On January 24, 2022, the United States Supreme Court issued a decision discussing the fiduciary duty of prudence plan administrators must uphold when administering defined contribution plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). In this case, Hughes v. Northwestern University,[1] the Court determined that a breach of the duty of prudence should be considered in light of the 2015 Supreme Court decision Tibble v. Edison International.
Northwestern University (“Northwestern”) offered two types of investment plans to eligible employees: a retirement plan and a savings plan. Both were defined-contribution plans in which participating employees maintained individual investment accounts that were funded by pre-tax contributions from the employees’ salaries and, when applicable, matching employer contributions. Each participant was able to choose from a menu of option selected by Northwestern, the plan administrators.
These plans also involved fees, two of which were relevant to the Hughes case: (1) fees for investment management services that compensate a fund for designing and maintaining the fund’s investment portfolio and (2) fees for recordkeeping services. The first type of fees were calculated as a percentage of the assets the plan participant chooses to invest in the fund (i.e. the expense ratio); the second type were either calculated as a percentage of the assets for which the recordkeeper is responsible or as a flat rate per participant account.
As explained by the Court, under ERISA plans fiduciaries must discharge their duties “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims.” Because Northwestern administered these plans on behalf of current and former employees, including the plaintiffs, this fiduciary duty of prudence applied to Northwestern.
Plaintiffs alleged Northwestern violated ERISA’s required duty of prudence in the following ways:
- By failing to monitor and control recordkeeping fees, resulting in unreasonably high costs to plan participants;
- By 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
- By offering options that were likely to confuse investors.
Based on these allegations, Northwestern filed a motion to dismiss which was granted by the District Court and affirmed by the Seventh Circuit. Specifically, the Seventh Circuit determined that because plaintiffs’ low-cost investment preferences were available as plan options, this eliminated any concerns that other plan options were imprudent because plaintiffs could pick and choose what they invested in.
The Court disagreed, stating that the Seventh Circuit’s reasoning posed a “categorical rule inconsistent with the context-specific inquiry that ERISA requires” and failed to consider Northwestern’s duty to monitor all plan investments and remove any imprudent ones. Simply put, the Court believed the Seventh Circuit erred in relying on the participants’ ability to choose their own investments to excuse Northwestern’s imprudent decision-making. Instead, the Court believed the Seventh Circuit should have relied on the standard set forth in Tibble v. Edison International.
In Tibble, the Court interpreted ERISA’s duty of prudence in terms of trusts and determined that a fiduciary, like a plan administrator, has a continuing duty to monitor investments and remove any imprudent ones. Like the plaintiffs in Hughes, the Tibble plaintiffs alleged their plan fiduciaries offered higher retail class mutual funds as plan investments when identical lower priced institutional class mutual funds were available. Although three of these higher-priced investments were added outside of the statute of limitation period, the Court addressed whether the plaintiffs nonetheless identified a potential violation with respect to these funds.
The Court concluded that the plaintiffs did indeed identify a potential violation because a fiduciary is required to conduct a regular review of its investment. Thus, the rule set forth in Tibble, and the rule that should have been utilized in the Seventh Circuit’s decision, was that a plaintiff may allege that a fiduciary breached the duty of prudence by failing to properly monitor investments and remove imprudent ones.
Using the Tibble Rule, it was clear to the Court that even though plaintiffs were participating in defined-contribution plans in which they were able to choose their own investments, plan fiduciaries were still required to conduct their own independent evaluation to determine which investments “may be prudently included in the plan’s menu of options.” If the fiduciaries failed to remove an imprudent investment from the plan within a reasonable amount of time, this duty of prudence would be breached. The Seventh Circuit’s exclusive focus on investor choice, the Court found, omitted this aspect of the duty of prudence and lead to a flawed conclusion.
Thus, the Court vacated the Seventh Circuit’s judgment so that the allegations could be reevaluated in their entirety, stating the Seventh Circuit should consider on remand whether plaintiffs had plausibly alleged a violation of the duty of prudence as stated in Tibble. Because the duty of prudence turns on the prevailing circumstances at the time of the fiduciary act, this inquiry, the Court stated, will be context specific. Given the inquiry will be context specific, the Seventh Circuit’s overbroad view that control over investments eliminates concerns for a breach of the duty of prudence will not be applicable on remand.
This decision leads to the question of what plan administrators of defined contribution plans to their employees can do to ensure this duty of prudence is not breached. Based on the Court’s ruling, there are a few key points plan administrators should remember:
- Giving plan participants the option to choose their own investments from a menu of investment options does not relieve plan administrators of their fiduciary duty of prudence under ERISA.
- Plan administrators must continuously monitor investments available to plan participants to ensure that the available investment options are also the most prudent investment options.
- Plan administrators must remove any imprudent investment options within a reasonable period of time or risk breaching this fiduciary duty of prudence.
[1] https://www.supremecourt.gov/opinions/21pdf/19-1401_m6io.pdf.
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