The plaintiffs in a 403(b) excessive fee suit have persuaded a federal appellate court that (some of) their claims warrant a further consideration.
One of the first of the 403(b) university excessive fee suits, the plaintiffs brought this suit against NYU in its capacity as the fiduciary of plaintiffs’ retirement plans (New York University and the NYU School of Medicine), alleging a number of breaches[i] of NYU’s fiduciary duties under ERISA. Following a bench trial in the U.S. District Court for the Southern District of New York, which rejected their claims, the plaintiffs—represented by the law firm of Schlichter, Bogard & Denton—appealed.
Specifically, they challenged “(1) the dismissal of their claim that NYU breached its duty of prudence by offering particular share classes of mutual funds in the retirement plans, (2) the denial of leave to amend their complaint to name additional defendants, (3) the striking of their demand for a jury trial, (4) the use of written declarations rather than live examination for direct testimony in the bench trial, (5) some of the district court’s findings in NYU’s favor after the bench trial, and (6) the denial of their motion for a new trial, which argued that the judge presiding over the trial (Forrest, J.) should have been disqualified.”[ii]
What they got was a split 2-1 decision (Sacerdote v. N.Y. Univ., 2d Cir., No. 18-2707, 8/16/21) in favor of the plaintiffs on two of the issues, agreeing with the district court on the remainder, and a direction to the lower court to rethink its previous conclusions based on the assessment of the appellate court in an opinion written by Senior Judge John M. Walker Jr., joined by Judge John O. Newman (who joined the panel after the death of Senior Judge Ralph K. Winter in December 2020), with Judge Steven J. Menashi in dissent, supporting the NYU defendants on all issues raised.
That said, perhaps the biggest news from the decision (other than the reviving of the case itself) was the Second Circuit’s alignment on an issue now before the U.S. Supreme Court—which party bears the burden of proof that alleged fiduciary breaches were responsible for plan losses. “Although plaintiffs bear the burden of proving a loss, the burden under ERISA shifts to the defendants to disprove any portion of potential damages by showing that the loss was not caused by the breach of fiduciary duty,” the court said here—in the process aligning its sense of the law with the First, Fourth, Fifth, and Eighth circuits, a position the majority claimed was “aligned with the Supreme Court’s instruction to “look to the law of trusts” for guidance in ERISA cases,” citing the Tibble case, as well as LaRue v. DeWolff, Boberg & Assocs., Inc.). More on that in a bit.
On appeal, the plaintiffs argued that: (1) the district court erred in dismissing the share-class claim; (2) the district court erred in denying the motion to amend the complaint to add individual Committee members as defendants, an error that later prejudiced two of their post-trial motions; (3) they were entitled to a jury trial under the Seventh Amendment; (4) the use of written declarations for all direct testimony violated the Federal Rules of Civil Procedure and denied them a fair trial; (5) the district court’s trial findings in NYU’s favor on the recordkeeper-consolidation claim and the investment-retention claim were clearly erroneous; and (6) Judge Forrest should have been disqualified from presiding over this case.
The appellate court proceeded to agree with (1) and (2)—but vacated the rest.
With regard to the notion that the allegations about the share class choice were not sufficiently argued, the court noted that to survive scrutiny the complaint had to allege “…nonconclusory factual content raising a plausible inference of misconduct” without relying on “the vantage point of hindsight.” At the same time, they acknowledged that “ERISA plaintiffs generally lack the inside information necessary to make out their claims in detail unless and until discovery commences,” and that as a consequence “…a claim under ERISA may withstand a motion to dismiss based on sufficient circumstantial factual allegations to support the claim, even if it lacks direct allegations of misconduct.”
Noting that “the complaint sets forth cost differentials of specified basis points for the dozens of mutual funds as to each of which, they claim, NYU should have offered lower-cost institutional shares instead of higher-cost retail shares,” information that was in prospectuses and thus available to the plan fiduciaries. “In sum, plaintiffs have alleged that a superior alternative investment was readily apparent such that an adequate investigation”—simply reviewing the prospectus of the fund under consideration—“would have uncovered that alternative.” And, since in reviewing a motion to dismiss, reasonable inferences in favor of the plaintiffs are the standard, “…we believe that plaintiffs have sufficiently alleged that NYU acted imprudently in offering the number of retail-class shares identified in the complaint.”
In doing so, the court called out the district court’s rationale that “prudent fiduciaries may very well choose to offer retail class shares over institutional class shares” because retail shares offer greater liquidity “provides no basis to dismiss pleadings that otherwise generate plausible inferences of the claimed misconduct,” ultimately concluding that, “This claim should have been, and now must be, litigated on the merits.”[iii]
A cautionary note for (future) plaintiffs: The court cautioned against using cost ranges from other ERISA cases as benchmarks, noting, “We cannot rule out the possibility that a fiduciary has acted imprudently by including a particular fund even if, for example, the fees that fund charged are lower than a fee found not imprudent in another case.”
On the other hand, while the dissent stated that “if revenue sharing is prudent, so too is offering retail shares,” the majority—which had “no quarrel with the general concept of using retail shares to fund revenue sharing”—nonetheless pointed out that “…there was no trial finding that the use here of all 63 retail shares to achieve that goal was not imprudent,” and that “simply concluding that revenue sharing is appropriate does not speak to how the revenue sharing is implemented in a particular case.” Ultimately, the majority concluded, “Discovery should take place—and it may turn out to be minimal—before the claim is dispensed with.” The dissent in the case, written by Judge Steven J. Menashi, interpreted the decision to offer only some of the options as retail class shares as evidence that there was a deliberative process.
Burden of Proof
As for the burden of proof, the majority took issue with the district court’s position that the plaintiffs had to prove that the alternative fee ranges proposed by their expert were “the only plausible or prudent ones,” noting that in so doing, “the district court failed to shift the burden onto the defendant.” Instead, they note that, “had plaintiffs been able to prove that the charged fees were imprudent, and had the plaintiffs shown a prudent alternative, the burden would have shifted to the defendant to disprove that the entire amount of loss should be awarded as damages.”
There was also the matter of a refusal by the district court to allow an amendment to the defendants named in the suit—and here too the Second Circuit disagreed with the lower court’s assessment. “Had Meagher and Sanchez been named in the complaint as defendants, the district court would have had to enter judgments specific to each of them after trial, finding whether each had breached her fiduciary duty as an individual member of the Committee. Given the district court’s harsh assessment of Meagher and Sanchez’s performance as fiduciaries, it is hardly inevitable that the district court would have found in their favor and declined to remove them as fiduciaries had it been required to enter those judgments.” In fact, attentive readers may well recall that the district court had some very damning things to say about those committee members (Meagher was the co-chair of the committee), and the apparently dismal performance of their duties.
As for the other issues raised, the court dispensed with them quickly, holding that:
- the plaintiffs waived their jury demand;
- the district court’s use of written direct testimony was not an abuse of discretion;
- the district court did not err in ruling for NYU on the tried claims; and
- Judge Forrest’s attenuated connection to NYU did not require disqualification, noting that “Judge Forrest’s connection to NYU is the sort of “remote, contingent, or speculative” relationship that “is not the kind of interest which reasonably brings into question a judge’s impartiality”—going on to state that “...plaintiffs’ theories of impropriety are too far-fetched to reasonably call Judge Forrest’s impartiality into question.”
“In sum,” the majority concluded, “we hold that plaintiffs adequately pled a breach of the fiduciary duty of prudence in Count V’s share-class claim, and we cannot find the district court’s dismissal of this claim harmless on the present record. We therefore vacate its dismissal and reinstate the claim for further proceedings. We also find that the district court erred in denying plaintiffs’ motion to amend to name individual Committee members as defendants. We therefore vacate denial of leave to amend and vacate denial of the ensuing Rule 52(b) and 59(e) motions for post-trial findings concerning two of those individuals,” sending the case back to the district court for “further proceedings consistent with this opinion.”
What This Means
While the result is surely better for plaintiffs than an out-and-out dismissal, a determination that there are triable issues is far from a determination that the allegations made are valid. Consequently, it’s by no means certain that the district court’s further consideration of the particulars raised here will produce a different result. On the other hand—and this time there will be a different judge, of course—it might.
That said, and despite the final decision of the district court, it’s worth recalling—and reminding plan committees—of the harsh criticism of a couple of the committee members by that court—members who the appellate court has approved adding to their complaint—and the essence of that criticism. To that end, you might want to check out “Expert Opinions.”
[i] The appellate court cited the case history as including charges that the NYU fiduciary defendants “permitted TIAA-CREF to mandate inclusion of specific proprietary accounts, requiring use of TIAA-CREF as the recordkeeper, in the Plans (Counts I and II); incurred unreasonable recordkeeping fees (Counts III and IV); incurred unreasonable investment fees, unnecessary marketing and distribution fees and mortality and expense risk fees, and thus caused unreasonable performance losses (Counts V and VI); and failed to monitor the investments (Count VII).” The Second Circuit noted that “the only claims that survived dismissal were the imprudence claims in Count III and one of the imprudence claims in Count V. Specifically, Count III survived dismissal on the grounds of imprudence regarding incurring excessive recordkeeping costs (the 9 18-2707-cv recordkeeping claim); employing a revenue-sharing method to pay recordkeepers (the revenue-sharing claim); and failing to consolidate to a single recordkeeper for each Plan (the recordkeeper-consolidation claim). Count V survived on the ground of imprudence in continuing to include the underperforming CREF Stock Account and TIAA Real Estate Account as investment options (the investment-retention claim). Thus, those portions of Counts III and V were permitted to proceed to trial.”
[ii] The appellate decision notes that by mid-July 2018, it had become public knowledge that Judge Forrest would be leaving the bench. She resigned from the bench effective Sept. 11, 2018, and returned to her prior firm (Cravath, Swaine & Moore LLP), the following day. Just a couple of weeks later the plaintiffs here moved for a new trial (pursuant to Rule 60(b)) on the grounds that Judge Forrest should have been disqualified from the case—based on a connection to NYU through a colleague at Cravath.
[iii] For his part, Judge Menashi explained in his dissent that “…the trial record reveals that NYU in fact investigated its alternatives and made a considered decision to offer retail shares rather than institutional shares. NYU did so for a perfectly reasonable reason: the excess cost of the retail shares paid for the recordkeeping fees under NYU’s revenue-sharing model.”