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 the Supreme Court’s decision.
Northwestern University 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.
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.
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.
As is typical of 401(k) fee litigation, plaintiffs alleged that there were “otherwise-identical alternative investments,” and comparable, lower-cost recordkeeping, available.
The Supreme Court’s decision
The Supreme Court first described the standard to be applied to these issues as the one first articulated by it in Tibble v. Edison: that “[a] plaintiff may allege that a fiduciary breached the duty of prudence by failing to properly monitor investments and remove imprudent ones.” [Emphasis added.]
Applying that standard, 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:
In rejecting petitioners’ allegations, the Seventh Circuit did not apply Tibble’s guidance. Instead, the Seventh Circuit focused on another component of the duty of prudence: a fiduciary’s obligation to assemble a diverse menu of options. The court determined that respondents had provided an adequate array of choices, including “the types of funds plaintiffs wanted (low-cost index funds).” … In the court’s view, these offerings “eliminat[ed] any claim that plan participants were forced to stomach an unappetizing menu.”
This reliance by the Seventh Circuit “on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents” was an error. A similar analysis applied with respect to the recordkeeping claims, where “[t]he [Seventh Circuit] noted that ‘plan participants had options to keep the expense ratios (and, therefore, recordkeeping expenses) low.’”
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.”
The Supreme Court therefore vacated the Seventh Circuit’s decision and remanded the case to the Seventh Circuit for re-consideration.
Standard to apply on review
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.]
Takeaways for plan sponsors
Choice is not a “categorical” defense: The theory first proposed in the Seventh Circuit’s decision in Hecker v. Deere, on which it relied in its (now vacated) decision in Hughes v. Northwestern – that a diverse set of investment options may be a defense to a claim that one of those options may be imprudently costly – has now been explicitly rejected.
Fiduciaries may make a range of reasonable judgments:Nevertheless, there is a “range of reasonable judgments” that a fiduciary may come to in any specific context.
Motions to dismiss may be harder to win under this standard:A critical issue for sponsors in 401(k) prudence litigation is the ability to dispose of speculative lawsuits via a motion to dismiss. The Supreme Court’s emphasis that a court’s analysis of prudence issues must be “context specific” may make it more difficult for sponsor fiduciaries to win such motions to dismiss. How courts subsequently apply the rules under Hughes will be critical.