In this episode of our ongoing podcast series addressing emerging issues for fiduciaries of 401(k) and 403(b) plans to consider as part of their litigation risk management strategy, Doug Hallward-Driemeier, chair of Ropes & Gray’s appellate & Supreme Court practice; Amy Roy, a litigation & enforcement partner; and Josh Lichtenstein, a benefits partner and head of the ERISA fiduciary practice, discuss some important updates in the ERISA retirement plan litigation space, including the Supreme Court’s recent opinion in Hughes v. Northwestern University and a new decision in the ongoing saga of Anderson v. Intel Corp. Investment Policy Committee.
Josh Lichtenstein: Hello, and welcome to the latest episode in our podcast series focusing on issues affecting sponsors and fiduciaries of 401(k) and 403(b) retirement plans. I am Josh Lichtenstein, an ERISA and benefits partner based in New York, and I am pleased to be joined by Doug Hallward-Driemeier, the chair of our appellate & Supreme Court practice who is based in Washington, D.C., and Amy Roy, a litigation & enforcement partner who is based in our Boston office. It’s great to be speaking with you both of you again today. As regular listeners of this series may recall, Amy joined us for one of the earliest episodes in this series last spring to discuss the important Anderson v. Intel Corp. Investment Policy Committee case (which addressed the use of alternative assets, such as private equity, in defined contribution plans), and Doug and I covered the Northwestern 403(b) plan litigation in our sixth episode shortly after the U.S. Supreme Court decided to grant certiorari last July. Since the start of 2022, there have been some important developments in both of these two cases, and so, we thought it would be a good time to revisit them.
After much anticipation, the Supreme Court issued a unanimous opinion in Hughes v. Northwestern University earlier this year, which vacated the Seventh Circuit’s decision to affirm the dismissal of an ERISA lawsuit and remanded the case for reconsideration of the plaintiff-participants’ allegations. Consequently, the plaintiffs will have another opportunity to assert that the plan fiduciaries actually violated ERISA’s duty of prudence based on the number of investment options they included on the plan menu, the decision to contract with multiple recordkeepers, and the decision to include investment options on the investment lineup that were allegedly high-cost, yet allegedly underperformed.
Doug, in our conversations about the decision, you mentioned Northwestern as a missed opportunity for the Court. Could you explain what you mean by that for our listeners?
Doug Hallward-Driemeier: Thanks, Josh. It’s nice to be joining you again for another one of these podcasts. When we spoke about the Northwestern case last summer, there was a sense shared by many (including me) that the Court would provide some much-needed guideposts on what the applicable standard for pleading a breach of fiduciary prudence under ERISA would be in connection with management of a defined contribution plan. And going further, I think there was even a glimmer of hope that the Court would adopt a more rigorous standard that would make it harder for these types of allegations to survive, and thus, make it less attractive for plaintiffs’ firms outside of cases where there would appear to be some genuine issue regarding fiduciary governance. Unfortunately, in my view, the Court issued a narrow opinion and decided to punt these issues back to the lower courts without a lot of guidance on how to determine whether allegations like these plaintiffs’ are sufficient, and to focus just on the facts of the case on remand. In that sense, it feels to me like a missed opportunity for the Court to clarify a really key procedural aspect of ERISA litigation and to stem the tide of these lawsuits.
The Court disagreed with the Seventh Circuit and ruled that the participant’s ability to choose prudent options does not itself discharge the fiduciaries’ duty both to (a) conduct an independent evaluation to determine whether the inclusion of each investment option on a plan menu is prudent and (b) to continue to monitor whether each option on the menu remains prudent. Furthermore, if a fiduciary fails to remove an imprudent investment option from the plan menu within a reasonable time, then they would breach their duty of prudence. The Court relied in its relatively short opinion on its 2015 decision in Tibble v. Edison International, which held, in part, that a fiduciary has a continuing obligation to monitor investments and to remove imprudent ones separate from, and in addition to, the fiduciary’s duty to carefully choose investments in the first place.
Some might look at the opinion and say that the Court’s reliance on Tibble and its recitation of the plaintiffs’ allegations without appearing to suggest that they were insufficient might provide lower courts with a doctrinal basis or some suggestion that they should permit more relatively thin complaints, like this one, to survive past the pleading stage. On the other hand, I’d like to highlight the last sentence of the opinion in which the Court called for deference to fiduciary decision-making, and they acknowledged how “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary might make based on her experience and expertise.” So, in that sense, I think the Court attempted to find a middle ground, and given these counterbalancing principles, I don’t think that this decision will actually move the needle all that much in this area.
Josh Lichtenstein: Thank you for the explanation and for all of those insights, Doug. I see what you mean about it being a missed opportunity after you explained all of that. So, even though we didn’t get the clarity that we were hoping for around the pleading standard, it does feel to me that the Court’s rejection of the Seventh Circuit’s rule is still significant. It seems to teach us that plan fiduciaries can’t just effectively stick their heads in the sand and assume that their current lineups are safe because they offer some good, well-vetted options. Instead, they need to engage with the entirety of the plan’s investment menu, continue to monitor each of those options like you were just explaining, and proactively remove or replace investments that the fiduciary has determined are no longer appropriate for the plan based on sound and consistent benchmarking data and other diligence. Of course, this requires more work from plan sponsors if they have larger and broader investment menus versus a plan sponsor with a smaller and a more streamlined menu.
Put another way, it feels like the decisions are coming together to say it’s all about (i) having a process, (ii) following that process and (iii) documenting the process. This decision reiterates the importance of having a good process in place for evaluating investment options and for deciding when to remove and/or replace certain investments as part of that ongoing monitoring. Of course, the process that the fiduciary follows and the decisions that he or she makes are also going to have to be well-documented. While there is no way to guarantee that a plan sponsor won’t get sued, taking these steps, it seems, could certainly help to mitigate the risk of a successful claim being actually brought by plaintiffs, and based on the Supreme Court’s “reasonable judgments” language which you were highlighting, Doug, it seems like having good documentation could help to garner at least some judicial deference in the event of a future lawsuit.
Doug Hallward-Driemeier: Yes, I think that’s a great point Josh. I absolutely agree that having a diligent process is critical—even more so now in light of the Northwestern decision—but as I’ve been thinking about this, it seems to me that the Court’s decision rests, to some extent, on a pretty fundamental assumption that plan fiduciaries actually have some freedom and ability to make changes and swap investments in and out of the lineup as they deem it necessary. And by my understanding, based on discussions with you and others, it’s not clear that that assumption always holds up. And I guess I’m thinking, for example, about individual annuity products commonly found in many college and university 403(b) plan options. These types of products, as I understanding it, plan fiduciaries may find themselves with their hands tied due to an annuity-provider’s contractual provisions—they may be unable to make easy changes or swap plans out. So, I was wondering if you had any thoughts on what fiduciaries should be doing in situations with investments like that?
Josh Lichtenstein: I’m really glad you raise that issue, Doug, because this is really a pretty challenging situation for investment committees for these types of plans. 403(b) plans they have a long and complicated history, much more so than the 401(k) plans commonly seen at most private employers. And as a result, we often see a substantial portion of the assets of these plans invested in these kinds of legacy individual annuity products that you were describing—they have complicated terms, and they limit the ability for the plan participants to reallocate or change investments once they are allocated and are very limiting for the plan sponsors.
Congress amended the tax code in 1974 to allow 403(b) plans to invest in a broader range of investments, such as mutual funds—similar to how 401(k) plans invest in mutual funds now—but many 403(b) plans still have assets held in these fixed annuities and variable annuities, and these are primarily offered by insurance companies. And, especially for the older plans, there could be a significant amount of assets in these legacy accounts or the assets they are held in these individual annuity contracts. And it leads to this difficult situation where the 403(b) plan sponsors can’t just pick up and move the annuity contracts to another recordkeeper and just consolidate with a single menu of investment options the plan sponsor maintains, because the participant is actually the annuity policyholder in these contracts and they’re in control of the contract, including any changes. So, in effect, the plan sponsors might actually feel powerless with respect to a portion of the 403(b) plan assets that are invested in these individual annuity contracts, and they’re honestly right to feel powerless.
So, going back to the question of: What can a 403(b) plan fiduciary actually do when their plans have these legacy individual annuity products and they can’t remove them on their own? I think there are three things to keep in mind:
- The fiduciary may want to document that they have reviewed and explored any options for actually changing or modifying those annuity investments. As we always say, part of having a diligent process in place is having robust documentation of any review that a fiduciary’s undertaken, and that remains true even when the documentation says that you have tried but found that you’re constrained from making certain modifications to the investment lineup. Basically, if you’re hamstrung, you want to make sure that a record that describes how and why you’re stuck in this situation, and make sure that you can show that you’re periodically revisiting those products as the market changes and evolves to see if there are any changes that can actually be made.
- There may be ways for you to engage in this sort of ongoing monitoring that the Court describes in the Tibble and Northwestern cases that you were talking about. For example, a fiduciary might decide to freeze participation in these legacy products, that at least kind of stops the bleeding. Or, the fiduciary may decide to freeze particular investments with respect to all new contributions. If a plan fiduciary—working in consultation with their investment advisor—determines that certain investments really don’t meet the criteria that they’ve established otherwise for products to be offered on the plan’s investment lineup, then I think that’s a scenario where you really do want to be proactive. Although you might not be able to force out the existing funds or contracts or products, you’re still modifying the lineup by taking the position that it is no longer an actively available option on the menu vehicle to select.
- Finally, even if you can’t control or remove the products, you should make sure that you’re engaging in robust participant education. In this case, you might actually want to educate your participants about the different products and alternatives on the lineup, including the fact that they have the power to control these investments or move their money out of an individual annuity product in their capacity as the individual policyholder. And on that note, and as our listeners are well aware, participant-oriented materials often actually come from the insurance companies and vendors directly—and they feel very much like they are marketing materials, whether they are branded as educational or not, they often do feel like they have a marketing spin. That said, plan administrators and recordkeepers often do offer participant education more generally, which can also be helpful in assisting participants in better understanding and evaluating their own portfolios beyond just what they are getting from the vendors.
And on the subject of process, I’d like to switch to the Intel case at this point. Amy, as we have covered in the prior episode in this series, the underlying question in the Intel litigation is really: Whether the inclusion of alternative assets, like private equity, hedge funds and commodity investments on a D.C. plan menu, constitutes a breach of ERISA's fiduciary standards? Both the 2021 decision from Judge Koh as well as her latest decision from January, which we are going to talk about, to grant Intel’s motion to dismiss the plaintiffs’ first amended class action complaint, never really got to the question of: Is it appropriate to include these specific alternative assets? Can you elaborate on that, Amy?
Amy Roy: Sure, Josh. So, Judge Koh’s most recent decision in the now long-running Intel litigation is effectively a dissertation on choosing benchmarks. As she explained in her decision, the plaintiffs there failed in their amended complaint to “provide factual allegations explaining why their chosen benchmarks are ‘meaningful’ benchmarks that have similar aims, risks, and rewards as the Intel target date funds (TDFs).” So, instead of describing why the Intel target date funds have similar aims, risks, and rewards as the plaintiffs’ chosen comparators, the plaintiffs only concluded that these comparators were “common.” For instance, the plaintiffs identified goals and features that were common to all target date funds, and in doing so, focused on characteristics such as how a target date fund is (i) a long-term investment vehicle, (ii) consists of a combination of asset classes, (iii) how a target date fund has a “glidepath” that reduces risk over time, and (iv) is only moderately risky overall. However, the plaintiffs did not provide any information regarding the investment strategies, glidepaths, and fees of any specific target date funds with the same target date as the Intel target date funds. And so, according to Judge Koh’s opinion, courts have consistently held that conclusory allegations that funds have “the same investment style” or “materially similar characteristics” are just not sufficient to state a claim for relief, and without more factual allegations about how and why the funds the plaintiffs cited were similar to the Intel target date funds at issue, the plaintiffs simply failed to identify meaningful benchmarks. And without finding a meaningful benchmark, a court is not in a position to evaluate whether an allegation of a violation of the duty of prudence is plausible because a plaintiff’s comparison of “apples to oranges is not a way to show that one is better or worse than the other.”
Josh Lichtenstein: Thanks for explaining that, Amy. It’s really interesting to hear that Judge Koh just went through so much detail in going through these benchmarking issues. We don’t often see judges go into that level of thoroughness, and it’s really I think interesting and instructive. But going beyond the benchmarking issues, the opinion also addressed flaws in the plaintiffs’ allegations that the Intel defendants breached their duty of loyalty under ERISA. What was it about these claims by the plaintiffs that the judge found to be problematic?
Amy Roy: As the plaintiffs did in their first complaint, in their amended pleading, the plaintiffs alleged that the Intel investment committee engaged in prohibited self-dealing because Intel Capital, a subsidiary of Intel, had “partnered with investment companies, such as hedge fund and private equity investors to co-invest in and secure sequential funding for third-party startups.” In their amended complaint, the plaintiffs tried to bolster these claims by describing, among other things, how Intel Capital, an Intel subsidiary, invested in privately held companies that supposedly benefited Intel’s business, and that Intel used those Intel target date funds to incentivize these hedge funds to give follow-up funding to the beneficial privately held companies. And the plaintiffs also alleged that Intel and Intel Capital invested in the private equity of companies that complemented Intel’s business, and “used hedge funds to come in and invest in those same companies” when those same companies sought a second round of funding.
But even though the plaintiffs expanded their breach of loyalty allegations in their amended complaint, Judge Koh still found nonetheless that they failed to plausibly allege that the plan fiduciaries acted in a way that aided Intel Capital in its venture capital investments at the expense of investors as they were required to do. In particular, the plaintiffs again failed to provide any factual allegations to support their claim that the aim of the Intel plan investment committee’s investment in private equity and hedge funds was to aid its subsidiary Intel Capital and its venture capital investments. For example, the plaintiffs never alleged that the plan investment committee had any influence over any investment firm’s decision to invest in one of the startups in which Intel invested. The plaintiffs also failed to provide any factual allegations to support their claim that the Intel investment committee engaged in self-dealing. So, according to Judge Koh, the plaintiffs really only pled factual allegations that, at most, support a potential conflict of interest, not a real conflict, and of course, the Court has previously held that allegations that defendants may have a potential conflict of interest is just not sufficient to state a claim for breach of the duty of loyalty under ERISA.
That all said, to me, the bigger takeaway from this latest decision is that Judge Koh’s comprehensive and exacting evaluation of the benchmarks the plaintiffs offered tells us something about how a courts might evaluate these sorts of ERISA cases going forward. I think it speaks to the deference that we would generally expect a judge to show for plan fiduciaries who had a good process in place. The outcome of that process doesn’t have to be “right” so to speak in terms of generating the best performance, as long as the fiduciaries have utilized a rigorous, objective and diligent process for making those plan decisions—deference really ought to be paid to those fiduciaries. This is actually a lot like the holding from the Supreme Court that you and Doug were just discussing.
Josh Lichtenstein: Thanks for that, Amy. And thanks for making that connection between the two cases—it’s interesting to think about the common threads in jurisprudence we see in this area. I agree also that here, the sponsor made a choice to use non-traditional, highly customized products as plan investments, which allegedly performed poorly, but even still, the process won out. I think it demonstrates, like you were saying, that plan fiduciaries should be able to construct a lineup for the participants that they think is in the participants’ best interest, even if it doesn’t adhere to industry best practice or even if it doesn’t actually result in choosing either the most conservative investments or the best performing investments—it’s really the process that matters.
So, from that vantage point, this decision may give some comfort to all the plan sponsors out there who are considering including alternative investments in their own defined contribution plan menus in various capacities, as long as they follow a rigorous and appropriate process in making that decision, and as we’ve said a number of times over this podcast, documenting that decision. I think that if you read the opinion in conjunction with the DOL’s 2020 information letter on the use of alternatives in 401(k) plans and the statement that the DOL issued just at the end of December which clarified but did not materially change the guidance from the information letter, then fiduciaries who are attentive to process should take at least some level of comfort in knowing that if they use and incorporate these types of alternative investments in plan menu, and as long as they do it in a manner that is rigorous and documented, that they might not necessarily get second-guessed by a judge if it gets challenged in court.
On that note, the DOL’s supplemental statement actually leaves in place its view that a plan fiduciary would not be violating its duties under ERISA solely by reason of offering a professionally managed asset allocation fund with a private equity or other alternative component as a designated investment alternative subject to the conditions set forth in that 2020 information letter. The statement goes on to address concerns they raise about the applicability of the 2020 information letter to certain, smaller plans and fiduciaries by emphasizing how plan fiduciaries that are going to select or evaluate a product that includes alternatives, like PE, needs to have the particular skills, knowledge and experience to be able to actually evaluate the performance and fees of the underlying products and underlying portfolio investments. In other words, if a fiduciary does not possess the expertise needed to evaluate these products, then they may need to seek assistance from an investment manager or other investment professional who does have the requisite experience.
I think we’ve covered a lot of interesting ground, and I think it’s also nice that we were able to explore similar connections between these different cases. And with that, I want to thank Amy and Doug for joining me today, and sharing many valuable insights about these two important cases. For more information on the topics that we have discussed, please visit our website at www.ropesgray.com. And of course, if we can help you navigate any of the topics we covered, please don't hesitate to reach out. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including on Apple and Spotify. Thanks for listening, and we look forward to being with you again soon.
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