In Hughes v. Northwestern University the Supreme Court ruled that participants’ fiduciary claims against Northwestern University’s defined contribution plans should be reinstated, overturning a decision from the U.S. Court of Appeals for the Seventh Circuit. The lower courts had dismissed the case, relying heavily on the fact that the Northwestern plans offered both lower cost and higher cost funds and that the plaintiffs were free to select the lower cost alternatives.
On January 25 the United States Supreme Court ruled in Hughes v. Northwestern University that participants’ fiduciary claims against Northwestern University’s defined contribution plans should be reinstated, overturning a decision from the U.S. Court of Appeals for the Seventh Circuit.
The plaintiffs had alleged that the Northwestern plan fiduciaries breached their ERISA duties in a number of ways—including the use of (excessively) expensive investment options, the use of an (excessively) expensive recordkeeper, and the use of a confusingly large number of investment options (at one point, 242 different investments). The case was dismissed by the district court (Divane v. Northwestern University) and the dismissal was affirmed by the Seventh Circuit Court of Appeals. In dismissing the case both the District Court and the Seventh Circuit relied heavily on the fact that the plans offered both lower cost and higher cost funds and that the plaintiffs were free to select the lower cost alternatives. In effect, the lower courts concluded that the diverse range of investments available gave the Northwestern fiduciaries a free pass on the prudent selection of investments.
The Supreme Court, in a brief—and unanimous—opinion disagreed with the lower courts. The Supreme Court decision should not come as a surprise to anyone that seriously considers the ERISA fiduciary requirements. After all, the essence of the lower courts’ decisions was that if a plan fiduciary makes some prudent choices, it can then be imprudent with other choices. This approach disregards other Supreme Court decisions (cited by the Supreme Court in the Northwestern case) that “a fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.”
An (Intentionally) Missed Opportunity
The Supreme Court ruled on only one narrow question—whether the Seventh Circuit erred in its reliance on the existence of some lower-cost investments as a basis for dismissing claims challenging the use of (other) higher-cost options. That is reasonable—the Supreme Court only needs one reason to overturn a lower court decision and any further discussion of other points presented to the Supreme Court beyond that is “dictum”—incidental and not really a core part of the decision.
However, that is also unfortunate. There are currently a number of key issues reverberating through the lower courts that will have a greater impact on ERISA litigants than the one issue addressed by the Supreme Court in the Northwestern case. Several of these cases center on the important question of when an ERISA case can be dismissed (i.e., thrown out before the expensive discovery stage). These other cases are important because ERISA fiduciaries are highly likely to settle if they cannot get a dismissal.
By way of background, there are a few important things to remember:
- A lawsuit must allege facts that that support a plausible claim by the plaintiff—facts that allow the court to draw a reasonable inference that the defendant is liable.
- An ERISA fiduciary can be liable for a breach of fiduciary responsibility if the fiduciary fails to act prudently. Prudence is assessed by looking at the fiduciary’s processes—not the outcomes.
These two ideas clash in the typical ERISA lawsuit. The typical ERISA plaintiff claims to have no knowledge of the fiduciary’s processes. So, instead, the plaintiffs allege that a plan paid higher fees than “comparable” plans or funds performed more poorly than “comparable” funds. This alleged disparity in fees or performance has been enough for many courts to draw the inference of imprudent fiduciary processes and, therefore, has been enough to allow these lawsuits to survive the motion to dismiss and move to the discovery phase and the likely settlement.
The trajectory of these cases involves several leaps of faith by the courts—that the facts alleged really do create the inference of an imprudent process and that the “comparable” plans and funds cited by plaintiffs are, indeed, comparable. Courts have, generally, been willing to make these leaps of faith—inferring from the facts alleged that the fiduciary process was flawed and enabling these suits to survive the motions to dismiss—thus, providing plaintiffs the opportunity to engage in discovery—and settlement talks.
However, several recent cases have taken a new, harder look at these motions to dismiss. In effect, these cases are deciding that the conclusory claims by plaintiffs are not adequate to permit the suits to proceed. These cases include, among others, Albert v. Oshkosh Corporation, Forman v. Trihealth, Inc., Smith v. CommonSpirit Health, Kong v. Trader Joe’s Co., and Kurtz v. Vail. As stated by the district court in Kurtz v. Vail:
While certainly specific, plaintiff’s allegations are insufficient to support a claim for breach of fiduciary duty. Nowhere in the complaint does plaintiff allege anything imprudent about defendant’s process. In fact, it does not address at all Vail’s process for selecting or retaining fund options, monitoring expenses, or managing the overall Plan. Nor does it provide any factual allegations regarding whether defendant employed the appropriate methods to investigate and determine the merits of any investments. The allegations related to three-year investment returns depend on hindsight and say nothing about the information defendant had available to it at the time it was making decisions regarding the Plan.
As noted, the Supreme Court’s decision in the Northwestern case was based on a very narrow issue. This leaves plan fiduciaries, lawyers and courts to wrestle with myriad knottier issues around what claims are adequate to survive a motion to dismiss (thus, precluding discovery and likely settlement talks). For example:
- When can the use of past fund performance support a claim that a fiduciary’s process failed the ERISA prudence standard?
- Can fees for actively managed funds be compared to fees for indexed funds, without considering other underlying differences?
- Can disparities in recordkeeping fees (without more focused comparison of services provided) support a claim that a fiduciary’s process failed the ERISA prudence standard?
The name of the game for lawyers (on both sides of these cases) is the motion to dismiss. The Northwestern decision dealt with only one narrow part of this issue. We can expect more to come.