Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.
Lawsuits against employers offering retirement benefit plans have been on the rise. Recent suits, discussed in this update, have provided some guidance for employers.
In January 2022, the Supreme Court issued the Hughes v. Northwestern University opinion that could have clarified the appropriate pleading standard for claims alleging a breach of the duties imposed under ERISA on the fiduciary of a 401(k) retirement plan. The much-anticipated decision largely avoided dealing with this issue, however, finding only that the Seventh Circuit erred by relying too heavily on the diverse menu of investment options offered and the participants’ ultimate choice over their investments to excuse allegedly imprudent decision-making by the plan’s fiduciaries. In remanding the case for further evaluation under the proper pleading standard, the Court observed that “courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise” when assessing whether a plausible claim for breach of ERISA’s fiduciary duty of prudence has been made.
Appellate Courts Applying Hughes
Since the decision was issued, several appellate courts, including the Sixth, Seventh, Eighth, and Ninth Circuits, have issued opinions applying Hughes to evaluate whether an allegation of a breach of fiduciary duty by a fiduciary of a 401(k) retirement plan states a claim for relief under ERISA.
The first appellate court to apply the Hughes decision was the Ninth Circuit. In Kong v. Trader Joe’s, the appellate court reversed and remanded a district court’s decision to dismiss a complaint for failure to state a claim. In the decision, the Ninth Circuit noted Hughes’ comment that “the appropriate inquiry” at the pleading stage is “necessarily  context specific,” but reiterated that allegedly wasting money suggested imprudence. Accordingly, the court found that the operative complaint’s allegation that the plan offered retail class shares of an investment fund when otherwise identical but less expensive institutional class shares were available could support a plausible breach of fiduciary duty claim. Despite noting that revenue-sharing may provide an alternative explanation for why the retail shares could be, on the whole, less expensive and thus prudently offered, the court reasoned that the complaint still stated a claim for relief because the alternative explanation that an imprudent fiduciary process had led to improper share class selection urged by the plaintiffs was still plausible.
The next circuit to apply Hughes was the Sixth Circuit. It issued two opinions. In the first, Smith v. CommonSpirit Health, the court affirmed dismissal of a complaint alleging that a retirement plan should have offered a different mix of fund investment options—asserting actively managed funds should have been replaced with passively managed funds—and also challenging the fees paid to plan service providers as imprudently high. In dismissing the complaint, the Sixth Circuit emphasized Hughes’ language stating that the prudence of any fiduciary’s decision-making process turns on the prevailing circumstances at the point in time when the decision was made, that there are tradeoffs for each fiduciary decision, and that giving “due regard” to the range of reasonable judgments available, such that both “common sense” and the “strength of competing explanations for the defendant’s conduct” is important.
Applying these standards, the Sixth Circuit squarely rejected as implausible the breach of fiduciary duty claim premised upon the inclusion of actively managed funds in the plan simply because passively managed comparators allegedly performed better and cost less. In so doing, the court explained that index funds are not proper comparators for actively managed funds, meticulously outlining the differences in glidepath and risk profile before noting that the inclusion of both within a plan menu is a reasonable and prudent response to consumer behavior. Going further, the court opined that even if the funds could be compared meaningfully, merely alleging that one fund outperformed another over some limited period of time does not permit an inference of an imprudent fund selection or retention process given the long-term investment goals of 401(k) plans. To this point, the court also noted that, since the case had been filed, the challenged active funds had outperformed the index funds, demonstrating the folly of relying on short-term performance metrics alone as an indicator of procedural imprudence. Instead, the complaint must contain allegations that there were real-time indicators of such catastrophic performance that a reasonable investor would not choose to invest in the fund. No such facts were alleged.
Finally, regarding fees, the Sixth Circuit rejected the claim because—although it alleged the recordkeeping fee charged was above the “benchmark” for reasonableness—there were no facts alleged to bring any context to the fee charged, such as the level of services provided. Because there were no facts about the services being provided in exchange for the allegedly imprudent fee, the complaint did not plausibly state that the fee was unjustified by the services being provided.
The next Sixth Circuit case was Forman v. TriHealth, Inc. In this opinion, the Sixth Circuit relied upon and reiterated its reasoning from CommonSpirit Health, dismissing similar claims of underperformance and over-expense based upon the inclusion of actively managed funds in the plan and allegedly excessive fees. The TriHealth opinion did, however, permit one narrow claim to survive, holding that the assertion that the plan imprudently offered more expensive retail class shares for an investment fund stated a plausible claim for breach of ERISA’s fiduciary duty of prudence. In so holding, the court acknowledged the existence of revenue sharing as a potential alternative plausible explanation, but found that because the inference of imprudence drawn in the complaint and the inference of prudence based on revenue-sharing were equally plausible, the complaint should be permitted to proceed through discovery. That said, the opinion indicated discovery on this issue should be narrow and seemed to suggest it would be proper for an early summary judgment motion.
The Seventh Circuit has also applied the Hughes decision. In Albert v. Oshkosh, the Seventh Circuit affirmed a district court’s decision to dismiss a complaint for failure to state a claim, echoing both CommonSpirit Health and TriHealth in holding that recordkeeping fees are not imprudent simply because of allegations that lower fees exist—instead, there must some allegation that the fee charged was too high in relation to the specific services rendered to the plan. The court also rejected a threadbare comparison between the performance and cost of actively and passively managed funds, finding it was insufficient to raise an inference of imprudence. Finally, the plaintiff in Oshkosh attempted to “reverse” the typical share class allegation, claiming that the retail class shares and revenue sharing should have been offered over institutional class shares of an investment fund because that would have apparently resulted in a lower net cost. The court rejected this claim as implausible, reasoning that it was unclear from the allegations in the complaint whether the alleged revenue sharing would be paid back to the plan itself or end up elsewhere, such that the fact of revenue sharing alone did not raise an inference of lower cost for the same fund and resulting imprudence.
The Eighth Circuit is the most recent appellate court to apply Hughes. In Matousek v. MidAmerican Energy Co., the Eighth Circuit affirmed the dismissal of a complaint alleging imprudence based on underperforming funds and excessive recordkeeping fees because the complaint failed to identify better, prudent alternatives in support of either claim. Specifically, the court rejected as implausible allegations of excessive record-keeping fees based upon comparison to industry averages, noting that such a comparison says nothing about the type or quality of services performed in exchange for the fee and thus does not provide a meaningful benchmark for comparison. On the investment performance front, the court likewise rejected as implausible the complaint’s threadbare comparison of the challenged funds to purported “peer group funds,” noting the lack of detail about whether these peer funds “hold similar securities, have similar investment strategies, and reflect a similar risk profile” rendered them improper, meaningless comparators. And, even where peer group funds were identified by name, the court found, after taking judicial notice of each fund’s prospectus, that differences in articulated fund goals and glidepath rendered the comparisons improper. Absent plausible allegations that a prudent alternative fund exists, the complaint failed to state a plausible claim for relief and dismissal was proper.
From these cases, a few trends emerge. First, courts tend to reject as implausible complaints based on the assertion that active funds should have been replaced by passive index funds due to “better performance” over a 3- to 5-year period and “lower cost.” Instead, courts are recognizing the different purposes and glidepaths of actively managed and passively managed funds, and that the long-term nature of 401(k) investing means both types of funds can (or even should) be offered as a prudent response to customer demand. Absent some other real-time indicator of catastrophic performance failure such that no reasonable person would remain in the fund, it does not appear that the 3- to 5-year performance indices currently being used by plaintiffs to mark performance are adequate, standing alone, to plausibly allege imprudence.
Second, courts are viewing with more skepticism imprudent recordkeeping fee claims based upon nothing more than a comparison to the market average. Instead, courts are requiring allegations that, if true, show that the fiduciary’s consent or approval of the specific fee charged to the specific plan at issue was imprudent given the specific services being provided in exchange for that fee.
Finally, it appears that courts are willing to recognize claims of imprudence sufficient to survive a Rule 12(b)(6) challenge where the complaint includes an allegation that the plan continued to offer the retail share class of a fund when the institutional share class was available. However, both circuits that have addressed claims premised on this allegation post-Hughes have acknowledged the existence of revenue-sharing as an “equally plausible” explanation for the alleged events, noting that it could make the retail share class less costly to participants overall and negate any inference of imprudence. As such, it may be wise to consider attacking such claims through early summary judgment motions or judgment on the pleadings, particularly where plan literature or other documents make clear that revenue sharing negates any inference of imprudence that can be drawn from the allegations of the complaint. It should also be noted that a record of the plan’s fiduciary decision-making process can be a critical element in defending against these types of claims if they survive these initial challenges and are allowed to proceed to the merits.