Supreme Court Considers the Right Balance in ERISA Excessive Fees Case
On December 6, 2021, the Supreme Court heard argument in Hughes v. Northwestern University. In Hughes, the Court will address the pleading standard for claims arising under the Employee Retirement Income Security Act of 1973 (“ERISA”) that a plan fiduciary breached its duty of prudence by paying or charging its participants excessive fees. For over a decade, plan fiduciaries and participants have disputed this question to mixed results in the federal courts, and while the Court may provide an answer in Hughes, argument has not made clear what that answer may be. Below is a summary of oral argument in Hughes. A decision has not yet been issued.
The participants allege that Northwestern breached its duty of prudence by paying and charging them excessive fees.
ERISA imposes fiduciary duties on plan administrators, 29 U.S.C. § 1104(a), and subjects them to personal liability for breaching those duties, see id. §§ 1109(a), 1132(a)(2). At issue in Hughes is the duty of prudence, which requires plan fiduciaries to exercise “the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” Id. § 1104(a)(1)(B). Current and former employees of Northwestern University who participated in the university’s defined-contribution plans allege that Northwestern breached this duty of prudence in two ways. First, they allege that Northwestern overpaid for recordkeeping fees, paying four to five times the amount of a reasonable fee. The participants allege that Northwestern could have taken several steps to reduce recordkeeping fees, including consolidating from two recordkeepers to a single recordkeeper, putting out a proposal for competitive bidding on recordkeeping services, or negotiating with the existing recordkeepers for rebates or fee reductions. Second, they allege that Northwestern offered investment options that charged excessive investment fees. The participants allege that Northwestern offered high expense retail-class versions of mutual funds when it could have offered identical low cost institutional-class versions of those same funds. In addition, they allege that Northwestern offered too many investment options, which both reduced its ability to qualify for lower-cost share classes of funds and caused the participants confusion as they sought to make sound investment decisions. The district court dismissed the complaint, and the Seventh Circuit affirmed. As to the excessive recordkeeping fees, the court of appeals held that a plan fiduciary is not obligated to select any particular recordkeeping fee arrangement, and the participants had failed to explain how a move to the proposed single recordkeeper arrangement was either feasible or beneficial to the participants. As to the investment fees claim, the court held that because plan participants had low cost investment options available to them, the inclusion of additional, higher expense options was not imprudent.
The justices search for the proper balance between preventing plan misconduct and imposing too many burdens on plan fiduciaries.
At argument before the Supreme Court, a clear consensus on the proper pleading standard for excessive fees cases did not emerge. The justices seemed to agree that a bare allegation that a plan fiduciary offered options that were too expensive does not suffice to state a claim for a breach of the duty of prudence. Beyond that, the justices’ questions related to the proper balance between, on the one hand, deterring and punishing imprudent plan management and, on the other, imposing too great a burden on plan fiduciaries. Justice Thomas asked whether the participants’ claims were just second-guessing Northwestern’s decisions. Justice Gorsuch expressed concern that the claims raised questions about judicial competence, particularly in determining when choice, usually considered a positive, should be restricted. Justice Breyer pressed the participants’ counsel to state the extent plan fiduciaries must go to manage fee costs, suggesting that while a fiduciary should not spend $1,000 for an apple at a grocery store, the beneficiary cannot expect the fiduciary to make the best bargain on every item at the store. He emphasized that the Court faced a real “dilemma,” given the “enormously complicated” decisionmaking at issue, between allowing plan fiduciaries to get away with mismanagement and enabling participants to bring an action against any plan decision. Justice Breyer struggled to find a solution “that prevents those two evils.” Chief Justice Roberts echoed Justice Breyer’s concerns, suggesting that a person asked to fill a car with gas should pick the cheapest station at the intersection but should not be expected to drive another 10 miles to find the cheapest alternative. He emphasized the statutory language in ERISA, proposing that the prudence duty is an “average,” not “highest,” standard.
Justices Sotomayor and Kagan propose a middle ground.
Justices Sotomayor and Kagan appeared sympathetic to the plan participants’ arguments but did not embrace all aspects of their claims. Justice Kagan proffered that there were two dimensions to the participants’ claims: First, Northwestern failed to bargain and use its existing leverage to obtain lower fee rates, and second, had the university consolidated its plans by reducing the number of recordkeepers and funds offered, it could have redistributed the plans’ money into the remaining funds that would have qualified for lesser expenses. As to the former, Justice Kagan suggested it “just sounds like negligence” and “bad . . . trustee management” for a plan to offer a more expensive retail class of a fund when all it needed to do to get the less expensive institutional rate was ask for it. As to the latter, she found the consolidation claim “a harder one” for the participants to make. She suggested there may be value to having two record keepers and a downside to having a non-diverse set of funds – where to draw the line would be challenging for courts to decide. Justice Kagan seemed to view a claim that Northwestern failed to “negotiate hard enough” plausible but stated she would “have to think about” a claim based on consolidation. She made efforts elsewhere to suggest that the complaint could state a claim for excessive fees “even if you put aside the issue of consolidation.”
Justice Sotomayor largely agreed with Justice Kagan’s comments, calling the offering of more expensive funds when a cheaper one could have been obtained by asking for it the participants’ “strongest argument.” Like Justice Kagan, Justice Sotomayor assumed there may be some value in having two companies serve as record keepers and failed to see how a participant could allege enough to render that arrangement imprudent. When Justice Sotomayor asked whether there could be “a happier medium” than the one advocated by Northwestern, counsel for the university proposed the Court make clear that this claim is not sufficient while specifying what claim would be, but Justice Sotomayor quickly retorted that would be hard to do with respect to the pricing of some of the funds but may be possible with the consolidation allegations.
The Court is wary of excessive litigation.
Justice Kavanaugh directly asked the question of how the Court should weigh the concern that “these class action complaints are such that the game is to get past pleading stage.” Working it out at trial “doesn’t happen in the real world” because of the enormous pressure to settle, and Justice Kavanaugh suggested that the participants’ emphasis that “[t]his is just the pleading stage” does not grapple with the reality of how these class action complaints operate. He wondered whether it was the Court’s job to deal with these practical considerations or if it should be left to Congress. Justice Alito also asked how many cases make it beyond the pleading stage. Chief Justice Roberts also raised another prudential concern – to what extent should a court place weight on the fact that a plan fiduciary, like Northwestern, ultimately made the fix that the plan participant asserts should have been made sooner? He wondered whether that created a perverse incentive not to improve plans.
The Court seems unlikely to dispose of the case on standing or the “large menu” defense.
Two arguments raised by Northwestern in their briefing did not receive that much attention. As to whether the lead plaintiffs satisfy the requirements for Article III standing, Justice Gorsuch asked a few questions on whether the complaint had sufficiently alleged that the lead plaintiffs were confused by the plans’ investment options to support an injury for purposes of standing. No other justice engaged with that question. As to the “large menu” defense adopted by the Seventh Circuit, counsel for Northwestern appeared less willing to defend that position. In response to Justice Kagan’s assertion that it cannot be correct that a fiduciary can insulate itself from liability by offering prudent investments with reasonable fees, even when it offers imprudent investments with “gouging” fees, counsel for Northwestern refrained from answering the question directly but instead tried to dispute the hypothetical's relevance to the present facts, claiming that any differences in price were marginal and not “gouging.”
The discussion at oral argument suggests even the justices most sympathetic to the participants were not willing to endorse all aspects of their claims, making a full reversal less likely. It is possible that the Court could adopt the middle ground suggested by Justices Sotomayor and Kagan, but beyond those two and possibly Justice Breyer, the rest of the Court did not express much support for this position. The Supreme Court’s ruling is expected by June.
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.