Justices to consider obligation of retirement-plan sponsors to pare investment options
on Dec 3, 2021 at 4:26 pm
Monday’s argument in Hughes v. Northwestern University will give the justices yet another opportunity to explain the fiduciary obligation of the sponsors that control the defined-contribution plans on which so many of us depend for our retirement.
This case comes to the justices under ERISA, the Employee Retirement Income Security Act of 1974. Responding to a shocking pattern of self-dealing and mismanagement in employee pension plans, the statute federalized a great deal of the law governing those plans. As employers have shifted from defined-benefit plans to defined-contribution plans, employees increasingly have focused on the investment choices of the sponsors and fiduciaries of those plans – the fiduciaries operating the plans often are executives at the employers. Adopting a standard from the common law of trusts, ERISA obligates them to act with the “care, skill, prudence, and diligence [of] a prudent man [sic].” Hughes will be the fourth argument the court has heard about that standard in the last eight years.
Although Hughes involves several ancillary allegations, the central claim is that Northwestern has fallen short of its duty of care by including high-fee investment options in the menu of funds in which employees can put their contributions. One allegation is that Northwestern offers higher-fee “retail” funds from institutions that offer lower-fee “wholesale” versions of the same funds. Another is that Northwestern could have lowered fees if it had limited the number of options: Larger investments flowing into the remaining options would have given it the leverage to bargain for lower fees. The general idea is that Northwestern simply offers a huge number of options (more than 200) without any attention at all to the level of fees any particular fund charges. To put the case in context, the allegations against Northwestern are not unusual; similar class actions have been brought in recent years, many of them against large universities. Nor are the stakes small: A court approving a settlement this fall involving my employer (Columbia University) recited that settlements in such cases have saved retirees more than $2 billion.
April Hughes and the other plaintiffs – all current or former employees of Northwestern – present this as a simple case asking the justices to apply normal pleading rules. ERISA draws its general fiduciary duty from the common law of trusts, and that duty requires diligence and prudence in all aspects of the fiduciary’s behavior. A duty to minimize the costs of investments is and always has been well within the conception of the fiduciary’s obligation. The allegations of the complaint fall well within any reasonable understanding of that duty under the general idea that it is imprudent to waste beneficiaries’ money.
Northwestern ridicules the beneficiaries’ contentions as “paternalistic” complaints that they’ve been given too many choices. For its part, as long as each individual option is sound, standing alone, the beneficiaries should not be able to make out a claim for breach of fiduciary duty simply because some of the options are less cost-effective than others. If Hughes and the other participants are so motivated by low-fee options, they should pick the low-fee options from the menu, and Northwestern offers many such options.
Raising the stakes to something of significance far beyond this case, Northwestern argues that Hughes fundamentally misunderstands the standard for pleading a breach of fiduciary duty. It is not enough to make some general allegation of imprudence, pointing to actions other fiduciaries have taken. Hughes, for example, alleges that other universities have been able to lower the fees their participants pay by following the recommendations that Hughes includes in her complaint. Rather, Northwestern contends, Hughes must identify on each point the specific action that a fiduciary could have taken and also show (in the complaint) that a prudent fiduciary “could not have concluded” that the action would do more harm than good.
Hughes draws that elevated standard from Fifth Third Bancorp v. Dudenhoeffer, a case involving plans that invest in employer stock. The court tailored the standard in that case to the difficulty plans face in responding to nonpublic adverse information about the employer. Action by the plan to divest itself of employer stock might be problematic, both because it could violate securities laws and because it might end up harming the plan more than it helps – if divestment leads to a collapse in the stock price of the employer.
Hughes argues here that the elevated pleading standard is limited to the “damned if I do, damned if I don’t” context of Fifth Third, but Northwestern argues that the high standard is necessary to avoid the “devastating consequences” that ERISA plans face from “endless lawsuits” challenging fiduciaries for nothing more than compliance with traditional industry practices. For Northwestern, it makes no sense to force courts to become second-guessing “investment managers,” auditing each and every fee of each and every investment option the plan makes available.
Northwestern’s strategy is not unusual. The court’s recent opinions in the area have spent a lot less time parsing a traditional common-law duty of prudence than they have worrying about the evils some justices see in the untrammeled spread of class actions. If the court pigeonholes this as an “abusive class-action” problem, then the use of elevated pleading standards to prevent defendants from being forced into inappropriate settlements will seem natural to the justices who worry about class actions. We’ll know a lot more after the argument about whether Hughes can persuade the justices to look at this from a more traditional fiduciary perspective.
Correction (Dec. 6 at 6:55 p.m.): An earlier version of this article misstated the year that the Employee Retirement Income Security Act was enacted. It was enacted in 1974, not 1973.