When the Supreme Court accepted certiorari in Hughes v. Northwestern University (“Hughes”), it was hoped that the Court would adopt pleading standards that would bring consistency to the adjudication of ERISA breach of fiduciary duty class action lawsuits directed at 401k and 403b plans.
Unfortunately, the Court issued a narrow ruling that left unresolved the issues that have been dividing the lower courts for years. See No. 19-1401 (U.S. Jan. 24, 2022). The Court did send some signals, however, as to how a workable pleading standard could be developed in the future.
The Need for a Clear and Workable Pleading Standard
The need for Supreme Court guidance in this burgeoning area of litigation was palpable. Since 2015, hundreds of cases have been filed against plan sponsors, fiduciaries, and service providers of 401k and other participant-directed account plans.
In response to motions to dismiss, courts have issued inconsistent rulings on nearly identical allegations, with many complaints withstanding dismissal in whole or in part. And by surviving motions to dismiss, plaintiffs have generated over a billion dollars in recoveries through settlement, with over $350 million of the proceeds earmarked for attorneys’ fees. These recoveries come despite the fact that, in the seven cases that actually proceeded to trial, plaintiffs have prevailed on only two of the many claims that were asserted in these cases.
The Opportunity Presented by Hughes
Hughes appeared to present an opportunity to “right this ship” with a clear statement as to how the issues that have divided the courts should be resolved at the pleadings stage. It was one of a series of lawsuits commenced in 2016 by the same law firm and asserting virtually identical claims against the fiduciaries of university 403b plans. And, as in the 401k plan cases, the complaint contained several of the familiar claims that have generated inconsistent rulings on motions to dismiss, such as those targeting (i) retail share classes for certain mutual funds that were allegedly more expensive than available institutional share classes for identical funds; (ii) other investment funds that allegedly overcharged or underperformed relative to comparable investments; and (iii) recordkeeping fees that allegedly exceeded industry norms.
The opportunity for Supreme Court review was presented when the Seventh Circuit issued its ruling in Hughes v. Northwestern (previously styled Divane v. Northwestern). The Court affirmed the district court’s dismissal of the same claims that were found to be viable in an earlier Third Circuit decision involving another university 403b plan, Sweda v. Univ. of Pa., 923 F.3d 320 (3d Cir. 2019). In so ruling, the Seventh Circuit provided various legal reasons why plaintiffs’ claims failed—e.g., there is no requirement in ERISA to offer the cheapest fund—and also gave weight to defendants’ “valid reasons” for having made the challenged decisions.
For example, the Court found that the share class claim was insufficiently pled, in part because the extra fees charged by the retail version of some mutual funds may generate revenue sharing credits that were used to pay recordkeeping fees that would otherwise have been paid out of participant accounts.
Similarly, the Seventh Circuit found that the claim for excessive recordkeeping fees was insufficiently pled, in part because the complaint did not identify another recordkeeper that would have performed the same services for less. The Seventh Circuit also stated throughout its ruling, however, that plaintiffs’ claims were insufficient because the plans included a wide range of options and, therefore, plaintiffs could choose not to invest in the more expensive funds.
The Supreme Court granted certiorari to resolve: “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 ERISA.”
The Supreme Court’s Disappointing Ruling
The Supreme Court ruling was foreshadowed by the oral argument. Instead of focusing on core issues that animated many of the 401k and 403b plan cases, the Justices were distracted by incidental issues unique to the university cases, such as whether there was value to retaining multiple recordkeepers if it enabled participants to invest in more than one recordkeeper’s products and whether plaintiffs had adequately pled that the alternative cheaper share classes were actually available to the plan, given the minimum asset requirements for those share classes.
None of the Justices paused to consider whether, independent of these concerns, these pleadings—without more—should be deemed sufficient to state a viable claim. Even more disconcerting was the fact that none of the Justices seemed inclined to focus on defense counsel’s effort to articulate a coherent pleading standard that would enable district courts to more competently and consistently adjudicate motions to dismiss.
Even more disconcerting was the fact that none of the Justices seemed inclined to focus on defense counsel’s effort to articulate a coherent pleading standard that would enable district courts to more competently and consistently adjudicate motions to dismiss.
Ultimately, the Supreme Court ruled on the narrowest possible grounds. In an opinion authored by Justice Sotomayor for a unanimous court, with Justice Barrett recusing herself, the Court vacated and remanded the Seventh Circuit’s ruling because of what it characterized as the Seventh Circuit’s “exclusive focus on investor choice”; and for failing to apply the “guidance” set forth in Tibble v. Edison Int’l, 575 U.S. 523, 530 (2015), which held that plan fiduciaries have an ongoing duty to monitor investments and remove imprudent investments within a reasonable time.
Having determined that this aspect of the Seventh Circuit’s decision, standing alone, called into question the dismissal of the claims, the Court declined to address the various other arguments put forward by the Seventh Circuit for dismissing the complaint. Instead, it remanded the case to the Seventh Circuit with instructions to reevaluate whether plaintiffs’ claims plausibly alleged a violation of the duty of prudence.
The Court also referenced its prior decision in Fifth Third Bancorp v. Dudenhoeffer, 573 US 409 (2014), which set forth pleading standards for employer stock claims, and stated that “[b]ecause the content of the duty of prudence turns on ‘the circumstances . . . prevailing’ at the time the fiduciary acts the appropriate inquiry will necessarily be context specific.”
Finally, the Court offered that “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”
The Upshot: Nothing Very Good, But Nothing Very Bad Either—and a Potential Silver Lining
The Supreme Court’s cursory review of the Seventh Circuit’s decision was a missed opportunity to stem the tide of inconsistent rulings on motions to dismiss by framing a coherent pleading standard and applying it to the claims presented. But it would be a mistake to view the decision as a rousing victory for the plaintiff’s bar.
The Supreme Court’s cursory review of the Seventh Circuit’s decision was a missed opportunity to stem the tide of inconsistent rulings on motions to dismiss by framing a coherent pleading standard and applying it to the claims presented.
When all is said and done, the ruling stands for the unremarkable proposition that a court cannot dismiss a complaint merely because the plan offered a mix and range of investment options and, therefore, plaintiffs could have avoided costlier investment options by selecting other available options. As to any other reasons for dismissing, the Court was silent, but it certainly had not closed the door.
Moreover, the Court’s closing remarks clearly signaled its expectation that the lower courts would apply a pleading standard that mirrors the standards it has adopted elsewhere. Perhaps most telling was the Court’s reference to Dudenhoeffer. It bears noting that, at first, Dudenhoeffer appeared to be a great victory to the plaintiffs insofar as the Court overturned the dismissal of an employer stock complaint because it was predicated on a presumption of prudence that the Court found to be invalid. But what ultimately proved to be of greater consequence was the Court’s articulation of an alternative pleading standard that required plaintiffs to plead facts that, if proven, would demonstrate that it was more likely than not that a reasonable fiduciary would not have made the challenged decision. Since that standard was adopted, not a single employer stock complaint has withstood a motion to dismiss.
Application of the Dudenhoeffer standard here should similarly lead to dismissal of claims that fail to contain allegations precluding the more obvious explanations for higher fee structures.
While Hughes may be a missed opportunity to straighten out the pleading standards governing 401k/403b plan litigation, the ruling may yet pave the pathway for a future ruling that does. Unfortunately, until then, it is unlikely that we will see any letup in the pace of these lawsuits.
Editor’s Note: This article was written for 401k Specialist by Proskauer Partner Myron D. Rumeld, co-chair of the Firm’s ERISA Litigation Practice, and associates Tulio D. Chirinos and Dan Wesson.
SEE ALSO:
• Hughes v. Northwestern Bottom Line: Harder to Dismiss Cases
• Plaintiffs Score Win in Excessive Fee Case Vs. Northwestern