Hughes v. Northwestern Offers Important Takeaways for Public and Taft-Hartley Pension Trustees

Shareholder Advocate Spring 2023

April 25, 2023

Late last month, the United States Court of Appeals for the Seventh Circuit revived an Employee Retirement Income Security Act of 1974 (“ERISA”) lawsuit by participants in two Northwestern University’s 403(b) retirement savings plans. Following guidance from the Supreme Court’s 2022 Hughes v. Northwestern decision, a three-judge panel reinstated two of the seven original ERISA claims against Northwestern, which administers approximately $5 billion in assets in the two plans. Specifically, the three-judge panel reconsidered three claims by participants regarding breach of fiduciary duties: “that Northwestern (1) failed to monitor and incurred excessive recordkeeping fees, (2) failed to swap out retail shares for cheaper but otherwise identical institutional shares, and (3) retained duplicative funds.” On March 23, the Appeals Court ruled the first two claims could proceed. The revival of these claims could result in more litigation about fiduciary decisions made by retirement plans. The decision will directly affect Taft-Hartley retirement plans, which are subject to ERISA; it also offers reminders of how all pension plan officials should carry out their fiduciary duties to participants.

As background, in August 2016, participants filed suit against Northwestern’s two retirement plans alleging seven different ERISA violations, including violations of duty of prudence, ERISA-prohibited transactions, and Northwestern officers’ failure to monitor fiduciaries. Among the seven claims, two are especially worth mentioning given their applicability to all types of pension plans.

First, participants claimed a breach of fiduciary duty by Northwestern because of excessive recordkeeping fees. Participants asserted Northwestern paid four to five times more for recordkeeping fees by using an uncapped revenuesharing arrangement. According to plaintiffs, Northwestern should have reduced its expenses by combining two recordkeepers into one and leveraging its larger size to bargain for fee rebates. Second, participants alleged a breach of fiduciary duty by Northwestern because it failed to monitor the plans’ investments. Here, participants argued the plans held too many funds that resulted in confusion among participants and generated additional expenses. Like the first claim, plaintiff argued Northwestern should have leveraged its size to bargain for replacing retail shares for lower-cost institutional-class shares of the same funds.

In May 2018, a federal district court judge dismissed the case. In March 2020, the Seventh Circuit affirmed the district court’s dismissal. But in January 2022, the Supreme Court unanimously vacated the Seventh Circuit’s decision and remanded the case back to the district court. In a brief six-page opinion, Associate Justice Sonia Sotomayor reaffirmed and applied the Supreme Court’s holding from its 2015 Tibble v. Edison decision. Her opinion held that courts must determine whether participants alleged a violation of the duty of prudence as set out in Tibble. As part of its inquiry, courts must determine whether a plan fell short of its fiduciary duty by failing to routinely monitor investments and recordkeeping costs and remove imprudent investments or recordkeepers within a reasonable time. The Supreme Court also rejected the Seventh Circuit’s reliance on the so-called “categorical rule” where “providing some low-cost options eliminates concerns about other investment options being imprudent.”

Although Hughes v. Northwestern arises from ERISA law that does not directly apply to public pension funds, the most recent Seventh Circuit opinion remains highly instructive for those pension funds because ERISA reflects relevant trust law and the common law that is applicable to all pension plans. As such, ERISA provides guidance for and is a standard for public pension plan conduct. Specifically, the Seventh Circuit’s decision to revive two breach of fiduciary duty claims against Northwestern provides two key takeaways for all retirement plan fiduciaries, regardless of whether they are subject to ERISA.

First, pension funds should establish and follow processes governing their investment plan and carefully document such processes. The Hughes opinion states that “courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” The language from Hughes is a reminder that pension plan fiduciaries should create and adhere to procedures when evaluating investment options and recordkeepers. Furthermore, such processes should be well-documented. It’s important to remember that a duty of prudence requires fiduciaries to follow a standard of conduct, not outcome. In other words, the courts will not judge pension plans by the results of their investment decisions, but by the process to reach such decisions.

Second, a pension plan that maintains large numbers of investment options, including low-cost options, could still violate its fiduciary duty. In Hughes, the Supreme Court stated the Seventh Circuit erred by focusing on the fact that Northwestern’s savings plans offered different funds, including low-cost index funds. The Supreme Court then stated that “plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.” The Hughes decision is a reminder that pension plans should routinely review their investment funds and remove poorly performing funds. In the event pension plans elect to keep funds with higher fees, they should again document the process and state the reasons for doing so.