Hughes v. Northwestern University

Issues 

Whether allegations that an employer 403(b) retirement plan charged excessive fees when lower cost investment products and services were available are sufficient to bring a claim for a breach of fiduciary duty under ERISA?

Oral argument: 
December 6, 2021

This case asks the Supreme Court to determine the standard to bring a claim that applies to a breach of fiduciary duty under the Employment Retirement Income Security Act (“ERISA”) for allegations of excessive investment fees and recordkeeping fees. April Hughes and other employees at Northwestern University brought suit, claiming Northwestern’s breach of fiduciary duty in ERISA retirement plans, pointing to a large investment option menu and higher-than-average fees. In particular, petitioner April Hughes and others argue that an ERISA’s fiduciary duty of care stems from trust law, and that Northwestern’s imprudent investment and recordkeeping decisions caused excessive fees and breached their duty of care. Respondent Northwestern University answers that context-specific scrutiny is the proper standard for fiduciary duty under ERISA, and that its plan’s cost reflects its prudent investment and recordkeeping decisions. The outcome of this case will impact those people that participate in savings programs that are offered by their employers and the employers themselves, as well the fiduciary duties of said employers, the rights of the beneficiaries, and the available investment options of the beneficiaries.

Questions as Framed for the Court by the Parties 

Whether allegations that a defined-contribution retirement plan paid or charged its participants fees that substantially exceeded fees for alternative available investment products or services are sufficient to state a claim against plan fiduciaries for breach of the duty of prudence under the Employee Retirement Income Security Act of 1974?

Facts 

April Hughes, Laura Divane, and others (collectively referred to as “Hughes”), employees at Northwestern University (“Northwestern”), entered into defined contribution plans, administered and developed by their employer Northwestern, under the Employee Retirement Income Security Act (“ERISA”). Divane, et al. v. Northwestern University, et al. at 983. Northwestern offered both the Northwestern University Retirement Plan (“the Retirement Plan”) and the Northwestern University Voluntary Savings Plan (“the Voluntary Savings Plan”), and employees such as Hughes entered into one or both of them. Id. Participants of the Retirement Plan invested part of their salary into the plan and receive matching contributions from Northwestern. Id. In contrast, participants of the Voluntary Savings Plan invested part of their salary into the plan, but Northwestern did not provide matching funds. Id. Northwestern served as the fiduciary and administrator of the plans. Id. At the time, Northwestern offered 429 investment options through both plans. Id. at 983–984.

In October 2016, however, Northwestern reduced the available offerings to approximately forty investment options, derived from the Teachers Insurance and Annuity Association of America and College Retirement Equities Fund (“TIAA-CREF”) and Fidelity Management Trust Company (“Fidelity”). Id. at 984. One of the options under these plans was the TIAA-CREF Traditional Annuity (“Traditional Annuity”), which had “severe restrictions and penalties for withdrawal.” Id. In addition, the Traditional Annuity required a TIAA-CREF Stock Account Fund (“Stock Account Fund”), and a separate Teachers Insurance and Annuity Association (“TIAA”) recordkeeper. Id. The Stock Account Fund and recordkeeper were paid through an expense ratio, instead of a flat annual fee. Id. at 984–985.

In 2016, Hughes filed suit against Northwestern for “breaching its fiduciary duties under ERISA.” Id. at 983. Seeking monetary and injunctive relief, Hughes argued that Northwestern breached its duties of loyalty and prudence by charging excessive administrative and management fees, yielding performance losses, and failing to monitor their designated fiduciaries. Id. at 983–985. Hughes noted, as well, that the “streamlin[ing]” of Northwestern’s investment options indicated that, prior to 2016, Northwestern’s investment offerings had been imprudent. Id. at 984. Post 2016, Hughes contended that Stock Account Fund had a history of performing poorly for investors, and that Northwestern’s administration of the fund, in particular in record-keeping, drove up investor fees. Id. at 984–985. In response, Northwestern filed a motion to dismiss, and moved that the court deny all other requests. Id. at 4.

The United States District Court for the Northern District of Illinois (“District Court”), granted Northwestern’s motion to dismiss, holding that Northwestern did not breach its fiduciary duties. Id. at 985–986. In particular, the District Court held that Northwestern did not breach its fiduciary duty by offering the Stock Account Fund or any particular investment option, since Hughes was not required to use them and could have used alternative options that Northwestern offered. Id. While the District Court conceded that Northwestern could have breached its fiduciary duties by only offering high-cost options, Northwestern did not do this and instead offered a range of high and low-cost options. See id. at 986. The District Court also reasoned that Northwestern’s decision to offer a wide range of options in it of itself did not constitute a breach. Id.

Hughes subsequently appealed to the United States Court of Appeals for the Seventh Circuit. Id. at 987. The United States Court of Appeals for the Seventh Circuit affirmed the District Court’s ruling. Id.

The United States Supreme Court granted Hughes’ petition for certiorari on July 2, 2021.

Analysis 

SCOPE AND STANDARD TO DETERMINE FIDUCIARY DUTY

Petitioner April Hughes (“Hughes”) argues that the standard to determine fiduciary duty under ERISA stems from trust law. Brief for Petitioner, April Hughes, et al., at 20. Hughes maintains that common law requires a trustee to charge a brokerage fee based on market rates and to incur expenses that are reasonable and necessary. Id. at 22–23. Thus, Hughes contends that ERISA applies similar prudent investment rules to its fiduciary duties. Id. at 21–22. Hughes further claims that ERISA requires a fiduciary to exercise its duties and to manage investments with “care, skill, prudence, and diligence.” Id. 19. In other words, Hughes claims that an ERISA’s fiduciary is required to act in a reasonably prudent matter to protect the interests of participants and beneficiaries. Id. Additionally, Hughes argues that a prudent fiduciary performs certain duties, and three of these responsibilities include: the duty to incur “necessary or appropriate” expenses; the duty to act prudently when assigning investment responsibilities to vendors; and the duty to monitor investment fees and recordkeeping fees. Id. 21–22.

Respondent Northwestern University (“Northwestern”) disagrees, arguing that trust law principles do not apply to fiduciary duty under ERISA. Brief for Respondents, Northwestern University, et al., at 22. Instead, Northwestern contends that context-specific scrutiny is the proper standard for fiduciary duty under ERISA. Id. at 19. Northwestern claims that, under ERISA, the fiduciary’s duty of care is connected to the characteristics of the specific plan, and that a fiduciary is allowed to adjust the price of investment services and products based on the nature of the plan. Id. at 19–20. Moreover, Northwestern disagrees that a fiduciary is obligated to complete certain responsibilities. Id. at 19. To support this assertion, Northwestern claims that that ERISA grants the fiduciary extensive flexibility and discretion to execute decisions on behalf of the participants and beneficiaries. Id. Put succinctly, Northwestern argues that a fiduciary’s duties are not as inflexible as a “straight jacket.” Id.. Given the context of Northwestern’s investment plans, Northwestern argues that it was not obliged to exclude the expensive retail-class funds from its plans, despite the availability of identical lower-priced institutional-class funds. Id. at 21.

FIDUCIARY DUTY IN INVESTMENT FEES

Hughes argues that an ERISA’s fiduciary has a duty to use the least expensive investment options and to reduce the number of investment options. Brief for Petitioners at 29, 36–37. To support this assertion, Hughes claims that ERISA requires a fiduciary to incur expenses that are reasonable and necessary and to eliminate imprudent investments. Id. Here, Hughes argues that Northwestern failed to satisfy its duty of care for three reasons, which then caused the plans’ investment fees increased exponentially. Id. First, Hughes maintains that Northwestern failed to monitor the investment fees and recordkeeping fees. Id. at 2–3, 11. Second, Hughes claims that Northwestern inclusion of expensive retail-class mutual funds in its plans demonstrates that it did not make a “cost-conscious” investment decision. Id. at 30. Hughes argues that a prudent fiduciary would have used the identical lower-cost institutional-class funds. Id. For that reason, Hughes maintains that Northwestern’s investment decision caused participants to “lose millions of dollars of their retirement savings.” Id. Third, Hughes contends that it was imprudent for Northwestern to design plans with multiple and duplicated investment options, which caused high expenses and led to confusion among participants. Id. at 35–36.

Northwestern disagrees that ERISA imposes a duty on a fiduciary to use the least expensive investment funds options. Brief for Respondents, at 21. Northwestern asserts that its defined-contribution plans, much like other ERISA plans, are participant-directed options, wherein the fiduciary does not micro-manage a participant’s investment options. Id. at 19–20. Instead, Northwestern contends that a fiduciary’s main duties include providing participants multiple investment options and information to “make their own choices.” Id. at 20. Thus, Northwestern argues that it was prudent for its retirement plans to include expensive retail-class mutual funds, because participants still could have chosen from a broad range of lower-cost investment funds options. Id. at 21. However, Northwestern also argues that replacing the expensive retail-class was not an option, because many of the plan participants were not eligible for the cheaper institutional-class funds. Id. at 37. Northwestern claims that many of its participants’ retirement saving amounts failed to meet the minimum investment needed to purchase an institutional-class fund. Id. Additionally, Northwestern asserts that these was no reports of other higher education institutions’ retirement plans receiving a waiver for investment minimums for institutional-class funds. Id. at 39. Finally, Northwestern contends that there is no proof that duplicative options caused confusion among participants. Id. at 35–36.

FIDUCIARY DUTY IN RECORDKEEPING FEES

Finally, Hughes claims that Northwestern’s imprudent actions caused excessive recordkeeping fees. Brief for Petitioners at 32. Hughes claims that the average plan’s recordkeeping fee is approximately one million dollars. Id. However, Hughes maintains that Northwestern’s recordkeepers charged “several times a reasonable rate.” Id. at 43. Indeed, Hughes points out that Northwestern plans’ recordkeepers fees were an astonishing four to five million dollars. Id.at 32. Hughes further identified three ways Northwestern’s imprudent actions caused excessive recordkeeping fees. Id. First, Hughes argues that Northwestern failed to use a single recordkeeper to manage its retirement plans. Id. Hughes maintains many higher education institutions have used single recordkeepers as a solution to reduce the cost of their retirement plans, contending that Purdue University, Pepperdine University, and Loyola Marymount University, among others, employed a single record keeper to manage their retirement plans, and consequently these plans have become less expensive. Id. at 33–34. Second, Hughes claims that Northwestern failed to search the market for equally competitive recordkeepers that offered identical plans and lower-cost services. Id. at 34. Third, Hughes maintains that Northwestern failed to negotiate lower fees or rebates with current recordkeepers. Id. at 32. To illustrate, Hughes points out that the California Institute of Technology (“CalTech”) offers a retirement plan like Northwestern’s plans, but not only consolidated its plan to a singular recordkeeper but negotiated with its existing recordkeeper a rebate worth fifteen million dollars. Id. at 34.

Northwestern disagrees that its actions caused excessive recordkeeping fees. Brief for Respondents at 29. Northwestern argues that Hughes has no proof that the average plan’s recordkeeper cost around one million dollars. Id. at 32. Northwestern also disagrees that it was imprudent for its plans to retain two recordkeeper, instead arguing that its plan, including keeping two recordkeepers, was consistent with industries standards. Id. Moreover, Northwestern claims that Hughes failed to show that a single recordkeeper would have performed better than two recordkeepers. Id. at 31. Additionally, Northwestern argues that it was not a viable option for its plans to adopt a single recordkeeper. Id. at 30. First, Northwestern argues Hughes failed to show the university could have hired one recordkeeper at a lower rate. Id. at 29. Second, Northwestern explains was that both the Teachers Insurance and Annuity Associate of America (“TIAA”) and the Fidelity recordkeepers were necessary components to the plans, and therefore both had to be retained. Id. at 30. According to Northwestern, the TIAA’s recordkeeper’s popularity prevented its elimination and the Fidelity recordkeeper was needed to purchase fidelity investment options. Id. Therefore, Northwestern argues that, given the importance of both recordkeepers to the plans, the additional expense incurred to retain both was a necessary service. Id.

Discussion 

INVESTORS AND THEIR RETIREMENT PLANS

In support of Hughes, the AARP et al. (“AARP”) assert that millions of Americans are reliant on funds that are derived from their employment for their retirement, much like the 127 plaintiffs in this case. Brief of Amici Curiae AARP, et al., in support of Petitioners, at 20. Moreover, the Investment Law Scholars, in support of Hughes, argue that ruling in favor of Northwestern would incentivize fiduciaries to offer as many investment options as possible to their employees, in order to escape fiduciary liability for offering bad options. Brief of Amici Curiae Investment Law Scholars, in support of Petitioners at 25. According to the Service Employees International Union (“SEIU”), such overly large menus disincentivizes investment by investors. Brief of Amici Curiae Service Employees International Union, in support of Petitioners, at 5. Moreover, the SEIU asserts that such menus are likely to increase investment errors. Id. at 6. For example, the SEIU contends that investors, when faced with an excessive number of investment options, will be more likely to spread their retirement funds among all or a significant number of the investment options. Id. at 7. In doing so, the investors will be less likely to prioritize their optimal investment options. Id. In addition, the SEIU argues that investors will be overwhelmed by the excessive choices and will be more likely to fall prey to alphabeticity bias. Id. at 8–9. As such, the SEIU asserts that investors will minimize their investment potential by selecting investment options based on their position on the menus and not their costs and benefits. Id.

In support of Northwestern, the Chamber of Commerce argues that ruling for Hughes would harm beneficiaries by incentivizing fiduciaries to offer menus of investment options that prioritize lower fees at the expense of innovative services and high-reward investments. Brief of Amici Curiae Chamber of Commerce et al., in support of Respondents at 33–34. In addition, the Chamber of Commerce posits that fiduciaries like Northwestern would be pressured into offering investment options that offer minimal services for their beneficiaries. Id. Similarly, the Investment Company Institute contends that forcing fiduciaries to offer fewer investment options would impede investment diversification efforts by the beneficiaries. See Brief of Amici Curiae Investment Company Institute, in support of Respondents at 16. And, according to the Committee on Investment of Employee Benefit Assets (“CIEBA”), ruling for the Petitioner would lower the pleading standards for ERISA claims. Brief of Amici Curiae Committee on Investment of Employee Benefit Assets, in support of Respondents at 9–10. As a result, CIEBA argues that further ERISA suits would be incentivized, which would increase the cost of participating in ERISA plans. Id. at 10. CIEBA then asserts that these heightened costs might encourage certain employers to no longer offer ERISA plans. Id.

FIDUCIARY DUTIES AND BENEFICIARY RIGHTS

In support of Hughes, the Investment Law Scholars argue that affirming the lower court’s decision would allow administrators to reduce their fiduciary duties. Brief of Amici Curiae Investment Law Scholars, in support of Petitioners at 24. In particular, the Investment Law Scholars assert that administrators would be able to escape fiduciary liability when they offer bad investment options if they offer reasonably good investment options alongside them. Id. As a result, the Investment Law Scholars argue that administrators would no longer be duty bound to remove imprudent investment options from their offerings. Id. at 25. Similarly, the AARP argues that ruling in favor of Northwestern would shift the burden of determining which options contain imprudent fees and the responsibility of filtering options from the fiduciaries to the beneficiaries. Brief of AARP, at 16.

In support of Northwestern, the Chamber of Commerce contend that ruling for Hughes would encourage fiduciaries to restrict investment options and consequently limit their beneficiaries’ right to choose their own investments. Brief of Chamber of Commerce, at 33–34. In addition, the Chamber of Commerce argue that ruling for Hughes would inappropriately expand the duties of fiduciaries, by forcing fiduciaries to be aware of all available investment options in the marketplace, and the risks and rewards associated with each option. See id. at 24. To avoid the breach of fiduciary duty, the Chamber of Commerce also contend that fiduciaries would be required to offer only the most innovative investment options. Id.

Conclusion 

Written by:

Theresa Oliver

Sam Zarkower

Edited by:

Rachel Skene

Acknowledgments