Over the past two years, a spike in class actions under the Employee Retirement Income Security Act has been a cause for concern for many fiduciaries. While 2020 saw a record high of over 200 ERISA class actions filed, 125 new class actions were filed in 2021 proving it to be another busy year for this specific litigation. According to the Jackson Lewis Class Action Trends Report 2022, since January 2020, more than 150 class actions were filed nationwide challenging the mismanagement of 401(k) and 403(b) defined contribution retirement plans.
With these cases being filed in such quantity, many plan sponsors have been seeking more clarity and a stricter pleading standard for excessive fee cases. In January, the U.S. Supreme Court's highly anticipated ruling in Hughes v. Northwestern University signified that retirement plan fiduciaries need to be more cautious when monitoring investment options and the costs associated with their plans. The court case was, on the surface, about whether the plaintiffs had a plausible claim for breach of fiduciary duty. However, it has broader implications for retirement plan sponsors' responsibilities going forward.
Hughes v. Northwestern University
In this case, current and former university employees claimed that two of their pretax retirement plan options had unreasonably high costs due to poor plan management. They noted that plan sponsors did not monitor fees closely, and they chose retail share classes that came with higher fees than institutional shares of the same investments. Additionally, participants claimed that there were too many options involved in the plans, leaving investors unsure of the most effective route to devote their retirement earnings.
Both the district court and the Seventh Circuit court dismissed the case because the claimants did not show a clear breach of fiduciary duty under ERISA. The Supreme Court rejected this reasoning and remanded the case to be reviewed under the proper legal standard outlined in their decision.
The Supreme Court's Ruling
In its ruling, the Supreme Court clarified the standards for claims against ERISA fiduciaries. First, fiduciaries need to monitor the diverse range of investments offered within their plans and remove any imprudent investment options promptly. Failure to do so constitutes a breach of fiduciary duty under ERISA.
If a plan offers both retail and institutional share classes, providing both options does not reduce this fiduciary responsibility. Offering lower-cost alternatives does not make it acceptable to have higher-cost share classes included in the plan’s menu unless it is considered a prudent investment option. Additionally, plan sponsors cannot assume that employees have the investment knowledge required to correctly pick between two similarly presenting investments. Fiduciaries must determine the prudence of every investment option they offer and whether they should be included or removed from the plan.
It was acknowledged in the ruling that the Courts need to look at the context of the investment decisions made by fiduciaries when assessing whether the claims made by plan participants are plausible. The Supreme Court stated in their opinion that, “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.” If there were other downsides to a lower-cost investment and the fiduciary considered those downsides and decided to avoid them by picking a higher-cost option, this could be considered reasonable professional judgment.
Impact For Retirement Plan Sponsors
For fiduciaries, the ruling raises the bar for ERISA compliance. It also does nothing to discourage future lawsuits for excessive retirement plan fees. In light of the ruling, fiduciaries who manage retirement plans need to practice good fiduciary hygiene, carefully monitoring the plan's investment choices and paying special attention to fees.
First, fiduciaries need a structured plan for managing their responsibilities. If a retirement plan committee is made up of employees and managers who don't have enough investment expertise, they should outsource the plan to a fiduciary committee that does. These committees should meet regularly and document the decisions they make in these meetings. They should also consult with outside investment advisors to ensure that they're taking the retirement plan in the right direction.
Since fiduciaries must monitor all of the plan's investment options and remove unacceptable ones, it may be beneficial to decrease the number of options offered in their plans. A Vanguard study found that large 401(k) plans offered an average of 26.3 investment options in 2010, but the average decreased to 15.4 in 2020. Reducing the number of options would allow fiduciaries to strengthen a prudent process for monitoring, selecting and removing options. Plan participants would also benefit as Hughes v. Northwestern University made clear that excessive choice can cause confusion and lead to poor investment choices. Fiduciaries also need to look carefully at administrative charges and management fees. If a plan qualifies for institutional prices on mutual fund shares, it probably shouldn't be buying retail class shares.
What Should Plan Sponsors Do Now?
As many fees are hidden within investments themselves, understanding and examining your 408(b)(2) fee disclosure documents periodically is indispensable. These disclosures provide the ability to monitor and assess all service providers involved in a plan and whether the fees being charged, both direct and indirect, are reasonable. Additionally, any changes made to investment-related information are required to be disclosed at least annually, but a new fee disclosure can be requested at any time.
Holding quarterly investment committee meetings and developing an investment policy statement are good alternatives to help plan sponsors with the monitoring of their plans fees. However, if plan sponsors seek methods to offload some of their responsibility and reduce their fiduciary liability, there are a few options to consider.
One option would be to hire a 3(21) Investment Advisor as a third-party to provide professional expertise, advice and recommendations towards your investment offerings. It is important to note that 3(21) advisors have limited fiduciary liability. In this situation, all decision-making power remains with the plan sponsor along with fiduciary liability for fees and performance of investments.
Additionally, plan sponsors could reduce their duties and liability risk further by hiring a 3(38) Investment Manager to take full authority over investment lineup decisions. They are responsible for researching, selecting, managing and monitoring investment options in a plan, taking the burden away from the plan sponsor. In this situation, the plan sponsor’s fiduciary responsibility is positioned in the choosing and monitoring of the manager and the fees they charge.
Plan sponsors could also consider joining a Pooled Employer Plan (PEP). As the Pooled Plan Provider (PPP) is the designated fiduciary and plan administrator, employers’ administrative, fiduciary and investment management duties are minimized. Similar to the hiring of a 3(38) Investment Manager, employers have a fiduciary obligation to prudently select and monitor the pooled plan provider.
While Hughes v. Northwestern University is technically a ruling about whether a particular group had a valid claim, it has important implications for how fiduciaries need to act when managing retirement plans. The court's ruling defined standards for how claims against ERISA fiduciaries would be considered. These standards require fiduciaries to monitor the full range of investment options within a plan to make sure that they are solid investments with reasonable fees. Notably, having both high and low-cost options does not make investments with excessively high fees acceptable. Plan managers need to eliminate high-cost options, not simply expect plan participants not to choose them. The ruling does not limit future lawsuits, so fiduciaries should be especially cautious in managing retirement plans going forward.
Brian Menickella is a co-founder and managing partner at The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, PA.
Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice.
