A recent Supreme Court decision confirms that fiduciaries who control the investment options available to participants in self-directed, defined contribution pension plans, such as Section 401(k) plans, have an ongoing obligation to monitor the prudence of the investments offered by the plan. On January 24, 2022, in an 8-0 unanimous decision (with Justice Barrett not participating), the Court held, in Hughes v. Northwestern University, that offering low-cost investment options does not insulate fiduciaries from potential fiduciary liability that may arise from imprudently offering higher-cost options.
The fiduciary obligation under ERISA to monitor a plan’s investment options and to remove imprudent options is not new. Investment options in a 401(k) plan might be considered imprudent if, for example, investment returns are underperforming relative to a comparable benchmark for an extended period of time, or management or other fees are materially higher compared to other available options of a similar investment strategy. In 2015, the Supreme Court held that fiduciaries were subject to these obligations in Tibble v. Edison Int’l, 575 U.S. 523 (2015). The Tibble decision led to litigation against several Section 401(k) plans with respect to the fees associated with plan investment options, particularly against plans sponsored by colleges.
In Hughes, current and former employees of Northwestern University filed a lawsuit alleging that the fiduciaries of Northwestern’s 401(k) plans had breached their duties by failing to monitor and control the plan’s recordkeeping fees and by offering retail share classes with higher fees than the institutional share classes for the same investments.
Northwestern’s motion to dismiss was granted by the district court and affirmed by the Seventh Circuit. In affirming the dismissal, the Seventh Circuit focused on the fact that participants were provided a diverse selection of investment options, including low-cost index funds. The Seventh Circuit held that, because the plans made these low-cost options available to participants, there was no claim for breach of fiduciary duty. Even if the plans imprudently offered higher-cost investments, participants directed the investment of their account and could have chosen to invest in lower-cost alternatives.
Writing for the Court, Justice Sotomayor rejected that reasoning, explaining that, in defined contribution plans in which participants choose their own investments, fiduciaries maintain the obligation to monitor the prudence of investment options, and that the failure to timely remove imprudent investment options results in a breach of fiduciary duty. The Supreme Court held that, even when plans offer lower-cost investment options, a fiduciary nevertheless retains an ongoing obligation to monitor all of the plan’s investment options, and to remove those that are no longer prudent. Accordingly, the Court remanded the case to the Seventh Circuit for further consideration.
To be clear, this holding does not appear to change the obligations that 401(k) plan fiduciaries have to participants under ERISA. It was understood, especially after the decision in Tibble, that defined contribution plan fiduciaries were subject to the ongoing obligation to monitor investments. The ruling does, however, put to rest the argument that offering lower-cost investment options effectively immunized fiduciaries from imprudently offering higher-cost options.
While eliminating a potential defense against fiduciary breach claims, the Court also recognized the challenges facing plan fiduciaries, cautioning, in conclusion, that “[a]t times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs,” and noting that courts must give “due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” Accordingly, it is important for fiduciaries to continue to document their investment-monitoring practices in consultation with plan providers.
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