But just how big of a win is it?
The U.S. Supreme Court recently issued a unanimous decision in Hughes v. Northwestern University, reversing and remanding a lower court ruling that had dismissed the case against a retirement plan sponsor. This decision reaffirms that the Employee Retirement Income Security Act’s (ERISA) fiduciary duty of prudence requires continuous monitoring of all investment options under a plan, especially when lower-cost share classes are available for funds.
There was hope the court would say that as long as there were prudent options in the plan, a duty to replace imprudent ones would be overridden. But, the court rejected that argument. While that holding provides a clear instruction to ERISA fiduciaries, what remains unanswered is the standard that plaintiffs must satisfy in their pleadings to survive a motion to dismiss. Some of the language in the court’s opinion suggests this standard could be a high one, resulting in this decision potentially being a Pyrrhic victory for plaintiffs.
Summary of ERISA fee litigation decision
Current and former employees of Northwestern University sued the university and its investment committee for breaching their ERISA fiduciary duty of prudence with respect to two 403(b) plans that allowed participants to direct the investment of their accounts. In particular, the plaintiffs alleged that the fiduciaries failed to monitor fees and expenses of investment options, resulting in funds with excessive fees that underperformed. They also asserted that the university offered too many investment options (over 400), which was confusing.
The District Court and Seventh Circuit dismissed the case as a matter of law. They explained that because prudent (low-cost) funds were available, the plaintiffs had the ability to select the investments they wanted. The ability to select prudent options eliminated any concerns about imprudent options. The Supreme Court, in an 8-0 decision, rejected that interpretation and remanded the case back to the Seventh Circuit. The court held that the Seventh Circuit erred by relying exclusively on participant choice. Being an ERISA fiduciary means there is a continuous duty to monitor investments and to remove imprudent ones. Accordingly, the court remanded the case so the lower courts could evaluate the specific claims presented by the plaintiffs.
Implications of unanimous decision
If the court affirmed the Seventh Circuit, that decision would have provided more breathing room for the plan fiduciaries as compared to current law. While that may appear to be a victory for plaintiffs in the future, such a victory could prove to be limited. Today’s opinion does not rule directly on the question that the plaintiffs had asked the high court to consider — whether a complaint can survive a motion to dismiss when it alleges that a defined contribution retirement plan paid or charged its participants fees that substantially exceed fees for alternative available investment products or services. Instead, the court chose to identify the lower court’s error in saying choice excuses the inclusion of imprudent investments.
The plaintiffs asserted that a complaint should survive a motion to dismiss by simply alleging that the plan paid or charged its participants fees that substantially exceed fees for alternative available investment products or services. The court’s opinion, however, has language that suggests such a standard should not apply. The opinion states: (1) the evaluation of a fiduciary’s decision is a context-specific inquiry; and (2) “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” The court did not need to include this language to reach its decision, so its inclusion could be interpreted as a signal that complaints that do not take into account such subtleties could be deficient.
Action items for plan fiduciaries
Until the pleading standard gets resolved, what should fiduciaries do? Essentially, they need to follow the best practices they should have been following all along. In particular, the decision reminds fiduciaries to be mindful of the following responsibilities:
- Review and analyze each investment option. Having a large investment menu is not enough to protect fiduciaries. If anything, a large menu may capture poorly performing funds with high fees and thus may be counter-productive. The court made clear in its decision that a fiduciary has a duty to analyze whether the inclusion of each investment option is prudent.
- Continuously monitor whether retaining investment options is prudent. In addition to selecting investment options prudently, the court’s decision stressed that fiduciaries also have an ongoing duty to monitor investments and remove imprudent ones. Fiduciaries periodically should review both performance and fees to determine whether retention of funds is prudent.
- Document the decisions made to add, remove or retain funds. The court’s language about providing deference to reasonable judgements of fiduciaries means that fiduciaries should document the process and analysis behind investment lineup decisions. A well-documented record can show courts that fiduciaries acted prudently under any given set of circumstances.
The first two items can help reduce the risk of being sued. The third item can help fiduciaries receive deference from a court in the event of a lawsuit. Consulting with financial and legal counsel can help fiduciaries strengthen these defenses.