Northwestern ERISA Case Highlights Compliance Lessons

By Philip Koehler and Anne Hall (January 20, 2022)

Litigation against Employee Retirement Income Security Act retirement and health plan sponsors and administrators has plagued workplace fiduciaries for the last two decades. Then, in 2020, ERISA lawsuits reached unprecedented levels and affected fiduciaries of ERISA retirement and health plans nationwide. Unwary 401(k) and 403(b) plan sponsors, fiduciaries and service providers were subject to more than 200 ERISA class actions during 2020. The basic complaint in these lawsuits — most of which involved a fiduciary breach claim — is that the fiduciaries caused the plan to incur losses by imprudently:

  • Failing to negotiate and monitor the direct and indirect compensation that the plan paid to service providers — administrators, record-keepers and investment advisers;
  • Relying upon faulty processes for the selection or retention of investment options in the plan’s fund lineup; and
  • Failing to monitor investment fund performance and reassess the cost efficiency of available options and share classes in accordance with the plan’s investment policy statement, thereby subjecting the participants to fees that substantially exceeded fees for alternative available investment products or services.

With ERISA class actions at an all-time high, the U.S. Supreme Court recently agreed to review the U.S. Court of Appeals for the Seventh Circuit’s 2020 decision in Hughes v. Northwestern University.[1]

The U.S. acting solicitor general, working with the U.S. Department of Labor, had asked the court to resolve a split among circuits as to the pleading standards a trial court should follow in determining whether a complaint’s factual allegations of the fiduciaries’ breach are sufficiently plausible to survive a defendant’s motion to dismiss for failure to state a claim.

At a minimum, the court is faced with making a decision that may either increase or decrease the likelihood that a fiduciary breach complaint will survive a motion to dismiss. At stake is the ability of plaintiffs to successfully bring motions for wide-ranging discovery and have their day in court. In pure economic terms, a more relaxed pleading standard means substantial increases in the time and expense of defending workplace fiduciaries and fiduciary service providers named in these lawsuits.

This article evaluates the issues before the Supreme Court in Hughes. It also provides an overview of best practices for plan sponsors aimed at avoiding costly and time-consuming ERISA fiduciary breach claims.

Hughes v. Northwestern

In Hughes, Northwestern University offered two U.S. Code Section 403(b) retirement plans. Out of the 242 investment options, the plans included seven index funds and 129 retail share class funds.

The plaintiffs in Hughes allege that the fiduciaries breached their duty of prudence by entering into a bundled service agreement with one of the plan’s record-keepers that mandated the inclusion of a suite of the record-keepers’ investment options, including some allegedly imprudent investment options.

The Seventh Circuit explained that nothing in the plan required participants to invest in the purportedly underperforming products and, moreover, the plaintiffs failed to evaluate the decision to enter into a bundled service agreement against a relevant standard.

Rather than allege what a hypothetical prudent fiduciary would have done differently, in the Seventh Circuit’s view, the complaint merely criticized Northwestern for making a rational business decision.

Inclusion of Certain, Higher-Cost Investment Options

The Hughes plaintiffs also alleged that fiduciaries breached their duty of prudence by allowing the plan to offer identical, but higher cost investment options.

The challenge to specific options included under the agreement failed because, according to the Seventh Circuit, “it would be beyond the court’s role to seize ERISA” as a means to eliminate those options disfavored by individual litigants where the plans also included the lower-cost, conservative options they preferred.

The Seventh Circuit concluded that, even if the plaintiffs were correct that the plans offered retail share class options with “layers of fees,” this was not in and of itself sufficient to sustain a claim because the plaintiffs failed to allege that the plans omitted their preferred low-cost index fund alternatives.

The Seventh Circuit held that “the ultimate outcome of an investment is not proof of imprudence” and plan fiduciaries “may generally offer a wide range of investment options and fees without breaching any fiduciary duty.”

In its decision in favor of Northwestern, the Seventh Circuit highlighted that the plan fiduciaries documented decision making, specifically the reason for inclusion of the investments at issue in the plan investment lineup.

Record-Keeping Costs

Lastly, the plaintiffs claimed that the fiduciaries acted imprudently when they engaged in a deficient service provider selection process that did not include a request for proposal or demand lower record-keeping fees, which resulted in the plan’s payment of excessive record-keeping costs.

The Seventh Circuit explained that ERISA does not require a plan (1) to negotiate a record-keeping agreement that charges a fixed per-participant fee — as opposed to the asset-based agreement negotiated by Northwestern, or (2) to have one record-keeper or mandate a specific record-keeping arrangement.

Furthermore, in the Seventh Circuit’s view, the plaintiffs did not explain how it was better to have a fixed per-participant fee and conceded that the plans had valid reasons for maintaining multiple record-keepers, including that doing so allowed the plans to include the various options preferred by participants.

Crucially, the Seventh Circuit concluded that the higher-fee investments were not imprudent because the plan included, in totality, a meaningful mix of investments. This is the so-called mix of investment options defense.

As a rebuttal, in his amicus brief, the acting solicitor general contended that fiduciaries are not excused from their prudence duty not to offer a plan menu that includes imprudent investment options with unreasonably high fees on the ground that they also included other prudent investment options.

In Tibble v. Edison International,[2] the Supreme Court previously held in 2015 that an ERISA fiduciary has an ongoing “duty to monitor investments and remove imprudent investments from a menu of options.” This duty exists independently from a fiduciary’s duty to make prudent initial investments and requires fiduciaries to monitor and review investments in a reasonable manner given the type of investment and strategy involved.

During oral argument Justice Elena Kagan, with some support from Justices Stephen Breyer and Sonia Sotomayor, expressed skepticism that the mix of investment options defense is compatible with Tibble.

The outcome of the Hughes case could have far-reaching impact for retirement plan sponsors, fiduciaries and service providers. The court will be determining the proper context and standard to grant or deny a motion to dismiss at the pleading stage in excessive fee complaints.

If the court determines a low pleading standard to survive a motion to dismiss or that the proper prudence standard for ERISA fiduciaries applies with respect to selection of each investment option — versus the entire menu of investment options — fiduciary breach cases may skyrocket in future years.

The importance, therefore, of implementation and maintenance of a robust fiduciary compliance paradigm for employer-sponsored ERISA plans cannot be overstated.

Fiduciary Best Practices

In recent years, more plaintiff firms have successfully targeted smaller — i.e., with assets under $1 billion — ERISA plans. The following provides three key strategies for ERISA plan sponsors to mitigate exposure to fiduciary breach claims:

Establishment and Maintenance of Prudent Process

In fiduciary breach cases, courts have made clear that a prudent process is key to avoidance of liability. Generally, the duty of prudence is measured by process. Plaintiffs will attack any potential weakness in a plan’s process.

Documentation, including a committee charter that provides a road map for initial and ongoing fiduciary compliance is crucial to avoidance of fiduciary breach issues. Implementation and maintenance of and consistency among the investment policy statement, committee charter and company bylaws are important documents for the company retirement plan fiduciary compliance library.

For these documents to insulate from liability, however, plan fiduciaries must understand and abide by the terms of these governing documents. Comprehensive documentation, along with active and engaged retirement plan committee members makes it difficult for plaintiffs to succeed in a fiduciary breach claim.

Careful, Ongoing Monitoring of Service Providers

Upon selection of a retirement plan service provider, plan fiduciaries must annually review the reasonableness of such service providers’ fees. Retirement plan committee members should engage in a request for proposal every three years — or more frequently — to benchmark service provider costs and service levels and to avoid any claim of imprudent payment of excessive fees.

Plan fiduciaries should carefully memorialize their active engagement to ensure service provider fees are reasonable. Careful review all service provider contracts to ascertain whether and to what extent service providers may use participant data is an important endeavor by committee members for avoidance of fiduciary breach claims.

Consistent and Timely Evaluation of Investment Lineup and Performance

With respect to the investment lineup, plan fiduciaries should be aware of which investments include costly indirect fees and revenue sharing.

Retirement plan decision makers should carefully review and understand whether investments outside the current plan investment lineup provide similar returns with lower management fees.

Retirement plan committees should meet at least quarterly and carefully review and monitor the investment lineup with the aim of taking immediate action to remove an underperforming investment from the current plan investment lineup.

Conclusion

In recent years, ERISA — and, more specifically, fiduciary breach — litigation has involved companies of all sizes and across a wide industry spectrum.

While it is impossible to predict how the court will rule in Hughes, this case reinforces the importance of the implementation and maintenance of a dynamic fiduciary compliance paradigm for ERISA retirement and health plans.

Important aspects of a fiduciary compliance paradigm include: comprehensive documentation, an understanding of and adherence to plan governance documents, and careful and consistent monitoring — and when prudent, removal — of a plan’s service provider. Quarterly committee meetings, along with timely benchmarking and removal of underperforming investments are important measures for demonstration of a prudent process.

These measures are key components of a robust ERISA fiduciary compliance paradigm that mitigates exposure to costly, time-consuming ERISA class action and, more specifically, fiduciary breach lawsuits.

Philip J. Koehler is lead ERISA counsel and Anne Tyler Hall is a managing partner at Hall Benefits Law. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. [1] 953 F.3d 980 (7th Cir. 2020), cert. granted sub nom., Hughes v. Northwestern University , No. 19-1401 (July 2, 2021). [2] Tibble et al v. Edison International et al , 575 U.S. ___ (2015), 135 S. Ct. 1823, 191 L. Ed. 2d 795, 2015 U.S. LEXIS 3171.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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