Abuse-of-discretion review extends to plan investment suits

Two federal appellate courts have made it materially harder to sue plan fiduciaries over poor investment decisions. Within weeks of each other, the Third and Seventh Circuits applied the abuse-of-discretion standard of review to class actions under ERISA Section 502(a)(2), the catch-all for fiduciary misconduct. The standard has governed benefit-denial claims since Firestone Tire & Rubber Co. v. Bruch in 1989; now it reaches investment suits as well.

Under this standard, a court does not ask whether it would have made the same investment choice. It asks only whether the fiduciary's decision was arbitrary or capricious—whether, in the Third Circuit's phrase, the fiduciary abused its discretion. The standard is deliberately forgiving, because plan documents commonly vest committees and trustees with broad discretion.

The standard matters most before trial. Groom Law's analysis notes that it shapes the pleading stage as well as trial: a complaint that does not make an abuse of discretion plausible fails to state a claim. So the deferential review works for defendants twice, easing dismissals now and merits wins later.

The first case, In re Quest Diagnostics ERISA Litigation, involved 401(k) participants who said a fiduciary committee breached its duty of prudence by selecting and keeping underperforming funds. The district court granted summary judgment for the committee; the Third Circuit affirmed. The plan's investment policy statement gave the committee discretion over fund choices, and the court held that such discretion 'is not subject to control by the court except to prevent an abuse ... of his discretion.' The relevant question, it said, is whether the fiduciary considered issues pertinent to the challenged investments.

The second, Rush v. GreatBanc Trust Co., reached the same conclusion by another route. There, an ESOP trustee, GreatBanc Trust, approved the sale of a company held by the plan; participants argued the sale price was too low. After a trial, the district court entered judgment for the defendants, and the Seventh Circuit affirmed. The trustee's discretion over the sale, the appellate court reasoned, put the decision under the abuse-of-discretion standard.

For plaintiffs' lawyers, a bad outcome is no longer enough. A fund that lags its benchmark for years, or a company sale that later looks stingy, does not by itself plead an abuse of discretion. The complaint must allege—and the evidence eventually show—a process failure: a failure to weigh relevant information, an unexplained departure from the plan's own criteria, a decision made on a record that cannot support it.

Litigation strategy will shift earlier. Defendants will move to dismiss with fresh confidence; plaintiffs will comb plan documents for signs the fiduciary strayed from its own mandate. Since the standard turns on the written grant of discretion, the battle will be over plan language and the record of committee meetings and trustee deliberations.

For plan sponsors and their liability insurers, the rulings cut litigation exposure in a concrete way. A fiduciary lawsuit's risk rests on two things: the fiduciary's conduct and the standard of review. The second just moved in the sponsor's favor. Participants lose leverage accordingly: settlements become less likely when a claim can be dismissed for failing the plausibility test.

The rulings come as another question about plan investment risk remains open: the Department of Labor has not settled on a benchmark rule for private-asset allocations in defined contribution plans, a gap Retirement Capital Daily has tracked this month. That rule would dictate what fiduciaries may invest in; these decisions dictate how sharply a court will second-guess them once they do. In these two circuits, the answer is not very sharply at all.