Benchmarking Divides Judges Juggling Flood of 401(k) Lawsuits

The recent influx of 401(k) plan litigation has attorneys and courts weighing how to best compare particular investments or fee structures against potential alternatives—a choice that could mean the difference between a case failing at the outset or advancing.

As judges make their way through the more than 250 proposed class actions filed by retirement plan participants since 2020, differences have emerged in how carefully they scrutinize the comparisons made between a specific plan’s fees and investments and the alternatives held up as better options. These comparisons, typically called benchmarks, attempt to evaluate a given fund or fee structure by looking at how it stacks up against similar alternatives.

Benchmarking investments is a common practice for retirement plan fiduciaries, who have a legal obligation to ensure their plans offer prudent investments and charge reasonable fees. The plaintiffs’ bar as well relies on benchmarks to argue that a particular plan doesn’t meet federal legal standards.

Taking a strict approach, the US Courts of Appeals for the Sixth, Eighth, and Tenth circuits have rejected challenges that lacked detailed comparisons to funds with similar strategies, objectives, and risk profiles. Some district judges have done the same.

Other courts have allowed cases to advance without looking closely at benchmarks. According to federal district judges in New York, Texas, and Florida, among others, passing judgment on a benchmark is something courts do after more information has been surfaced through the discovery process.

Finding the right benchmarks for a lawsuit is possible if plaintiffs are willing to put in some effort, according to attorneys interviewed by Bloomberg Law.

Making Comparisons

Benchmarking is useful because it provides a “standard against which to judge the thing you own,” Shannon Zimmerman, director of manager selection at Morningstar Inc., said. It allows investors to understand how a fund behaved in comparison to how it was expected to behave when initially selected, he said.

Court document.

A good benchmark is a fund that has similar goals, risks, and potential rewards to that of the investment being assessed, Charles Field, managing partner at Sanford Heisler Sharp LLP’s San Diego office, said.

Benchmarking can also be done to assess the fees a retirement plan pays for administrative and recordkeeping services, which are frequently challenged in court alongside plan investments. Recordkeeping benchmarks should look at plans of similar size, in similar industries, and with similar demographic characteristics, Christopher Giambrone, co-founder of CG Capital, said.

Not Impossible

Some courts have been skeptical of 401(k) lawsuits that use aggregated data or industry-wide averages as benchmarks.

The Eighth Circuit’s recent decision in Matousek v. MidAmerican Energy Co. rejected investment challenges that rested on comparisons to a collection of “peer group” funds because the challengers didn’t explain what types of funds fell into each group. The lawsuit was “missing details” about the securities, investment strategies, and risk profiles of the investments being compared, the court said.

Peer group comparisons are often insufficient, Field said, because these groups sometimes include funds with different management styles or other salient differences.

A better benchmark is one “the plan itself uses,” he said. The annual statements plans send to participants typically include an explanation of how the plan’s funds performed relative to a stated benchmark, Field said.

Using this information is a “pretty good indication that you’ve got a decent benchmark, because the plan and its fiduciaries found it was appropriate,” Field said.

Another good place to look is in a mutual fund’s prospectus, which will identify the benchmark the offering company uses to gauge performance, he said.

If they’re willing to put some work into it, attorneys bringing 401(k) challenges can learn a lot about a plan’s funds and how they stack up against similar alternatives, Erin Haldorson Weber, a partner in Winston & Strawn LLP’s Chicago office, said.

“These are things that with a little bit of work can be determined pretty easily,” she said.

Closer Scrutiny

The courts that more carefully scrutinize 401(k) benchmarks may be trying to tamp down on the flood of “cookie-cutter” complaints that challenge investments using “practically word-for-word” language, Weber said.

“I think it’s become apparent at least to some courts and appellate courts that there needs to be some kind of real analysis and work that has to go into these complaints in order for them to survive,” she said.

Some recent lawsuits have tried to compare a given plan’s funds to the “absolute best performance” that could be found using hindsight, which isn’t the correct standard for liability under federal law, Daniel Aronowitz, president of Encore Fiduciary, said.

“You can always find something that did better, but the only fair way to compare funds are with apples-to-apples comparisons,” he said.

Some cases that fared poorly were centered on comparisons between actively managed funds—those in which investment managers handpick underlying funds—and passive funds, which typically track a predetermined set of investments and generally carry lower fees.

But that’s “just not a good comparison,” Sanford Heisler’s Field said.

National Standard

Even with some courts looking more closely at benchmarks, more 401(k) lawsuits are advancing to discovery than not, according to Aronowitz.

He called the different approaches used by courts a “crapshoot” that fails to properly weed out the many illegitimate cases that are filed.

“There needs to be one national pleading standard and then plan sponsors can know what they’re doing,” Aronowitz said.