The lawsuit against Northwestern University (Hughes v. Northwestern University) claiming that it breached its fiduciary duties with respect to its two 403(b) retirement plans has been a seven-year saga that has taken the case up and down the levels of the federal court system, all the way to the United States Supreme Court and back. For those just tuning in, this case is one of the many “excess fee” cases brought against retirement plans in recent years and more specifically is one of the many suits brought against large university 403(b) plans alleging various ERISA violations. We continue to see multi-million dollar settlements regularly reported in these types of cases.
The plaintiffs filed suit in 2016, alleging that Northwestern violated its duty of prudence under ERISA by, among other things, offering needlessly expensive investment options and paying excessive recordkeeping fees. The district court and the 7th Circuit Court of Appeals ruled in favor of the defendant’s motion to dismiss the complaint, with the 7th Circuit’s dismissal based in part on its conclusion that the inclusion of funds with excessive fees in the plans did not constitute a fiduciary breach as long as lower-cost funds were also available in the menu of investment choices. However, the Supreme Court disagreed, saying that based on the precedent of its Tibble v. Edison decision, plan fiduciaries must separately evaluate and monitor all the options that are in a plan’s investment menu. Unless fiduciaries remove an imprudent investment from the plan within a reasonable time they are in breach of their fiduciary duty. The Supreme Court sent the case back down to the 7th Circuit to determine the plaintiffs’ allegations in light of Tibble, and to reconsider whether the claims should be dismissed by applying the pleading standard established in other prior Supreme Court cases.
On March 23, 2023, the 7th Circuit issued its opinion after the remand from the Supreme Court. Following the Supreme Court’s direction, the 7th Circuit changed its original holding and reinstated some, but not all, of the plaintiff’s claims and remanded the case back to the district court.
The 7th Circuit’s holding is significant because it potentially makes it easier for a plaintiff in an excess fee case to survive a motion for summary judgment. From the perspective of the defendant retirement plan sponsor, once a case is allowed to continue beyond summary judgment, defending it can start to become expensive.
While some of the issues in Hughes are primarily applicable to 403(b) plans, the ERISA principles and pleading standards discussed have general applicability to the 401(k) cases as well. Some of the 7th Circuit’s conclusions include the following:
1. Pleading standard: The Court articulated the pleading standard for an excess fee claim to prevail on a motion to dismiss. Under this standard, a plaintiff must allege enough facts to show that a prudent fiduciary would have taken steps to reduce fees and remove imprudent investments. While the defendant can provide an explanation why such steps were not followed or not available, this decision appears to lower the bar for the plaintiff to rebut that explanation and avoid being dismissed.
2. Excess recordkeeping fees: The plaintiff alleged that the fiduciaries failed to monitor and control recordkeeping expenses. The plan engaged two recordkeepers and fees were charged based on a percentage of assets and not as a flat fee per participant. The Court reaffirmed that ERISA does not require a flat fee structure and acknowledged that Northwestern had an alternative explanation about why it used multiple recordkeepers. But the Court also observed that just because the recordkeeping arrangement was not a per se ERISA violation, it doesn’t mean it was a prudent choice. The determination of prudence would require further analysis so the claim should not be dismissed. The Court also found that plaintiffs had plausibly alleged that Northwestern’s failure to obtain comparable recordkeeping services at a substantially lesser rate was outside the range of reasonable actions that the university could take as plan fiduciary, so they had met their pleading requirement to defeat a motion to dismiss.
3. Fund class: Plaintiffs alleged that Northwestern retained more expensive retail-class shares of mutual funds when, by using Northwestern’s size and correspondent bargaining power, less expensive but otherwise identical institutional class shares were available to the Plans. Northwestern argued that the institutional class shares were “not necessarily available”. But the Court said that the plaintiffs were only required to plead that the cheaper institutional fund shares were “plausibly available”. Northwestern also argued that there were advantages to retail funds over institutional funds. The Court did not find this argument more persuasive than the plaintiffs’ claim that institutional funds were far less expensive, so the Court said that the plaintiffs had stated a claim that could not be dismissed at this point.
4. Duplicative Funds: Plaintiffs claimed that the excessive number of options in the Plans caused “decision paralysis” and led to investor confusion. The Court affirmed its prior dismissal of this claim, saying that the plaintiffs had not identified how plaintiffs were confused and personally injured by the multiplicity of funds and that unspecific allegations that a fiduciary provided too many funds, without more, do not state a claim for breach of the duty of prudence.
Take-aways:
It appears that the 7th Circuit holding in Hughes may make it easier for plaintiffs bringing an excess fee case to construct pleadings that can survive a motion to dismiss. We will need to see how the lower courts apply this and if other circuits follow this approach. But in any event, it does not change our standard approach: plan fiduciaries must develop and follow systems and processes to ensure that their duties and obligations under ERISA are being met. This will help a plan’s fiduciary to be ready before a lawsuit starts. Some general tips for fiduciaries include:
Regularly monitor the performance and expenses of investment options, recordkeepers, and other service providers
Take action to replace a fund or service provider when it is no longer prudent to use them
Review plan documents and service agreements. Make sure they are up to date and that the plan is operated in conformance with the plan document
Keep current with new developments and conduct regular fiduciary training
Monitor other fiduciaries to the plan
Review your plan’s cybersecurity practices and controls
Create regular processes and document your decisions
Review insurance policies and coverages: fiduciary, cyber, fidelity, and other as needed
For more information or if you want assistance in complying with this requirement, please feel free to contact your Boutwell Fay LLP attorney or email us at attorneys@boutwellfay.com.
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