Recently, the United States Supreme Court issued a stark reminder to plan sponsors and fiduciaries of defined contribution plans. In a January 2022 case, Hughes v. Northwestern University, the justices unanimously ruled in favor of the school’s retirement plan participants who alleged plan fiduciaries breached their duties. The Supreme Court ruled that, as fiduciaries, plan sponsors are required to regularly assess investment options for suitability, purge imprudent investments, and retain only those that remain suitable. This ruling is consistent with prior verdicts, and importantly, continuous monitoring of all plan investments is explicitly required by the Employee Retirement Income Security Act (ERISA).
As for the specifics of the case, past and present plan participants claimed the University breached their fiduciary duties by:
(1) Failing to monitor and control the fees paid by the plans for recordkeeping, resulting in unreasonably high costs to plan participants.
(2) Offering a number of mutual funds and annuities in the form of “retail” share classes that carried higher fees than those charged by identical “institutional” share classes.
(3) Offering too many investment options (over 400), thereby causing confusion among participants and leading them to make poor investment decisions.
With this decision, the country’s highest court lent strong support to our firm’s long-held views.
A sufficient fiduciary process requires that all plan investment alternatives be prudently selected, with careful consideration to expenses, share classes, asset classes and performance relative to comparable options. Second, investments must be monitored on an ongoing basis to justify their continued availability in the plan.
For instance, investment management fees paid by participants for each investment must, on an individual investment basis, be evaluated by the Committee and be supported as reasonable for the performance relative to similar investment options available in the marketplace.
We believe this fiduciary standard exists for each of the plan’s listed investment alternatives, regardless of whether participants choose to invest in the fund. Even if minimal participant assets are invested in a given fund, a proper review and evaluation is still required.
As fiduciaries, we are obligated to look out for “red flags” that indicate a plan’s investment options are no longer suitable. To protect plan participants, our team continually assesses investment options for suitability, retaining only those that meet the due diligence criteria. The Supreme Court clearly states this as a critical fiduciary process.
Respondents violated their duty of prudence by offering needlessly expensive investment options and paying excessive recordkeeping fees. The Court of Appeals (prior court ruling) held that petitioners’ allegations fail as a matter of law based on the court’s determination that petitioners’ preferred type of low-cost investments were available as plan options. In the court’s view, this eliminated any concerns that other plan options were imprudent. That reasoning was flawed. Such a categorical rule is inconsistent with the context-specific inquiry that ERISA requires and fails to take into account respondents’ duty to monitor all plan investments and remove any imprudent ones (emphasis added).
In simple terms, if there are imprudent investment options in a retirement plan, they cannot be ignored just because there are other prudent investment options available as well.
Many investments may charge different management and record keeping fees depending on the size of the plan. Fiduciaries should recognize that as plans grow, lower fee versions of existing offerings may become available and provide an opportunity to lower costs to participants. As a best practice, sponsors should retain investment consultants to research the availability of lower-fee options of existing investments.
Evaluation of each investment in the plan (for both performance and costs) must be ongoing, and most importantly, be well-documented. Without such written documentation, the fiduciaries may be hard pressed to prove their exercise of the required prudence.
Given that it travelled as high as the Supreme Court, the Northwestern case attracted much attention from the retirement industry. And rightly so, as more than likely the SCOTUS ruling will accelerate the flow of excessive fee cases against plan sponsors of 401(k) and 403(b) plans.
To protect yourself as a fiduciary, sponsors should consult with their plan advisor to obtain updates regarding any funds that have become litigation targets and more closely scrutinize any offerings that may exhibit the same flaws. Responding to these “red flags” will go a long way towards limiting litigation risk.
A simple step plan sponsors may consider is to offer additional index funds and self-directed brokerage accounts. This may mitigate the risk posed by more expensive actively managed options.
Taking this action in addition to continually reviewing and benchmarking investment options, as well as removing imprudent investments, can make plans unattractive for ERISA lawsuits. If you have questions about the potential liabilities within your plan, please don’t hesitate to reach out to me or our team.
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Steven J. Kaczynski, Jr.
CFA®, AIFA®, CPFA®, MST, MBA