Source: https://iainsight.wordpress.com/2019/04/11/erisa-risk-management-and-the-forensic-erisa-attorney/
Timestamp: 2019-04-25 14:25:24+00:00

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The Braden-Tibble-Tussey Trilogy – A LaRue Like Epiphany?
← Putnam Investments, LLC v. Brotherston: Pivotal Point for 401(k)/403(b) Industries?
Head tilt, accompanied by polite stare.
Head tilt, to the other side, polite stare.
Then I smiled and told them that I analyze 401(k) and 403(b) plans and, if needed, design “win-win” plans that provide plan participants with meaningful “retirement readiness” investment options, while also reducing the fiduciary risk of the plan and the plan fiduciaries. That explanation usually results in more questions and an interesting discussion. People may not like attorneys, but EVERYONE like to talk money and their retirement accounts.
Life’s too short not to have a little harmless fun. A friend of mine in PR suggested the “branding” title a couple of months ago. I’ll be paying her and her husband’s green fees for the awhile.
Interestingly enough, many people tell me that they may not remember my name after a meeting or event, since they meet so many people, but they always remember my title and what I do – “forensic ERISA attorney.” I often get several follow-up calls and/or emails after a meeting or an event. Again, people care about money and their retirement accounts. Plan sponsors care about avoiding, or at least reducing, any potential personal liability.
I have already posted several articles about the Putnam Investment, LLC v. Brotherston case and Putnam’s petition asking SCOTUS to hear their case. At this point, SCOTUS has not indicated whether it will hear the case.
If SCOTUS does grant certiorari and decides to uphold the First Circuit’s decision, or declines to hear the case at all, then Putnam will have the burden of proof on causation. I believe that the implications of that burden extend well beyond the immediate case.
Based on the research of numerous noted and well-respected investment experts, the evidence overwhelmingly shows that most actively managed mutual funds are cost-inefficient, that they fail to cover their investment costs.
These findings should not really come as a surprise to anyone. Actively managed funds typically have higher costs than comparable index funds due to higher management fees and higher trading costs. The challenge for actively managed funds is to then justify such higher fees/costs by producing higher returns for investors.
However, there seems to be an increasing trend of some actively managed funds choosing to essentially “track” the performance of a comparable index funds in order to avoid a significant deviation for the index fund’s performance. By avoiding significant differences in returns, actively managed funds hope to avoid the potential loss of clients.
However, this strategy of holding a fund out as being actively managed and charging higher fees for such purported services, while essentially providing the same returns as a comparable, yet less expensive, index funds is generally referred to as “closet” or “shadow” indexing. While “closet” indexing may reduce the risk of variances in returns, it effectively ensures the cost-inefficiency of the actively managed mutual fund involved, since there will be little chance of the active funds making up the cost differential between the active and the passive fund.
The issue of “closet” indexing is not just a U.S. phenomena. Canada and Australia have been among the leaders in addressing the problem. Questions are now being raised in the U.S. and internationally as to whether the strategy constitutes a securities violation since investors are not effectively receiving the services they were led to believe, at least to the extent they were led to believe.
My posts on the Brotherston decisions have resulted in a number of inquiries from pension plans asking me what they need to do and how to do it to reduce potential liability exposure. Since ERISA liability is based on past events over the last three or six years, there is nothing that can be done to avoid or minimize liability for past acts.
While no one knows what SCOTUS may do on the pending petition for cert, the good news is that regardless of the Court’s eventual decision, the prudent choice would be for plans and plan service providers to act proactively to ensure that their plan’s investment options are prudent and cost-efficient going forward, and to regularly monitor the plan’s investments, replacing those that are no longer cost-efficient. The ability to show that the plan had a fundamentally sound due diligence program in place and actually followed such system would be valuable in responding to any audits and/or ERISA claims that might arise.
Plan fiduciaries cannot blindly rely on plan service providers or other third parties. ERISA requires that plan sponsors and other plan fiduciaries conduct their own independent and objective investigation. The failure of a plan’s fiduciaries to do so is a per se breach of their fiduciary duties.
I do believe that the Brotherston case is a potential turning point for 401(k)/403(b) plans, as the evidence strongly suggests that they will not be able carry the burden of disproving that actively managed mutual funds in their plan caused plan participants to suffer financial losses due to the relative cost-efficiency of the active funds. Furthermore, unless the mutual fund industry makes dramatic, and highly unlikely, changes in their current business platforms, it is unlikely that 401(k) and 403(b) plans that continue to opt for actively managed mutual funds as investment options within their plans will be able to meet the challenge of the burden of proof on causation going forward.
Meanwhile, we anxiously await SCOTUS’ decision.
1. Laurent Barras, Olivier Scaillet and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANCE, 179, 181 (2010).
2. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, available online at https://www.ft.com/content/6b2d5490-d9bb-11e6-944b-eb37a6aa8e.
3. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Fund Advisors, L.P., August 2016.
5. Fink v. National Sav. and Trust Co., 772 F.2d 951, 962 (D.C.C. 1984).
6. DiFelice v. U.S. Airways, 497 F.3d 410, 423 and fn. 8.
7. Gregg v. Transportation Workers of America Intern., 343 F.3d 833, 841 (6th Cir. 2003).
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Putnam Investments, LLC v. Brotherston: Pivotal Point for 401(k)/403(b) Industries?

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