Putnam Investments to Settle 401k Self-Dealing Lawsuit for $12.5 Million

Boston, MAParticipants in the Putnam Retirement Plan have agreed to settle their ERISA lawsuit against Putnam Investments and other Plan fiduciaries for $12.5 million and certain prospective changes in plan administration. Following close on the heels of the U.S. Supreme Court’s decision not to review the lower court’s determination, the settlement leaves open two important questions that arise in countless 401k mismanagement lawsuits. But by keeping these issues alive, the end of Brotherston v. Putnam Investments represents a qualified victory for 401k plan participants.

The issues are both about proving that participants lost money. The questions still hanging in the air are:

• To show that there was a loss, is it enough for participants to show that that plan’s investment options did not perform as well as a set of index funds selected by the participants for comparison; and
• Must plan participants, like John Brotherston, show that the plan fiduciaries caused losses to the plan or does it fall to the fiduciaries to show that their decisions were not the cause of any losses that might have happened?

Different federal courts have decided these in different ways. These questions will continue to appear in ERISA lawsuits until they are finally answered.

What happened at Putnam 

According to the complaint, those who chose the investment options offered to participants in Putnam’s 401k plan sought to promote Putnam’s mutual fund business and maximize profits at the expense of the participants. They loaded the Plan exclusively with Putnam’s mutual funds without investigating whether participants would be better served by investments managed by  unaffiliated  companies.

In addition, the plan fiduciaries failed to remove poorly performing funds. They no bona fide process for selecting mutual funds for the plan, indiscriminately adding every mutual fund that Putnam offered. Neither did they have a meaningful process for monitoring the investments and removing those that performed poorly. The retention of these proprietary mutual funds cost plan participants millions of dollars every year.

Breach of ERISA fiduciary duty

These claims are now familiar from many of the self-dealing lawsuits filed by employees of financial service companies. The prioritization of Putnam’s profits over prudent management of plan assets allegedly constitutes a breach of the duties of prudence and loyalty that ERISA imposes on plan fiduciaries.

There have been a lot of these self-dealing lawsuits, involving financial giants such as Wells Fargo, Fidelity, John Hancock, JPMorgan Chase and Morgan Stanley. Clearly, if the Supreme Court had taken Brotherston and answered the two seminal questions in ways favorable to Putnam Investments, plan participants would have lost an important tool to protect their retirement savings from predatory employers.

But the questions are complicated. Which answers would have been friendly or unfriendly to either side?

How can participants show a loss?         

These 401k self-dealing lawsuits have always presented a proof problem because participants have to make a counterfactual argument – “if only I had had the opportunity to invest in X instead of Y, I would have made $Z more.”

The solution may lie in ERISA’s expectation that plan fiduciaries, including investment managers, act with more than a good heart and an empty head. They are held instead to what is often described as the “prudent expert” standard. That standard requires those who manage defined contribution retirement plans to use care, skill, prudence and diligence and to act as someone familiar with such matters would act.

They need not rise to the level of expertise evidenced by Warren Buffett, but his oft quoted 1996 advice to Berkshire Hathaway shareholders is not a bad place to start:

“Most investors, both institutional and individual, will find the best way to own common stock is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”

Second, it is important to note that the question about what evidence is necessary to show a loss, as distilled in Supreme Court reporting, was crafted by the petitioner for certiorari –Putnam Investments. It omits all reference to allegations of self- dealing.

The phrasing of the question might lead someone unfamiliar with the lawsuit to think that the plan participants had simply gone looking, for litigation purposes, for the best investment results they could possibly find, regardless of whether the funds were comparable.

Whose job is it to prove or disprove?   

Defendants generally do better when the burden of proof rests with the plaintiff. Imagine that you were the defendant in murder case, for example. Would you rather that the prosecution had to prove that you murdered the dear departed or would you rather have to show that, dead though he was, you didn’t do the deed. The second choice is obviously much harder on a defendant. Metaphorically speaking, it could lead you on an endless search for a one-armed man who is the real guilty party.

The same is true of fiduciary misdeeds. Fiduciaries generally do better when plan participants have to establish a clear link between an investment decision and the decline in value of plan assets. All a fiduciary has to do is suggest that the state of the stock market or some other intervening cause led to the decline. Doubt is enough.

The federal circuits are split on these issues. In the First Circuit, where Brotherston was initially brought, resolved both issues in favor of the plan participants. Had the same case been brought in six other circuits, the decision on the burden of proof, at least, would very likely have gone the other way.