A recent holding from the 1st U.S. Circuit Court of Appeals is a reaffirmation that ERISA’s “duty of prudence” for fiduciary managers of employer-sponsored retirement plans speaks to process, not investment results, attorneys say.

The plaintiffs in the case contended that a “stable value fund” offered through their employer’s retirement plan was imprudently managed and monitored and resulted in depressed returns because it was invested too heavily in cash or cash equivalents, an allocation they characterized as a “radical departure” from the practice of similar funds.

However, a three-judge panel agreed with the U.S. District Court in finding that the plaintiffs’ complaint was mere “hindsight criticism” of the investment strategy and that there was no breach of duty since the funds were invested as advertised.

Following closely on the heels of the court’s similar decision in Ellis v. Fidelity Management Trust Company in January, 1st Circuit Judge David J. Barron wrote that although the fund manager, Galliard Capital Management, may have followed a more “cash-focused” course than similar funds, “we do not see how [that] fact alone can suffice to support a plausible claim that such decision-making was imprudent.”

The 30-page decision is Barchock, et al. v. CVS Health Corporation, et al.

Process-based test

Robert C. Corrente was local counsel for defendant CVS and its benefits plan committee.

The Providence, Rhode Island, lawyer said the opinion reflects the prevailing rule that a conduct-based test is going to be applied “in cases like this, rather than looking at the ultimate return on investment.”

In arguing that industry surveys of similar funds are an indicator of the appropriate percentage of monies to be held in cash, the plaintiffs looked past the fact that the CVS fund made investments in the way it said it would, Corrente added.

“It did exactly what it promised to do,” he said, noting that the stable value fund — or SVF — at issue was the second most conservative investment approach among the retirement plan options available to the employees.

Providence ERISA attorney Kimberly I. McCarthy agreed, noting the fact that the plaintiffs had no complaints about the investment disclosures.

“The duty of prudence does not require a plan fiduciary to guess right; it’s about the process. If the investments were made consistent with the description in the investment policy statement, you are fine from a fiduciary standpoint, and it doesn’t matter that others are doing it differently,” she said. “If the disclosures had promised something that the fund didn’t deliver, there might have been a different result.”

Although the Ellis holding foreshadowed the outcome here, Corrente said the new question in Barchock was whether the plaintiffs could use what they termed as the plan’s “radical departure” from the practice of like funds as a basis of liability, a view that the 1st Circuit rejected.

To prevail on that front, McCarthy said the plaintiffs would have to show more about the fund being an outlier, perhaps that it was so far out of the norm that it was imprudent per se. They could also demonstrate something like collusion, with the fiduciaries personally benefitting from the fund, she said.

“You have to be able to show that the actual investments were such a departure from how the funds were represented that it becomes a misrepresentation,” said Pierce Atwood’s Brooks R. Magratten of Providence. “You are not going to have a cause of action simply because a fund is an outlier. That by itself will not carry the day.”

The ruling is a practical one, he added, with the panel not wishing to get into the business of micromanaging pension funds.

“The court seems to be saying that as long as you can still call this a stable value fund and the participants have not been misled in a material way, it is not going to jump in and tell Galliard what to do,” Magratten said.

McCarthy recognized the ruling’s real-world approach.

“No one knows how the stock market will go, and that’s why we can’t have a rule on results,” she said. “In fact, the goal of ERISA is not to maximize profits, but diversification and a long-term view to make sure plan participants are protected.”

The holding also is a reminder for ERISA practitioners to make sure investment policy statements are updated and followed, McCarthy said.

“That was the keystone of this case — that the investments matched the policy.”

With the recent decisions in Ellis and Barchock, Magratten observed that the door for suing a fund manager in the ERISA context is not absolutely closed. Success will depend on showing a fundamental disconnect between the way the fund is described and the way it is actually invested, he said.

Another takeaway, Magratten said, is that plan fiduciaries have a duty to monitor and make sure that monies are being invested in accordance with the fund’s philosophy.

McCarthy offered a cautionary note that nothing in Barchock should be interpreted as holding out a stable value fund as a preferred qualified default investment alternative, or QDIA.

“In fact,” she said, “the Department of Labor recently said that target date funds are the safe harbor for QDIAs.”

Sonja L. Deyoe, local counsel for the plaintiffs, declined to comment on the ruling.

‘Radical departure’ or conservative management?

The plaintiffs, employees of CVS, each allocated a portion of their retirement investments to a stable value fund, part of a mix of “conservative” options available for their 401(k) defined contribution plan.

In 2016, they filed suit in federal court, contending that the plan’s fiduciary, Galliard Capital Management, breached its duty of prudence under ERISA by investing 27 to 55 percent of the fund’s assets in short-term debt obligations equivalent to cash, as opposed to intermediate-term investments that generally provide higher returns.

The plaintiffs further argued that such an allocation “departed radically” from the investment standards of similar funds and was a “severe outlier” when compared to the stable value industry as a whole.

The District Court judge dismissed the complaint for failure to state a claim, finding that plaintiffs were merely criticizing the performance of the fund with the benefit of hindsight. Such second-guessing could not support a claim under ERISA for breach of the duty of prudence, the judge found.

The 1st Circuit affirmed.

Considering the CVS stable value fund’s stated objectives, the panel found that the complaint failed to provide context for evaluating Galliard’s investment choices, and further concluded that the conservative investment goals disclosed to plan participants had been met.

Drawing upon the 1st Circuit’s recent holding on the duty of prudence in Ellis, Barron emphasized that “conservatism in the management of a stable value fund — when consistent with the fund’s objectives disclosed to the plan participants — is no vice.”

But the panel went further than Ellis and weighed in on the plaintiffs’ novel claim that imprudence can be inferred solely from an allegation that a cash-equivalent allocation “departs radically” from industry averages.

Barron exposed weaknesses with that theory, primarily that such an argument did not supply the required context for the plaintiffs’ imprudence claim.

“The complaint does not allege anything about the particular circumstances that Galliard faced in managing the fund,” Barron wrote. “It is hard to see how the fact that a stable value fund was run conservatively indicates that it was being run imprudently, where ‘plaintiffs make no argument that offering more conservative investments (such as money market funds) would constitute an ERISA violation.”

And, even if the court accepted the “radical departure” premise, the plaintiffs did not put forth sufficient evidence to make their case, he said.

“Given the paucity of allegations that the complaint makes about the circumstances facing the CVS stable value fund, it would be pure speculation to infer that Galliard did not have a good reason to make those ‘cash’-heavy decisions,” Barron wrote. “We see no reason to accept the plaintiffs’ implicit assertion that, in managing a stable value fund, a decision to take the path less traveled is for that reason imprudent.”

The argument that the underlying rationale of SVFs worked against Galliard’s allocation percentages was also rebuffed, since the plaintiffs failed to offer a theory for determining, based on the financial logic of SVFs, how much liquidity is “too much” so that imprudence could be reasonably inferred.

With the claim against Galliard thrown out, the 1st Circuit panel also dismissed imprudent monitoring claims against the CVS defendants.