The Seventh Circuit decision this week in George v. Kraft Foods Global should cause fiduciaries of pension and retirement plans – especially those offering company stock – to take notice. At a substantive level, fiduciaries should consider whether their method of offering company stock, as well as selecting service providers, is the most appropriate. At a broader level, fiduciaries should consider whether their efforts to deliberate, decide, and document issues affecting plan investments are sufficient. The Seventh Circuit’s decision also underscores the importance of using competitive bidding to select and retain service providers and consultants.
The plaintiffs in George v. Kraft Foods Global, Inc., No. 10-1469 (7th Cir. April 11, 2011), claimed that the Kraft 401(k) plan’s company stock fund was imprudently structured as a unitized stock fund. That is, instead of owning actual shares of company stock in their individual 401(k) accounts, participants owned funds comprised of the stock and a small amount of cash (approximately 5 percent) to allow for liquidity. There are pros and cons for offering shares directly or as part of a unitized fund; for example, unitized funds may allow for transactions to take place more quickly and save money when purchases and sales are “netted and aggregated,” but, on the other hand, the cash component contributes to a drag on the fund’s returns (at least when the value of the stock appreciates). Also, trading costs are usually borne by the unitized stock fund as a whole, which means that plan participants who rarely trade effectively subsidize frequent traders.
The Court did not suggest the “right” choice for the fiduciaries to have made in administering company stock investment options, but sent the case back to trial to resolve the question. As the Court noted, although “the Parties cite various e-mails and other correspondence among the Kraft plan fiduciaries and [the record keeper] regarding the cost, and benefits of various solutions to investment and transactional drag, . . . 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 [company stock funds] outweighed the benefits, or vice versa.” Had the plan fiduciaries deliberated, decided and documented their resolution of the issue, the class’ breach of fiduciary duty claim alleging $83 million in losses probably would not have been remanded for trial.
The Court also allowed the class to pursue a claim that the fiduciaries paid excessive record keeper fees. Through a competitive bidding process, the fiduciaries had retained Hewitt as record keeper in the mid 1990s, but later they renewed Hewitt’s contract on the basis of their experience and the recommendations of trusted consultants. Although the fiduciaries claimed that as a matter of law this was sufficient due diligence, the class, relying on the testimony of a record keeper “expert,” argued that the only way to ensure competitive pricing was through periodic RFP processes. Whether such steps are required remains to be seen, but the Court held that the expert’s opinion created enough of a factual dispute to send the case to trial. The expense associated with such proceedings, as well as the potential for an adverse judgment, are themselves burdens that may increase the settlement value of the case.
As a dissent by Senior Circuit Judge Richard Cudahy suggests, the Seventh Circuit’s decision may stretch fiduciary standards beyond existing practice. Noting that unitized stock funds are present “in the overwhelming majority of managed fiduciary funds investing in employer stock,” and that “competitive bidding may not always be required” when there are other bases for retaining service providers, Judge Cudahy concluded that “[t]his is an implausible class action based on nitpicking with respect to perfectly legitimate practices.” Although other courts may well follow Judge Cudahy’s lead, and although other defendants may enjoy greater success excluding or mitigating the adverse testimony from “experts,” the predicament in which the Kraft fiduciaries now find themselves might have been avoided had they documented adherence to more rigorous processes.
With the winds of Enron, Worldcom and their progeny at their back, class action plaintiff’s attorneys will for the foreseeable future challenge any number of fiduciary decisions that, at least in retrospect, result in substantial losses to retirement plans. As before, the fiduciary’s best defense against such claims is to deliberate, decide and document issues that may have an effect on plan investments and returns. And now, if the rulings in George v. Kraft Foods Global gain traction, they may want to be even more proactive in soliciting competitive bids for the selection and retention of service providers and consultants.