U.S. Supreme Court Weighs in on ERISA Breach of Fiduciary Duty Claim in Hughes v. Northwestern University

The U.S. Supreme Court this week unanimously decided an ERISA fiduciary duty case, Hughes v. Northwestern University, which will impact dozens of similar cases currently pending against fiduciaries of section 401(k) and 403(b) retirement plans. On January 24, 2022, the Court held that the U.S. Court of Appeals for the Seventh Circuit erred when it relied on plan participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by plan fiduciaries under the Employee Retirement Income Security Act of 1974, as amended (ERISA).

In 2016, participants in Northwestern University’s defined contribution retirement plans sued the university, its Retirement Investment Committee (which exercises discretionary authority to control and manage the retirement plans), and the individual officials who administer the plans (collectively, respondents) for breach of their fiduciary duty under ERISA.

The petitioners alleged that plan fiduciaries breached their duty of prudence under ERISA by: (1) failing to monitor and control the fees they paid for recordkeeping services; (2) neglecting to offer cheaper “institutional” class investments which were otherwise identical to the more expensive “retail” share classes; and (3) offering too many investment options (over 400), thereby causing participant confusion. The Court found that these allegations sufficiently stated a plausible claim against the plan fiduciaries for violation of their duty of prudence, thereby vacating the Seventh Circuit’s prior dismissal of the claims.

The Duty to Prudently Monitor a Plan’s Investment Menu is Paramount to the Individual Investment Choices of Plan Participants

The Court relied on its holding in Tibble v. Edison Int’l, 575 U.S. 523 (2015), which emphasized that an ERISA fiduciary has a continuing duty to monitor and review plan investments and to remove imprudent ones. The Court found that the Seventh Circuit did not apply Tibble’s guidance when it rejected petitioners’ allegations, but instead focused exclusively on another aspect of ERISA’s duty of prudence: a plan fiduciary’s obligation to offer a diverse menu of investment options.

Specifically, the Seventh Circuit determined that respondents provided an adequate array of investment choices, including “the types of funds plaintiffs wanted (low-cost index funds),” and further concluded that the available menu of investment options eliminated any concerns that the options were imprudent.

In the Seventh Circuit’s view, because petitioners’ preferred type of investments were available, they could not complain about the flaws in other options. The Court determined that such reasoning was “flawed.” It clarified that the diversity of a plan’s investment menu does not excuse the plan’s allegedly imprudent decisions, even if the menu includes lower cost investments that plan participants sought.

The Court noted that participants are limited to only those investment choices on the menu of investment options that plan fiduciaries have selected. Therefore, the Court held that, even where participants choose their own investments, fiduciaries “must conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.” According to the Court, a plan fiduciary’s “fail[ure] to remove an imprudent investment within a reasonable time” is a breach of the duty of prudence.

The Court also noted the Seventh Circuit’s “same mistaken focus” on investor choice when it rejected petitioners’ claims that respondents imprudently permitted excessive recordkeeping fees, on the grounds that participants could have chosen investments with lower expense ratios. The Court held that the Seventh Circuit’s exclusive focus on petitioners’ ultimate choice over their investments ignored the fact that ERISA requires a continuing duty to monitor and remove imprudent investment options from a plan’s menu.

Considerations

Many practitioners had hoped that the Court would use the opportunity in Hughes to clarify the requirements for a plaintiff in an ERISA fiduciary duty case to survive a motion to dismiss. For example, the Court could have ruled that it was not enough for plaintiffs to simply allege that lower-cost or better-performing investments were available outside of the plan’s menu of investment options, and that, instead, plaintiffs must allege that such other options had substantially the same objectives as the higher-cost or poorer-performing investments offered by the plan. The Court was silent on this point. Rather, the Court reiterated the position long-held by the U.S. Department of Labor that it is not sufficient for a plan fiduciary to offer numerous investment options in a section 401(k) or 403(b) plan, at least some of which are prudent. A plan fiduciary must prudently select and monitor each and every investment option offered on the plan’s investment menu.

Ballard Spahr Attorneys in the Employee Benefits and Executive Compensation Practice Group are able to advise retirement plan fiduciaries on how to fulfill their fiduciary duties under ERISA.

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