While Hughes involves 403(b) plans, the issues in it are effectively identical to those in the 401(k) fee litigation that has plagued our industry for nearly two decades.
On July 2, 2021, the Supreme Court agreed to review Seventh Circuit’s decision affirming dismissal of plaintiffs’ case for failure to state a claim in Hughes v. Northwestern, an excess fee case.
Until now, the Supreme Court has refused to hear appeals of lower court decisions on ERISA excess fee issues, most recently in 2020 denying review of the First Circuit’s decision for plaintiffs in Brotherston v. Putnam. (The Court’s decision in Tibble v. Edison was limited to the ongoing duty to monitor and its effect on the ERISA statute of limitations.)
While the U.S. Solicitor General argued against Court review of the pro-plaintiff decision in Brotherston, the SG argued for taking review of the Seventh Circuit’s pro-defendant decision in Hughes, identifying as the critical issue:
Whether participants in a defined-contribution ERISA plan stated a plausible claim for relief against plan fiduciaries for breach of the duty of prudence by alleging that the fiduciaries caused the participants to pay investment-management or administrative fees higher than those available for other materially identical investment products or services.
What’s the Deal?
The Court decision to take review in Hughes represents an opportunity not just for plaintiffs in this case but for sponsors and providers generally to get some clear guidance on what exactly the rules are for the selection of funds for a plan fund menu. Does the plan fiduciary have a duty to get the “best available deal” for participants or is a “good enough deal” good enough?
Critically, with respect to fees on investment funds, if the plan fiduciary includes in the fund menu a low-cost alternative investment (e.g., a large cap index fund with a single digit expense ratio), is it still liable because another fund available in the menu, e.g., carries a higher retail fee even though a lower-fee institutional share class is available?
Basing Fiduciary Duty on the Availability of Participant Choice
The Seventh Circuit has long staked out a pro-sponsor fiduciary position on this issue, stating, in Hecker v. Deere (Feb. 12, 2009), that:
The fact that it is possible that some other funds might have had even lower ratios is beside the point; nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems). [Emphasis added.]
That language has been quoted hundreds of times by defendants’ lawyers in excess fee cases, including in Northwestern’s brief to the Supreme Court on the Hughes petition for review. And the Seventh Circuit quoted extensively from Hecker (and its subsequent decision in Loomis v. Exelon Corp.) in its decision for defendant plan fiduciary in the Hughes:
We concluded in Hecker and Loomis that plans may generally offer a wide range of investment options and fees without breaching any fiduciary duty. Loomis, 658 F.3d at 673-74; Hecker, 556 F.3d at 586 (no breach of fiduciary duty where 401(k) plan participants could choose to invest in 26 investment options and more than 2,500 mutual funds through a brokerage window).
This theory of a plan fiduciary’s prudence obligation in choosing funds to be included in a plan’s fund menu would seem to allow a broad range of investment choices and fees so long as the participant can herself choose a low-cost option. Quoting the district court decision in Hughes:
Plaintiffs spend much of their lengthy amended complaint describing their clear preference for low-cost index funds, and the Court does not dispute that their preference is becoming conventional wisdom. Plaintiffs might have a different case if they alleged that the fiduciaries failed to make such funds available to them. Plaintiffs, though, allege that those types of low-cost index funds were and are available to them. … It does not matter that some of those expenses were retail expenses (Loomis, 658 F.3d at 672), and it does not matter that the plans offered additional funds that they did not want to choose (Loomis, 658 F.3d at 673-674). The types of funds plaintiffs wanted were and are available to them.
Or on a Sweeping Obligation to Get the Best Deal
Since the original Seventh Circuit decision Hecker v. Deere, the Department of Labor has objected to a broad reading of this approach to a fiduciary’s prudence obligation with respect to fund menu construction, petitioning for a rehearing en banc of the Seventh Circuit’s Hecker v. Deere decision (which was denied). This may in part account for the SG’s brief in favor of review of the Seventh Circuit in this case.
It appears to be DOL’s position that, with respect to designated investment alternatives (DIAs), the sponsor fiduciary has an affirmative duty to get plan participants the best available deal, even where the plan includes hundreds of options.
With Many Questions Left Unanswered
But DOL’s position leaves a number of unanswered questions:
It would seem, although it is hard to get a straight answer from DOL on this issue, that a plan could allow a brokerage window that included, e.g., retail share classes of mutual funds. But how many funds/investment options do you need to have to have a “brokerage window?” Northwestern had 187 options in one plan and 242 options in the other. Is that enough? Why not? What exactly is the legal basis for any distinction here?
DOL’s theory of the imposition of fiduciary obligations with respect to a fund in the fund menu (and not in a brokerage window) appears, under regulations under ERISA Section 404, to depend on whether the fund is a “designated investment alternative.” The use of that term is (as they say) “problematic,” given that DOL has adopted two different definitions of “designated investment alternative” under ERISA Section 404, one under 404 (a) and a different one under 404(c). And at least one court has had a hard time figuring out exactly what a DIA is (see Moitoso v. FMR).
And what about 404(c)? ERISA Section 404(c) by its terms says that a fiduciary is relieved of liability for participant choices where “a participant or beneficiary exercises control over the assets in his account.” And, with respect to a fund menu, DOL’s regulations simply require that the plan offer “a broad range of investment alternatives.” Isn’t 242 options (or, for that matter, 187) enough? If not, what is enough?
So, What’s at Stake …
The Supreme Court agreeing to review Hughes v. Northwestern presents the very real possibility that finally someone – the Supreme Court – will say something authoritative about exactly what a plan fiduciary’s obligations are in building a fund menu. Must the fiduciary inspect every fund to make sure it carries the lowest possible fee? Or is simply giving participants an adequate choice, including low-cost index funds—the sort of choice an ordinary investor has—“good enough?”
It would be even better if the Court clarified the scope of ERISA Section 404(c) and the (apparent) exemption from most fiduciary requirements for brokerage windows.
It would be nice if the Court came down on the side of the sponsor fiduciary on these issues. But, really, any clear answer on these issues would be a step forward. At least plan fiduciaries would then know—clearly—what was required of them.
Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.
Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.
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