In early 2022, the U.S. Supreme Court considered a case brought against Northwestern University’s retirement plan committee for not offering the lowest-cost retirement plan or the best available investment funds. The Supreme Court disagreed with the 7th U.S. Circuit Court of Appeals’ decision to dismiss the case, sending it back to that court to reevaluate.
Motions in the remanded case, Hughes v. Northwestern, were ruled on by the 7th Circuit again in a March 23 ruling by a three-judge panel. With the Supreme Court guidance, the panel decided two of three claims against the plan sponsor should go back to a district court for further consideration. The upshot, according to legal analysis, is that the new ruling will likely open the door to more litigation attempts regarding fiduciary decisions related to retirement plan administration and fees covered by the Employee Retirement Income Security Act of 1974.
The circuit court’s “focus on ‘plausibly alleging fiduciary decisions outside a range of reasonableness’ and conducting a context-specific inquiry into that range of reasonableness will likely result in more questions—and most certainly more litigation,” Faegre Drinker ERISA attorneys Kimberly Jones and Isaac Hall wrote in response to the ruling.
The three claims the 7th Circuit considered from the plaintiffs, a group of Northwestern employees as represented by April Hughes, were: 1) failure to monitor and manage recordkeeping fees; 2) failure to swap out higher-fee retail shares of mutual funds and annuities for cheaper, yet identical, institutional shares; and 3) keeping duplicative funds in the plan that caused participant confusion in making investment decisions.
The panel ruled that the first two claims can go ahead. The court dismissed the third claim because the plaintiffs did not bring it forward when the case was remanded from the Supreme Court, also noting it did not meet the standards to continue.
The opinion, by U.S. Circuit Chief Judge Diane S. Sykes, U.S. Circuit Judge David F. Hamilton and U.S. Circuit Judge Michael B. Brennan, sends the case back to the U.S. District Court for the Northern District of Illinois, Eastern Division.
‘Equipoise’ Goes to the Plaintiff
In its decision, the 7th Circuit panel referred to the duty of prudence mandated in ERISA, in which a plan fiduciary is required to “systematically review” funds in the plan both at inclusion and at regular intervals. It also noted precedent that a fiduciary only incur “reasonable” costs because “expenses, such as management or administrative fees, can sometimes significantly reduce the value of an account in a defined-contribution plan.”
When considering similar precedent, the Supreme Court wrote in 2022 that “at times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the reasonable range of judgements a fiduciary may make based on her experience and expertise.”
The 7th Circuit, however, disputed that analysis in its March decision, noting that the case the Supreme Court cited for precedent, Fifth Third Bancorp v. Dudenhoeffer, was based on an employee stock ownership plan in which fiduciaries allegedly had negative inside information about the stock the plan contained and put the duty of prudence on it being “context specific.”
In Hughes v. Northwestern, the 7th Circuit stated in its most recent ruling that the real emphasis should be on the “difficult tradeoffs” that fiduciaries face, as well as the “reasonable range of judgments.” When viewed through that lens, the 7th Circuit considered whether there was an “obvious alternative explanation” that the fiduciary should have assessed for the plan.
“Where alternative inferences are in equipoise—that is, where they are all reasonable based on the facts—the plaintiff is to prevail,” the court wrote.
The ruling included the caveat that, in some cases, a fiduciary’s conduct may be more reasonable and better supported than the plaintiff’s plea. In that circumstance, the case should be dismissed. But in instances where the plea can allege “fiduciary decisions outside the range of reasonableness,” they can continue.
Two Out of Three
In the original complaint, the plaintiffs alleged that Northwestern neglected to monitor its recordkeeping fees under its revenue-sharing fee arrangement. Instead, they alleged, the university continued to contract with TIAA and Fidelity Investments instead of consolidating to one plan through a process of bidding and negotiating for rebates from other providers.
Northwestern argued that the plea failed to demonstrate that consolidating into one recordkeeper was an option or that a different recordkeeper would have accepted a lower fee.
As reviewed most recently by the 7th Circuit, the judges decided that the plaintiffs gave enough evidence to make a case.
“Plaintiffs have sufficiently alleged that recordkeeper consolidation and soliciting an equally capable but lower-cost recordkeeper were available options,” the 7th Circuit wrote. “Plaintiffs point to other institutions that had successfully consolidated and reduced fees. And they maintain that the market is competitive with equally capable recordkeepers who can provide comparable services for less.”
On the second count in question, the plaintiffs originally alleged that Northwestern selected and retained retail investment options with “high expenses and poor performance relative to other investment options.” Those options, they argued, are often available to large defined contribution plans as fund managers will provide a discount for use.
Northwestern, for its part, argued that the plaintiffs had not provided enough evidence that institutional-class shares were actually available to the plans. The university also said retail-class shares are better than institutional offerings because their higher fees allow plans, through revenue sharing, to foot the bill for recordkeeping and other expenses.
Here again, the 7th Circuit found in the most recent decision that a plaintiff is only required to show that lower-cost institutional shares were plausibly available.
“Northwestern’s alternative explanations about the unavailability of institutional-class shares or the advantages of using higher revenue-sharing payments in retail shares to defray recordkeeping costs, could explain Northwestern’s failure to swap out its retail for institutional shares,” the decision stated. “But based on the facts pleaded, these alternative inferences are not strong enough to overcome the equally, if not more, reasonable inference that Northwestern failed to use its size to bargain for cheaper institutional shares.”
Finally, the 7th Circuit noted in the most recent decision that the allegation of offering too many funds causing confusion did not change prior precedent and that without more evidence, it should be dismissed as a breach of fiduciary duty.
For Fiduciaries, Troubling
The attorneys at Faegre Drinker concluded in a post about the ruling that plan fiduciaries may find the 7th Circuit’s latest decision “particularly troubling.” The decision, they noted, does not require plaintiffs to allege actual alternatives for the retirement plan decisions; only that other options are possible.
“The standard does not affect how plan fiduciaries review, choose, and monitor investment choices and recordkeeping fees, but makes it easier to second-guess those decisions without fully understanding the ‘circumstances prevailing’ at the time the fiduciary acts,” they wrote.
Willkie Farr & Gallagher LLP represents Northwestern. Schlichter Bogard & Denton LLP represents the plan participants. Neither firm immediately responded to request for comment on the ruling.
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