Alert December 09, 2021

Supreme Court Hears Case On Pleading Standard In Suits Alleging Breach of Fiduciary Duty Relating to Retirement-Plan Fees and Expenses

On December 6, 2021, the U.S. Supreme Court heard argument in Hughes v. Northwestern University, a case debating the allegations necessary to state a plausible claim for breach of ERISA’s fiduciary duties in cases challenging a defined-contribution plan’s investment line-up or the plan’s administrative expenses. The Justices seemed uncertain both about how to articulate a pleading rule that would allow plausible claims to proceed while weeding out speculative ones, and also about which category the plaintiffs’ allegations fall into.

In this case, the plaintiffs challenged the investments included in Northwestern University’s large and diversified 403(b) plan line-ups, and the recordkeeping fees of its retirement plans. The district court dismissed the complaint for failure to state a claim, and the Seventh Circuit affirmed in an opinion focusing on participant choice and rejecting “paternalistic” lawsuits that seek to “seize ERISA for the purpose of guaranteeing individual litigants their own preferred investment options.”

The plaintiffs sought Supreme Court review, and the Court granted certiorari after asking the Solicitor General to weigh in on the petition. Notably, the petition for certiorari took a broad view of plan line-up challenges, contending that a plaintiff can state a fiduciary-breach claim simply by alleging that an alternative investment or recordkeeping option with lower fees was available on the market. But the Solicitor General’s brief took a more cabined view, asking the court to consider the narrow question of “[w]hether participants in a defined-contribution ERISA plan state[_] a plausible claim for . . . breach of the duty of prudence by alleging that the fiduciaries caused the participants to pay investment-management or administrative fees higher than those available for other materially identical investment products or services.” The Court granted review without limitation, however, meaning that all of the plaintiffs’ challenges presented in their cert. petition were fair game at the merits stage. Those challenges included (1) the use of retail share-class versions of mutual funds that were available as institutional share classes with lower expense ratios (but also lower revenue-sharing benefits and minimum-investment requirements); (2) the maintenance of a large and diversified investment line-up with hundreds of investment options, some of which had a similar investment style; and (3) the use of two recordkeepers, rather than one, allegedly with excessive recordkeeping fees.

At Monday’s argument, the Supreme Court seemed divided and uncertain. Several of the Justices echoed the Seventh Circuit’s concerns about paternalism and participant choice. Justice Gorsuch and Justice Kagan, for example, seemed skeptical of claims premised on the notion “that choice is bad.” Both made the common-sense observation that more choice is “usually a good thing.” Justice Kagan, in particular, noted skepticism with lawsuits criticizing the inclusion of actively managed funds, noting that “it’s not unreasonable for a fiduciary to have both.” Several Justices also seemed skeptical of lawsuits complaining about aspects of plan management that are consistent with industry norms, like the choice of two recordkeepers rather than one — a choice made my many plan fiduciaries.

At least a few justices also seemed concerned that district courts are not institutionally equipped to effectively micromanage plan-management decisions. Justice Breyer noted the complicated nature of these decisions and the incentives that exist for lawsuits to be filed, noting that “it’s the easiest thing in the world” for lawsuits to second-guess fiduciary decision-making: “If they have a lot of choices, you say you had too many choices, and if they have only a few choices, you say you had too few choices. And so whatever they do, you’re going to say this was wrong.”

At the same time, several Justices seemed concerned that the Seventh Circuit’s approach allows plan fiduciaries to “insulate” themselves from a lawsuit for truly imprudent decisions as long as some of their decisions are prudent ones. And while several of the Justices seemed to agree that cost is not the only thing fiduciaries should consider, they also seemed inclined to agree that well-pleaded allegations that fiduciaries were not making efforts to minimize costs — for example, that fiduciaries offered higher-cost versions of “identical” investment options than lower-cost versions that were available — could plausibly state a prudence claim. However, the justices posited multiple questions about whether institutional share classes with allegedly cheaper fees than their retail share counterparts were actually identical to retail share classes and actually available to Northwestern’s plans.

Above all, the Justices seemed to struggle with articulating a standard that would not foreclose plausible imprudence claims at the pleading stage, but also not open the door to discovery for every excessive-fee complaint seeking to second-guess complicated, discretionary fiduciary decisions. This struggle is similar to the challenges faced by the Supreme Court in Fifth Third Bancorp v. Dudenhoeffer, a case similarly addressing the standard for pleading a fiduciary-breach claim in the context of plans offering employer stock. Where the Court will ultimately draw the line is anything but certain at this point. The Court’s decision is expected by the end of June.

A final note: at some rather humorous parts of the argument, the concerns expressed about the judiciary’s institutional competence to meaningfully evaluate complicated plan-management decisions were on display. Justice Breyer offered one hypothetical involving a “Space Shuttle Fund” that “invests in space shuttles” and a second involving “the large institutional farm fertilizer fund” — options unlikely to be found in a retirement-plan line-up. Chief Justice Roberts, for his part, inquired about mutual funds offered by “the gecko” (referencing Geico, a private auto insurance company that does not manage mutual funds), before correcting himself and asking, “the gecko’s not funds, right? That’s just insurance?”