Sixth Circuit holds that retail vs. institutional share class claim cannot be dismissed on motion

We recently discussed a June 8, 2022, decision by the Sixth Circuit for defendants, upholding their motion to dismiss a 401(k) ERISA prudence case based on a claim that the selection as the plan’s default investment of a target date fund that used actively managed funds, rather than the same fund operator’s passive fund TDF, was imprudent. In this article we discuss a July 22, 2022, decision by the same court, in favor of plaintiffs and denying defendants’ motion to dismiss, holding that a claim based on the use of a retail share class, rather than a less-expensive institutional share class, was sufficient to survive a motion to dismiss.

Background

Defendant TriHealth is a healthcare provider. Plaintiffs are participants in TriHealth’s 401(k) plan. They make a number of claims typical of 401(k) ERISA prudence litigation. The one we focus on in this article is their claim that “for seventeen of the offered mutual funds [i.e., funds included in the plan’s fund menu], … the plan failed to offer cheaper institutional shares instead of more expensive retail shares.”

Holding

The court began its analysis of plaintiffs’ claim by referencing the Supreme Court’s decisions in Hughes v. Northwestern Universityand Fifth Third Bancorp v. Dudenhoeffer:

In assessing the prudence of a plan administrator’s decision-making process, context often is destiny. The various “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.” Hughes v. Nw. Univ. A “careful, context-sensitive scrutiny of a complaint’s allegations” provides “one important mechanism for weeding out meritless claims.” Fifth Third Bancorp v. Dudenhoeffer.

It then found that “[e]ven if a prudent investor might make available a wide range of valid investment decisions in a given year, only an imprudent financier would offer a more expensive share when he could offer a functionally identical share for less.”

CommonSpirit distinguished

The court distinguished the current facts – the prudence of using a retail share class when an institutional share class was available – from the facts in its recent decision in CommonSpirit:

TriHealth … argues that [plaintiffs] needed to “provide a sound basis for comparison—a meaningful benchmark”—to state a claim, namely more specific allegations about the characteristics of the lower-cost share classes with comparisons to the performance of the more expensive share classes and to the market as a whole. … Important though the “meaningful benchmark” hurdle may be, it is at its most salient when a beneficiary challenges an investment choice in a vacuum. The plaintiff in that setting must do the work of showing that the comparator investment has sufficient parallels to prove a breach of fiduciary duty. [citing CommonSpirit] But if the plaintiff, as in this case, alleges that the fiduciary should have chosen a less expensive share class (with the same investment strategy, portfolio, and management team), the meaningful benchmark comes with the claim.

Thus, while a passive fund TDF is not a good comparator for an active fund TDF (even from the same fund operator), an institutional share class is a good comparator for a retail share class (for the same mutual fund).

Proving that the use of retail share classes was prudent

The court acknowledged that defendants might have had a (prudent) reason for choosing a retail share class over an institutional share class:

Taken in their most flattering light, [plaintiffs’] allegations permit the reasonable inference that TriHealth failed to exploit the advantages of being a large retirement plan that could use scale to provide substantial benefits to its participants. … Equally reasonable inferences in the other direction, we appreciate, could exonerate TriHealth once all of the facts come in. Perhaps the fund is not large enough or does not have enough participants interested in a particular investment to qualify for the less expensive share class. Perhaps the plan has revenue-sharing arrangements in place that make the retail shares less expensive or that benefit plan participants on the whole. But at the pleading stage, it is too early to make these judgment calls. “In the absence of further development of the facts, we have no basis for crediting one set of reasonable inferences over the other. Because either assessment is plausible, the Rules of Civil Procedure entitle [plaintiffs] to pursue [their imprudence] claim (at least with respect to this theory) to the next stage.”

Thus, whether or not the use of a retail share class was (in fact) prudent would depend on a trial (or a motion for summary judgment) on the facts. And, plaintiffs were allowed to proceed to discovery.

Practicality of discovery

As we have discussed, the motion to dismiss in these cases is often (even, typically) the critical decision point. Where a claim is allowed to proceed to discovery, defendants argue that settlement is (in many cases) inevitable, as the cost of discovery will outweigh the benefit of any further litigation.

The Sixth Circuit took a different point of view of this issue:

This wait-and-see approach … makes sense given that discovery holds the promise of sharpening [ERISA’s] process-based inquiry. Maybe TriHealth “investigated its alternatives and made a considered decision to offer retail shares rather than institutional shares” because “the excess cost of the retail shares paid for the recordkeeping fees under [TriHealth’s] revenue-sharing model.” [Citations omitted.] Or maybe these considerations never entered the decision-making process. In the absence of discovery or some other explanation that would make an inference of imprudence implausible, we cannot dismiss the case on this ground. Nor is this an area in which the runaway costs of discovery necessarily cloud the picture. An attentive district court judge ought to be able to keep discovery within reasonable bounds given that the inquiry is narrow and ought to be readily answerable.[Emphasis added.]

Takeaways for plan sponsors

It appears, in the Sixth Circuit at least, that plan fiduciaries will be open to litigation, which they will not be able to dispense with on a motion to dismiss if they select (for the plan’s fund menu) retail share classes, where institutional share classes would be available to them in that plan.

It may be possible, where, e.g., revenue sharing on the retail share class makes it a “better deal” for participants than the institutional share class, that a plan fiduciary may do something “in advance” to avoid this litigation risk. That is, before a plaintiff can be found and a lawsuit is filed. It’s not clear, at this point, what that “something” might be. And sponsors considering using retail share classes will want to consult with counsel on this issue.

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As we said in our last article, this is an evolving area of the law. Other courts (in other circuits) may view these issues differently.

We will continue to follow these issues.