The U.S. Supreme Court has issued a highly anticipated ruling in an Employee Retirement Income Security Act (ERISA) lawsuit known as Hughes v. Northwestern University.
The question before the high court was whether participants in a defined contribution (DC) ERISA plan stated a plausible claim for relief against plan fiduciaries for breach of the duty of prudence by alleging that the plan sponsor fiduciaries caused the participants to pay investment management and administrative fees higher than those available for other materially identical investment products or services.
Specifically, the plaintiffs in the case sued the defendants for allegedly breaching ERISA’s duty of prudence in the following three ways: failing to monitor and control recordkeeping fees, resulting in unreasonably high costs to plan participants; offering mutual funds and annuities in the form of “retail” share classes that carried higher fees than those charged by otherwise identical share classes of the same investments; and offering options that were likely to confuse investors.
Initially, the district court hearing the case granted the respondents’ motion to dismiss—a ruling which the 7th U.S. Circuit Court of Appeals affirmed, concluding that the petitioners’ allegations failed as a matter of law. But following its review of the case and the parties’ oral arguments, the Supreme Court has unanimously determined that the 7th Circuit in fact “erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by [the defendants].”
In its new ruling, the Supreme Court explains that the act of determining whether petitioners state plausible claims against plan fiduciaries for violations of ERISA’s duty of prudence requires “a context-specific inquiry of the fiduciaries’ continuing duty to monitor investments and to remove imprudent ones, as articulated in Tibble v. Edison International.” The Tibble case, which the Supreme Court ruled on in 2015, similarly involved allegations that plan fiduciaries had offered higher priced retail-class mutual funds as plan investments when materially identical lower priced institutional-class mutual funds were available.
As summarized in the new ruling, the Tibble order concluded that the plaintiffs in that instance had identified a potential violation with respect to certain funds because “a fiduciary is required to conduct a regular review of its investment.” The new ruling states that Tibble’s discussion of the continuing duty to monitor plan investments applies in the Northwestern case.
As the Supreme Court states in a summary syllabus attached to its new ruling, the plaintiffs in the case against Northwestern University allege that the defendants’ failure to monitor investments prudently—by retaining recordkeepers that charged excessive fees, offering options likely to confuse investors, and neglecting to provide cheaper and otherwise-identical alternative investments—resulted in the defendants failing to remove imprudent investments from the menu of investment offerings.
“In rejecting [the plaintiffs’] allegations, the 7th Circuit did not apply Tibble’s guidance but instead erroneously focused on another component of the duty of prudence: a fiduciary’s obligation to assemble a diverse menu of options,” the summary states. “But [the defendants’] provision of an adequate array of investment choices, including the lower-cost investments plaintiffs wanted, does not excuse their allegedly imprudent decisions. Even in a defined contribution plan, where participants choose their investments, Tibble instructs that plan fiduciaries must conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.”
The new ruling concludes that, if the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they indeed breach their fiduciary duty.
“The 7th Circuit’s exclusive focus on investor choice elided this aspect of the duty of prudence,” the ruling states. “The court maintained the same mistaken focus in rejecting [the plaintiffs’] claims with respect to recordkeeping fees on the grounds that plan participants could have chosen investment options with lower expenses.”
Technically, the Supreme Court has vacated the appealed judgment “so that the 7th Circuit may re-evaluate the allegations as a whole, considering whether [the plaintiffs] have plausibly alleged a violation of the duty of prudence as articulated in Tibble under applicable pleading standards.” The ruling instructs the 7th Circuit to remember that “the content of the duty of prudence turns on the circumstances prevailing at the time the fiduciary acts, so the appropriate inquiry will be context specific.”
One attorney offering some early interpretation of the ruling is Andrew Oringer, partner in Dechert’s ERISA and executive compensation group. He says that the Supreme Court, in this unanimous decision, did not take the opportunity to act as traffic cop in giving the rules of the road for the establishment of investment menus under 401(k) plans. Rather, the ruling seems to have determined that having a broad menu is not in and of itself enough to prevent potential fiduciary liability or litigation—which he says is not surprising. As such, the high court remanded the case for further factual consideration, given the range of reasonable judgments a fiduciary may make based on the fiduciary’s experience and expertise.
“For those hoping for an early dismissal that would have made the cases much harder, that did not happen,” he adds. “For those hoping that the case would expressly criticize aspects of the fiduciaries’ conduct in this particular case, that did not happen either.”