Compliance November 30, 2009

Court Rules Wal-Mart 401(k) Suit Requires Further Discussion

The 8th U.S. Circuit Court of Appeals has vacated a district court's dismissal of a suit alleging Wal-Mart Stores, Inc. breached its fiduciary duties to 401(k) participants by selecting investment options that charged excessive fees.

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In its opinion, the appellate court said the district court erred in concluding that Jeremy Braden lacked standing to maintain claims for the period before he began participating in the plan (see “Wal-Mart Captures Resounding Excessive Fee Suit Victory”). The court found Braden satisfied the requirements for constitutional standing because he alleged actual injury to his own plan account, and that injury is fairly traceable to the defendants’ conduct because Braden alleged a causal connection between their actions –even those taken before his participation in the plan–and his injury.

The appellate panel also concluded that the district court erred in finding the complaint inadequate because it did not allege sufficient facts to show how Wal-Mart’s decision making process was flawed. “Accepting Braden’s well pleaded factual allegations as true, he has stated a claim for breach of fiduciary duty,” the court said.

In addition, the court determined the injury is likely to be redressed by a favorable judgment.

Braden alleged that Wal-Mart and other employees involved in administering the plan failed to adequately evaluate the investment options included in the plan, and that the process by which the mutual funds were selected was tainted by their failure to consider trustee Merrill Lynch’s interest in including funds that shared fees with Merrill Lynch.

While the appellate court said the district court correctly noted that none of Braden’s allegations directly addresses the process by which the plan was managed, it said it is reasonable, however, to infer from what is alleged that the process was flawed.

The Allegations

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Braden's allegations included that: 

  • The plan comprises a very large pool of assets, that the 401(k) marketplace is highly competitive, and that retirement plans of such size consequently have the ability to obtain institutional class shares of mutual funds, but despite this ability, each of the ten funds included in the plan offers only retail class shares, which charge significantly higher fees than institutional shares for the same return on investment.
  • Seven of the plan's ten funds charge 12b-1 fees from which participants derive no benefit.
  • Defendants did not change the options included in the plan despite the fact that most of them underperformed the market indexes they were designed to track.
  • The funds included in the plan made revenue sharing payments to the trustee, Merrill Lynch, and that these payments were not made in exchange for services rendered, but rather were a quid pro quo for inclusion in the plan.

"If these allegations are substantiated, the process by which appellees selected and managed the funds in the Plan would have been tainted by failure of effort, competence, or loyalty. Thus the allegations state a claim for breach of fiduciary duty," the opinion stated.

Duty to Disclose

In its opinion in Braden v. Wal-Mart Stores Inc., the 8th U.S. Circuit Court of Appeals noted that the district court concluded that the Employee Retirement Income Security Act (ERISA) does not require disclosure of revenue sharing arrangements and that the other information 401(k) participant Jeremy Braden sought was not material. The appellate panel disagreed, citing a 6th Circuit opinion that said information is material if there is a substantial likelihood that nondisclosure "would mislead a reasonable employee in the process of making an adequately informed decision regarding benefits to which she might be entitled."

Braden alleged that defendants' had a duty to disclose to participants that plan funds charged higher fees than comparable funds, that Wal-Mart had access to more cost effective institutional shares, and that defendants did not select or evaluate the funds on the basis of the fees they charged. "A reasonable trier of fact could find that failure to disclose this information would mislead a reasonable participant in the process of making investment decisions under the Plan," the 8th Circuit opinion said.

In his complaint, Braden estimated that fees unnecessarily cost the plan some $60 million over the past six years and will continue to waste approximately $20 million per year (see "Participant Files Excessive 401(k) Fee Suit Against Wal-Mart" and "Wal-Mart Answers Excessive 401(k) Fee Allegations").

The appellate court vacated the district court's opinion and sent the case back for further proceedings.

The opinion can be found here.


IMHO November 29, 2009

IMHO: The Benefits of the Doubt

Those who were wondering when—or perhaps if—the issues raised in those revenue-sharing lawsuits would ever actually be tried got a strong, affirmative response last week.

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This time, the 8th U.S. Circuit Court of Appeals found triable issues of fact in a case involving Wal-Mart’s 401(k) plan (“8th Circuit Says Wal-Mart 401(k) Suit Requires Further Discussion”), sending the case back for another hearing by the trial court that had dismissed issues raised in the lawsuit, while also taking the time (at least in a footnote) to distinguish some of its findings from a similar case (Hecker v. Deere) that had failed to clear the bar in another circuit. 

But, IMHO, what distinguishes the ruling in Braden v. Wal-Mart Stores Inc. from all the revenue-sharing cases that have been adjudicated thus far is that the 8th Circuit judges were willing to concede that the plaintiff had alleged facts that, at least on the surface, were sufficient to support a potential claim. 

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Now, in fairness, the court applied a fairly traditional standard of review in evaluating the motion to dismiss; to give the benefit of the doubt, if you will, to the perspective of the party who has not made a motion to dismiss the case without moving to trial—and it admonished the lower court for not doing so in plain language.  In its ruling, the 8th Circuit not only said that the lower court “ignored reasonable inferences supported by the facts alleged,” it went on to criticize that court for not only drawing inferences in favor of the party (Wal-Mart) that had made the motion to dismiss, but for criticizing the plaintiff for “failing to plead facts tending to contradict those inferences.” 

What’s Different

So, what did the court find compelling enough to give this case a fuller hearing?  The “relatively limited” (10) menu of fund options “selected by Wal-Mart executives despite the ready availability of better options”—“better” in this case including the fact that they were retail rather than institutional class mutual fund shares (there are other, and IMHO weaker, allegations about performance relative to benchmarks and the use of actively managed funds, rather than index alternatives).  And then, perhaps by way of “explaining” the use of these allegedly inferior options, plaintiff Braden notes that the Wal-Mart plan funds “made revenue sharing payments to the trustee, Merrill Lynch, and that these payments were not made in exchange for services rendered, but rather were a quid pro quo for inclusion in the Plan.” 

Now, IMHO, the plaintiff’s case isn’t ironclad.  Even in its ruling sending the case back for another shot, the 8th Circuit noted that “there may well be lawful reasons appellees chose the challenged investment options.”  However, that court also pointed out it was not the plaintiff’s job to rule out those alternatives—nor was it, in the appellate court’s view, appropriate for the trial court to basically assume that because there might be alternative explanations, no further inquiry was warranted. 

The Duty to Disclose

There is another interesting aspect to the case, IMHO—and it has to do with the duty to disclose revenue-sharing arrangements.  While I believe all of the cases presented to date have claimed that such a duty exists—and that every court that has heard that argument to date has just as readily refuted it—the 8th Circuit had a different take.  “In the context of this case, materiality turns on the effect information would have on a reasonable participant’s decisions about how to allocate his or her investments among the options in the Plan,” the court noted.  The impact of that materiality was heightened by allegations that “those payments corrupted the fund selection process—that each fund was selected for inclusion in the Plan because it made payments to the trustee, and not because it was a prudent investment,” according to the court.  And that means that, “[i]f true, this information could influence a reasonable participant in evaluating his or her options under the Plan,” the court said – even as it acknowledged that there is no per se duty to disclose these arrangements. 

Finally, the 8th Circuit took the lower court to task for basically insisting that the plaintiff prove that the revenue-sharing payments were unreasonable before trial (a threshold that it notes would have been impossible, even if legitimate, since the arrangement between Wal-Mart and Merrill Lynch was confidential). 

The 8th Circuit’s actions here don’t necessarily portend a shift in result for these cases, nor should it suggest that there is anything about this particular case that is markedly distinctive from similar cases brought in other jurisdictions.  That said, to this point, the courts have, IMHO, been extraordinarily willing to give the employer/fiduciaries the benefit of the doubt in these revenue-sharing cases.   

It will be interesting to see how the allegations hold up to a full adjudication of the facts.

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