The Brotherston decision, and SCOTUS' decision not to hear Putnam's appeal, have drastically changed the 401(k) landscape. Given the anticipated adoption of the First Circuit's position and logic by other jurisdictions, plan sponsors and plan advises face a daunting challenge to meet the applicable fiduciary prudence standards established under the Restatement (Third) of Trusts. This presentation proposes a post-Brotherston three-step procedure in addressing 401(k) fiduciary prudence issues for plan sponsors, plan advises and ERISA attorneys.

1. InvestSense
MISSION POSSIBLE:
BLUEPRINT FOR 401(k) INVESTING
AFTER BROTHERSTON
JAMES W. WATKINS, III, J.D., CFP®, AWMA®
MANAGING MEMBER

2. InvestSense
Brotherston v. Putnam Investments
“First, there is what the Supreme Court has called the
"ordinary default rule." Under this rule, courts
ordinarily presume that the burden rests on plaintiffs
"regarding the essential aspects of their claims." That
normal rule, however, "admits of exceptions." For
example, "[t]he ordinary rule, based on
considerations of fairness, does not place the burden
upon a litigant of establishing facts peculiarly within
the knowledge of his adversary.”

3. InvestSense
Brotherston v. Putnam Investments
“Second, ERISA brings to bear its own interpretative
guidance… [W]hen the Supreme Court confronts a
lack of explicit direction in the text of ERISA, it
regularly seeks an answer in the common law of
trusts.
[T]he common law of trusts] places the burden of
disproving causation on the fiduciary once the
beneficiary has established that there is a loss
associated with the fiduciary's breach. This burden
allocation has long been the rule in trust law.”

4. InvestSense
Brotherston v. Putnam Investments
“More importantly, the Supreme Court has made
clear that whatever the overall balance the common
law might have struck between the protection of
beneficiaries and the protection of fiduciaries,
ERISA's adoption reflected ‘Congress'[s] desire to
offer employees enhanced protection for their
benefits.’
[I]t would be strange to reject trust law's rules on
burden allocation in favor of an attempt to reduce
employer costs, especially where the benefit of such a
reduction would flow exclusively to employers whose
breaches were followed by losses to the plan.”

5. InvestSense
Brotherston v. Putnam Investments
“For the foregoing reasons, we…hold that once an
ERISA plaintiff has shown a breach of fiduciary duty
and loss to the plan, the burden shifts to the fiduciary
to prove that such loss was not caused by its breach,
that is, to prove that the resulting investment decision
was objectively prudent.”

6. InvestSense
Fiduciary Prudence Post-Brotherston
Going forward, I propose a three-step procedure for both
ERISA plaintiffs and plan sponsors in advocating or
defending actions alleging a plan sponsor’s breach of their
fiduciary duty of prudence.
1. Tibble v. Edison International
2. Restatement (Third) of Trusts
3. The Active Management Value Ratio™

7. InvestSense
Tibble v. Edison International
“We have often noted that an ERISA fiduciary’s duty
is derived from the common law of trusts’…. In
determining the contours of an ERISA fiduciary’s
duty, courts often must look to the law of trusts.
Under trust law, a trustee has a continuing duty to
monitor trust investments and remove imprudent
ones. This continuing duty exists separate and apart
from the trustee’s duty to exercise prudence in
selecting investments at the outset.”

8. InvestSense
Restatement (Third) Trusts
Section 90 of the Restatement, commonly known as
the “Prudent Investor Rule,” provides that
1. A fiduciary has a duty to be cost-conscious. (cmt. a)
2. A fiduciary has a duty to select mutual funds that
offer the highest return for a given level of cost and
risk or, conversely, funds that offer the lowest level of
costs and risk for a given level of return. (cmt. f)
3. Actively managed mutual funds that are not cost-
efficient are imprudent. (cmt. h(2))

9. InvestSense
The Active Management Value Ratio™
“The incremental fees for an actively managed mutual
fund relative to its incremental return should always
be compared to the fees of a comparable index fund
relative to its returns. When you do this, you’ll
quickly see that the incremental fees for active
management are really, really high – on average, over
100% of incremental returns.”
Charles D. Ellis

10. InvestSense
The Active Management Value Ratio™
The Active Management Value Ratio™ (AMVR) is
simply an version of the well-known economic
cost/benefit metric. The AMVR compares the
costs and returns of an actively managed mutual
funds to the costs and returns of a comparable
index fund.

11. InvestSense
The Active Management Value Ratio™
When we perform a forensic analysis of a individual mutual
fund or a portfolio of mutual funds, we perform three
separate analyses based on:
1. The AMVR.
2. The InvestSense Quotient (IQ) – a proprietary metric that
analyzes a fund in terms of efficiency, both cost and risk
management, and overall consistency of performance.
3. The InvestSense Stress Test – a proprietary metric that
evaluates a fund’s performance under various economic and
market conditions.

12. InvestSense
4Q 2019 AMVR Cost-Efficiency Analysis
Nominal AER Nominal RAR
Fund Symbol IC IC IR IR R-sqrd
AF GFAO R6 RGAGX 0.26 1.34 -0.45 -0.36 95
AF Washington R6 RWMGX 0.23 1.76 -2.24 -1.69 98
Dodge Cox DODGX 0.48 2.23 -1.94 -2.62 93
Fid Contra K FCNKX 0.68 5.35 0.02 0.07 98
TRP Blue Chip Gro R RRBGX 1.18 9.30 2.04 -0.18 98
Vang PRIMECAP VPMAX 0.26 1.34 -0.15 -0.35 95

13. InvestSense
The Active Management Value Ratio™
The preceding chart is an example of the AMVR
report we prepare for clients. We provide two sets
of both costs and returns analyses, allowing the
client to choose the cost and returns variables they
want to use in calculating a fund’s AMVR.
The funds represent six of the most commonly
used non-index funds in U.S. 401(k) plans.

14. InvestSense
The Active Management Value Ratio™
AMVR = Incremental Cost/Incremental Return
Most plan sponsors currently use nominal cost and
returns in calculating the AMVR for the funds in
their plan.
Most plaintiffs’ attorneys use the correlation-
adjusted costs and risk-adjusted returns data , as
they arguably provide a more meaningful
evaluation of a fund’s effective costs and returns.

15. InvestSense
Going Forward
The First Circuit Court of Appeals’ Brotherston
decision and SCOTUS’ decision not to hear the
case creates a significant and challenge for plan
sponsors and plan advisers going forward.
The fiduciary prudence standards created by the
Restatement (Third) of Trusts include a
requirement that actively managed be cost-
efficient to be chosen or recommended for 401(k)
plans.

16. InvestSense
Going Forward
The challenge for plan sponsors and plan advisers will
be more daunting given the fact that studies have
consistently shown that the overwhelming majority of
actively managed mutual funds are not cost-efficient,
with most not even being able to cover their costs.
The prudence process proposed herein provides plan
sponsors and plan advisers with a simple means to
provide plan participants with quality investment
options, while avoiding unnecessary liability exposure.

17. InvestSense
AMVR FAQ
For more information on the Active Management Value
Ratio™, including instructions on how to calculate the
metric, visit the following blogs:
“The Prudent Investment Fiduciary Rules”
(iainsight.wordpress.com)
“CommonSense InvestSense:
The Power of the Informed Investor”
(www.investsense.com)