A recent appeals court ruling could bolster the ongoing fight against forced arbitration in retirement plans, a tactic employers are increasingly using to avoid class actions that challenge how their plans are run.
Supporters of mandatory individual arbitration clauses say they help employers solve disputes faster and spend more money on benefits instead of legal fees. Opponents say they prevent a retirement plan participant from litigating on behalf of everyone, or from banding together in court with other plan members, to recoup funds that were lost due to plan mismanagement.
A Second Circuit ruling against the use of such agreements could impact how the Seventh Circuit decides a similar challenge later this month—potentially offering clarity to an issue that courts have split on, leaving employers and plan sponsors confused. Arguments in the case are scheduled for March 30.
The goal of forced individual arbitration is to make the process so onerous that no one brings a case and if they do, it’s only one with very limited damages, said Jerry Schlichter, founding and managing partner at Schlichter Bogard & Denton LLP.
But Schlichter warned employers risk mass arbitration when they add these provisions to their plans.
“If these arbitration clauses are enforced then employers are going to be looking at potential massive numbers of arbitration, paying the cost of each individual arbitration and litigating over and over and over again similar issues,” he said.
There are pros and cons to using the agreements, but differing court opinions over whether they can be enforced has plan sponsors questioning if they should include them—and how to write them if they do, said Christine Richardson, a partner at Pillsbury Winthrop Shaw Pittman LLP who counsels large employers on all aspects of employee benefits.
“I don’t think there’s an easy answer to any of this,” she said.
The U.S. Court of Appeals for the Second Circuit—in a March 4 ruling against retirement plan manager Ruane Cunniff & Goldfarb—said forced arbitration would “unacceptably undercut the viability and public purpose” of lawsuits that Congress explicitly allowed participants to bring under the Employee Retirement Income Security Act (ERISA) to hold plan managers liable for mismanaging funds.
That part of the ruling could greatly affect how the Seventh Circuit decides the validity of these provisions, said Leah Nicholls, a senior attorney at Public Justice PC, a public interest advocacy group in Washington, D.C.
The Second Circuit says that individual arbitration agreements are incompatible with ERISA’s enforcement scheme because these types of lawsuits are brought on behalf of the entire plan since the remedy impacts everyone, Nicholls said.
“It doesn’t make any sense under ERISA to bring an individual action for these types of breach of fiduciary duty claims,” she said.
The court’s remarks weren’t part of the legal reasoning needed to reach a decision in the case, so there’s debate over how much weight they carry. But the opinion still marks a split from the Ninth Circuit, which said in 2019 that agreements that force employees to settle claims brought under ERISA in arbitration are generally enforceable.
That ruling, in Dorman v. Charles Schwab Corp., led more retirement plans to start including them, said Jan Jacobson, senior counsel for retirement policy at the American Benefits Council.
“Arbitration can be quicker and more cost effective not only for the plan, but for the participants,” she said.
Similar Dispute Pending
In the Seventh Circuit, Triad Manufacturing Inc. is appealing a lower court’s refusal to force individual arbitration or toss out a lawsuit brought against the company for allegedly selling overpriced shares of company stock to its employee retirement plan.
But the case differs from the one before the Second Circuit.
In the Second Circuit case, the arbitration agreement was in an employee handbook. The plan’s investment adviser, Ruane Cunniff, argued the handbook blocked a lawsuit challenging how it was managing the assets of DST Systems Inc.'s 401(k) plan. But the court ruled the ERISA claims weren’t related to the participants’ employment.
The arbitration clause Triad is fighting to save at the Seventh Circuit was included in the retirement plan itself. The company argues that established precedent and policy favor arbitration, and there’s nothing stopping participants from seeking the same relief individually.
“Plan-wide relief can still be achieved through individual arbitration and any losses could be restored to the individual accounts of the participants in the same manner as they would through litigation in federal court,” the company said in its appeal.
If the Seventh Circuit splits from the Second Circuit and rules forced individual arbitration agreements in retirement plans are enforceable, it could create an issue that’s ripe for Supreme Court review.
But the court’s decision could instead turn on the nuances of the case and miss the big overarching question of whether individual arbitration agreements are enforceable, said Richardson, noting the arbitration agreement at issue here was added to the plan later on, which may have required participant notice.
“I think we’re going to have to stay tuned,” she said.
The case is Smith v. Bd. of Dirs. of Triad Mfg., Inc., 7th Cir., No. 20-02708.