In this case, experts assist the Court on three pivotal issues; one expert actually develops the test adopted by the Court to resolve one of the issues. Putnam Investments is an asset management company that creates, manages and sells mutual funds. As an employer, it maintains defined-contribution 401(k) plans for its employees and, among the investment options, are mutual funds that Putnam manages. Plaintiffs claim that Putnam violated the duty of prudence by including among the investment options all of its funds without regard to their suitability for all participants. They also claim that Putnam's selection and monitoring procedures were deficient and, as adviser, it participated in "prohibited transactions" under ERISA by drawing advisory fees from the portfolio funds in an unfavorable fashion.
The District Court held a bench trial on the claims and dismissed them all. Plaintiffs appeal in this case and prevail, in part. Starting with the prohibited transaction allegations, the Court looks to the reasonableness of Putnam's fees. Since the fees charged by Putnam affiliates for servicing the funds were within ranges approved by other courts in parallel matters and the public was participating in these funds as well, the District Court ruled that market competition kept the fees reasonable. To reach that conclusion, the trial court rejected expert testimony (Steve Pomerantz) that Putnam's fees were "materially higher on average" than competing funds. On the other hand, it credited the testimony of Defendants' expert (Erik Sirri) that Putnam's funds were used by other plans. Indeed, from 2009 to 2014, the Plan paid about $500,000 less than had it "invested at the average expense ratio of peer group funds." Both experts earn points from the Court, but, in the end, it cannot find "clear error" in the determination of reasonableness on the fund fees claim.
Next, the Court evaluates the 1106(b) prohibition in relation to DOL PTE 77-3. That exemption allows investments in in-house mutual funds, under four conditions, only one of which -- the "all other dealings" requirement -- applies. Here, the Court takes issue with the District Court's recognition of an offset to the fees charged by Putnam in the form of discretionary contributions it made to the Plan. Putnam made those contributions qua employer, not in its role as fiduciary, the Court objects. Remove them from the equation and the PTE exemption may fail. Turning to expert Pomerantz, the Court credits calculations of a $5 million shortfall, "as a result of the Plan's inability to capture revenue sharing payments," while some other plans did receive such payments. Putnam's contention that the Plan was provided with offsetting recordkeeping and other administrative services may be valid, but the Court will leave it to the District Court on remand to run the numbers.
Finally, on the duty of prudence claim, the First Circuit calls a do-over, because the trial court failed to follow appropriate burden-shifting procedures. ERISA defines "loss," according to the Court, as including the concept of opportunity loss. Stuffing cash in a mattress, it states by way of illustration, does not avoid an ERISA loss, when that money can be prudently invested or, as the Restatement of Trusts phrases it, "properly administered" by the trustee or fiduciary. The Court borrows from trust law to develop a concept of "chargeable loss" under ERISA. To determine if a chargeable loss occurred in the Putnam Plan during the class period, the Court looks again to the calculations of Dr. Pomerantz. Did Plaintiffs get anything for the actively managed fees it paid on most Putnam funds, or would they have done just as well with a passive index fund or investment trust? Dr. Pomerantz tested each fund's return against a "comparator" passive fund and found a net portfolio-wide loss of more than $40 million. In the Court's view, while there are open questions and some potential failings in the analysis, "plaintiffs' evidence was sufficient to support a finding of loss."
Given a breach and a loss, Putnam's fate seems to hang on causation. To be compensable under ERISA, the loss must "result[ ] from" the breach of fiduciary duty. It becomes the fiduciary's obligation, then, "to prove that the resulting investment decision was objectively prudent." In this case, that would mean that Putnam will have to show that Dr. Pomerantz's loss calculations would not have been mitigated by prudent selection and monitoring procedures. It may seek to do so on remand to the District Court.
(ed: * In adopting this burden-shifting approach, the First Circuit follows the Fourth, Fifth and Eighth Circuits. **As we reported in SOLA 2019-12, the Putnam Defendants are moving forward on a petition for a writ of certiorari. SIFMA filed an amicus Brief, dated Feb. 15, 2019, supporting SCOTUS review and numerous other amici are participating.)