On January 24, the U.S. Supreme Court issued a short unanimous opinion in Hughes v. Northwestern University. The importance of the opinion will likely be modest. At a basic level, all the Supreme Court did was reinstate a case that was thrown out of the lower courts too early.
The case is a class action, similar to many filed against the biggest American universities, challenging the investment options offered to university employees in their 403(b) retirement plans (the tax-exempt organization equivalent of a 401(k) plan). The key allegations are that Northwestern and its Retirement Committee breached their fiduciary duties to the plan participants by (1) failing to choose cheaper institutional share classes instead of retail share classes, (2) retaining two different recordkeepers who charged excessive recordkeeping fees, and (3) including too many investment options (over 400) that caused confusion. The lower courts dismissed the case for failing to state any valid claim. The Supreme Court reversed and directed the United States Court of Appeals for the Seventh Circuit to reconsider the case.
There are two key takeaways from the Hughes v. Northwestern opinion:
- First, the Supreme Court held that fiduciaries cannot judge the prudence of higher-fee investment options based solely on the availability of other lower-cost investment options in the plan. As Justice Sonia Sotomayor wrote, “Even in a defined-contribution plan where participants choose their investments, 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.”
- Second, the Supreme Court recognized that plan fiduciaries have a range of judgments that are all proper, provided they are reasonable. In Justice Sotomayor’s words, “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.”
So there are two guardrails to steer between. On the one side, fiduciaries cannot select a menu of higher and lower-cost investment options and forget to evaluate them, regularly and individually. On the other side, fiduciaries have a range of reasonable choices they can make using a prudent process. The width of the space between is difficult to gauge. Once the case returns to the lower court, we will see if it can proceed or if it will be dismissed again.
One last observation: The Supreme Court did not address the claim that including too many options can confuse plan participants. The United States, which joined the case on the side of the employees, did not take a position on this claim. Whether the use of a large number of investment options (such as through a self-directed brokerage option) will satisfy prudence requirements will have to wait for a future opinion to resolve.