The U.S. Supreme Court ruled in favor of participants in the Northwestern University retirement plans, breathing life again to their breach of fiduciary duty claims under the Employee Retirement Income Security Act (ERISA).

In its January 24, 2022 decision, the Court unanimously (8-0 with Justice Barrett taking no part) vacated the judgment in the university’s favor that had previously been entered by the District Court and affirmed by the U.S. Court of Appeals for the 7th Circuit, and remanded the case back to the 7th Circuit to enable that court to reevaluate the allegations as a whole. Hughes v. Northwestern University, No. 19-1401, U.S. Supreme Court, January 24, 2022 (Hughes).

Given the wave of so-called “excessive fee” cases brought against private employers and universities in recent years, this decision could be viewed as adding further fuel to the fire.

Background

Northwestern University sponsors two defined contribution plans – the Northwestern University Retirement Plan and the Northwestern University Voluntary Savings Plan. The participants in these plans first sued Northwestern in the U.S. District Court for the Northern District of Illinois in 2016, alleging that it breached its fiduciary duty of prudence by failing to monitor the Plan’s investments in a number of ways, including:

• retaining recordkeepers that charged excessive fees;
• offering too many options likely to confuse participants; and
• neglecting to provide cheaper and otherwise-identical alternative investments.

These investment options allegedly resulted in lower investment returns for participants than they otherwise would have received if Northwestern acted with prudence.

The District Court granted Northwestern’s motion to dismiss the amended complaint, finding the plaintiffs failed to state a claim upon which relief can be granted, and denied leave to further amend. It agreed that Northwestern met its fiduciary duty of prudence by offering an array of investment options that included some lower cost investments. Divane v. Northwestern Univ., 2018 WL 2388118, *14 (N.D. Ill., May 25, 2018).

On appeal, the 7th Circuit affirmed the District Court’s decision, determining that the plan’s fiduciaries had provided an adequate array of choices, including “the types of funds plaintiffs wanted (low-cost index funds).” Divane v. Northwestern Univ., 953 F.3d 980, 991 (7th Cir. 2020).

The Supreme Court’s Decision

The Supreme Court found that the 7th Circuit erred by only focusing on one component of the duty of prudence – a fiduciary’s obligation to assemble a diverse menu of investment options.

Writing for the Court, Justice Sonia Sotomayor noted that the 7th Circuit failed to apply the Court’s decision in Tibble v. Edison Int’l, 575 U.S. 523 (2015). Hughes at 5. In Tibble, the plan’s fiduciaries provided “higher priced retail-class mutual funds as Plan investments when materially identical lower priced institutional-class mutual funds were available.”

The Court found that the plan fiduciaries in Tibble violated the duty of prudence by failing to monitor the plan’s investment options and remove imprudent ones (i.e., retail-class mutual funds). The standard under Tibble is for fiduciaries to conduct a regular, independent evaluation of each investment to determine whether that investment should prudently be included in the menu of options. Applying the same principles to Hughes, the Court held that the 7th Circuit erred in focusing solely on the variety of investment options in the plans since fiduciaries are still required to remove imprudent investments, such as those that charge excessive investment fees.

According to the Court, “[i]f the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.” Id. at 5. In remanding the case, the Court stated that the 7th Circuit “should consider whether the plaintiffs have plausibly alleged a violation of the duty of prudence as articulated in Tibble, applying the pleading standard discussed in Ashcroft v. Iqbal, 556 U.S. 662 (2009), and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).” Hughes at 6.

What Should Fiduciaries Do Now?

The Court’s decision certainly does not provide plan fiduciaries with a road map on how to successfully get these cases disposed of on motions to dismiss. If anything, the decision suggests that lower courts should undergo a deeper analysis of the facts to determine whether fiduciaries acted prudently given the totality of the circumstances present at the time the relevant actions were taken.

One thing is clear: for sponsors of defined contribution plans, both large and small, now is a good time for employers to consult experienced ERISA counsel to conduct a compliance assessment by reviewing and monitoring investment costs, performance, and diversification of their investments. Based on this assessment, employers should remove imprudent investments and document the rationale of their decisions.

Employers may also want to adopt an investment policy statement (or revise it if they have one already) to assist them with achieving these objectives. Lastly, employers should review their fiduciary liability policy to ensure there is adequate coverage should they get hit with an ERISA excessive fee lawsuit.

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