In this sixth episode of our Ropes & Gray podcast series addressing emerging issues for fiduciaries of 401(k) and 403(b) plans to consider as part of their litigation risk management strategy, Doug Hallward-Driemeier, chair of Ropes & Gray’s appellate and Supreme Court practice, and Josh Lichtenstein, a benefits partner and head of the ERISA fiduciary practice, discuss the Supreme Court’s decision to hear the Northwestern University retirement plan case next term, which will examine what the applicable pleading standard should be for bringing a claim of fiduciary imprudence in violation of ERISA in connection with the management of a defined contribution plan. The podcast also includes an update on the DOL’s cybersecurity guidance.
Josh Lichtenstein: Hello, and thank you for joining us on this latest episode in our Ropes & Gray podcast series on emerging issues in the 401(k) litigation risk assessment and management space. I’m Josh Lichtenstein, an ERISA partner based in our New York office, and I am excited to be joined today by my colleague, Douglas Hallward-Driemeier, the chair of Ropes & Gray’s appellate and Supreme Court practice, who is based in Washington, D.C. In today’s episode, we are going to discuss the U.S. Supreme Court’s recent decision to grant certiorari in the Northwestern University 403(b) plan case, where the Court will be tasked with determining what the bar should be on asserting a plausible claim for breach of ERISA’s duty of prudence. Even though the case specifically concerns a 403(b) plan, which is sponsored by a not-for-profit institution, a Supreme Court decision on this topic could have important implications for any fiduciary of an ERISA-governed defined contribution plan in light of the ongoing wave of excessive fee lawsuits that we have been focusing on in this series.
But before we go further, I want to provide an important update to our listeners concerning another topic that we have discussed previously on this series—the U.S. Department of Labor’s (DOL) cybersecurity guidance. Back in April, the DOL released three publications to address certain cybersecurity and data privacy issues for benefit plans, which covered (i) online security tips for plan participants and beneficiaries; (ii) tips for plan sponsors and fiduciaries for prudently selecting service providers with strong cybersecurity practices; and (iii) best practices for plan fiduciaries and recordkeepers for managing cybersecurity risks. You can find the previous podcast in the series on this topic on our homepage and a hyperlink will also be provided in the transcript of this episode. According to recent quotes from the DOL officials, this guidance package appears to just be the beginning of the agency’s work in this area. The Department has made it clear that cybersecurity is a critically important issue to the Department of Labor that is going to be an enforcement priority for the foreseeable future.
While it is unclear if and when the DOL will propose more prescriptive standards or release additional guidance, over the last few months, we’ve heard of agency investigators starting to ask detailed questions and submitting lengthy requests for documents pertaining to cybersecurity matters in the course of ongoing plan audits. To our knowledge, the DOL has not started directly auditing plan sponsors’ or service providers’ cybersecurity practices other than in the context of these broader examinations, but it could just be a matter of time before that begins. The current environment seems to echo how the agency carried out its missing participant enforcement program several years ago. Right now, plan sponsors and service providers should be acquainting themselves with the DOL’s guidance package and paying careful attention to cybersecurity risks that their plans may face. It’s important to keep in mind that the recommended measures in the DOL’s guidance are fairly technical and jargon-heavy, and so implementing changes in response to them may require input from other colleagues within your organization, like IT or your chief information officer, as well as from third-party consultants.
So now, moving on to today’s topic, Doug, would you like to give some background to our listeners on the Northwestern case?
Doug Hallward-Driemeier: Of course, and thanks, Josh. I’m so happy to be speaking with you today about this very interesting topic. So, back in 2016, participants in two 403(b) plans sponsored by Northwestern University sued the plan fiduciaries—the school and its retirement investment committee, including the committee members individually—alleging a breach of ERISA’s duty of prudence on several theories that are prevalent in these types of suits. First, they claimed that the plans included too many investment options; second, they said the plans allegedly wasted money by contracting with multiple recordkeepers who put their own proprietary products into the plans; and third, they asserted the plans retained investment options that were high-cost and underperformed. In May 2018, the district court dismissed the lawsuit for failure to state a claim, reasoning that the participants had multiple options and were not required to invest in the products that they considered to have excessive fees or to underperform, and furthermore, just because the plaintiffs thought low-cost index funds might have been a better long-term investment, the plans had valid reasons for choosing the investments that they did.
The plaintiffs appealed to the Seventh Circuit, but the appellate court affirmed the dismissal in March 2020. A few months later, noting that the Seventh Circuit’s ruling created a circuit split on the issue, the plaintiffs filed a petition for certiorari urging the Supreme Court to take up the question whether allegations that a defined contribution plan paid or charged excessive fees are sufficient, on their own, to state a claim for breach of the ERISA duty of prudence.
Josh Lichtenstein: And that brings us to July 2, 2021, when the Supreme Court agreed to hear the Northwestern University’s 403(b) plan excessive fee lawsuit next term. I know that the Court has taken up a number of ERISA cases in recent years, despite them famously disliking ERISA cases. Doug, can you talk about this perceived circuit split, and why the Supreme Court decided to grant cert now in this case?
Doug Hallward-Driemeier: Well, like you said, Josh, the Court has taken up a number of ERISA cases recently and one could see the decision to grant cert in Northwestern as part of a line of cases in recent years in which the Supreme Court has weighed in to clarify key procedural aspects of ERISA litigation, such as in Intel (concerning the applicable statute of limitations for bringing a lawsuit under ERISA) and Thole (concerning Article III standing and the ability to seek ERISA relief for an alleged fiduciary breach of defined benefit plans). The Supreme Court now has yet another opportunity to weigh in on a key procedural aspect of ERISA litigation that could help to clarify the landscape. In this instance, the Court is being asked to resolve the apparent split among the circuit courts and uncertainty about whether allegations that a defined contribution plan charged its participants substantially excessive fees relative to alternative available investments is sufficient to state a claim for breach of the duty of prudence under ERISA. In their cert petition, the plaintiffs had argued that other courts of appeals had held allegations similar to those made in Northwestern sufficient to survive motions to dismiss—those were the Third Circuit in a suit brought against the University of Pennsylvania (in which the participants were actually represented by the same firm representing participants in the Northwestern litigation—Schlichter Bogard & Denton), and the Eighth Circuit in a case brought against Washington University in St. Louis.
In particular, the petitioners noted how all three cases involved allegations of paying excessive recordkeeping fees by retaining multiple recordkeepers and failing to solicit competitive bids or negotiate lower fees, and of offering mutual funds with higher investment management fees—such as by including retail-class shares of mutual funds when lower-cost institutional-class shares of the same mutual funds were available. The petition argued that the Seventh Circuit was incorrectly placing the burden on the participants to negate the fiduciaries’ explanations for their behavior, instead of drawing inferences in the participants’ favor at the pleading stage. Then, in October 2020, the Supreme Court invited the federal government to submit a brief outlining the government’s position, and in its amicus brief, the Solicitor General discussed the apparent circuit split and supported granting certiorari.
Josh Lichtenstein: That context is really helpful. So, do you think that this is simply about resolving a circuit split, or do you think there is more to this grant of cert?
Doug Hallward-Driemeier: Well, I think this is an issue that was ripe for the Supreme Court review at this point, as a decision could provide greater uniformity regarding the pleading standard for these ERISA fiduciary duty cases. As we have seen in these three circuit court opinions, as well as in the various lower court rulings over the last few years, there is some confusion and disagreement as to whether a plan participant can state a claim simply by alleging fees in excess of alternative investments, or whether a plan fiduciary can defend and defeat such a claim by noting that the plaintiffs’ allegations are equally consistent with an inference of prudent behavior.
It’s notable that in Northwestern, the Seventh Circuit did not think it was creating a new legal standard different from what the Third Circuit employed in the University of Pennsylvania case. The Seventh Circuit explicitly noted how it found the Third Circuit’s approach to be sound and not inconsistent with its own. The Third Circuit had explained how “a court assesses a fiduciary's performance by looking at process rather than results, focusing on a fiduciary's conduct in arriving at [a] decision and asking whether a fiduciary employed the appropriate methods to investigate and determine the merits of a particular investment."
Similarly, the Eighth Circuit in the Washington University case (which was decided after the Seventh Circuit ruled in Northwestern) explained how it is the process by which decisions are made, “rather than the results of those decisions,” which needs to be analyzed. So said differently, if a fiduciary acts prudently when it makes a decision, that decision is not actionable, even if it leads to a bad outcome.
So, that said, it was notable that two of those courts allowed the allegations to proceed past the motion to dismiss, while the Seventh Circuit held that the allegations failed even to state a claim. The Supreme Court likely construed that, as the Solicitor General had, as evidence that the courts were applying distinct standards and that clarification would be helpful.
Josh Lichtenstein: Those are really excellent points, Doug. So, in other words, the focus should be on the process rather than results, and presumably, the pleading standards should reflect that and should require plaintiffs to show not only that some of the investment options of the plan menu were more expensive or underperformed relative to what else might have been chosen, or that recordkeeper fees are higher than peer plans, but should actually show that the fiduciaries failed to follow an appropriate process to select those funds or recordkeepers. That makes a lot of sense to me from an ERISA standpoint because we always say “prudence is process” when counseling clients. I guess the question is really: What needs to be asserted at the pleading stage about an allegedly flawed process in order for the complaint to survive a motion to dismiss? It sounds like according to the Eighth Circuit, the complaint only needs to give the district court enough room to infer from what is alleged that the process was flawed, and it seems like even circumstantial allegations about the fiduciary's methods could be enough, just based on retroactively evaluating the funds the fiduciary chose. Doug, what do you make of that standard?
Doug Hallward-Driemeier: Well, this is really what the Supreme Court will be grappling with here. To me, allowing these types of lawsuits to proceed based on circumstantial allegations, as you just described, seems too lax and would result in too many complaints surviving the initial pleading stage, even when they are without merit. That standard also strikes me as being in direct contrast with what the Supreme Court has said in its leading cases regarding pleading standards in other circumstances, like in Iqbal—namely that, “[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.”
Josh Lichtenstein: Along those lines, as the Supreme Court is taking a fresh look at the allegations made by the plaintiffs in Northwestern, do you think it’s possible that the Court may look to other sources of federal law to answer the question of what pleading standards should be in the ERISA fiduciary arena?
Doug Hallward-Driemeier: Absolutely—other sources of federal law can be useful resources for the Court on cases such as these, where the procedural issue of the pleading standard is at the fore. The mutual funds context comes to mind, in particular. In the seminal Jones v. Harris decision, the Supreme Court held that, in determining whether claims alleging that a mutual fund’s management fees were excessive are cognizable under Section 36(b) of the Investment Company Act, it is important to determine whether a fee structure was the result of an arm’s-length bargaining and requires a determination that the fee charged was “so disproportionately large it bears no reasonable relationship to the services rendered.” The Court could take a cue from that process-based focused approach in Jones, though, of course, it is hard to predict with any certainty what the Court might do here.
Josh Lichtenstein: That makes a lot of sense, especially because we know that the Court has drawn on some other bodies of federal law, federal common law in ERISA cases in the past, such as the law of trusts. Wherever the Court ultimately lands on this issue, it is sure to have major implications for plan sponsors and other types of fiduciaries for ERISA retirement plans. Even a narrow opinion could still have a significant impact if it embraces a robust standard of pleading, and could help to root out some of the seemingly frivolous complaints that have been brought over the last few years and eliminate costly and time-sensitive litigation and settlements. For instance, in Thole last year, a fairly narrow holding pertaining to Article III standing requirements, which you mentioned before, has protected defined benefit plan fiduciaries from many claims of alleged violations of ERISA’s duty of prudence and loyalty due to poorly invested plan assets or allegedly poorly invested plan assets. In fact, the fairly steady stream of cases that have alleged fiduciary misconduct in the DB plan space has basically dried up in Thole’s aftermath—it’s had a really big impact. Moreover, we have seen numerous examples of DC plan sponsors and fiduciaries trying (unsuccessfully so far) to apply the Thole rationale to the DC plan space to try to knock some of these cases out at the earlier stages.
Doug Hallward-Driemeier: Again, it is hard to tell the future. These “business cases” tend to not be as ideologically divided as some other issues on the Supreme Court’s recent docket. In those cases, it is often right to predict that the Court will issue some very narrow decision. But here, there’s a distinct chance that the Court will decide to provide some real substantive guidance in this ERISA space.
Josh Lichtenstein: Well, real substantive guidance would be very welcomed, so hopefully that prediction winds up being true. We’ll certainly be watching this case closely, and will have more to say following oral arguments and whenever an opinion is published. Doug, I want to thank you for joining me today and sharing some valuable insights. For more information about 401(k) and 403(b) plan litigation risk assessment and management, you can also visit our website at www.ropesgray.com. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including Apple, Google and Spotify. Thank you again for listening, and take care.