On January 24, 2022, in a unanimous decision, the Supreme Court vacated the Seventh Circuit’s decision in Hughes v. Northwestern – an ERISA prudence case implicating a number of issues that have been raised in 401(k) fee litigation. The Court rejected the Seventh Circuit’s reliance on the availability of lower cost alternatives as a defense to claims that the cost of certain funds and of plan recordkeeping was unreasonably high, remanding the case for consideration under the rule in Tibble v. Edison, that a fiduciary has an obligation to remove imprudent investments.
In this article we briefly review three post-Hughes v. Northwestern cases. In all three cases, the courts found that plaintiffs’ claims – that plan fiduciaries violated ERSIA’s prudence requirement by including funds in the plan fund menu when there were other, “identical” lower-fee funds available – were sufficient to avoid a motion to dismiss and that plaintiffs could proceed to discovery.
Background – Supreme Court decision in Hughes v. Northwestern
In its decision in Hughes v. Northwestern, the Supreme Court found that the Seventh Circuit had improperly focused on the availability of alternative low-cost options when it should have been reviewing the prudence of each option. This reliance by the Seventh Circuit “on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents” was an error.
Instead of such a “categorical rule” – e.g., that a diverse fund menu may excuse the inclusion of certain “imprudent” funds – courts must apply a “context-specific inquiry” taking into account the sponsor fiduciary’s “duty to monitor all plan investments and remove any imprudent ones.”
In characterizing the analysis the Seventh Circuit should engage in on remand, the Supreme Court stated:
“Because the content of the duty of prudence turns on ‘the circumstances . . . prevailing’ at the time the fiduciary acts, … the appropriate inquiry will necessarily be context specific.” [Citing Fifth Third Bancorp v. Dudenhoeffer] At times, 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. [Emphasis added.]
Follow up to Hughes v. Northwestern – Goodman v. Columbus Regional Healthcare System
On January 25, 2022, the United States District Court for the Middle District of Georgia denied defendant fiduciaries’ motion to dismiss ERISA prudence claims with respect to the selection and continued retention of funds in Columbus Regional Healthcare’s defined contribution plan and the fiduciaries’ failure to “adequately monitor or manage the Plan’s administrative expenses,” most critically with respect to recordkeeping fees.
With respect to fund selection/retention, plaintiffs (as is common in 401(k) fee litigation) alleged: (1) That Columbus Regional Healthcare “offered mutual funds in the form of retail share classes even though it could have obtained otherwise identical institutional share classes of the same investments with significantly lower fees.” (2) That Columbus Regional Healthcare “selected and maintained investments with a history of underperformance, then failed to remove them from the investment menu when they continued to underperform.” And (3) that the Columbus Regional Healthcare plan’s “investment menu focused on an active management strategy” that “highlighted” high-fee actively managed funds, making them the plan’s default option, and limited passive fund options.
In finding that plaintiffs’ pleadings were adequate to survive a motion to dismiss – with respect to which plaintiffs’ allegations are assumed to be true – the district court explicitly referred to the Supreme Court’s decision in Hughes v. Northwestern:
The Supreme Court has suggested that a defined contribution plan participant may state a claim for breach of ERISA’s duty of prudence by alleging that the plan fiduciary offered higher priced retail-class mutual funds instead of available identical lower priced institutional-class funds. [Citing Hughes v. Northwestern.] And the Court is satisfied that Plaintiffs state a plausible claim that continuing to offer underperforming mutual funds with excessive expense ratios despite a consistent history of underperformance would violate ERISA’s duty of prudence.
With respect to recordkeeping fees, the court found (similarly) that plaintiffs’ allegations – that the fees “were nearly double what a reasonable recordkeeping fee would have been for a similarly sized ERISA plan” – were adequate to survive a motion to dismiss.
The significance of the motion to dismiss
In effect, in Goodman v. Columbus Regional Healthcare, the court treated issues of the prudence of fees, the comparability of different funds, and the underperformance of funds as issues of facts to be determined after discovery, rather than foreclosed by a motion to dismiss.
Thus, with respect to the underperformance claim, the court stated:
The parties disagree on the existence and extent of the alleged underperformance, and each side argues that its method for calculating the numbers provides the correct analysis. The Court finds that Plaintiffs adequately alleged underperformance for purposes of the present motion to dismiss, though a more fully developed record may establish otherwise at the summary judgment stage.
As many (including, in oral argument, some Supreme Court justices) have noted, however, rather than go to the expense of extensive discovery, after a denial of a motion to dismiss, many of these cases are settled.
Two Ninth Circuit decisions
The Ninth Circuit recently issued two (“unpublished”) decisions, in Davis v. Salesforce (April 8, 2022) and Kong v. Trader Joe’s (April 15, 2022), in both of which it reversed lower court grants of motions to dismiss in 401(k) fee cases.
In both cases, the court found that allegations – that (e.g., in Trader Joe’s) plan fiduciaries failed “to monitor and control the offering of a number of mutual funds in the form of ‘retail’ share classes that carried higher fees than those charged by otherwise identical ‘institutional’ share classes of the same investments” – were sufficient to survive a motion to dismiss. The court held that defendants’ explanation – that the decision to include retail funds was justified by related revenue sharing agreements – was “unavailing” at the stage of a motion to dismiss. In effect, the prudence of the retail fee + revenue sharing arrangement would have to await a trial on the facts.
Indeed, in Salesforce, the court went so far as to allow plaintiffs’ allegations that defendants should have used (allegedly lower cost) collective trusts rather than mutual funds:
Plaintiffs have also adequately alleged, in the alternative, that defendants imprudently failed to investigate and timely switch to available collective investment trusts, which plaintiffs allege had “the same underlying investments and asset allocations as their mutual fund counterparts” but had better annual returns and a lower net expense ratio.
Again, the court found that the value of differences between mutual funds and collective trusts would have to be sorted out in a trial of the facts: “Whether the different regulatory regimes governing mutual funds and collective investment trusts justified defendants’ delay in making the switch earlier is itself a factual issue that cannot be resolved at the pleading stage.”
The Salesforce court did not, however, extend this treatment to plaintiffs’ claims with respect to actively managed funds, holding that “plaintiffs have not plausibly alleged that defendants breached the duty of prudence by failing to adequately consider passively managed mutual fund alternatives to the actively managed funds offered by the plan.”
Finally, we note that, in reaching its decision in Trader Joe’s, the Ninth Circuit included a citation of Hughes v. Northwestern, noting that “the appropriate inquiry will necessarily be context specific,” language which could (at a stretch) be read to imply that these issues are necessarily fact-based.
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These decisions represent a disturbing development following on the Supreme Court’s decision in Hughes v. Northwestern.
It is certainly possible to read Hughes as a remand to the Seventh Circuit to determine how these sorts of claims – where imprudence is alleged based on an (arguably superficial) comparison of fees, and without considering factors such as revenue sharing or the non-comparability of funds – should be considered at the motion to dismiss stage.
These courts (the ones deciding the cases discussed above), however, seem to be reading Hughes v. Northwestern as explicitly holding that those sorts of claims are sufficient to survive a motion to dismiss.
Nevertheless, it is still early days. The Hughes v. Northwestern decision is barely three months old. And we do not have a Seventh Circuit decision on remand.
We will continue to follow this issue.