A Place at the Table for Actively Managed Funds

Some plan fiduciaries contend that passively managed funds allow one to avoid ERISA liability. But are they a panacea? A recently released white paper suggests they are not.

In “Actively Managed Funds Remain Appropriate Investment Options For 401(k) Plans,” a paper by Stephen M. Saxon and Jason H. Lee, Principals at Groom Law Group, say that while some plan fiduciaries believe that offering actively managed funds poses greater risk than passively managed funds, it is “wishful thinking” to think that offering only passively managed funds obviates risks.

In fact, say Saxon and Lee, while offering only passive managed funds may not entail the same risks as actively managed funds, there are risks nonetheless. And they offer as proof three lawsuits in which plan fiduciaries were accused of acting imprudently in selecting passively managed funds: Bell v. Anthem, Inc., No. 1:15-cv-2062 (S.D. Ind. filed Dec. 29, 2015, Pledger v. Reliance Trust Co., No. 1:15-cv-4444 (N.D. Ga. filed Dec. 22, 2015) and White v. Chevron Corp., No. 16-cv-793 (N.D. Cal. filed Feb. 17, 2016).

“We do not believe that there is a need for plan fiduciaries to even consider offering only passively managed funds to plan participants,” say Saxon and Lee, because “there is no legal basis for concluding that ERISA or the DOL prefers passive management over active management, or vice versa” and that ERISA and the Department of Labor (DOL) do not disfavor actively managed funds. They say that ERISA “does not mandate specific investments or investment types as necessarily prudent or imprudent” and that “the DOL also ‘has not specified that any particular investment product or category is illegal or per se imprudent’ under the Best Interest Contract Exemption” (BICE). In addition, they observe, “the DOL has never issued an opinion that a particular type of investment strategy is inherently better than another.”

Saxon and Lee also suggest that including actively managed funds in a plan’s investments can reduce plan fiduciaries’ potential liability. Why? Because:

• no court has ruled that actively managed funds are inherently less appropriate for 401(k) plans than passively managed funds;

• most 401(k) plan litigation has centered on paying allegedly excessive fees for an investment fund when there was a less expensive alternative for the same strategy — a claim one can made whether that strategy is active or passive;

• it is reasonable for a plan fiduciary to conclude that even if it has a higher fee than a comparable passively managed fund, a particular actively managed fund can be expected to deliver better investment results on a net-of-fee basis;

• the relevant facts that plan fiduciaries may consider when choosing between actively and passively managed funds include that actively managed funds do not need to “track” an index down in a bear market; and

• plan fiduciaries that prudently select and monitor an investment fund are not liable if the fund loses money or underperforms.

“Even if an investment in a fund were to become worthless, the plan fiduciaries are not necessarily imprudent in having allowed plan participants to invest in the fund,” Saxon and Lee argue, adding that in DiFelice v. U.S. Airways, Inc., “The court explained that, although the stock fund ultimately lost its value through the bankruptcy, the decision of an ERISA fiduciary “cannot be measured in hindsight” and an investment’s diminution in value does not alone establish a breach of fiduciary duty.”