What You Should Know About Recent Trends in 401(k) Fee Litigation


litigation-6-25-18.pngParticipation in 401(k) plans has grown astronomically since they came into existence almost 30 years ago. Today, tens of millions of employees participate in 401(k) plans, and total assets under management exceed $7 trillion. It is little wonder that 401(k) plans have increasingly become targets for litigation over the last decade. In 2017 alone, dozens of new cases were filed against 401(k) plans, with settlements collectively exceeding $145 million. Litigation has also extended to substantively similar 403(b) plans. It is therefore important for plan sponsors and administrators to be aware of recent litigation trends and take appropriate steps to minimize litigation risks.

Basis of 401(k) Fee Litigation
401(k) plans are “employee welfare benefit plans” governed by the Employer Retirement Income Security Act (“ERISA”) and, as such, must be managed exclusively for the benefit of plan participants. Plan sponsors and administrators (collectively “plan fiduciaries”) are accordingly subject to a fiduciary duty—which courts refer to as “the highest duty known to law”—requiring them to act prudently (i.e. with the “care, skill, and prudence” of a prudent person) and loyally (i.e. only for the benefit of plan participants) towards plan participants. Practically, this means that plan fiduciaries must carefully consider the expenses of the plan; and the type and cost of investment options.

Common Allegations in 401(k) Fee Suits
Flowing from the fiduciary duties owed, fee suits commonly allege that plan fiduciaries:

  • Should have offered substantively identical but less expensive investment options;
  • Did not obtain the best possible price from plan service providers; and
  • Failed to adequately monitor the cost of investments and administrative expenses over time.
  • Poor investment performance (though many courts have found that poor performance alone does not indicate that the fiduciary’s decision-making process was flawed); and
  • Prohibited transactions claims, as ERISA prohibits fiduciaries from making payments to “parties in interest” from plan assets (though often, courts have found that exemptions clearly applied to permit payments).

Recent Trends in 401(k) Fee Litigation
Recent trends indicate the plaintiffs’ bar has broadened their sights: increasingly targeting other defendants apart from larger 401(k) plans, and alleging new bases of breach.

Plaintiffs’ Bar Increasing Targets of Litigation
Historically, plaintiffs have targeted larger 401(k) plans. Recent settlement successes against 401(k) plans have buoyed the plaintiffs’ bar, and smaller plans are increasingly targeted. Large universities, which offer 403(b) plans, are also increasingly targeted. In August 2016, a dozen suits were filed against universities. In 2017 and 2018, new suits have continued to be filed with regularity against universities.

Recent Bases of Fiduciary Breach
There has been an uptick of claims targeting investment options. Plaintiffs are challenging proprietary funds (wherein fiduciaries include their own proprietary funds in the 401(k) plan), alleging that those investments benefit the fiduciary at the expense of plan participants. Plaintiffs are also targeting money market funds, claiming that the plans should have offered stable value funds instead; as the latter serves the same purpose but yields highest interest rates.

What Can I Do to Minimize Litigation Risk?
Unfortunately, there is no magic bullet. Plaintiffs’ firms are savvy, and whether plan fiduciaries have discharged their fiduciary duties is often a fact-sensitive inquiry; meaning that early resolution of litigation (i.e. at the motion to dismiss stage), is not always possible.

However, ERISA does not impose a duty on fiduciaries to achieve perfect outcomes. As long as fiduciaries consistently strive to make decisions in the best interests of plan participants, they have a good chance of demonstrating that they have discharged their fiduciary duties when challenged in court. In other words: process, process, process. Brotherston v. Putnam Investments, LLC, 2017 WL 1196648 (D. Mass. Mar. 30, 2017) illustrates this. There, plaintiffs claimed that Putnam’s proprietary products were too expensive and that Putnam lacked a fiduciary process. The court had the opportunity to review Putnam’s processes post-discovery, and found that there was no evidence to show that Putnam had breached its fiduciary duties by placing its interests ahead of participants, or that a reasonable fiduciary “in the shoes of” Putnam would have chosen a different investment lineup.

Thus, while obtaining early judgment may be difficult, establishing a robust process to consistently monitor the plan’s investment selection and plan expenses is key to demonstrating discharge of fiduciary duties and increasing the odds of success on a dispositive motion later in the litigation.

Shareholder Lawsuits in a Sale: Are They Legit or is it a “Stick-Up” Business?


12-8-14-Hovde.jpgA troubling litigation trend in recent years has been the surge in lawsuits related to mergers and acquisitions. My first introduction to this phenomenon came in 2011 while representing a publicly traded bank in the Southeast that sold to a larger, stronger in-state buyer. Within an hour of announcing the deal, multiple class action lawsuits were filed in a variety of different states. Proponents of these suits contended that the sale process was flawed and that directors breached their fiduciary duties by not maximizing shareholder value. They cited the existence of restrictive deal protections that discouraged additional bids and conflicts of interest, such as change-of-control payments as well as insufficient disclosure in the proxy statement. The suit in 2011 was eventually settled with the selling shareholders receiving “beefed-up” disclosure with no increase in consideration. Plaintiffs’ lawyers, however, were awarded significant fees. These suits have become a given in virtually all transactions involving public sellers, including very small transactions. While essentially none of these lawsuits seem to have any true merit, they must be dealt with and settled in order to avoid costly and protracted litigation, including the risk of injunction that could block a deal.

In a paper originally published in January 2012 and subsequently published in January 2013 entitled “A Great Game: The Dynamics of State Competition and Litigation,” Matthew Cain, a Notre Dame business professor, and Ohio State University Associate Professor of Law Steven Davidoff reviewed all merger transactions since 2005 with over $100 million in deal value that involved publicly traded targets. They found a disturbing trend. According to the research, approximately 40 percent of deals in 2005 attracted litigation, whereas 97.5 percent (78 out of 80) of deals in 2013 resulted in a shareholder lawsuit. As the authors observe, “in plain English, if a target announces a takeover, it should assume that it and its directors will be sued.” The primary driver of this increased litigation, of course, is the money to be made in the settlement process. While fees paid to plaintiffs’ attorneys have been coming down over the years, the median fee paid in 2013 was still a hefty $485,000. The court system does seem to be coming around to the dubious nature of these suits with judges knocking down attorney’s fees, especially on disclosure-only settlements which made up nearly 85 percent of settlements in 2013. With these types of lawsuits following even the smallest bank transactions, there is increasing hope that reduced fees will discourage the practice.

Although there appears to be very little benefit to selling shareholders in these lawsuits, they are likely here to stay since large fees can sometimes be extracted in the process. It’s important for a board to understand this reality and be prepared for it. While these suits rarely derail a well-constructed M&A transaction, settling and paying this “merger tax” often makes the most sense to ensure a smooth close. Buyers should factor in this added cost to their purchase price and deal with the lawsuits accordingly. Until legal fees in unmeritorious lawsuits are knocked down in a way that discourages their filing, they will remain an unfortunate reality in M&A.

Should Banks Settle Lawsuits?


There has been an enormous upswing in shareholder litigation following acquisitions. A survey by Ohio State University professor Steven Davidoff and Securities and Exchange Commission fellow Matthew Cain found that 97.5 percent of acquisition deals of a publicly traded company in 2013 resulted in a shareholder lawsuit, an increase from 39 percent in 2005. Why all the lawsuits? Well, there is money to be had in settling such lawsuits, as the acquirer and seller are very eager to carry on with their deal and not be held up by expensive litigation. Bank Director asked a panel of attorneys whether banks should settle such lawsuits, or fight them to avoid encouraging more lawsuits. 

Should banks settle when they are hit with a M&A lawsuit?

taylor_william.pngThe question of whether a bank should settle when hit with a lawsuit in connection with an M&A deal, and if so when, depends heavily on the circumstances. The reality is, however, that these shareholder class action suits are essentially a given in any transaction involving a publicly traded seller. In nearly all cases, regardless of the circumstances, the plaintiffs’ lawyers will assert, first, that the directors breached their fiduciary duties in connection with the sales process that was followed and in accepting the deal terms that were agreed and, two, that the disclosure in the proxy statement issued in connection with the shareholder meeting to approve the transaction is deficient. A well advised board will be aware of this reality and plan accordingly. As a practical matter, these suits rarely are an impediment to a transaction and should certainly not dissuade a board from pursuing a transaction that is in the best interests of the shareholders.

—William L. Taylor, Davis Polk & Wardwell LLP

Reed-Michael.pngLike so many questions the answer lies in the particular facts and circumstances. But the automatic inclination to settle these strike suits has dissipated somewhat as management, and more importantly judges, have shown less patience with these types of suits, and as a consequence, awarded increasingly nominal amounts of attorney fees, if any at all. This cottage industry of the plaintiffs’ bar grew up in the era of large bank mergers where these types of suits and settlement amounts were viewed simply as mere nuisances. As the transactional activity has moved to the smaller bank market, so have the plaintiffs lawyers. But these suits have also taken on greater meaning for middle market transactions. The CEO of a bank that intends to engage in multiple acquisitions should seriously consider contesting the first strike suit to send the signal to the plaintiffs’ bar that this bank will not be easy prey.

—Michael Reed, Covington & Burling, LLP

Bielema-John.pngCarey-Michael.pngWhile these actions ostensibly seek monetary relief, such as an increase in the merger consideration, most of them ultimately settle on terms that call for some additional disclosures to the shareholders in advance of the vote on the transaction, and, of course, an attorney’s fee award for the plaintiffs’ lawyers. There are two primary reasons for these settlements. First, the risk, however small, of having a large transaction enjoined or otherwise disrupted is often seen as outweighing the relatively minimal nature of the settlement relief. Second, a settlement is not without its benefits, as, once approved by the court, the settling defendants can obtain a full and complete release of any claims that were or could have been brought by the shareholders in connection with the merger transaction.

—John Bielema and Mike Carey, Bryan Cave LLP

Kaslow-Aaron.pngUnfortunately, settling these suits is a necessary evil. Judges are often reluctant to dismiss shareholder suits on the basis of a pre-trial motion, so settling is the only way to avoid the risk of an injunction that blocks the deal or the expense of litigating through trial. Refusing to settle and hoping the plaintiff goes away is probably more of a gamble than the parties are willing to take. The good news is that judges are beginning to doubt the value of many of these disclosure-only settlements in which the companies agree to provide additional disclosure to shareholders, and they are knocking down the attorney’s fees. Reducing the fees that accompany these settlements is the best way to discourage these questionable suits.

—Aaron Kaslow, Kilpatrick Townsend & Stockton LLP

Reichert-John.pngThe decision to settle depends, in part, on the nature and size of the deal. Why settle an unmeritorious lawsuit? The threat of delaying a merger transaction can kill the deal, so settling by agreeing to provide some additional disclosures, paying the plaintiffs’ attorneys’ fees and making a token payment to shareholders often makes sense. Acquirers often factor this so-called merger tax into their purchase price considerations to assure that the transaction gets completed. Be careful, though—paying the merger tax can result in higher future directors and officers (D&O) insurance premiums, or larger retentions under those policies. On the other hand, some acquirers in states with favorable business judgment statutes and a reasonable judiciary are fighting unmeritorious lawsuits. Those challenges show an impressive win-loss ratio for boards. Also encouraging is that some courts have dismissed the suits outright or refused to approve settlements and the attorneys’ fees provided in them.

—John Reichert, Godfrey & Kahn, S.C.

FDIC D&O Lawsuits Surge in 2013


2-19-cornerstone-research.pngFederal Deposit Insurance Corporation (FDIC) litigation activity associated with failed financial institutions increased significantly in 2013. The FDIC filed 40 director and officer (D&O) lawsuits in 2013, compared with 26 in 2012, a 54 percent increase from 2012. The pace of new lawsuits in 2013 slowed in the fourth quarter to only three, however, compared with 10, 15, and 12 in the preceding quarters. 

These findings are included in “Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions—February 2014,” a Cornerstone Research report.

Analysis
The surge in FDIC D&O lawsuits in 2013 stems from the high number of financial institution failures in 2009 and 2010. Of the 140 financial institutions that failed in 2009, the directors and officers of 64 (or 46 percent) have either been the subject of an FDIC lawsuit or have settled claims with the FDIC prior to the filing of a lawsuit. For the 157 institutions that failed in 2010, 53 (or 34 percent) have either been the subject of a lawsuit or have settled with the FDIC.

The FDIC’s D&O lawsuits in 2013 particularly focused on the largest institutions that failed in 2010. Of the largest 20 failures in 2010, 15, or 75 percent, have already been subject to FDIC lawsuits or settled claims with the FDIC.

Claimed Damages
From the beginning of 2010 to the end of 2013, the FDIC has filed 84 D&O lawsuits. It has explicitly stated damages amounts in 77 of the 84 complaints against directors and officers of failed financial institutions, for a total of at least $3.8 billion in claimed damages. While nearly half of the 84 lawsuits were filed in 2013, only $1.2 billion, or 32 percent of the FDIC’s claimed damages, is attributable to the lawsuits filed in 2013. This pattern mirrors the relatively smaller size of the institutions that that were the subject of 2013 D&O lawsuits.

Defendants and Charges
Inside and outside directors, together, have also routinely been named as defendants in FDIC D&O lawsuits. This pattern continued in 2013 (75 percent of lawsuits filed in 2013). Outside directors were exclusively named as defendants in rare instances and only in lawsuits filed in 2013 (8 percent). Somewhat more common were lawsuits in which only inside directors were named (15 percent of 2013 lawsuits, compared with 23 percent of lawsuits filed before 2013).

Chief executive officers continue to be the most commonly named officers in FDIC D&O lawsuits. The FDIC named CEOs in 83 percent of the complaints filed in 2013. In contrast, chief credit officers, chief loan officers, chief operating officers, or chief banking officers were named in 43 percent of the 2013 lawsuits.

All 40 lawsuits filed in 2013 included allegations of gross negligence, and 32 included additional allegations of negligence. Thirty-five of the 40 lawsuits included allegations of breach of fiduciary duty.

Settlements
Of the FDIC’s 84 D&O lawsuits, at least 17 have settled in whole or in part and one has resulted in a jury verdict. The FDIC has also settled disputes with directors and officers prior to the filing of a complaint. Settlement agreements published by the FDIC indicate that in at least 82 instances, the agency has resolved disputes with directors and officers. In these settlements, as many as 38 agreements, or 46 percent, required payments by the directors and officers. Directors and officers agreed to pay at least $34 million in these cases. 

Future Trends
While the FDIC’s filings of new D&O lawsuits hit a lull in the fourth quarter of 2013, new filings are unlikely to continue at such a slow pace in the first half of 2014. Three lawsuits have already been filed in January, and as motions and discovery unfold in existing lawsuits, this year will be interesting to follow. For example, a recent ruling in the U.S. Court of Appeals for the Eleventh Judicial Circuit pertinent to the many Georgia-based lawsuits allows directors and officers to assert defenses related to the FDIC’s post-receivership conduct that will directly affect loss causation and damages arguments. These types of judicial rulings may greatly influence the relative negotiating strength of the FDIC and defendants. How this ruling and others like it affect the likelihood of settlements may determine whether we see protracted litigation in the FDIC’s D&O lawsuits or movement to settle cases earlier.