On July 2, 2021, the Supreme Court agreed to review Seventh Circuit’s decision affirming dismissal of plaintiffs’ case for failure to state a claim in Hughes v. Northwestern, an excessive fee case.
In Hughes the Seventh Circuit took a view of excessive fee litigation that is in some respects at odds with the approach of other circuits, rejecting plaintiffs’ claims (1) that recordkeeping fees should be evaluated on the basis of a flat/per capita fee comparison with plans of similar size and (2) that investment fees are “excessive” and imprudent (under ERISA) where there is an identical lower cost investment alternative.
The decision to review this case presents the possibility that the Court will for the first time speak to issues that plaintiffs and defendants have been disputing for at least a decade.
In this article we highlight what is (perhaps) the most significant of those issues – the ERISA pleading standard for claims a plan fiduciary authorized or allowed a plan to pay excessive/imprudent investment and/or recordkeeping fees.
Northwestern maintains two ERISA-covered 403(b) plans, the Voluntary Savings Plan and the Retirement Plan. While 403(b) plans differ in some respects from 401(k) plans sponsored by for-profit businesses, the issues raised by plaintiffs are more or less identical to those raised in excessive fee lawsuits against corporate 401(k) sponsors, and plaintiffs’ attorney, Schlichter Bogard & Denton, LLP, is the principal law firm bringing excessive 401(k) fee cases.
Before October 2016, the Voluntary Savings Plan offered 187 options and the Retirement Plan offered 242 investment options. Both plans’ fund menus included investments through Teachers Insurance and Annuity Association of America and College Retirement Equities Fund (TIAA-CREF) and Fidelity Management Trust Company. TIAA-CREF was the recordkeeper for the TIAA-CREF offerings; Fidelity was recordkeeper for other plan offerings.
The Solicitor General’s brief in favor of review and reversal
Significant in this case (and possibly significant in the Supreme Court’s decision to accept it), on May 25, 2021, the US Solicitor General filed a brief in support of plaintiffs’ motion for review, arguing that, “[t]aking petitioners’ factual allegations as true at the pleading stage, [plaintiffs] have shown that [defendants] caused the Plans’ participants to pay excess investment-management and administrative fees when respondents could have obtained the same investment opportunities or services at a lower cost,” and that that showing is sufficient to state a prudence claim under ERISA.
The SG argued that the Supreme Court should review two specific claims by plaintiffs: (1) Plaintiffs’ allegation “that respondents selected retail-class investment funds for inclusion in the Plans even though identical institutional-class investment funds with lower management fees were available to the Plans based on their size.” And (2) plaintiffs’ allegation “that respondents failed to use any of several available methods to monitor and reduce the Plans’ cost of recordkeeping services.”
These are two of the major issues that have vexed excessive fee litigation for some time.
As is common in many of these excessive fee cases, plaintiffs claim that some of the 187/242 investment options available in the two plans were retail share classes in mutual funds for which there was an available, less expensive institutional share class, and that the failure by plan fiduciaries to negotiate for an institutional share class for these funds was imprudent.
The Seventh Circuit rejected this argument. It held that, regardless of the pricing of the retail share class mutual funds, because plan participants had available to them other, low-priced options that they could have chosen, inclusion of additional, higher priced options did not violate ERISA, citing earlier decisions by it to this effect:
We concluded in Hecker [v. Deere] and [Loomis v. Exelon] that plans may generally offer a wide range of investment options and fees without breaching any fiduciary duty. … Hecker (no breach of fiduciary duty where 401(k) plan participants could choose to invest in 26 investment options and more than 2,500 mutual funds through a brokerage window).
The Solicitor General argued that this rule, allowing a “wide range of investment options and fees,” conflicts with ERISA: “fiduciaries are not excused from their obligations not to offer imprudent investments with unreasonably high fees on the ground that they offered other prudent investments.”
And, while a “’bare allegation that cheaper alternative investments exist in the marketplace” [quoting Braden v. Wal-Mart] may not, on its own, state a claim, where a sponsor fiduciary is alleged to have “selected certain investment options instead of alternatives, offered by the same investment providers, that differed only in their lower costs,” that allegation alone is sufficient to state an ERISA prudence claim.
As we have discussed in the past, this sort of claim – that a fiduciary could have chosen identical, lower cost funds – has been a feature of excessive fee litigation for some time. It has been used to argue (as here) that selecting a retail fund share class, instead of an institutional share class, is imprudent. It has also been used to argue that the use of higher priced index funds is imprudent. Plaintiffs lawyers have tried, with less success, to extend this theory to claims that the use of mutual funds instead of collective trusts and/or separate accounts, the use of money market funds instead of guaranteed investment contracts, and (most speculatively) the use of actively managed funds instead of passive funds, are all imprudent.
In this regard, the SG has, effectively, adopted plaintiffs view of this issue. In fairness, DOL has always objected to a robust reading of Hecker v. Deere that would allow the inclusion of “overpriced” funds so long as competitively priced funds were also included in a plan fund menu.
The SG’s argument with respect to recordkeeping fees was even more focused. In dismissing plaintiffs’ recordkeeping fee claim, the lower court argued that a plan fiduciary is not required to adopt any particular sort of recordkeeping arrangement and that the plaintiffs had not shown that the flat fee arrangement for which they argued would benefit participants.
Rather than focus on what recordkeeping fee arrangement the plans’ fiduciaries had adopted, in its brief the SG focused on the inadequacy of the sponsor fiduciaries’ process, arguing that they “acted imprudently because a reasonable plan fiduciary would have monitored the recordkeeping fees paid by the Plans’ participants, determined whether those fees were competitive, and attempted to reduce them with-out experiencing diminished services.”
In that regard, the SG cited plaintiffs’ allegations that defendants could have “demanded ‘plan pricing’ rebates from [TIAA] based on the Plans’ economies of scale” and “failed to conduct a competitive bidding process for the Plans’ recordkeeping services.”
Thus, the SG, and DOL, seem to be taking the position that institutional pricing (for plans of sufficient size) and regular RFPs are, in effect, an ERISA minimum.
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As we discussed in our article on fiduciary obligations with respect to brokerage windows, it is still unclear – where a plan offers a variety of investment options, including “high priced” and “low priced” options – for which of those funds a fiduciary has a prudence obligation. Obviously, a rule something like the one articulated by the Seventh Circuit – that a variety of fund/pricing options can be offered as long as there are low-cost options available – would be appreciated by most sponsors and sponsor fiduciaries. But any clarity on this issue would be an advance over the current situation.
With respect to recordkeeping, a rule like that proposed by the Seventh Circuit would introduce flexibility into the recordkeeper selection process that would be appreciated by most sponsors.
We will continue to follow this issue.