7th Circuit revives excessive fee claims after high court ruling 

April 25, 2023

In a closely watched lawsuit, the 7th US Circuit Court of Appeals found that participants in Northwestern University’s 403(b) plans can proceed with allegations that the plans’ fiduciaries violated ERISA by allowing excessive fees (Hughes v. Northwestern Univ., No. 18-2569 (7th Cir. March 23, 2023)). The ruling follows last year’s US Supreme Court opinion overturning the 7th Circuit’s earlier decision affirming dismissal of the case (Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022)). The 7th Circuit joins a growing number of federal appeals courts allowing participants to pursue claims that defined contribution (DC) plan fiduciaries imprudently offered retail share class mutual funds instead of cheaper — but otherwise identical — institutional share classes. In contrast with other recent appeals court decisions, the 7th Circuit also revived claims that plan fiduciaries failed to rein in the plans’ recordkeeping fees. But the court affirmed dismissal of a third claim that the fiduciaries had confused participants by imprudently offering too many duplicative funds.

When first considering this lawsuit several years ago, the 7th Circuit agreed with the district court’s dismissal because the plan’s investment lineup included lower-cost investment options, and participants could choose to avoid the more expensive funds. However, the Supreme Court disagreed, ruling that the mere presence of prudent investment options doesn’t insulate fiduciaries from potential liability for other allegedly imprudent funds.

The high court returned the case to the 7th Circuit with the instruction to consider whether participants had plead sufficient facts that, if true, plausibly alleged a fiduciary breach. This is the “pleading standard” that plaintiffs must meet to survive a motion to dismiss. The Supreme Court explained that courts should make a context-specific evaluation of participants’ claims in light of the circumstances prevailing at the time of the alleged fiduciary breach. The high court also said lower courts must “give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”

On remand, the 7th Circuit interpreted the high court’s direction as requiring participants to plausibly allege that fiduciaries made decisions outside a “range of reasonableness.” Participants also must identify a prudent alternative action that was plausibly available. The court also explained that the range of reasonableness accorded in a particular case depends on the circumstances prevailing at the time of the fiduciary action, and courts must give due regard to alternative explanations for a fiduciary’s decisions. The 7th Circuit found that the participants met this pleading standard for their claims regarding the retail share class funds and excessive recordkeeping fees. But the court affirmed dismissal of a third claim regarding duplicative funds.

Excessive fee cases often involve claims that fiduciaries acted imprudently by offering retail share class mutual funds instead of cheaper — but otherwise identical — institutional share classes. In this case, the fiduciaries argued that this claim should be dismissed because the participants’ pleadings failed to allege that the plans actually could have offered institutional share class funds, which often have minimum investment thresholds. But the court explained that the pleading standard discussed above doesn’t set as high a bar: Participants only had to plead that institutional share classes are plausibly — rather than actually — available. The court found the participants met this standard by asserting that large 403(b) plans like the ones in this case have been able to wield their bargaining power to negotiate exceptions to such investment thresholds.

The decision allowing participants’ institutional share class claims to proceed is consistent with other federal appeals court rulings since the Supreme Court’s Northwestern opinion. This trend suggests that plans offering retail share classes may continue to be at risk of facing similar claims. However, the court’s opinion also indicates that the existence of an “obvious” alternative explanation for a fiduciary’s actions — one suggesting the fiduciary’s conduct falls within the range of reasonable judgments — requires more detailed factual allegations to avoid dismissal. This implies that imprudent share class claims may have a tougher time in court if fiduciaries can show their plan in fact didn’t qualify for institutional share classes.

The court also revived the participants’ claims that the fiduciaries acted imprudently by continuing to allow uncapped revenue-sharing payments to the plans’ recordkeepers and failing to consolidate the services with a single recordkeeper to obtain lower pricing. In support of their claims, the participants asserted that other recordkeepers provide competitive pricing for comparable services and gave examples of similar university-sponsored 403(b) plans that reduced recordkeeping expenses by negotiating a flat fee structure through competitive bidding.

The court deemed those claims sufficient to plausibly allege that the fees were excessive relative to the services provided. Although the fiduciaries offered reasonable alternative explanations — including the potential loss of popular investment options and the payment of surrender charges if the plan consolidated or changed recordkeepers — those explanations didn’t account for fiduciaries’ alleged failure to monitor and negotiate lower fees with the existing recordkeepers.

The court’s decision bucks the recent trend of federal appeals courts upholding dismissal of excessive recordkeeping fee claims — including another 7th Circuit ruling issued by a different three-judge panel last year (Albert v. Oshkosh Corp., No. 21-2789 (7th Cir. Aug. 29, 2022)). However, these other rulings involved more generalized allegations comparing plan expenses to industry averages that don’t reflect recordkeeping services of similar type or quality.

In addition, appellate rulings since the high court’s Northwestern decision haven’t squarely addressed similar challenges to the use of uncapped revenue-sharing arrangements to pay plan recordkeeping expenses. Such claims are more likely to accompany imprudent share class claims because institutional share classes typically don’t participate in revenue-sharing arrangements. While confirming that the use of revenue sharing to pay plan administrative expenses isn’t automatically an ERISA breach, the 7th Circuit emphasized that fiduciaries must regularly monitor such arrangements to ensure their continued reasonableness.

The 7th Circuit considered participants’ claims that fiduciaries could have avoided participant confusion and obtained lower-cost investments by eliminating duplicative investments and offering only a single fund for certain investment strategies. The court determined that the allegations about participant confusion weren’t specific enough to meet the pleading standard because they failed to identify how participants were injured. However, the court said the allegations that fund consolidation would have lowered costs could be considered to the extent those assertions support participants’ imprudent share class claims.

The ruling underscores how the case-by-case nature of the pleading standard set by the high court in Northwestern leaves room for some types of excessive fee claims to survive dismissal. The 7th Circuit rejected the fiduciaries’ argument in this case that excessive fee claims should be subject to a heightened pleading standard derived from the Supreme Court’s ruling in Fifth Third Bancorp v. Dudenhoeffer (573 U.S. 409 (2014)). Dudenhoeffer’s demanding pleading standard has overwhelmingly favored plan sponsors and fiduciaries but only applies to claims involving fiduciaries having inside information that would affect a plan’s employer stock investments (claims not present in this case).

While some claims in this case — like consolidation of multiple recordkeepers — are unique to 403(b) plans, the 7th Circuit’s in-depth exploration of the high court’s pronouncements on the pleading standard for excessive fee allegations may prove persuasive for other courts evaluating similar fiduciary breach claims for DC plans in general. But other circuit courts could adopt interpretations either more or less deferential to fiduciary decision-making at the motion-to-dismiss phase, which could create conflicts among the federal appeals courts. A court’s finding that participants’ ERISA claims meet the pleading standard doesn’t mean those claims will ultimately prevail on the merits, but fiduciaries may face increased pressure to settle to avoid the expense of ongoing litigation.

• Hughes v. Northwestern University, No. 18-2569 (7th Cir. March 23, 2023)
• Albert v. Oshkosh Corp., No. 21-2789 (7th Cir. Aug. 29, 2022)
• Hughes v. Northwestern University, 142 S. Ct. 737 (2022)

• DC plan sponsors prevail in two recent stock-drop rulings (Nov. 30, 2022)
• 7th Circuit still skeptical of excessive fee claims after high court ruling (Oct. 20, 2022)
• 6th Circuit issues mixed rulings in two ERISA excessive fee cases (Aug. 23, 2022)
• More excessive fee suits revived after high court’s Northwestern decision (June 17, 2022)
• High court declines to raise the bar on excessive fee cases (Feb. 8, 2022)