A Q&A with Chairman and co-founder Bruce Stangle and Managing Principal D. Lee Heavner
Employer-sponsored retirement plans lost nearly $4 trillion in value during the financial crisis, leading to complex litigation over the causes of these losses.
Here, Dr. Stangle and Dr. Heavner discuss some key points about economic analyses in ERISA litigation.
Q: Have you noticed an increase in ERISA litigation?
Dr. Stangle: Definitely. Many are predicting that large market losses will lead to a wave of new, complex ERISA litigation. Where we used to see suits filed primarily by individuals, we’re now seeing a rising percentage of ERISA class actions. The ramifications of this shift are important because damages claims in ERISA class actions can reach billions of dollars, as they are not limited to out-of-pocket costs. Plaintiffs also may seek recission through which a defendant must make a plaintiff class whole based on an economic assessment of what the value of a plan portfolio should have been in a world without the alleged wrongdoing.
Q: Which are the most common allegations economists are asked to address in ERISA litigation?
Dr. Heavner: The most common allegations include claims that plan fiduciaries imprudently selected service providers such as investment managers, and claims that investment managers made imprudent investments. We also frequently see allegations that include claims that plan fiduciaries imprudently offered company stock as an investment option.
Both types of allegations may arise in situations where investments offered within a defined contribution plan experience large losses. Consider the example of a fixed-income fund offered within a defined contribution plan that experiences large losses because of investments in mortgage-backed securities. In this situation, plaintiffs may allege that the plan fiduciaries imprudently selected that fund as a plan investment option. Plaintiffs also might allege that the portfolio manager imprudently invested in mortgage-backed securities.
In evaluating the merit of such allegations, it’s important to remember that investment losses occur for many reasons, and large losses do not imply that any party acted imprudently. It is not appropriate to use hindsight to evaluate investment decisions. Rather, such analyses should be based on information that was available when the decisions were made.
Analysis Group’s work on Florida State Board of Administration (FSBA) v. Alliance Capital Management dealt directly with the issue of investment prudence. Alliance Capital managed an FSBA portfolio that incurred losses resulting from investments in Enron stock. The FSBA then sued Alliance Capital for allegedly failing to research Enron sufficiently, and for not following an agreed-upon investment strategy. Our work in this matter included supporting experts in analyzing the portfolio managers’ investment decisions. The analysis showed that the investments in question were consistent with the investment agreement and with the managers’ historical strategy, which had delivered large returns for the FSBA.
“Many are predicting that large market losses will lead to a wave of new, complex ERISA litigation. Where we used to see suits filed primarily by individuals, we’re now seeing a rising percentage of ERISA class actions.”
Q: How does ERISA litigation over investment losses differ from securities fraud litigation?
Dr. Stangle: The big differences have to do with standards for pleadings and class certification, and potential damages exposure. In Dura Pharmaceuticals v. Broudo, the U.S. Supreme Court decided unanimously that plaintiffs in securities fraud cases had to demonstrate causal linkages between stock price drops and alleged bad acts by defendants. But in the ERISA context, the key question often is whether fiduciaries acted prudently. A plaintiff in an ERISA litigation doesn’t have to allege that a fraud occurred or that an alleged fraud caused investment losses. Plaintiffs need only allege that a particular investment was imprudent.
Also, damages in securities fraud cases differ from damages in ERISA cases in at least two important ways. First, they generally are limited to out-of-pocket losses, whereas ERISA damages are not. One reason the computations of alleged ERISA damages are so complex is that plaintiffs sue for damages based on what they actually lost, plus the “but- for” increases in portfolio value that they would have had if their fund had performed under ideal circumstances.
Second, damages in securities fraud cases generally are limited to damages caused by the alleged fraud, so plaintiffs typically are not entitled to recover losses that resulted from a decline in the overall stock market. But in ERISA cases, plaintiffs may seek to recover all losses – including but-for losses – associated with an investment option that allegedly was offered imprudently.
Finally, the way damages are computed in ERISA cases broadens the set of issues related to class certification. That’s because the interests of members of a proposed ERISA litigation class may differ greatly with respect to the definition of the class period, the method for computing damages, or both. These issues are much less common in securities fraud cases.
Q: What errors have you seen experts make when conducting ERISA damages analyses?
Dr. Stangle: Experts opining on damages often assume that the defendants’ allegedly imprudent behavior prevented plaintiffs from achieving anticipated investment results. However, some experts pose unrealistic but-for worlds to support their damage claims. I have seen experts use benchmark investments that vastly outperformed all other investments that a class member could have chosen. I’ve also seen experts base their analyses on benchmark investments that were not even available to plan participants. The first type of damage claim is unrealistic because of the “hindsight bias” Dr. Heavner alluded to earlier. And with the second type, the expert is relying on unrealistic assumptions. Either problem can be fatal to a damages analysis.
Q: Where is ERISA litigation headed?
Dr. Heavner: We expect ERISA litigation involving complex economic issues to remain prevalent into the foreseeable future. Specifically, stock drop and other investment prudence litigation will remain common as the courts continue to sort out claims arising from the recent collapse of securities prices. Disputes over fees and the selection of investment vehicles also will remain common. Finally, the recent economic downturn has led to increases in employee severance, which may be followed by increased litigation over the value of pension benefits for terminated employees. ■
From Analysis Group Forum (Fall/Winter 2009)