The Supreme Court recently handed down its much-anticipated decision in Hughes v. Northwestern University. The question before the Court is whether the petitioners – current and former participants in two retirement plans maintained by the University – plausibly stated a claim for breach of fiduciary duty. The Court held that the petitioners did plausibly state such a claim and remanded the case for further review.

While the dispute was nominally about mere pleading standards, the stakes could not be higher. What began in 2007 as a handful of challenges against large 401(k) plans maintained by name-brand U.S. employers has turned into a torrent. In the last six months alone, more than a hundred fiduciary breach cases have been filed against plans of all sizes. The decision will likely do little to stem that rising tide.

This post reports on the decision and considers its significance to retirement committees and other fiduciaries who oversee and administer plans with participant-directed investments.

Background

This case concerned two defined contribution retirement plans that were funded by pretax elective contributions. The petitioners, three current or former employees of the University who participated in the plans, brought suit in Federal district court against the University and its retirement committee alleging that that they violated their statutory duty of prudence by:

• 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 too many options that were likely to confuse investors.

The case was but one in a long line of cases alleging that defined contribution plan fiduciaries imprudently selected or failed to monitor plan investments with excessive fees that underperformed alternative, lower-priced investments. Many plan sponsors and their advisors had hoped that the Supreme Court would take the opportunity to enunciate clear, limiting pleading standards that would discourage cases with little or no merit. As explained below, many were left wanting.

The Supreme Court’s Decision

The Supreme Court clarified the standards on which claims against ERISA fiduciaries must be judged. Relying on its prior precedent and reaching back to “ERISA basics,” the Court held as follows:

• The Diverse Range of Investment Options

Fiduciaries must monitor all plan investments and remove imprudent investment options from the plan’s investment menu. Moreover, the failure to eliminate poor investments from a retirement plan within a reasonable time constitutes a breach of fiduciary duty under ERISA.

• Retail vs. Wholesale

On the subject of whether offering retail share classes that carried higher fees than those charged by otherwise identical share classes, the Court stated that offering a mix of retail and institutional share class funds to participants does not relieve the fiduciaries from having to determine which investments may be prudently included in the plan’s investment choices and which should not.

• Context-Specific Analysis

Assessing 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. According to the Court: “At times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”

Consequences for Retirement Committees and Other Fiduciaries

The Supreme Court’s decision, which is both brief (a mere eight pages) and unanimous (8–0 with Justice Barrett taking no part), dashes any hopes for a stricter pleading standard in ERISA excessive fees cases. This is in our view unfortunate. These cases are being filed in increasingly large numbers. The proximate consequence of the decision is to further raise the compliance bar.

Based on Hughes, retirement committee members and other fiduciaries should, at a minimum, do the following:

• Practice good fiduciary hygiene.

Good fiduciary hygiene starts with prudent governance. Boards, LLC managers, partners, etc. are well advised to formally offload their plan administrator responsibilities to a fiduciary committee that is knowledgeable (or made to be so with proper training) and subject to a formal charter. In the vast majority of cases, fiduciary committees should be advised by competent outside investment consultants. Meetings should be held periodically (e.g., quarterly), and the committee proceeding should be documented in minutes. These steps are minimum requirements – table stakes.

• Limit, monitor and curate the plan’s menu of investment options.

Plan fiduciaries must continuously monitor all plan investments and remove those that are imprudent. Because this rule applies irrespective of the number of investment options, it behooves plans to limit that number. There is little agreement on the ideal number of options, and the proper number of options may vary depending on the particular industry or other surrounding circumstances. A recent SHRM report citing a 2020 study by Vanguard Investments claims that the average number of investment options for large 401(k) plans 2019 was just over 17. As the number of options grow, so too does the amount of work necessary to ensure that each fund option is and remains a prudent choice.

• Pay particular attention to sales loads, management fees and administrative charges.

The inclusion of retail classes of mutual fund shares is a plan that otherwise qualifies for institutional prices is a recipe for trouble, particularly where there is no substantive difference between the more and less expensive options. This is an instance in which committees and other fiduciaries can benefit from the advice of competent investment consultants.