Opinion ID: 214359
Heading Depth: 2
Heading Rank: 1

Heading: Defendants' Operation of CSFs

Text: Plaintiffs first argue that defendants made imprudent decisions with respect to the company stock funds, or CSFs. The Plan offers two such funds to participants, one that invests in Kraft common stock and one that invests in Altria common stock. These funds are operated on a unitized basis, meaning that participants own units of the fund rather than shares of the relevant company stock. Although the CSFs invest almost exclusively in the common stock of the relevant companies, they also contain a small amount (roughly 5% of the overall value of the fund) of cash and other similar highly liquid investments. The parties refer to the non-stock portions of the CSFs as the cash buffers. The value of a CSF unit is determined by the value of the relevant company stock as well as the value of the fund's cash buffer. The main benefit of unitization is that it allows participants to quickly sell their interests in the funds and either receive distributions or transfer their contributions to other Plan funds. When a participant initiates a sale of units, Plan administrators use cash from the cash buffer to make an immediate distribution to the participant or to immediately transfer the participant's investment in the CSF to another Plan fund. Without the cash buffer, the participant could not receive a distribution or reinvest the relevant funds until Plan administrators sold enough stock to fund the transactiona process that normally takes three business days. Another benefit of unitization is that it allows the Plan to save transaction costs by netting participant transactions. Absent unitization, every time a participant initiated either a purchase or sale of stock, the Plan would have to enter the market and pay a brokerage commission and various fees on the associated transaction. With unitization, the Plan can offset a participant's request to purchase with another participant's request to sell, and the Plan will need to enter the market and pay transaction costs only to the extent necessary to meet a net inflow or outflow of investment in the relevant fund. Plaintiffs argue that the unitized structure of the CSFs resulted in two problemswhich the parties refer to as investment drag and transactional drag. Investment drag is caused by the cash buffer. When the relevant company stock appreciates in value, the value of a unit of the associated CSF also appreciates. However, because investment in cash is less risky than investment in stock, the return on the cash component of the CSF will not be as high as the return on the stock component. Thus, having cash in the fund when the stock goes up results in lower returns than would have been experienced had the cash portion of the fund been used to buy more stock. This phenomenon is what the parties mean by investment drag. Note, however, that describing this phenomenon as drag is appropriate only if the value of the stock rises over the relevant period. If the value of the stock declines, a unit of the fund will not decline in value to the same extent as a share of stock, since the value of cash is relatively stable. Thus, in a market in which the relevant stock is declining, the presence of cash in the fund would be a good thing. [5] Transactional drag involves the transaction costs incurred by the fund in connection with participant transactionsi.e., requests to buy and sell units of the fund. A request to buy into or sell out of a fund generally requires Plan administrators to buy or sell shares of Kraft or Altria stock, and the Plan thus has to pay the brokerage commissions, SEC fees, and other costs associated with the trade. As noted above, the unitized nature of the fund allows administrators to net requests to buy and sell against each other in order to minimize transaction costs. However, when transaction costs are incurred, they are deducted from the overall value of the fund rather than allocated to the specific participants who initiated the transactions. Each participant thus bears a pro rata share of the fund's total transaction costs regardless of the number of transactions he or she initiates. This means that frequent traders do not bear the full cost of their trades and that infrequent traders essentially subsidize frequent traders. Plaintiffs argue that this gives all participants an incentive to trade frequently, which in turn results in higher transaction costs for the fund. These higher transaction costs are what the parties mean by transactional drag. Plaintiffs argue that the investment and transactional drags associated with the unitized structure of the CSFs caused investment in the CSFs to underperform direct investment in Kraft and Altria common stock by $83.7 million between 2000 and 2007. Plaintiffs' expert, Ross Miller, arrives at this figure by estimating what the funds would have earned had they not been unitizedi.e., had participants owned shares of the relevant stock directly rather than indirectly through a fund. At this point, we must pause to identify the precise contours of plaintiffs' claim. Plaintiffs' legal theory is breach of fiduciary duty under ERISAmore specifically, breach of the prudent man standard of care outlined in ERISA section 404(a). 29 U.S.C. § 1104(a). To decide the issues presented by this appeal, however, we need to identify the act or omission (or series of acts or omissions) constituting the alleged breach of the prudent man standard of care. As to that, it is reasonably clear that we are dealing with omissions rather than overt acts: plaintiffs argue that defendants should have done something to minimize or eliminate investment drag and transactional drag. But what is it that plaintiffs think defendants should have done? Plaintiffs do not precisely answer this question. However, it is reasonably clear that plaintiffs think that defendants should have done one or more of the following: (1) eliminate unitization and the cash buffer and allow participants to own shares of Altria and Kraft stock directly (thereby eliminating both investment and transactional drag), and/or (2) impose measures designed to reduce the number of participant-initiated transactions (thereby reducing transactional drag). In connection with (2), plaintiffs suggest that defendants could have imposed a trading limit that would have limited the number or frequency of trades participants could make. The next problem is identifying when plaintiffs think defendants should have taken the above measures. As noted, plaintiffs contend that the failure to eliminate unitization and the cash buffer caused the Plan to miss out on $83.7 million in investment gains between 2000 and 2007. However, nothing in the record indicates that at the beginning of this periodi.e., in the year 2000 or earlierdefendants were in possession of information that would have caused a prudent man to realize that his inaction would cost the Plan $83.7 million or cause the Plan to incur other losses of similar magnitude. The district court, in granting summary judgment to the defendants, did not explicitly address the question of when defendants might have breached their fiduciary duties. However, the district court's decision was based on its determination that defendants had weighed the costs and benefits of implementing plaintiffs' proposed solutions and concluded that the costs of making any changes to the CSFs outweighed the benefits. (App. at 51-60.) The court then deferred to the fiduciaries' decision. This approach implies that the district court had set its sights on a relevant time periodi.e., a time when defendants weighed the costs and benefits and reached a decision. However, we are not directed to any place in the record that identifies when defendants made this decision. Although we are not explicitly directed to a decision, it is reasonably clear that any decision would have been made between 2002 and 2004. During this time period, the Kraft plan fiduciaries and the fiduciaries of Altria's 401(k) plan engaged in discussions about transactional (and, to a lesser extent, investment) drag in the CSFs maintained by both the Kraft plan and the Altria plan. (Recall that during this time period, Altria was Kraft's parent company.) One fiduciary determined that, in 2001, the transactional drag on the Kraft plan's Altria CSF was $3.6 million, which resulted in an average cost of $145 per participant per year. The CSFs in the Altria plan were experiencing even higher transaction costs, and fiduciaries of the Altria plan eventually informed the fiduciaries of the Kraft plan that they were taking measures to reduce these costs. By 2003, Altria had moved to a structure known as real-time trading, which was essentially the opposite of unitization: under real-time trading, each participant owned shares of the relevant stock rather than units of a fund that invested in the stock. Around this same time, the Kraft plan's recordkeeper, Hewitt, informed Kraft plan fiduciaries that although Hewitt did not offer a real-time trading service, it could implement other solutions to transactional drag, including various trading restrictions. (The Altria plan used a different recordkeeper, Fidelity, and Fidelity offered a real-time trading service.) Hewitt also informed Kraft that it was willing to work with Kraft to develop a real-time trading solution if Kraft wanted to adopt one in response to transactional drag within the Kraft plan CSFs. The parties also cite various emails and other correspondence among Kraft plan fiduciaries and Hewitt regarding the costs and benefits of various solutions to investment and transactional drag. This correspondence continues into 2004 and seems to come to an end in about December of that year. Despite all this discussion of investment and transactional drag, however, we can find nothing in the record indicating that defendants ever made a decision on these mattersi.e., that they actually determined whether the costs of making changes to the CSFs outweighed the benefits, or vice versa. We know that the status quo from 2004 persists to this day, but the record does not tell us whether this persistence is the result of a deliberate decision to maintain the status quo or whether it was caused by the fiduciaries' decision to table the matter. Although the district court made various statements indicating that it thought that Plan fiduciaries had made a reasoned decision to maintain the status quo, [6] it did not cite a document or affidavit, or any deposition testimony, explaining what that decision was, and we have been unable to find anything. Moreover, on appeal, defendants' recitation of the facts contains no citation to any such decision. Instead, they offer the following in their statement of facts: In 2003, Altria changed the CSFs in its 401(k) plan to a non-unitized format using Real Time Trading, which Fidelity offered to its recordkeeping clients, including Altria. When this happened, the responsible personnel considered making a similar change in the [Kraft] Plan. After extensive discussion regarding the costs and benefits of alternatives with the [Kraft] Plan's recordkeeper, Hewitt (which did not have a system similar to Real Time Trading), the Plan's CSFs were maintained as unitized. (Appellee's Br. at 11-12 (emphasis added).) The emphasized clause was obviously carefully worded to be consistent with both a deliberate decision to maintain the status quo as well as inertia. Thus, viewing the evidence in the light most favorable to plaintiffs, we must conclude that no Plan fiduciary ever made a decision regarding the solutions to investment and transactional drag that were proposed between 2002 and 2004. In light of the above, we view plaintiffs as arguing that defendants breached their fiduciary duties by failing to reach a decision regarding the proposed solutions to investment and transactional drag by the end of 2004. That is, we view plaintiffs as arguing that prudent fiduciaries armed with the information that had been presented to the Kraft fiduciaries between 2002 and 2004 would have at least decided between, on one hand, maintaining the status quo and, on the other, making changes to the CSFs in an effort to limit or eliminate investment and transactional drag. Under ERISA, a fiduciary's failure to exercise his or her discretioni.e., to balance the relevant factors and make a reasoned decision as to the preferred course of actionunder circumstances in which a prudent fiduciary would have done so is a breach of the prudent man standard of care. DiFelice v. U.S. Airways, Inc., 497 F.3d 410, 420-21 (4th Cir.2007); Armstrong v. LaSalle Bank Nat'l Ass'n, 446 F.3d 728, 733-34 (7th Cir.2006). As noted, the district court's grant of summary judgment rests on its finding that the undisputed facts established that defendants actually made a reasoned decision between the status quo and the various proposed solutions. Since we conclude that this finding is not supported by the record, we cannot affirm on the grounds given by the district court. Moreover, the district court's characterization of the fiduciaries' actions has clouded the presentation of the issues on appeal. Defendants devote most of their brief to arguing that we must defer to the Plan fiduciaries' decision; however, as noted, they fail to direct us to the decision entitled to deference. Although plaintiffs point out that defendants never made a reasoned decision, they also contend that even if they did there is a genuine issue of material fact as to whether that decision could be described as prudent. In this regard, plaintiffs argue that because Altria saw fit to switch to real-time trading, a reasonable trier of fact could conclude that it was imprudent for Kraft to fail to follow suit. [7] Given the state of the record, we think the best course is to reverse the district court's grant of summary judgment on this claim and remand for further consideration. However, before leaving this issue, we will provide some additional analysis of plaintiffs' claim in order to guide the parties on remand. First, we repeat that the record reveals a genuine issue of material fact as to whether Plan fiduciaries made a decision with respect to the proposed solutions to investment and transactional drag. [8] Likewise, there is a genuine issue of material fact as to whether the circumstances prevailing in 2004 would have caused a prudent fiduciary to make a decision on these matters. If during further proceedings these issues are resolved in plaintiffs' favor, then plaintiffs will have established that defendants breached the prudent man standard of care. In contrast, if defendants establish that prudence did not require them to make a decision, then plaintiffs' claim for breach of fiduciary duty will fail. [9] If plaintiffs establish that defendants should have made a decision, but defendants are able to show (1) that they made one and (2) that the decision involved balancing competing interests under conditions of uncertainty, then the question will be whether the fiduciaries abused their discretion. Armstrong, 446 F.3d at 734. Depending on how the above issues are resolved, the district court will have to consider whether any remedy is appropriate. If plaintiffs prove that defendants should have made a decision with respect to investment and transactional drag but did not, then plaintiffs would likely be entitled to an injunction requiring the fiduciaries to consider the proposed solutions to these issues and come to a decision. See Brock v. Robbins, 830 F.2d 640, 647-48 (7th Cir.1987) (discussing availability of injunctive relief for breach of duty of prudence). Alternatively, the district court might determine that circumstances have changed since 2004, and that ordering the fiduciaries to consider these issues today would be pointless. In that case, the district court would award no prospective relief. Plaintiffs might also seek an order compelling the fiduciaries to make good to [the] plan any losses caused by their breach of fiduciary duty. 29 U.S.C. § 1109(a). If the district court determines that the fiduciaries rendered a decision in 2004 and plaintiffs prove that the fiduciaries abused their discretion in making this decision, then the court could require the fiduciaries to make good any losses caused by this abuse. If, however, the court determines that the fiduciaries breached their fiduciary duties by failing to make a decision, then the question becomes whether plaintiffs can show that the failure to make a decision resulted in monetary loss. This might be difficult to do, in that it is impossible to know what would have happened had the fiduciaries made a decision. Nonetheless, the evidence may show that had the fiduciaries considered the appropriate factors they would have come to a decision that would have resulted in the CSFs performing better than they have over the past several years. For example, plaintiffs might be able to show that deciding to maintain the status quo would have been imprudent, and that any prudent alternative to the status quo would have improved the Plan's performance. We leave these matters for further exploration on remand, if necessary. In sum, because we find that the record reveals a genuine issue of material fact as to whether defendants breached the prudent man standard of care by failing to make a reasoned decision under circumstances in which a prudent fiduciary would have done so, we reverse the district court's grant of summary judgment on this issue and remand for further consideration.