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Brotherston v. Putnam Investments, LLC

United States Court of Appeals, First Circuit

October 15, 2018

JOHN BROTHERSTON, individually and as representative of a class of similarly situated persons, and on behalf of the Putnam Retirement Plan; JOAN GLANCY, individually and as representative of a class of similarly situated persons, and on behalf of the Putnam Retirement Plan, Plaintiffs, Appellants,


          James H. Kaster, with whom Nichols Kaster, PLLP, Paul J. Lukas, Kai H. Richter, Carl F. Engstrom, Jacob T. Schutz, and Eleanor E. Frisch were on brief, for appellants.

          Mary Ellen Signorille, William Alvarado Rivera, and Matt Koski, on brief for amici curiae AARP, AARP Foundation, and National Employment Lawyers Association.

          James R. Carroll, with whom Eben P. Colby, Michael S. Hines, Sarah L. Rosenbluth, and Skadden, Arps, Slate, Meagher & Flom LLP were on brief, for appellees.

          William M. Jay, Jaime A. Santos, James O. Fleckner, Alison V. Douglass, Goodwin Procter LLP, Steven P. Lehotsky, Janet Galeria, Kevin Carroll, and Janet M. Jacobson, on brief for amici curiae Chamber of Commerce of the United States of America, American Benefits Council, and Securities Industry and Financial Markets Association.

          Sarah M. Adams, Jon W. Breyfogle, Michael J. Prame, Groom Law Group, Chartered, Paul S. Stevens, Susan M. Olson, David M. Abbey, on brief for amicus curiae Investment Company Institute.

          Before Torruella, Thompson, and Kayatta, Circuit Judges.


         Plaintiffs John Brotherston and Joan Glancy are two former employees of Putnam Investments, LLC who participated in Putnam's defined-contribution 401(k) retirement plan (the "Plan"). They brought this lawsuit on behalf of a now-certified class of other participants in the Plan, and on behalf of the Plan itself pursuant to the civil enforcement provision of the Employee Retirement Income Security Act ("ERISA"). See 29 U.S.C. § 1132(a)(2). They claim that Putnam (as well as other Plan fiduciaries) breached fiduciary duties owed to Plan participants by offering participants a range of mutual fund investments that included all of (and, for most of the class period, only) Putnam's own mutual funds without regard to whether such funds were prudent investment options. They also claim that Putnam structured fees and rebates in a manner that was both unreasonable and treated Plan participants worse than other investors in those Putnam mutual funds. In a series of rulings before and after plaintiffs presented their evidence at trial, the district court found that plaintiffs failed to prove that any lack of care in selecting the Plan's investment options resulted in a loss to the Plan, and that the manner in which Putnam transacted with the Plan was neither unreasonable nor less advantageous than the manner in which Putnam dealt with other investors in its mutual funds. Finding several errors of law in the district court's rulings, we vacate the district court's judgment in part and remand for further proceedings.


         We begin with a basic outline of the undisputed facts and the procedural history of this case, reserving further details for our analysis.[1] Putnam is an asset management company that creates, manages, and sells mutual funds. Under the Plan, eligible employees of Putnam and its subsidiaries make contributions to individual 401(k) accounts and personally direct those contributions among a menu of investment options. Putnam itself also contributes to the employees' Plan accounts. Pursuant to the Plan's governing documents, Putnam Benefits Investment Committee ("PBIC") is one of the Plan's named fiduciaries and is responsible for selecting, monitoring, and removing investments from the Plan's offerings.

         The investment options offered under the Plan include many of Putnam's proprietary mutual funds. Between 2009 and 2015, over 85% of the Plan's assets were invested in these funds. Putnam offers two classes of shares in these funds: Y shares and R6 shares.[2] Most of Putnam's mutual funds offered under the Plan are "actively managed"; that is, they are operated by an investment advisor seeking to beat the market. From the beginning of the class period in November 2009 through January 31, 2016, the PBIC selected no mutual funds other than the propriety Putnam funds for inclusion in the portfolio of investment vehicles offered to Plan participants. During this period, Plan participants were given the option to invest in non-affiliated funds only through a self-directed brokerage account.

         The Plan itself did instruct the PBIC to include as investment options "any publicly offered, open-end mutual fund (other than tax-exempt funds) that are generally made available to employer-sponsored retirement plans and underwritten or managed by Putnam Investments or one of its affiliates," as well as several other Putnam funds and a collective investment trust administered by Putnam's affiliate, PanAgora Asset Management, Inc. But the parties presume, at least for purposes of this case, that this instruction does not immunize defendants from potential liability based on the duty of prudence in selecting investment offerings under the Plan. See Fifth Third Bancorp v. Dudenhoeffer, 134 S.Ct. 2459, 2468 (2014) ("[T]he duty of prudence trumps the instructions of a plan document . . . .").

         The district court found that the PBIC did not independently investigate Putnam funds before including them as investment options under the Plan, did not independently monitor them once in the Plan, [3] and did not remove a single fund from the Plan lineup for underperformance, even when certain Putnam funds received a "fail" rating from Advised Asset Group, a Putnam affiliate.[4]

         In November 2015, Brotherston and Glancy filed this lawsuit against Putnam, the PBIC, and various other Putnam individuals and entities (collectively, "defendants"). On behalf of themselves, two certified subclasses of other Plan participants, and the Plan itself pursuant to 29 U.S.C. § 1132(a)(2) (collectively, "plaintiffs"), they press two types of claims under ERISA. First, they claim that the fees charged by Putnam subsidiaries to the mutual funds offered in the Plan constituted prohibited transactions under ERISA. Second, they claim that Putnam, through its committees operating the Plan, breached its fiduciary duties by blindly stocking the Plan with Putnam-affiliated investment options merely because they were proprietary.[5] Three months after this lawsuit commenced, the PBIC added six BNY Mellon collective investment trusts to the Plan's investment options. It is undisputed that the process for choosing the BNY Mellon funds was prudent.

         By agreement of the parties, the district court decided plaintiffs' prohibited transactions claims on a case-stated basis at summary judgment. After seven days of a bench trial, during which plaintiffs but not defendants presented their case, the district court entered judgment on partial findings under Federal Rule of Civil Procedure 52(c). On all counts, the court found against plaintiffs, who now appeal.


         We begin our analysis with the order that dismissed plaintiffs' prohibited transactions claims. The case-stated procedure allows a court in a nonjury case to "engage in a certain amount of factfinding, including the drawing of inferences," where "the basic dispute between the parties concerns only the factual inferences that one might draw from the more basic facts to which the parties have agreed." Pac. Indem. Co. v. Deming, 828 F.3d 19, 22 (1st Cir. 2016) (quoting United Paperworkers Int'l Union Local 14 v. Int'l Paper Co., 64 F.3d 28, 31-32 (1st Cir. 1995)). In reviewing the entry of summary judgment on a case-stated record, we review legal questions de novo and factual determinations for clear error. See United Paperworkers Int'l, 64 F.3d at 31-32.

         A brief sketch of the statutory background frames our analysis. ERISA "supplements the fiduciary's general duty of loyalty to the plan's beneficiaries by categorically barring certain transactions deemed 'likely to injure the pension plan.'" Harris Tr. and Sav. Bank v. Salomon Smith Barney, Inc., 530 U.S. 238, 241-42 (2000) (citation omitted) (quoting Comm'r v. Keystone Consol. Indus., Inc., 508 U.S. 152, 160 (1993)). Two particular prohibitions, and their related exemptions, are at issue here.[6] The first prohibition appears in section 1106(a)(1), which states:

Except as provided in section 1108 of this title:
(1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect--
. . .
(C) furnishing of goods, services, or facilities between the plan and a party in interest . . . .

29 U.S.C. § 1106(a)(1)(C). The second prohibition appears in section 1106(b), which provides:

A fiduciary with respect to a plan shall not--. . .
(3) receive any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

29 U.S.C. § 1106(b).

         The design and operation of the Plan implicates both of these prohibitions. The Plan contracts with parties-in-interest (Putnam subsidiaries) for services, thereby implicating section 1106(a)(1).[7] And Putnam, through the service fees it charges the Putnam funds in which the Plan invests, receives a benefit "in connection with a transaction involving the assets of the [P]lan" (that transaction being the Plan's purchase of shares in the Putnam funds), thereby implicating section 1106(b). Putnam therefore runs afoul of each prohibition unless it qualifies for an applicable exemption. Defendants argue that several such exemptions apply. We address each in turn, beginning with those potentially applicable to the otherwise broad reach of the prohibition imposed by section 1106(a)(1) for causing a plan to purchase services from a party-in-interest.


         By its very terms, the prohibition of section 1106(a)(1) on transactions with parties-in-interest applies "[e]xcept as provided in section 1108." Section 1108 in turn provides two exemptions upon which defendants rely. The first exemption allows for:

Contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.

29 U.S.C. § 1108(b)(2) (emphasis added). The second exemption provides that a fiduciary shall not be barred from:

receiving any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan; except that no person so serving who already receives full time pay from an employer or an association of employers, whose employees are participants in the plan, or from an employee organization whose members are participants in such plan shall receive compensation from such plan, except for reimbursement of expenses properly and actually incurred.

Id. § 1108(c)(2) (emphasis added).

         Relevant here, Putnam mutual funds pay a monthly management fee to Putnam Investment Management, LLC ("Putnam Management") for investment management services and a monthly investor servicing fee to Putnam Investor Services, Inc. ("Putnam Services") for transfer agent services. Both Putnam Management and Putnam Services operate as part of Putnam and their profits flow directly to the parent company. So in the context of this case, the applicability of the two exemptions set forth in sections 1108(b)(2) and 1108(c)(2) hinges in the first instance on the answer to a common question: Were the payments received by these Putnam subsidiaries for their services to Putnam mutual funds reasonable?

         The district court made several findings on this question based on the case-stated record. First, it found that the net expense ratios for the funds in which the Plan invested ranged from 0% to 1.65% as of December 2011, and that there was no evidence that the range was materially different for the relevant class period. Brotherston v. Putnam Invs., LLC, 15-cv-13825-WGY, 2017 WL 1196648, at *6 (D. Mass. Mar. 30, 2017) Relatedly, the district court noted that other courts have upheld similar ranges. Id. Second, the court observed that, "[i]mportantly, all of the Putnam mutual funds the Plan invested in were also offered to investors in the general public, therefore, their expense ratios were 'set against the backdrop of market competition.'" Id. (quoting Hecker v. Deere & Co., 556 F.3d 575, 586 (7th Cir. 2009)). Finally, the court rejected the analysis of plaintiffs' expert, Dr. Steve Pomerantz, who purported to show that Putnam's fees were materially higher on average than the fees paid by other funds, on the grounds that his comparators were flawed. Id. at *7.

         In context, we read the district court's second finding as saying that the Putnam funds were both offered to and acquired by at least some other individuals and entities who had the freedom to invest in other funds in the marketplace. Such was precisely what defendants' expert, Dr. Erik Sirri, said in one of his reports.[8] Sirri's supplemental report stated that, in contrast to the conclusion drawn by plaintiffs' expert, the data "do not indicate that Putnam's funds have generally been rejected by impartial, unaffiliated fiduciaries of non-Putnam retirement plans." Rather, the report noted, "all but nine of the funds were offered by at least one other plan and several funds were offered by over one hundred different plans. Two-thirds of the funds were offered by at least nine other plans, and half were offered by at least 23 other plans."[9] In addition, Sirri concluded in his ...

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