On June 19, 2020, plaintiffs in Hughes v. Northwestern University – an “excessive fee” case – filed a Writ of Certiorari, asking the Court to review a Seventh Circuit decision affirming a district court’s grant of defendants’ motion to dismiss.
In Hughes v. Northwestern 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 that (1) recordkeeping fees should be evaluated on the basis of a flat/per capita fee and relative to plan size and (2) investment fees are “excessive” and imprudent (under ERISA) where there is an identical lower cost alternative.
On October 5, 2020, the Supreme Court invited the Acting Solicitor General to file a brief “expressing the views of the United States” in this case.
In this article we briefly review what may be at stake for 401(k) plan sponsors in a possible Supreme Court review.
Northwestern maintained 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.
A key element in the lower courts’ analysis of the case was the link between the TIAA-CREF Annuity, Stock Account, and recordkeeping. The TIAA-CREF Traditional Annuity, “a fixed annuity contract that returns a guaranteed, contractually specified minimum interest rate,” was a popular option under the plans. Termination of the TIAA-CREF annuity could be expensive for participants investing in it – withdrawals from the TIAA-CREF annuity were subject (in some cases) to a 2.5% surrender charge. And it was TIAA policy that if the Traditional Annuity were offered, then the plan must also offer the TIAA-CREF Stock Account and use TIAA as recordkeeper for all TIAA offerings.
This feature of Northwestern is not typical of corporate 401(k)s and may provide a basis for a decision (if the Supreme Court takes this case) that is in effect limited to clients of TIAA-CREF.
Among other claims, plaintiffs alleged that Northwestern plan fiduciaries breached their ERISA fiduciary duty of prudence by (1) including the TIAA-CREF Stock Account and certain other funds (including certain retail mutual funds) in the plan’s fund menu and (2) allowing TIAA-CREF to serve as a recordkeeper for its funds (and using two different recordkeepers), claiming that the fees charged by TIAA-CREF for investment and recordkeeping services were excessive.
The Seventh Circuit decision
Plaintiffs claimed that both plan recordkeeping fees and the fees for certain funds offered as investment options (including the Stock Account) were excessive. In evaluating these claims, the Seventh Circuit took an approach that differed in some respects from that of other circuits.
How should recordkeeping fees be evaluated?
As in other “excessive recordkeeping fee” cases, plaintiffs alleged that the plans should have paid a flat, per capita recordkeeping fee, and that given the size of the Northwestern plans, that fee should have been $35 per participant per year. Instead, under a revenue sharing arrangement, annual recordkeeping fees averaged $54-$87 for the Voluntary Savings Plan and $153 to $213 for the Retirement Plan.
The Seventh Circuit’s reasons for rejecting this claim included:
First, that Northwestern had a good reason – the popularity of the TIAA-CREF annuity and the expense of withdrawal from it – for continuing to offer the TIAA-CREF annuity and for accepting TIAA-CREF’s requirement that if the annuity is offered then the Stock Account must also be offered and TIAA must be the recordkeeper for both offerings.
Second, that any participant could avoid what plaintiffs considered to be the problems with TIAA-CREF’s products ”simply by choosing from hundreds of other options within a multi-tiered offering system.”
Third, the court questioned whether recordkeeping should (or must) be evaluated on a flat fee basis, finding that:
[P]laintiffs fail to support their claim that a flat-fee structure is required by ERISA, see [Hecker v. Deere] … (asset-based fees “violate no statute or regulation”), or would even benefit plan participants. Indeed, such a structure may have the opposite effect of increasing administrative costs by failing to match the pro-rata fee that individual participants could achieve at a lower cost through exercising their investment options in a revenue sharing structure. Either way, this court has recognized that although total recordkeeping fees must be known to participants, they need not be individually allocated or based on any specific fee structure.
A number of courts in other circuits have adopted a flat fee analysis as standard.
Must all funds in the plan be the “lowest cost?”
As in “excessive investment fee” cases, plaintiffs alleged that there were other identical (or nearly identical) lower cost funds available. In this regard, plaintiffs alleged that “some [plan investment] options were retail funds with retails fees, some had ‘unnecessary’ layers of fees, and some could have been cheaper but Northwestern failed to negotiate better fees.” And plaintiffs argued that the Eighth Circuit’s decision in Braden v. Wal-Mart Stores, Inc. supports “a blanket prohibition on retail share classes.”
The court rejected this argument, distinguishing Wal-Mart because there “the court found imprudence because the investment plan included a ‘relatively limited menu of funds’ – ten – which ‘were chosen to benefit the trustee at the expense of the participants.’”
The court then resurrected a robust reading of Hecker v. Deere, holding that:
We concluded in Hecker 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).
Further in this vein, the court quoted (and “echoed”) the district court:
The [district] court explained that the “[p]laintiffs might have a different case if they alleged that the fiduciaries failed to make [the low-cost index funds preferred by plaintiffs] available to them.” But plaintiffs’ allegations describe the freedom they had under the plans to invest in the fund options they wanted. … The court concluded “these allegations [cannot] add up to a breach of fiduciary duty.”
This language cuts against a number of post-Hecker precedents and highlights what has been a very gray area of fiduciary litigation – which funds must a fiduciary select-and-monitor-with-prudence, especially where the plan offers hundreds (or thousands) of investment alternatives? Consider decisions in recent cases involving brokerage windows (e.g., Moitoso v. FMR) that we discussed in our June 2020 article Fiduciary obligations with respect to a brokerage window.
Petition for Supreme Court review
Plaintiffs’ petition for Supreme Court for review of the Seventh Circuit’s decision argues that the allegations in Northwestern are “substantively identical” to claims that were approved in Third Circuit (Sweda v. University of Pennsylvania) and Eighth Circuit (Davis v. Washington University in St. Louis) decisions and that the Seventh Circuit’s holdings are in conflict with holdings in the Third, Eighth, and Ninth Circuits.
A “split in the Circuits” is generally considered a ground for the Supreme Court taking review of a case.
What is at stake for 401(k) plan sponsors in this litigation?
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 – to which 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.
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We will continue to follow this issue.