In a pair of recent rulings, the 6th US Circuit Court of Appeals considered whether to dismiss defined contribution (DC) plan participants’ fiduciary breach claims in light of the US Supreme Court’s decision in Hughes v. Northwestern University (No. 19-1401 (US Jan. 24, 2022)). In both cases, the 6th Circuit upheld the lower court’s dismissal of claims challenging the prudence of actively managed funds, as well as allegations of excessive investment and administrative fees. But in one case, the court revived allegations that plan fiduciaries imprudently offered retail share class mutual funds instead of cheaper — but otherwise identical — institutional share classes.
To avoid having a lawsuit dismissed, participants must plead sufficient facts that, if true, plausibly allege a fiduciary breach. In Northwestern, the Supreme Court reiterated that determining whether participants in a particular case have met this pleading standard requires courts to evaluate 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.”
The first of the 6th Circuit’s rulings focuses on allegations that fiduciaries imprudently selected actively managed target-date funds instead of less expensive passive funds (Smith v. CommonSpirit Health, No. 21-5964 (6th Cir. June 21, 2022)). To support these allegations, participants noted that the plan’s target-date series underperformed the same investment provider’s passively managed target-date funds over a recent five-year period.
While acknowledging that actively managed funds generally charge higher fees than passive investments, the court determined participants’ allegations fell short. First, the court concluded that the decision to offer actively managed funds isn’t itself a fiduciary breach. Instead, the court said “denying employees the option of actively managed funds, especially for those eager to undertake more or less risk” could actually be imprudent.
The 6th Circuit then turned to participants’ allegations that the funds themselves were imprudent. The court found that when evaluating a retirement plan with a long-term investment horizon, “simply pointing to a fund with better performance” over the short term, without considering the fund’s distinct investment objectives, isn’t sufficient to plausibly allege a fiduciary breach. The court noted that a contrary finding “would mean that every actively managed fund with below-average results over the most recent five-year period would create a plausible ERISA violation.”
Many of the claims in the second case (Forman v. TriHealth, Inc., No. 21-3977 (6th Cir. July 13, 2022)) mirrored those in CommonSpirit, and the 6th Circuit affirmed the lower court’s dismissal on the same grounds. However, the participants in this case also alleged that 17 mutual funds offered by the plan were retail share classes instead of lower-cost institutional share classes of the same funds — a claim nearly identical to one addressed in the Northwestern ruling.
The court rejected the plan sponsor’s argument that participants had failed to provide a meaningful benchmark because they hadn’t made specific allegations about the characteristics and performance of the institutional share classes. In reviving these claims, the court found that participants met the pleading standard because both share classes had “the same investment strategy, portfolio, and management team.”
The court also noted plan fiduciaries could have reasonable explanations for selecting retail share classes, such as revenue-sharing arrangements. However, the court determined that evaluating those other explanations would require more factual development than what would be appropriate at the motion-to-dismiss stage.
The court also upheld the dismissal of participants’ claims of excessive fees in both cases. Participants based their claims on comparisons of their plans’ administrative and investment fees to industry averages. However, the court said participants had failed to allege that the services covered by the fees were equivalent to services received by other plans included in those averages. Participants also failed to allege that administrative fees were excessive relative to the services provided to their plans.
The 6th Circuit is only the second appellate court to rule on motions to dismiss excessive fee cases since the high court’s ruling in Northwestern. Other circuit courts aren’t bound by these rulings but may look to the 6th Circuit’s reasoning as persuasive authority when evaluating similar excessive fee claims.