photo by Tony Webster
The tiny sliver of American private-sector workers still accruing benefits under a traditional defined-benefit pension owe a debt of gratitude to the Supreme Court for not driving a final stake through the heart of that hoary arrangement.
They should forward any thank-you’s exclusively to the court’s five Republican-appointed conservatives, however. The trial bar may note that the four Democratic-appointed justices in the court’s liberal bloc are still pleased to accept gifts of mallets and garlic cloves.
The high court ruled 5-4 last week that two retiree participants in U.S. Bank’s pension plan lacked standing to sue the bank and its plan trustees for financial injuries that the plaintiffs did not suffer when the stock market tanked during the financial crash more than a decade ago.
I typed that correctly. You read that correctly. James Thole and Sherry Smith, the two individual named plaintiffs who brought the suit, continue to receive their monthly benefits of $2,198.38 and $42.26 respectively, Justice Brett Kavanaugh wrote in the majority opinion. They would have received the same amount if they won their case or if they lost it. The attorneys who brought suit on their behalf, however, had more riding on the case, to the tune of about $31 million of prospective legal fees. It is fair to presume that this is the reason the case existed at all.
In a defined-benefit pension, employers set money aside in a separate fund that is organized as a trust in accordance with federal pension law. Trustees and their investment advisers manage the funds with the goal of achieving enough growth to pay the benefits promised to retirees. Actuaries provide new calculations, usually once per year, of how much money the employer needs to place in the trust to meet the plan’s obligations. They base that amount on estimates of beneficiaries’ future entitlements and lifespans, as well as on expectations of future contributions and investment growth.
If the plan’s balance is too low, the employer must make up the difference. If it is higher than needed, the employer can reduce future contributions, or in some cases stop accruing future benefits and recover part of the excess. (This is called terminating the plan, even though benefits continue to be paid.) As long as the employer is solvent, beneficiaries are financially indifferent to how the plan performs. If the employer fails, the federal Pension Benefit Guaranty Corporation typically makes up at least a portion of any shortfall.
As you may have heard, the stock market did not do very well during the financial crisis. From a peak in 2007, stocks plunged by about 50%, depending on your benchmark, to a trough in early 2009 before beginning a generally consistent recovery. This week, even amid a global pandemic, the Nasdaq composite stock index closed at a record high. The S&P 500 stock index moved into positive territory for the year and was within a single-digit percentage of its own record close.
While stocks are volatile over short periods, diversified stock portfolios are the surest way to achieve long-term asset growth to meet long-term obligations, such as pension claims. A lot of factors should be considered in determining the allocation of a retirement fund between stocks and less-volatile but lower-yielding investments like bonds and money market instruments.
The plaintiffs who sued U.S. Bank contended that the plan’s managers breached their fiduciary duties in two ways. One was by having all the plan’s investments in stocks. The plaintiffs said this choice caused the plan to suffer a “loss” of $1.1 billion between the pre-crash high in 2007 and 2010, ostensibly $748 million more than an “adequately diversified” plan would have lost in that time. (If the plan did not need to liquidate those stocks, it would likely have recovered any lost value, and considerably more, in the years following 2010. The lawsuit – typical of its type – disregarded this.) The second alleged breach of duty was using investment funds sponsored or managed by U.S. Bank itself, rather than lower-cost funds available through its rivals in the financial industry.
But the bank, not the plan’s current and retired employee participants, was on the hook financially for those decisions. If the plan’s stock investments or the fees it paid for its investment products left it underfunded, U.S. Bank – one of the nation’s largest and most closely regulated, with an ample capital cushion to meet obligations to shareholders and retirees alike – was responsible for covering the shortfall. The bank ultimately contributed $311 million to make up the plan’s funding deficit. (This would not have been a “return” of plan funds, as dissenting Justice Sonia Sotomayor claimed.)
Was it a breach of fiduciary duty for the plan to invest most or all of its assets in stocks? Not necessarily, although this is an aggressive approach for most plans. If the plan can count on large enough annual contributions to meet its cash obligations to current beneficiaries, and if it has the backing of an unusually large and stable employer – a leading American bank, for example – such an allocation can be reasonable.
As for using U.S. Bank’s own products, who else’s should it have used? If a sponsor like U.S. Bank must use its pension plan to provide economies of scale to rival vendors, the simple answer will be not to have a pension plan at all. Any financial benefit the bank receives from having plan assets invested in its own funds ultimately benefits the plan participants, the PBGC or both, by ensuring the sponsoring employer remains financially strong.
Kavanaugh noted that the considerations would be different if this had been a defined-contribution plan. In defined-contribution plans, such as 401(k)s, participants manage their own plan balances and bear the burden of any costs. They receive no guarantee of a specific level of future income. The outcome might also have been different if U.S. Bank trustees had failed to deliver the information that all retirement plans must provide to participants.
In her dissent, which her liberal-bloc colleagues joined, Sotomayor asserted that if plan participants had no right or incentive to challenge their plan’s trustees, there would be nobody in a position to do so. That is not true. The sponsoring employer, being on the hook for the financial results of the plan, has every incentive to keep a close eye on how it is being managed.
More than 80% of government employers, by some estimates, enjoy defined-benefit retirement plans, while as few as 4% are still covered in these arrangements in the private sector. Government plans are not subject to federal funding requirements; collectively, they are underfunded by trillions of dollars. Private-sector plans, in contrast, do not merely push their burdens off on future generations of taxpayers. These plans make real, substantial and immediate demand of employers. This is one reason why so few remain.
It is sometimes difficult to discern where ignorance of private business ends and sheer indifference begins on the court’s liberal wing. The stock market goes up and the stock market goes down. Already this year, it has been down by some 35% (as measured by the S&P 500) before recovering. It could go down again. If contingency-fee-based lawyers can drum up uninjured plaintiffs to sue over temporary market declines, then no defined-benefit pension plan can safely and economically operate in the interest of its beneficiaries.
Then again, the beneficiaries were never the point of this lawsuit. They had no financial stake in the outcome. This was a lawsuit driven by lawyers, for lawyers. At least this time, a Supreme Court majority stood tall for trustees and employers, the parties who had genuine skin in the game.