Skip to main content

You are here


Wildcats Win Appeal of 403(b) Suit

403(b) Plans

A federal appellate court has ruled in favor of the fiduciaries of a university 403(b) plan excessive fee lawsuit.

This was the second of the 403(b) university excessive fee suits to go to trial—and the second in which the university defendants prevailed, back in May 2018. 

The original suit, filed against Northwestern University in 2016 by the law firm of Schlichter Bogard & Denton, had argued that Northwestern had “eliminated hundreds of mutual funds provided to Plan participants and selected a tiered structure comprised of a limited core set of 32 investment options,” including five tiers—one a TDF tier, the second five index funds, the third consisting of 26 actively managed mutual funds and insurance separate account, and an SDBA. However, the suit notes that Northwestern continued to contract with two separate recordkeepers (TIAA-CREF and Fidelity) for the retirement plan, and only consolidated the Voluntary Savings Plan to one recordkeeper (TIAA-CREF) in late 2012. 

The suit also took issue—as most of these suits do—with the alleged inability of the plan fiduciaries to negotiate a better deal based on its status as a “mega” plan, for presenting participants with the “virtually impossible burden” of deciding where to invest their money (because of too many investment choices), and for including active fund choices when passive alternatives were available.

District “Court?”

Now on appeal in the Seventh Circuit, early in the opinion written by Judge Michael B. Brennan (joined by Judges Daniel A. Manion and William J. Bauer in the decision) described the plaintiffs’ amended complaint as “massive,” proceeding to note that it consists of “287 paragraphs over 141 pages,” before going on to state that “most of plaintiffs’ allegations, though, are not specific to certain defendants or to the plans here” (trust me, that didn’t seem to impress him).

Judge Brennan explained that the appeal was reviewing “whether the district court erred by dismissing plaintiffs’ amended complaint for failing to state a claim for relief under ERISA, denying plaintiffs’ request to file a second-amended complaint, and rejecting plaintiffs’ demand for a jury trial.”

About half the opinion (Divane v. Northwestern Univ., 7th Cir., No. 18-2569, 3/25/20) was devoted to revisiting the decision(s) and rationale(s) of the district court. Judge Brennan recounted comments such as “there is nothing wrong, for ERISA purposes, with the fact that the plan participants paid the recordkeeper expenses via … expense ratios,” that Northwestern was not required to try to “find a record-keeper willing to take $35/participant/year,” the rate that plaintiffs alleged was reasonable.”

“Freedom” Ring?

He noted that the district court also rejected plaintiffs’ claim that Northwestern breached its fiduciary duty because “the range of investment options was too broad,” explaining that the “[p]laintiffs might have a different case if they alleged that the fiduciaries failed to make [the low-cost index funds preferred by plaintiffs] available to them.” But Judge Brennan notes that “plaintiffs’ allegations describe the freedom they had under the plans to invest in the fund options they wanted,” that “those types of low-cost index funds were and are available to them,” showing that “the plans offered them the very types of funds they want[ed].”).

Brennan noted that the plaintiffs alleged Northwestern breached its fiduciary duty by “allowing TIAA-CREF to mandate the inclusion of the CREF Stock Account” in the plans and by allowing TIAA to serve as recordkeeper for its funds,” but wrote that “plaintiffs’ own allegations, though, contradict this claim.” Specifically, he commented that “many plan participants invested money in the Traditional Annuity, which was an attractive offering because it promised a contractually specified minimum interest rate,” but that that particular offering wasn’t what was objected to. Rather, “plaintiffs object to the plans offering additional TIAA products (including the Stock Account) and to TIAA serving as the recordkeeper for those products.” 

But, he wrote, “this ignores the benefit of using TIAA as a recordkeeper,” because it was that arrangement that allowed the plan to offer the popular option, and that, even “assuming plaintiffs’ allegations are true, they fail to show an ERISA violation,” because no participant was required to invest in the Stock Account or any other TIAA product. “Any participant could avoid what plaintiffs consider to be the problems with those products (excessive recordkeeping fees and underperformance) simply by choosing from hundreds of other options within a multi-tiered offering system,” Brennan wrote. “Participants were not bound to the terms of any TIAA funds simply because they were included in the plans. The allegations instead depict valid reasons for the plans to use TIAA as a recordkeeper and to keep the Stock Account as an option for participants.”

Forced “Field?”

As for the notion that the plan was forced to use TIAA as recordkeeper, “given the favorable terms and attractive offerings of the Traditional Annuity, which are outlined in plaintiffs’ amended complaint, it was prudent for Northwestern to accept conditions that would ensure the Traditional Annuity remained available to participants,” Brennan wrote, noting that this was “…especially true considering participants with existing Traditional Annuity funds would be subject to a surrender charge of 2.5% if that offering was removed.”

Brennan went on to note that while the “plaintiffs prefer low-cost index funds to the Stock Account does not make its inclusion in the plans a fiduciary breach.” He also pushed back on the allegation of a fiduciary breach in “establishing a multi-entity recordkeeping arrangement that allowed recordkeeping fees to be paid through revenue sharing,” noting that “plaintiffs fail to support their claim that a flat-fee structure is required by ERISA…or would even benefit plan participants. Indeed, such a structure may have the opposite effect of increasing administrative costs by failing to match the pro-rata fee that individual participants could achieve at a lower cost through exercising their investment options in a revenue-sharing structure.” Regardless, Brennan explained that while “total recordkeeping fees must be known to participants, they need not be individually allocated or based on any specific fee structure.”

“Multiple” Personality?

As for the issue of multiple recordkeepers (a common element in the university 403(b) lawsuits), Judge Brennan noted that while, “according to plaintiffs, multiple recordkeeping arrangements impose higher costs on plan participants,” Northwestern explained “it was prudent to have this arrangement so it could continue offering the Traditional Annuity among its offerings,” that “if Northwestern removed TIAA and hired a third-party recordkeeper, participants would have lost access to the Traditional Annuity and any funds invested in the annuity would have been subject to the 2.5% surrender charge.” Brennan wrote that the appellate court disagreed with the plaintiffs’ theory that Northwestern was required to seek a sole recordkeeper to satisfy its fiduciary duties, and found Northwestern’s decision to maintain two recordkeepers “prudent,” and “to the extent plaintiffs alleged Northwestern should have selected TIAA as its sole recordkeeper, that assertion also fails to state a claim for relief,” he wrote. “ERISA does not require a sole recordkeeper or mandate any specific recordkeeping arrangement at all.”

 Moreover, he noted that “There is, then, nothing wrong—for ERISA purposes—with plan participants paying recordkeeper costs through expense ratios. Northwestern was not required to search for a recordkeeper willing to take $35 per year per participant as plaintiffs would have liked.” He went on to note that “Plaintiffs have identified no alternative recordkeeper that would have accepted such a low fee or any fee lower than what was paid to Fidelity and TIAA. And plaintiffs have failed to explain how a hypothetical lower-cost recordkeeper would perform at the level necessary to serve the best interests of the plans’ participants. We find no ERISA violation with Northwestern’s recordkeeping arrangement.”

Options “Null?”

As for the issue of allegedly breaching its fiduciary duties by providing “investment options that were too numerous, too expensive, or underperforming,” Judge Brennan said that “Plaintiffs also spill much ink in their amended complaint describing their clear preference for low-cost index funds,” he writes. “We understand their preference and acknowledge the industry may be trending in favor of these types of offerings.” That said, he went on to write that “Plaintiffs failed to allege, though, that Northwestern did not make their preferred offerings available to them. In fact, Northwestern did. Plaintiffs simply object that numerous additional funds were offered as well. But the types of funds plaintiffs wanted (low-cost index funds) “were and are available to them.”

“Not only did Northwestern provide the plans with a wide range of investment options,” Brennan wrote, it also provided prudent explanations for the challenged fiduciary decisions involving alleged losses or underperformance.” Noting that the plaintiffs pleaded the same prudent reasons in their amended complaint, “We echo the district court in concluding that such allegations do not add up to a breach of fiduciary duty.”

“Taken as a whole,” Brennan wrote, “the amended complaint appears to reflect plaintiffs’ own opinions on ERISA and the investment strategy they believe is appropriate for people without specialized knowledge in stocks or mutual funds. Ultimately, defendants “cannot be faulted for” leaving “choice to the people who have the most interest in the outcome.”

What This Means

Of the roughly 20 universities that have been sued over the fees and investment options in their retirement plans since 2016, there have been six announced settlements; the largest to date with MIT, for $18.1 million, and prior to that Vanderbilt University, which in April 2019 announced a $14,500,000 cash settlement, as well as a long list of process/procedural changes that were, as with the MIT settlement, also to be monitored over a three-year period, and the most recent was about a month ago with Johns Hopkins, which settled for $14,000,000, also alongside a number of plan design/procedural changes. In March, Brown University settled for $3.5 million, as well as “other, structural relief.” In May 2018, the University of Chicago entered into a class action settlement for a $6.5 million cash payment and changes to the university’s $3 billion plan, while earlier that year Duke University announced a $10.65 million settlement

On the other hand, St. Louis-based Washington UniversityNew York University and, as noted above, Northwestern University have thus far prevailed in making their cases in court. The University of Pennsylvania, which in 2017 won at the district court level, in 2019 had that decision partially overturned by an appellate court, though the plan fiduciaries’ motion for an en banc review of that decision was rebuffed.

It is, perhaps worth noting that the Seventh Circuit has been a receptive jurisdiction for fiduciary defendants in these excessive fee cases, harkening all the way back to the case of Hecker v. Deere, continuing with Loomis v. Exelon, both of which were cited in this decision. All in all, in cases of this sort, this district in particular has been very receptive to the notion that so long as participants have an array of choices, plan fiduciaries won’t have fallen short in fulfilling their duties even if less-optimal alternatives are also included.

What remains important is that plan fiduciaries have in place a prudent, participant best interests-focused rationale for the choices they make—and a process in place to ensure that that focus is consistently applied.