By Daniel Aronowitz
Key Points
The Seventh Circuit held that the Northwestern excess recordkeeping and investment fee claims were plausible under the ERISA plausibility motion to dismiss standard. But the case involves an obsolete fee arrangement that even the Northwestern plan has replaced. Read correctly, the case only finds plausibility for fiduciary imprudence claims against plans with uncapped revenue sharing and retail share class investments without rebating the higher fees back to plan participants. Virtually no large plan today has this obsolete fee arrangement.
The recordkeeping and investment fees for large defined contribution plans have changed dramatically in the eight years since the Schlichter law firm sued Northwestern University and other large university plans. We have seen significant fee compression, more plans have stopped using revenue sharing as the primary method of paying recordkeepers, and most investment menus have been streamlined to maximize leverage for lower fees.
Against this backdrop, the Seventh Circuit on March 23 issued its opinion on remand from the Supreme Court in the Hughes v. Northwestern case. The Seventh Circuit held that the plan participants had met the plausibility standard for alleging fiduciary imprudence for excess recordkeeping and investment fees. But the fiduciary imprudence claims found plausible involve an obsolete fee and investment structure in which the largest plan had 242 investments, 129 of which were in retail share classes, and the plan had two recordkeepers with allegations of uncapped revenue sharing. Today, very few large plans in America are administered this way, and even the Northwestern plan committee had radically restructured this legacy arrangement to streamline its plan investments and reduce fees back in 2016 when it was sued.
Consequently, any interpretation of the Seventh Circuit’s opinion needs to be grounded in the understanding that the fact pattern of the case has limited relevance given the changes in modern plan administration. Our take on the decision is that it articulates an ERISA pleading standard in which courts will entertain claims of fiduciary imprudence for excess recordkeeping and investment fees, but even though this is technically a reversal of its 2020 decision involving the same facts, the Court is not easing the pleading standard. The Seventh Circuit, following the Supreme Court’s guidance, held that the pleadings standard is context specific. If context truly matters, the Northwestern case should be placed into the context that its legacy fee and investment arrangement is an outlier at the extreme end of the plan-fee spectrum. In this context, finding plausibility for fiduciary imprudence claims against a plan with an outdated fee structure has limited precedential value.
The question for the future is how this pleading standard applies to lower-fee plans that are sued. In an era of junk ERISA class-action lawsuits, all excess fee cases are not the same. The fact that the uncapped fees of the legacy Northwestern plan constitute plausible fiduciary imprudence under ERISA says nothing about 99%+ of all other large plans in America. The key for plan sponsors going forward is to distinguish the Northwestern fact pattern from every other excess fee case. Nearly every other pending excess fee case presents an entirely different and distinct context from the Northwestern case.
The Seventh Circuit’s Decision
The Seventh Circuit started its analysis with the impact of the Supreme Court’s decision in Hughes v. Northwestern on prior Seventh Circuit excess fee precedent, which had previously been the most friendly circuit for plan sponsors in the country. The Supreme Court’s decision in Hughes v. Northwestern abrogated a line of reasoning derived from Loomis v. Exelon Corp. and Hecker v. Deere that allowed a plan sponsor to defeat a claim that a higher-fee investment was imprudent as long as participants had a choice of lower-cost investments in the plan. It was a defense derived from ERISA section 404c, that participants in a participant-directed plan are responsible for the choice of investments and not the plan sponsor. But the Supreme Court rejected a categorical defense that plaintiffs’ “preferred type of low-cost investments were available as plan options.” As the Seventh Circuit previously held in the Oshkosh case, “ERISA does not allow the soundness of investments A, B and C to excuse the unsoundness of investments D, E, and F.”[i]
Nevertheless, Hughes v. Northwestern left untouched three principles from prior Loomis and Hecker v. Deere precedent. First, the use of revenue sharing for plan expenses does not amount to a per se violation of fiduciary duty under ERISA. The Seventh Circuit, however, caveated this principle by explaining that it does not foreclose the possibility of violating a fiduciary duty by failing to monitor and incur only reasonable expenses. Plan fiduciaries have a continuing duty to monitor their expenses to make sure that they are not excessive with respect to the services received. The duty of fiduciaries to be cost-conscious is derived from the Supreme Court precedent in Tibble v. Edison.[ii]
The second principle is that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund.” This is the often-cited quote from the Hecker v. Deere case. The Seventh Circuit caveated that this principle applies to claims of imprudent fund retention, but does “not address the duty of a fiduciary when it has access to a cheaper but otherwise identical fund from the same fund provider.” As the Tibble decision held, ERISA requires a fiduciary to assess whether a given fund is prudent in light of other investment options in a plan, comparable funds, and the expenses charged, among other factors.
Two important factors follow this second principle. First, as the Seventh Circuit held the first time they considered the case in Divane v. Northwestern, “Northwestern was not required to search for a recordkeeper willing to take $35 per year per participant as plaintiffs would have liked.” Further, as it held in the Oshkosh case, the Seventh Circuit used this principle to reject “the notion that a failure to regularly solicit quotes or competitive bids from service providers breaches the duty of prudence.”[iii] The Court thus expressly “reaffirm[ed] that a fiduciary need not constantly solicit quotes for recordkeeping services to comply with its duty of prudence.”
The third principle is that plans may generally offer a wide range of investment options and fees without breaching any fiduciary duty. Nothing in Hughes v. Northwestern undercuts this proposition, but, as noted above, the Supreme Court rejected any bright-line rule that a plan fiduciary may avoid liability by assembling a diverse menu of investment options that includes the types of investments a plaintiff desires.
The Pleading Standard for breach of the duty of prudence under ERISA
The Supreme Court had remanded the Hughes case to “consider whether petitioners have plausibly alleged a violation of the duty of prudence in Tibble, applying the pleading standard of Iqbal and Twombly.” But the Supreme Court “stop[ped] short of pronouncing a concrete [pleading] standard,” which has left the task of developing a coherent ERISA pleading standard to the lower courts. Instead, the Supreme Court offered limited guidance, in quoting from the Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 425 (2014), ERISA employer stock-drop case that the inquiry into the duty of prudence is “context specific.” And the Supreme court concluded with the sentence: “At times, 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.”
Northwestern argued that the last sentence in the Hughes opinion incorporated Dudenhoeffer’s heightened pleading standard for plans with employer stock investments into all ERISA imprudence cases, whereas plaintiffs read it as dicta that was not part of the pleading standard. Northwestern argued that this meant that plaintiffs must plead that an alternative prudent action which the fiduciary should have taken was “actually available” and that plaintiffs must “rule out reasonable explanations” for failure to take that action.
The court rejected Northwestern’s Dudenhoeffer standard as an overreach. The Court held that the duty of prudence inquiry is “context-specific,” but “no more.” The Court needs to consider alternative explanations, but plaintiffs do not have to rule them out conclusively at the pleadings stage. The basic text of plausibility requires a plaintiff to plead factual allegations that are enough to raise a right to relief “above the speculative level on the assumption that all allegations in the complaint are true.” Plaintiffs must provide “some further factual enhancement” to take a claim of fiduciary duty violation from the realm of “possibility” to “plausibility.” “Something more” is required to survive dismissal when there is an obvious alternative explanation that suggests an ERISA fiduciary’s conducts falls within the range of reasonable judgments a fiduciary may make based on her experience and expertise. Whether a claim survives dismissal necessarily depends on the strength or obviousness of the alternative explanation that the defendant provides. “Where alternative inferences are in equipoise – that is, where they are all reasonable based on the facts – the plaintiff is to prevail on a motion to dismiss.”
Applying the Northwestern Facts to the Seventh Circuit’s Plausibility Standard:
The remanded case before the Seventh Circuit asserted three claims: (1) excess recordkeeping fees; (2) excess investment fees for failure to replace 129 retail-share class funds with cheaper, but otherwise identical institutional-class shares of the same funds; and (3) excess investment fees because the plan had too many duplicative funds that increased costs and caused investor confusion. The Seventh Circuit found the first two excess fee claims plausible, but not the investor confusion claim.
(1) The Excess Recordkeeping Fee Claim is Plausible: Participants had alleged that the two Northwestern plans paid four to five times [$4-5m per year] more than a reasonable per-participant recordkeeping fee [purported to be $1m per year, or $35 per participant] by paying for two recordkeepers through uncapped revenue-sharing arrangements. Participants further alleged that Northwestern should have lowered its expenses by consolidating from two recordkeepers to one, soliciting bids from competing providers, and using the massive size and corresponding bargaining power of the plans to negotiate for fee rebates.
Northwestern countered that plaintiffs had not proven that there was a recordkeeper willing to service the plan for $35 per participant, or a recordkeeper willing to offer services below the amount charged by TIAA and Fidelity. It further argued that it was not possible to reduce the plan to one recordkeeper, because the plan participants risked losing access to the highly-desired TIAA annuity investment option.
The Court found the excess recordkeeping claim plausible based on what it asserted was its scrutiny of the context of the excess recordkeeping claims. The Court’s analysis is not intellectually satisfying, because it is mostly based on contrasting the recordkeeping claims in the Oshkosh and CommonSpirit cases. In those cases, the courts dismissed excess recordkeeping claims for failure to allege the quality or type of recordkeeping services of the comparator plans provided. Unlike those cases, the Court held that the Northwestern plaintiffs had alleged that there were recordkeepers “equally capable” of providing a high level of services to the plans comparable to the current recordkeepers. Plaintiffs also, according to the Court, alleged that recordkeeping services are highly “commoditized”: “[i]n short, plaintiffs allege that recordkeeping services are fungible and that the market for them is highly competitive.” The Court further distinguished CommonSpirit by holding that plaintiffs in that case had not pled that the fees were excessive relative to the recordkeeping services rendered.
Anyone who has read the respective complaints in Oshkosh and CommonSpirit knows that this is all hogwash because the recordkeeping claims in both cases were ineffectual and easy to distinguish. As we laid out in our last blogpost [see https://encorefiduciary.com/the-first-circuit-denies-three-motions-to-dismiss-in-cases-very-similar-to-the-complaints-in-commonspirit-and-oshkosh/], the recordkeeping claim in Oshkosh provided no evidence to substantiate that $87 was too high – the complaint did not even contain the now typical chart of 5-10 random large plans. And the excess recordkeeping fee claim in CommonSpirit was a throw-away claim at the end of the complaint that was based on a disingenuous comparison to small plans in the 401k Averages book. Finally, and most important, the per-participant recordkeeping fees in CommonSpirit were $30-34 per participant. It was a weak claim on its face because the recordkeeping fees were low.
Accordingly, the Seventh Circuit’s attempt to distinguish Oshkosh and CommonSpirit is not convincing and not fair to Northwestern. But to the extent there is any validity in the Court’s finding that the excess recordkeeping claims were plausible, the Court noted two additional supporting factors that are different than the Oshkosh case. First, the Court noted that plaintiffs had compared the plans to five other university plans that consolidated recordkeepers and lowered their plan fees. This is more proof than is usually provided in excess fee cases. In most cases, a large plan is compared to five to ten random plans with no similarities to the plan at issue. We would note, however, that the complaint in Northwestern had no numbers indicating how much the five university comparator plans paid for recordkeeping services, or how much they saved. The court skipped this important component. But the fees alleged were high. Plaintiffs in the Northwestern case alleged that the recordkeeping fees in the Northwestern plans totaled $153-$243 per participant with uncapped revenue sharing. We do not believe plaintiffs proved that the Northwestern plan paid higher than the comparator plans, but ultimately the uncapped revenue sharing and high fee numbers – more than two to three times what was alleged in Oshkosh – proved to be enough context to meet the plausibility test.
The second key distinction that persuaded the Seventh Circuit is that Northwestern restructured its plan in October 2016 and reduced fees to $40 per participant, which the court held suggested “that Northwestern’s recordkeeping fees were unreasonably high and that means to lower such fees were available.” As we discuss more fully below, we are disappointed that plan changes would be used against plan fiduciaries to support a finding of imprudence. We believe it shows quite the opposite, as it is evidence of fiduciary prudence to make plan changes. But the important point for plan sponsors is that the Northwestern case presents an outlier fact pattern — $150-250 per participant reduced to $40 per participant – that is different than most, if not all, cases, and easy to distinguish going forward.
(2) The Court finds the excess investment fee claim for failure to replace retail share classes plausible. Northwestern disputed that plaintiffs had properly asserted a share-class claim in the complaint, and fought plaintiffs’ right to file an amended complaint to clarify the claim. But the Court held that plaintiffs had alleged the failure to replace 129 retail-class shares funds with cheaper, but otherwise identical institutional-class shares of the same funds. For anyone reading the complaint, you would find a chart that spans for pages listing the 129 retail share class funds compared to their lower-fee institutional share class. Plaintiffs asserted that Northwestern should have used its size and bargaining power to replace retail-class shares of funds with cheaper but otherwise identical institutional-class shares of the same funds. Northwestern argued that the lower-fee share classes were not available to the plan, but plaintiffs argued that the plan would have been eligible for lower-fee share classes if it had consolidated its investments to leverage its size with fewer funds. Again, this is a distinct fact pattern from most other cases given the high number of funds being challenged.
The Court held that the share-class claim against Northwestern was similar to the Tibble case in which fiduciaries were accused of acting imprudently by offering six higher priced retail-class mutual funds as plan investments when materially identical lower priced institutional-class mutual funds were available. Northwestern argued that plaintiffs had not pleaded that institutional-class shares were actually available to the plans because they had not met the institutional minimums. But the Court stated that a plaintiff is required to show only that such cheaper institutional share were plausibly available. The Court was persuaded by the allegations that jumbo plans have massive bargaining power, and that it is common for large plans to request waivers of investment minimums for access to institutional shares, and the complaint even gave one example of a plan doing so. Northwestern also argued that revenue sharing was another alternative explanation for use of retail-class shares, but the court held that this was just one possible explanation that needed to be weighed against the plausibility of plaintiff’s assertion that the plans collectively paid four to five times as much in recordkeeping fees as they should have. Finally, the Court noted that five other federal circuit courts have found that retail-share class claims have a comparator “baked into the claim,” citing the Sixth Circuit in Forman v. TriHealth. As we note below, we are concerned about the slippery slope of allowing plaintiffs to allege without substantiation that investment providers waive fee minimums, but this case involved 129 retail share classes – again, an outlier fact pattern that is easy to distinguish in future cases. [For example, the complaint alleged that the S&P 500 index retail fees were 7-10 bps – fees that are ancient history after years of fee compression].
(3) The Excess Investment Fee Claim Based on Duplicative Funds Was Not Plausible: The final claim alleged that the plan contained too many funds and caused investor confusion, and that Northwestern should have removed duplicative funds that did nothing but add expenses to the plans. The Court was not persuaded by the claim that the duplicative and numerous (242 in the larger plan) investment options confused plan participants, and the complaint did not give any proof of confusion or injury. But it opened the door to the same evidence to the extent that it relates to the share-class claim discussed above.
The Euclid Perspective
The Hughes v. Northwestern decision involved an obsolete fact pattern. Very few large plans in America allow uncapped revenue sharing that is not rebated to plan participants, multiple recordkeepers, and over a hundred investments in retail share class claims. The case is about fighting a war that is long over. Except for the lingering Yale case, the 2016-17 excess fee cases against university plans are almost history. Those cases involve fee arrangements and investment options that are not typical of large defined contribution plans in 2023. What matters to plan sponsors is whether the ERISA plausibility pleading standard articulated by the Seventh Circuit will weed out the many excess fee lawsuits that continue to be filed against plans with lower fees and better investment options.
Our take is that if the Seventh Circuit is true to its finding that plausibility is measured by the specific context of each case, then the Seventh Circuit’s standard should be used to dismiss the vast majority of purported excess fee cases. Most plans being sued today are advised by excellent plan advisors, offer quality plan investment options and fees, and these plans are monitored by valid fiduciary best practices. Again, the specific context of the Northwestern plan was a problematic fact pattern that is now obsolete in the vast majority of all plans. Most courts that analyzed the university plans found excess fee claims plausible. But the vast majority of large plans today have different fees and investments, and must be distinguished from the legacy university plans.
Under the Seventh Circuit’s plausibility standard, the critical factor will be whether courts will allow plan sponsors to defend the lack of plausibility of excess fee claims with evidence of a prudent process at the pleadings stage. For example, will plan sponsors be able to proffer evidence that any revenue sharing was rebated to plan participants? Will plan sponsors be able to submit evidence of a sound fiduciary process in negotiating plan recordkeeping and investment fees? And finally, will they be able to offer evidence to rebut share-class claims with evidence that they requested lower fees, and secured the lowest possible fees available to the plans. If plan sponsors cannot rebut false fee claims at the pleading stage, then the pleading standard will open the door to continued strike lawsuits. In this regard, we have three key concerns about this decision as applied to other excess fee cases.
First, we are concerned that the Seventh Circuit too easily distinguished the CommonSpirit and Oshkosh decisions with respect to the recordkeeping fee claim. The Sixth Circuit had held (as did the Seventh Circuit in Oshkosh) that you have to provide context to prove an excess recordkeeping fee claim: that you have to compare the type and quality of services. But here the Court said this case was somehow different than what was alleged in CommonSpirit because “plaintiffs allege that recordkeeping services are fungible and that the market is highly competitive.” This is where bad facts make bad law, because the excess fee allegation in Northwestern was $150-250+ per participant, whereas CommonSpirit was $30-34 per participant. The cases are not comparable. In every case, plaintiffs allege that the RK services and contracts are fungible. We thought CommonSpirit and Oshkosh required actual proof of service types and quality of services, not just a generic claim that all recordkeeping services are fungible. Surely proof of service types and quality requires more than a blithe assertion that all recordkeeping services are highly competitive and fungible, or otherwise every excess recordkeeping claim would meet the plausibility standard. Again, we believe the unique context of the high fees in the Northwestern case can be differentiated and explain the Court’s ruling.
Second, we are concerned that the Court used Northwestern’s plan changes against them as contextual proof of excess fees against them. The fees were radically restructured in 2016. Instead of showing proof of imprudence, this could easily be argued as proof of a prudent process to make proactive changes. We are disappointed that plan remedial changes could be used as proof of imprudence, as this is a recurring fact pattern in cases in which plaintiff law firms allege that “changes are too little, too late.” This is a dangerous precedent for any plan proactively and prudently making changes to their plan.
Third, we are concerned about how the Court used the allegations by plaintiffs that lower fees were available without any real proof, accepting the argument that large plans have the ability to seek waivers for institutional fee minimums. We have seen other cases in which plaintiff law firms make disingenuous share-class claims, even with respect to low-fee index funds, that lower fee share classes are available. It is not fair for a court to infer fiduciary imprudence based on an allegation that investment firms give waivers of investment minimums without proof. The Northwestern case has to be read in the context of offering 129 retail share classes, which is an outlier, or otherwise this is a slippery slope that can make it too easy to second-guess the fees and fiduciary process of any large plan.
In the final analysis, the Seventh Circuit’s decision must be understood in the context of the unique and outdated fee and investment structure of the Northwestern plan. The fact pattern is obsolete and different from nearly every other recent purported excess fee case that has been filed in the last two years. The impact of the Seventh Circuit’s decision remains to be seen when applied against fiduciary imprudence claims that are based on lower recordkeeping and investment fees. Only then can we confirm that the Northwestern case is an outlier that was decided based on the context of an obsolete fact pattern.
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[i] Albert v. Oshkosh Corp., 47 F.4th 570, 575 (7th Cir. 2022).
[ii] Tibble v. Edison Int’l, 843 F.3d 1187, 1197 (9th Cir. 2016) (“[A] trustee is to ‘incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship.” (quoting RESTATEMENT (THIRD) OF TRUSTS § 90(c)(3))).
[iii] 47 F.4th at 579.
