Rick Fleming is the Securities and Exchange Commission’s first Investor Advocate. Established in 2014 under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC’s Office of the Investor Advocate has four core functions: to provide a voice for investors, to assist retail investors, to study investor behavior, and to support the SEC’s Investor Advisory Committee. While Mr. Fleming reports to the SEC Chair, the Investor Advocate has some independence, submitting reports directly to Congress without review from the SEC Commissioners or staff.Prior to becoming Investor Advocate in February 2014, Mr. Fleming spent 15 years as a state securities regulator, including over a decade as general counsel for the Office of the Kansas Securities Commissioner. He also worked as deputy general counsel for the North American Securities Administrators Association (NASAA), representing the state securities regulators organization before Congress and federal agencies. Mr. Fleming agreed to answer questions of interest to Shareholder Advocate readers after speaking at the National Conference on Public Employee Retirement Systems’ (NCPERS) Legislative Conference earlier this year.1
The questions were posed by Director of Institutional Client Relations Richard Lorant and New York based Partner Laura Posner. Like Mr. Fleming, Ms. Posner was a state securities regulator, serving as Bureau Chief for the New Jersey Bureau of Securities before joining Cohen Milstein. During her three-year tenure as the state’s top regulator, she also was an active member of NASAA, where she served as Chair of Enforcement.
Shareholder Advocate: As the first Investor Advocate, how have you worked to establish an office that can effectively influence the Commission on behalf of investors? How do you maintain your independence?
Rick Fleming: Congress has given the Office of the Investor Advocate unique tools to ensure our independence and enhance our influence. For example, we are authorized to make recommendations to the Commission, and the Commission must respond to our recommendations within 90 days. We also report directly to Congress and describe the Commission’s responses to our recommendations. However, I also report to the Chairman of the Commission, so I am in a role that can involve public disagreement with my boss. I have been fortunate to have worked for two Chairmen who have respected my role and do not take my criticisms of Commission actions personally. On the other hand, I live by some simple rules that help me maintain a constructive role at the Commission—for example, I do not criticize decisions publicly unless I have already made my position clear privately.
SA: How did your experiences as a state securities regulator in Kansas and as deputy general counsel for the NASAA influence your approach to this job? What are the biggest differences working at the federal vs. the state level? Any suggestions for making the relationships more symbiotic?
RF: My experience as a state regulator provided an ideal background for this position. In the federal government, you tend to become highly specialized in a very narrow area, but in state government you deal with a very wide range of issues. For example, I helped attorneys for small companies understand the ways to raise capital, and I dealt with numerous technical issues related to broker-dealer and investment adviser operations. I also “advocated” for investors nearly every day. I litigated enforcement matters, including criminal cases, and have argued cases in front of juries and the Kansas appellate courts. In addition, I have drafted regulations and testified before lawmakers numerous times. But, the biggest difference between state and federal government is that state regulators tend to maintain much closer contact with Main Street investors. This means that state regulators are in a good position to judge how federal rulemakings may impact real people, and I am hopeful that the SEC will take better advantage of state regulators’ insights.
SA: In December, as part of its rules-making process, the Commission issued a request for comment on “the nature, content and timing of earnings releases and quarterly reports made by reporting companies.” [Ed. Note: the comment period ended March 21, 2019.] You have said publicly that you would favor maintaining or increasing the frequency or reporting, a position that aligns you with investor advocacy groups like the Council of Institutional Investors but puts you at odds with comments made by the president last year. Why is reducing the frequency of financial reporting a bad idea? What can we do to discourage the “short-termism” practiced by some publicly traded companies?
RF: The justification for reducing the frequency of reporting has been to give management the space to run a company without having to fixate on quarterly performance. Management does not like how strongly the market can react to bad quarterly news, and I get that. But less frequent financial reporting will not solve the problem—it will just create even greater volatility when six-month or full-year reports come out. It also creates greater pressure for favored investors to gain access to corporate leaders, which would contribute to greater informational asymmetries in the marketplace. A better solution for quarterly volatility may be to discourage companies from issuing quarterly guidance. This is an idea that I think is worth exploring.
SA: At NCPERS earlier this year, you mentioned your general support for Regulation Best Interest, which would heighten the suitability standard under which brokers currently operate, but said it remains to be seen how close the final rule will be to a fiduciary standard—or, we might add, one that actually requires brokers to act in the “best interests” of their clients. How do you think the currently proposed rule could be modified to make it more robust?
RF: My view about Reg BI is that it should be judged by whether it actually reduces bad conduct. If, in the end, it merely requires brokers to disclose that they are doing bad things to customers, but they can disclose it in a way that doesn’t cause those customers to push back or walk away, then the disclosure isn’t good enough. So, for me, the key is not whether we label the new standard of conduct “fiduciary” or “best interest,” but whether the rule has enough teeth to actually make brokers stop selling products that pad their pockets when superior products are available to the customer at less cost. This means that the part of the proposed rule that requires brokers to “mitigate” financial conflicts of interest will be of critical importance.
SA: You are on the record against allowing companies with permanent dual-class shares and mandatory arbitration clauses to issue publicly traded stock. How important are these threats to corporate accountability to company shareholders and what other threats would you identify as important?
RF: One of my biggest concerns is the extent to which the for-profit exchanges have allowed their listing standards to deteriorate, particularly with respect to corporate governance. Things like dual-class shares (or non-voting shares) tip the balance of power too far from the shareholders to management, which I believe will ultimately damage the markets. The Council of Institutional Investors has sponsored some strong research showing that founder control may enhance value in the first few years after a company goes public, but founder control begins to detract from value in future years. I believe the exchanges should be doing more to address this concern and should strongly consider sunsetting dual-class shares if they are allowed at all. As far as other threats to shareholders, I am currently concerned with the Commission’s focus on proxy advisors. The business community does not like the influence wielded by proxy advisors, so they have called for increased regulation of those firms. They couch their arguments in terms of investor protection, but I have yet to hear from investors who want to “fix” proxy advisors by giving corporations a greater say in the recommendations they produce.
SA: As the SEC’s first Investor Advocate, you have had the opportunity to shape the role to some degree. Has your team changed its approach since 2014 as you have worked under two different administrations to fulfill the office’s mission?
RF: The change in administrations has not altered our approach. The biggest challenge has been the fiscal environment in the past two years, which resulted in a hiring freeze that hindered our ability to build out the office as quickly as I would have preferred. In particular, we are working to build up our research capacities. Although rulemakings at the Commission are required to go out for “public comment,” it is not usually the public we are hearing from, so I want to utilize tools like surveys and focus groups to get a much better sense of how Main Street investors behave and how changes to the rules will impact them.
1The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. Mr. Fleming’s answers reflect his views and do not necessarily reflect those of the Commission, the Commissioners or other members of the staff.
Shareholders suing Tivity Health over the company’s failure to adequately disclose that one of its largest customers was becoming a direct competitor cleared an important hurdle in March when a federal judge denied defendants’ motion to dismiss the class action lawsuit.
Cohen Milstein represents Oklahoma Firefighters’ Pension & Retirement System as sole lead plaintiff in the lawsuit, which accuses Tivity and three individual defendants of violating the Securities Exchange Act of 1934 by misleading investors about the terms of the contract renewal with United Healthcare (UHC), the company’s second largest customer, and the actual competitive threat posed by UHC. Tivity’s share price fell by more than a third on news that UHC had launched a senior fitness program that would rival SeniorSneakers, the flagship program which generates 82% of Tivity’s revenues.
Working in partnership with fitness centers, Tivity provides UHC and other health plan customers with fitness and health programs that the health plans offer to their members. Because of UHC’s importance to Tivity, analysts and investors were closely watching Tivity and UHC’s contract renewal negotiations in early 2017. As defendants reported it, the news looked good. On April 27, 2017, Tivity said it had renewed the contract for three years. While defendants refused to provide specifics when pressed by analysts, they said they were “pleased” with the contract’s “favorable terms.”
On November 6, 2017, however, investors learned that defendants had failed to disclose that UHC had been offering a rival fitness program to SilverSneakers in two states since late 2016, and planned to roll it out in nine more states starting in January 2018. The stunning disclosure sent Tivity stock tumbling by more than 34%, causing significant losses to Oklahoma Firefighters and other investors who bought stock during the March 6, 2017 to November 6, 2017 class period.
In denying defendants’ motion to dismiss, Judge Waverly D. Crenshaw, Jr. of the U.S. District Court for Northern Tennessee rejected all their arguments, including that the alleged actionable statements were immaterial and that certain statements were protected because they were forward-looking and therefore exempt from liability under “safe harbor” statutory provisions.
In his March 18 ruling, Judge Crenshaw found that Oklahoma Firefighters sufficiently pleaded that Tivity’s statements about the terms of the UHC contract were material to investors because (1) Tivity had said UHC was one its most important health plan customers and (2) Tivity had warned that a loss or major change to its contract with UHC—or UHC’s launch of a competitive program—would hurt its operations. Further underscoring the material nature of the events, Judge Crenshaw noted, defendants themselves reacted when the contract terms changed to allow UHC to compete directly with SilverSneakers and UHC launched its own program. “Tivity was hardly nonplussed,” he wrote. “It formed a committee to address the problem.”
Judge Crenshaw also held that defendants could not avail themselves of the statutory safe harbor for forward-looking statements about Tivity’s ability to strengthen market share, long-term opportunities, and improved performance because the statements “were provided in the context of cautionary statements that were boilerplate, not meaningful, and inconsistent with the historical facts” that UHC had started to compete with Tivity and Tivity was scrambling to try and “contain the UHC threat.” In addition to the company, the lawsuit names as defendants Chief Executive Officer Donato Tramuto, former interim Chief Financial Officer Glenn Hargreaves, and Chief Financial Officer Adam Holland. The case has moved into the discovery phase with Oklahoma Firefighters scheduled to move for class certification on July 1.
The case is Eric Weiner, et al. v. Tivity Health, Inc., et al., Case No. 3:17-cv01469, U.S. District Court, Middle District of Tennessee, Nashville Division.
The Connecticut Supreme Court limited the scope of a federal law that shields gun manufacturers and dealers, reviving a lawsuit filed by Sandy Hook families. The Brady and Cohen Milstein attorneys examine the ruling and explain how it may have a domino effect nationwide.
By Julie Goldsmith Reiser and Molly J. Bowen of Cohen Milstein, and Jonatha Lowy of The Brady Center to Prevent Gun Violence
On Dec. 14, 2012, 20 first-grade children and six staff were murdered in a mass shooting at Sandy Hook Elementary School. A Bushmaster semiautomatic assault rifle enabled the killer to fire 154 shots in 264 seconds.
Nine families sued the gun’s manufacturers, distributors, and retailers. Building on theories developed decades ago in a Brady lawsuit for victims of another assault weapon massacre, the Sandy Hook families argued that advertising the gun’s militaristic, hyper-aggressive attributes amounted to negligent marketing that was a cause of the shooting.
If the victims sued members of any other industry, they would have a right to discover facts that could support their claims. But victims of gun industry wrongdoing must first overcome the Protection of Lawful Commerce in Arms Act (PLCAA), a federal law that gives gun manufacturers and dealers unique exemptions from civil justice liability. PLCAA has provided even greater protections than legislators intended because courts have interpreted it overly broadly.
On March 14, the Connecticut Supreme Court properly reined in PLCAA’s protections, reversing the PLCAA-based dismissal of the Sandy Hook families’ case. Providing the most thorough analysis of PLCAA since its 2005 enactment, the court held that the victims’ wrongful advertising claim overcame PLCAA and may proceed into discovery.
This ruling should influence courts nationwide to construe PLCAA as it was intended—limiting cases where the gun manufacturer or dealer did nothing wrong, while allowing cases to proceed where the gun industry played a role in the harm or death.
By: Julie Goldsmith Reiser, Partner, Cohen Milstein Sellers & Toll and Elisa Mendoza, Vice President, ISS Securities Class Action Services
Investors have filed many lawsuits in recent years alleging that Wall Street banks and related entities have unlawfully colluded to rig financial and commodities markets to benefit themselves and harm investors. Filed primarily under federal antitrust laws, these cases continue to generate substantial settlements, over $5.8 billion to date, largely because of the banks’ brazen behavior across such a wide array of financial markets. In addition to providing monetary recoveries to investors, these lawsuits also seek to curtail the banks from overcharging investors in the largest and most important financial markets.
The complete report can be viewed here.
If you believe you may have a whistleblower claim or if you’d like to learn more about our Whistleblower and False Claims Act practice, please contact us at whistleblower@cohenmilstein.com or 202.408.4600 for a confidential and free-of-charge consultation.
Over the last two decades, federal and state governments have dramatically increased their payments to private health care companies that manage Medicare Advantage and Medicaid managed care plans, now paying them around $400 billion a year. For the more than 20 million Americans enrolled in one of these plans, these companies function as the control center for payment decisions, receiving payments from the government and making payments to providers.
Although these companies take in tremendous amount of taxpayer money, and have immense power regarding how to distribute these funds, a cloud of secrecy shields from public view their financial operations and profitability. The unique environment in which Medicare Advantage and Medicaid Managed Care plans operate – enormous amounts of money to be spent, a thicket of government reimbursement guidelines, little transparency, typically no party with equal bargaining power, and what amounts to an honor system – can create a recipe for cooking up fraud.
. . .
These aren’t merely theoretical problems. A recent government audit found that Medicare overpaid Medicare Advantage plans by approximately $7 billion in 2016 alone. And this audit did not examine possible underpayments to providers, nor did it examine the approximately $200 billion the federal government and states jointly pay through Medicaid.
Because the internal workings of these companies are largely kept secret from the government, enforcement actions by the Department of Justice are often prompted by lawsuits filed under the False Claims Act. This law, enacted in 1863, was initially aimed at shady contractors who sold the Union Army faulty rifles and ammunition, spoiled food, and other unusable goods. Having been amended and its scope expanded through the years, it today prohibits companies from defrauding the government in a broad array of contexts. The False Claims Act allows whistleblowers to initiate lawsuits on the government’s behalf. If the government recovers money from a lawsuit, the whistleblower earns a financial reward.
The assault on investors’ rights to sue in court continues, with yet another attempt to compel mandatory arbitration of investor claims through a change in company bylaws.
The latest onslaught is being championed by Hal Scott, a Harvard Law professor and frequent critic of securities lawsuits. In November, Scott submitted a shareholder proposal on behalf of a trust he represents to Johnson & Johnson, Inc., a New Jersey corporation, seeking to amend the company’s corporate charter to require arbitration of all federal securities claims. Scott’s draconian proposal further seeks to prohibit class and joined claims, as well as eliminate appeals or challenges of awards, rulings and decisions.
The stakes for shareholders are high. Arbitration is neither cost effective nor practicable for investors who have lost money due to corporate misconduct, and lacks important safeguards guaranteed by the court system—the rights to a jury trial, discovery and a public hearing, to name just three.
At the urging of President Trump, the Securities and Exchange Commission is studying the impact of allowing publicly traded companies to file financial reports just twice a year instead of quarterly, a reduced standard that would turn back the regulatory clock a half century.
On December 18, four months after President Trump raised the idea in a Tweet, the SEC asked for public comment “on the nature, content, and timing of earnings releases and quarterly reports made by reporting companies.”
Proponents of eliminating quarterly reports, such as President Trump and the US Chamber of Commerce, argue it would reduce unnecessary expenses associated with preparing the reports and encourage executives to focus on longer-term investments rather than quarterly earnings.
While replies aren’t due until March 18, market heavyweights like Larry Fink of BlackRock, Warren Buffet of Berkshire Hathaway and Jamie Dimon of JPMorgan Chase—all of whom decry “short-termism”— are already on the record in favor of quarterly financial reports.
So is the Council of Institutional Investors, which issued a statement the day of the Tweet. “Investors and other stakeholders benefit when regulations ensure that important information is promptly and transparently provided to the marketplace,” CII Deputy Director Amy Borrus said. “Investors need timely, accurate financial information to make informed investment decisions.”
That the SEC would consider such a measure is unsurprising, given the anti-regulatory posture of the Trump administration and Republican lawmakers. Over the last two years, the SEC appears to have focused chiefly on promoting capital formation, while pulling back on efforts to protect investors, police markets and ensure corporate accountability.
Enforcement, by most measures, is down since President Trump took office. Meanwhile, the Commission has floated ideas such as allowing companies to issue dual-class shares that permanently enhance insiders’ power over that of ordinary shareholders.
A basic premise of the federal securities laws is that investors are entitled to recover for harms caused by the revelation of a company’s false statements. But in First Solar Inc. v. Mineworks Pension Scheme, defendants argue that they cannot be held liable for losses caused by the revelation of the effects of their fraudulently concealed conduct until the fact of the fraud itself is also disclosed. After their arguments fell short at the trial and appeals court levels, they have petitioned the Supreme Court of the United States to consider their position. First Solar Inc., No. 18-164 (U.S.) (cert. petition pending).
During the class period alleged in the case, First Solar’s stock fell from nearly $300 per share to around $50. Plaintiffs allege that, during that period, defendants intentionally concealed the existence of serious defects in two of their products, and that, even after one of the defects was revealed, defendants continued to hide its full costs and impact. The market did not learn about the existence of the second defect during the class period. But defendants did incorporate the costs of the concealed defects into their earnings statements— albeit without explaining all the reasons for their poor performance to the public. Plaintiffs argue that their loss was caused, in part, by the market reaction to those statements. A trial court agreed that plaintiffs’ argument was sufficient to go to trial but permitted defendants to appeal that determination to the Ninth U.S. Circuit Court of Appeals.
The full article can be accessed here.
Responding to continued mass shooting tragedies, some public pension funds that own stock in companies that manufacture, distribute, and sell firearms are promoting responsible gun industry practices as a way to protect the value of their shares and enhance public safety.
Public funds from California, Connecticut, Florida, Maine, Maryland and Oregon teamed with private institutional investors to form a coalition representing over $4.8 trillion in assets to sign the Principles for a Responsible Civilian Firearms Industry, five goals that companies in which they invest should pursue to reduce risks to the value of their businesses.
Representing current best practices in firearm manufacture and sales, the principles issued in November apply to investments in all public and private companies operating in the firearms industry. The principles direct manufacturers to support and utilize new technology to make their firearms safer and facilitate tracing by law enforcement agencies. But they do not end there. Distributors, dealers and retailers—a large set of companies that include consumer retailers like Wal-Mart—play a critical role in ensuring that safe firearms make it to the hands of safe owners. The principles direct these companies to adopt practices that ensure the completion of background checks on purchasers, to train their employees to identify suspicious transactions, and to work collaboratively with law enforcement to prevent and catch those who engage in gun violence.
The full article can be accessed here.
A number of vexing issues facing ERISA practitioners came to a head in 2018 and are primed to be resolved in the coming year. This article will examine the cases raising these issues, and the impact their resolution in the coming year will have on retirees and the retirement industry.
Who Is in Control? Plan Participants’ Role in Retirement Plan Management Put Into Question
2018 continued the trend of courts grappling with ERISA’s “functional fiduciary” definition. In the coming year, the Tenth Circuit will decide whether a plan participant’s ability to divest from an investment option short-circuits a service provider’s fiduciary duty to retirement plan participants who allocated retirement assets into that option.
This issue arises in Teets v. Great-West Life & Annuity Insurance Company. Great-West concerns a “stable value” product created by Great-West Life & Annuity Insurance Company that pays investing participants a rate of return set by Great-West each quarter.[1] Great-West earns a profit for itself if and when it generates returns greater than the preset rate of return.[2]
The question presented in Great-West was whether the service provider was an ERISA fiduciary because it had the contractual discretion to set a rate of return for participants and exercised that discretion every quarter year.[3] Under ERISA, an insurance company is a fiduciary with respect to a plan to the extent, among other things, that the insurance company exercises any authority or control respecting management or disposition of the plan’s assets.[4]
The court noted that the contract was a plan asset, and Great-West exercised control with respect to the management of that asset by setting the rate of return every quarter, but refused to treat Great-West as an ERISA fiduciary, because the participants invested in the stable value product could still “vote with their feet if they dislike the new rate.”[5] In effect, the lower court said that a service provider does not have “discretion” over plan assets if a plan participant can divest before the rate Great-West sets is paid.
There are wide-ranging implications if the Tenth Circuit agrees with the lower court, affecting both a participant’s place in the fiduciary-beneficiary relationship and their ability to appropriately manage their retirement savings. If the onus is put on a participant to determine whether a rate of return is appropriate in given market conditions, they would likely need a crash course in financial literacy (and a new hobby) to benchmark the announced rate of return and determine whether market conditions indicate it is too low.
But most plan participants are not versed in these financial technicalities, which is why ERISA endows fiduciaries with the duty of care owed to the plan participants they serve.[6] Moreover, expecting participants to “vote with their feet” would require those participants to reallocate their retirement account balance. “Asset allocation is one of the most important factors in long-term portfolio performance.”[7] Participants may find themselves between a rock and a hard place if they are unhappy with a suboptimal rate of return from a retirement product, but cannot divest without causing a suboptimal asset allocation in their retirement account.
Given the implications of the Tenth Circuit’s impending decision, the authors of this article expect to hear more about this case in the coming year and beyond.
U.S. Bank: Will the Standard Challenge Finally Make Its Way to the Supreme Court?
The saga of U.S. Bank’s pension plan continued into 2018, and will likely continue into 2019. Participants in the U.S. Bancorp Pension Plan sued the plan’s fiduciary in 2013 for, among other things, mismanaging the pension plan by investing 100 percent of the pension in equities and selecting expensive proprietary mutual funds to do so.[8] This strategy was in place during the financial crisis in 2008, causing the pension plan to become severely underfunded as the stock market crashed — meaning the pension plan would not have enough money to pay the retirement benefits U.S. Bank promised employees.
After the case was filed, U.S. Bank made contributions to the plan sufficient to make the plan overfunded, and moved to dismiss on multiple grounds, including lack of Article III standing. The district court held that the case became moot once the plan became overfunded.[9] The plaintiffs appealed the court’s mootness decision, and U.S. Bank sought to defend the lower court decision by arguing that the plaintiffs no longer had Article III standing once the plan became overfunded.
The Eighth Circuit upheld the dismissal, but not on Article III standing or mootness grounds.[10] Rather, the Eighth Circuit held that, without an underfunded pension, a participant in that plan does not have “prudential standing” — that is, she is not in the class of people Congress authorized to sue under the statute. The dissent was quick to challenge this result, pointing out that ERISA permits wide-ranging injunctive relief separate and apart from restoration of losses, including the removal of fiduciaries, enjoinment of imprudent investment strategies and disgorgement of ill-gotten profits.
The plaintiffs in this case are seeking certiorari, and the U.S. Supreme Court has sought the U.S. solicitor general’s views on whether to hear the case.[11] So there is a decent likelihood that the Supreme Court will resolve this thorny legal issue in the coming year.
A failure by the Supreme Court to reverse the Eighth Circuit’s opinion will have wide-ranging implications for retirement savers. ERISA was promulgated in the wake of high-profile pension failures, to prevent the poor pension management that left retirees scrambling to secure their future after years of hard work and corporate promises. This pragmatic and essential purpose is frustrated if a participant is only authorized to bring a suit to remedy mismanagement once irreversible harm occurs.
Moreover, the Eighth Circuit’s opinion creates a perverse incentive for fiduciaries. Assuming fiduciaries will not sue themselves, the upshot of the Eighth Circuit’s holding is that pension fiduciaries can outright steal from a funded pension plan, and the only entity that can stop them is the U.S. Department of Labor, which has made well known it does not have the resources to police all misconduct.
Whose Burden? Courts Grapple With Which Party Must Prove Loss Causation in a Breach of Fiduciary Duty Case
Following the recent uptick in “proprietary fee cases,”[12] courts were faced with questions concerning which party bore the burden of proving that losses in a plan were caused by financial companies’ preference for in-house products. The First Circuit, in Brotherston et al. v. Putnam Investments LLC et al., recently highlighted a circuit split on this issue.
In Putnam, the plaintiffs alleged that defendants breached their fiduciary duties of loyalty and prudence by offering exclusively proprietary mutual funds in the plan, without consideration of nonproprietary investment alternatives, despite alleged issues with performance and fees.[13] Putnam made its way to a bench trial, where the judge refused to hold Putnam liable for having an investment process that was “no paragon of diligence,” explaining that the plaintiffs had failed to show any losses because, even without an “objective process,” the plan could “still end up with prudent investments, even if it was the result of sheer luck.”[14]
On appeal, the First Circuit reversed. The First Circuit explained that there are three elements to a breach of prudence claim — “breach, loss, and causation”[15] — and that the plaintiffs had proved the first two elements by showing that the defendants failed to monitor the plan investments independently, and that those plan investments underperformed alternative investments.[16]
This left the element of causation. The First Circuit explained that, because the plaintiffs had made a prima facie showing of a violation and loss, the burden shifts to the defendants to disprove causation.[17] In so doing, the First Circuit piled on top of a now 4-4 circuit split.
On one side of the split sit the First, Fourth, Fifth and Eighth Circuits. These four circuits have all held that, once a plaintiff makes a prima facie case of a violation and loss to the plan, the burden shifts to the fiduciary to disprove causation. These courts have looked to the common law of trusts for guidance on the burden, in the absence of statutory language expressly placing the burden on one party or the other. The common law of trusts shifts the burden to the trustee to disprove causation.[18]
On the other side of the split sit the Sixth, Ninth, Tenth and Eleventh Circuits. These courts have interpreted language from 29 U.S.C. 1109(a), stating that a fiduciary is liable for “any losses to the plan resulting from each such breach,” as placing the burden on plaintiffs.[19]
Putnam has asked the Supreme Court to settle the score, and with such a decisive split there is a good chance it will do so. If the Supreme Court takes this case and continues grounding its interpretation of ERISA in the common law of trusts, participants that are harmed by fiduciary misconduct will find fewer hurdles to recovery in four of the circuits.
So Long for Now? The Department of Labor’s Fiduciary Rule Meets Its Demise
A look ahead to 2019 would not be complete without discussing the DOL’s hotly contested fiduciary rule. The authors of this article previously wrote about the fiduciary rule near the end of 2017.[20] At that time, legal challenges to the rule had been percolating to circuit courts after surviving litigation in district courts in Texas, the District of Columbia and Kansas.
While the appeals to those cases were pending, the Trump administration poured cold water on the rule by filing a notice of proposed amendments seeking to delay the implementation of the rule’s key provisions, so that the DOL could consider possible changes to the rule.[21] The provisions targeted by the delays included the requirement that a fiduciary under the rule operate in a retirement investor’s best interest. Following the notice and comment period for this proposal, the DOL, on Nov. 24, 2017, officially delayed implementation of the rule’s key provisions for 18 months, until July 1, 2019.[22] The DOL also filed a brief in the Fifth Circuit, stating that the United States Government “is no longer defending” the validity of the rule’s prohibition against class action waivers.[23]
Subsequently, on March 15, 2018, a split panel in the Fifth Circuit vacated the rule in toto, holding that Congress had not given the DOL the authority to “expand[] the scope of DOL regulation” to the individual retirement account market, as the rule purported to do.[24] The Fifth Circuit’s analysis largely focused on whether the definition of “investment advice” provided by the rule conflicted with the term “investment advice” used in ERISA (29 U.S.C. § 1002).
The primary legal question that the Fifth Circuit answered was whether, under Chevron USA Inc. v. Nat. Res. Def. Council Inc., the term “investment advice” in 29 U.S.C. § 1002 was unambiguously defined by Congress such that the DOL was unable to provide a new technical definition to the term through regulation.[25] The Fifth Circuit held that Congress had given the term unambiguous meaning, which it borrowed from the common law fiduciary definition “requir[ing] trust and confidence” stemming from “individualized advice on a regular basis pursuant to a mutual agreement with a client.”[26] Because the rule did not require the relationship between an investor and broker to be founded on “trust and confidence,” the Fifth Circuit held that the rule was at odds with Congressional intent.
The dissent was split on this point, explaining that Congress had not defined the term “investment advice,” and had expressly authorized the DOL to adopt regulations defining “technical and trade terms used” in the statute.[27]
While this attempt to fill a regulatory gap in the ever-growing IRA market may have failed, a new chapter is likely to be written. The DOL announced that it is “considering regulatory options in light of the Fifth Circuit opinion,” and is slated to issue a revised fiduciary rule in September 2019.[28] Moreover, the Securities and Exchange Commission issued a proposed rule in 2018 that seeks to establish a “best interest” “standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customers.”[29]