.

These settlements include those pending formal court approval as well as those that have received approval. Defendants in each case denied wrongdoing.

Last year, ERISA proprietary-product settlements included Franklin Resources Inc. ($13.9 million); Massachusetts Financial Services Co. ($6.9 million); SEI Investments Co. ($6.8 million); and Eaton Vance Corp. ($3.5 million).

Sponsors' settlement decisions "are very individualistic considerations," said James O. Fleckner, a Boston-based partner at Goodwin Procter LLP who represents sponsors."It's hard to generalize" why they settle and when they decide to settle.

Some cases are settled relatively quickly. From the day complaints were filed, it took about seven months for Eaton Vance and about 18 months for McKinsey and respective plaintiffs to announce settlement terms. It took nine years for SunTrust Banks and plaintiffs to announce settlement terms.

One of Mr. Fleckner's clients, American Century Services LLC, which was sued in 2016, fought and won. American Century Investment Management provides proprietary funds to the plan. Following a bench trial in 2018, a U.S. district judge in Kansas City, Mo., ruled in January 2019 for the company and its fiduciaries. The judge rejected claims of ERISA violations regarding proprietary funds in a company plan.

The judge agreed with the plan's fiduciaries' belief "that participants wanted greater choice and could benefit from greater choice" in the plan lineup, said Mr. Fleckner, who declined to comment on other cases. The plaintiffs didn't appeal.

Complaints against financial services companies and their plan fiduciaries have some similarities to ERISA complaints against other plan sponsors. They can focus on fees and/or performance as well as on the number of products from the same provider in a DC plan.

However, a proprietary-products case "is different than a typical fee case because there is a stronger duty of loyalty claim" against sponsors, Ms. Costin of Alston & Bird said.

Duty of loyalty to participants and beneficiaries is a foundational ERISA principle governing plan fiduciaries as well as a constant reference in complaints against employers and their fiduciaries.

Sponsors' primary strategy is convincing a judge to dismiss an ERISA complaint. If not, the discovery process — in which both sides obtain documents from each other prior to a trial — "can be pretty costly," said Jennifer Eller, a Washington-based partner at Groom Law Group who represents sponsors in ERISA lawsuits. She declined to comment on specific cases.

"Sometimes, in-house litigation counsel says we need to get to the end of this," said Ms. Eller. "Other in-house counsel will say we have a principle to stand up for."

Getting past the dismissal stage gives plaintiffs lawyers a more comprehensive look at a sponsor's plan and practices, which means the "complaint can go in a different direction" than the allegations made in the initial lawsuit, Goodwin Procter's Mr. Fleckner said.

Settlements don't create legal precedents, and there's more to them than money. They often contain "prospective relief," which are administrative requirements for sponsors.

Non-monetary terms depend on individual case circumstances, Nichols Kaster's Mr. Richter said. "If the problem has been fixed, the need for prospective relief is not the same and may be moot," he said.

The goal of these requirements "is to provide greater assurance that the product will be properly evaluated and monitored on a go-forward basis," he said. Requiring an independent third party to review plan activity and procedures is often included in the settlement terms, Mr. Richter added.

"The monetary amount is the primary driver of a settlement," Ms. Costin said. "Plaintiffs lawyers want to get as much as they can. Sponsors want to pay as little as they can. Non-monetary terms are often a bridge between the amounts."

An example of a non-monetary provision in the McKinsey case was the requirement that an independent fiduciary, for at least three years, review the two DC plans and "all expense reimbursements to McKinsey, MIO or any other affiliated person or entity," the settlement document said. The independent fiduciary will have "final discretion to approve or reject reimbursements."

Putnam agreed to "annual fiduciary training for plan fiduciaries" for at least two years and the offering of "a suite of low-cost third-party passive investment options in the plan," said the settlement document.

Ms. Eller of Groom Law Group said the non-monetary terms in one case can serve as a guide for other plaintiffs' attorneys to insist on similar terms in their own settlement negotiations.

"The plaintiffs' bar is hoping to set the new standard" through non-monetary terms, she said. "I don't like the idea that settlement terms are the standard. I don't think they should be."