401(k) litigation — 2 cases employers must follow

If you think you’re immune from an employee lawsuit alleging a breach of fiduciary duty over the investment choices you offer in your 401(k) plan, think again. The ink is barely dry on the Supreme Court’s Hughes v. Northwestern decision and it’s already reverberating around federal courthouses.

Recap: Hughes v. Northwestern

In late January, the court released its opinion in Hughes v. Northwestern University.

This dispute began as a classic case of employees suing the fiduciaries of their 403(b) plan, alleging they breached their fiduciary duties by allowing investments with high fees. A federal trial court dismissed the case and a federal appellate court upheld the lower court’s decision. Appellate court: A fiduciary satisfies its duty of prudence under ERISA once employees are presented with investment options.

The Supreme Court reversed, ruled the appellate court applied the wrong standard; it remanded the case to the appellate court. Supreme Court: Whether employees have investment choices doesn’t alone satisfy ERISA’s duty of prudence. Fiduciaries must monitor those investment options and remove imprudent ones.

The takeaway: Defined contribution plans such as 403(b) plans and 401(k) plans don’t run on autopilot. You have a continuing duty to review the plan’s investment choices, including the fees charged by third-party administrators, and make changes when necessary. It’s usually sufficient if fiduciaries meet quarterly to review the plan’s performance.

Payroll Handbook D

401(k) plan litigation

The Supreme Court’s decision in Hughes was narrow. The court said simply presenting employees with investment options in a defined contribution plan, where some choices were bad and others weren’t, didn’t satisfy ERISA’s duty of prudence. Instead, the court ruled plan fiduciaries have an ongoing duty to monitor the plan’s investment options and remove imprudent ones.

The Hughes employees alleged plan fiduciaries violated their statutory duty of prudence by:

  • Failing to monitor and control record-keeping services fees
  • Offering mutual funds in the form of retail share classes, which carried higher fees than those charged by otherwise identical institutional share classes of the same investments
  • Offering more than 400 investment options, which caused them to make poor investment decisions.

The Supreme Court addressed none of these substantive issues, because it didn’t have to. Likewise, it didn’t rule plan fiduciaries breached their fiduciary duty in all excessive fee cases.

And this is where the mischief begins.

Goodman v. Columbus Regional Healthcare System

This is the first federal trial court decision issued after Hughes.

The Goodman employees sued the plan administrator, alleging the following breaches of fiduciary duty:

  • They were offered mutual funds in the form of retail share classes even though it could have offered identical institutional share classes with significantly lower fees.
  • The plan selected and maintained investments with a history of underperformance and didn’t remove them from the investment menu when they continued to underperform.
  • The investment menu focused on an active management strategy, which highlighted actively managed mutual funds with investment management fees exceeding the fees for similar passive index fund options.

So far, pretty typical for this type of litigation.

What’s wasn’t so typical: The federal trial court, relying on the Hughes decision, ruled against the employer’s motion to dismiss, concluding employees had stated a plausible claim that continuing to offer underperforming mutual funds with excessive expense ratios despite a consistent history of underperformance would violate ERISA’s duty of prudence.

Court: The Supreme Court has suggested employees may state a claim for breach of ERISA’s duty of prudence by alleging the plan fiduciary offered higher-priced retail-class mutual funds instead of available identical lower-priced institutional-class funds.

Actually, whatever the Supreme Court may have “suggested” in Hughes isn’t controlling. It’s what lawyers call dicta—incidental remarks carrying no weight. Even so, dicta can be powerful, if it catches on with other courts. Hence what may be the beginning of a raft of excessive-fee lawsuits.

The takeaway: The general consensus after Hughes is limited and extends only about this far—offering mutual funds with high-fee retail shares when identical low-fee institutional shares are available could be a breach of fiduciary duty.

Whether, say, you breach your fiduciary duty by offering employees 400 mutual funds to choose from needs to wait for another day and another lawsuit. For now, the only clear fallout from Hughes is your continuing duty to review the investment choices and your third-party administrators against other investments and TPAs and change them when necessary.

It’s usually sufficient if fiduciaries meet quarterly to review the plan’s performance.