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Supreme Court Rules 7th Circuit Erred in Annuity Plan Fiduciary Case

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What You Need to Know

  • Associate Justice Sonia Sotomayor wrote the opinion.
  • Associate Justice Amy Coney Barrett took no part in the consideration of the case.
  • Financial services groups have argued that letting participants sue over reasonable fiduciary decisions could increase plan litigation defense costs and ultimately hurt the participants.

The U.S. Supreme Court ruled 8-0 on Monday that federal courts should look at more than a 403(b) retirement plan’s flexibility and investment menu size when deciding whether the administrators have met the Employee Retirement Income Security Act standard for the duty of prudence.

For life insurance agents and brokers who help clients with decisions about annuities — or with any other arrangements that involve a federal fiduciary standard — the ruling may mean that offering individual clients, or employer-sponsored plan participants, a wide range of choices will provide only limited protection against a federal suit alleging that a fiduciary acted in an imprudent way.

The 7th U.S. Circuit Court of Appeals ”erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents,” Associate Justice Sonia Sotomayor wrote in an opinion for the court on the case, Hughes et al. v. Northwestern University et al. (Case Number 19-1401).

Sotomayor noted that in a 2015 ruling in Tibble v. Edison International, the Supreme Court held that ERISA retirement plan fiduciaries must decide which investments can be prudently put on a plan’s investment option menu. The fiduciaries can’t simply offer participants’ preferred options and wave off concerns about the other options, she said.

The 7th Circuit should “reevaluate the allegations as a whole,” Sotomayor said.

But Sotomayor added that the Supreme Court’s new ruling is not a reason to question everything an ERISA plan fiduciary does. “At times,” she wrote, “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”

Associated Justice Amy Coney Barrett did not participate in the decision, having served on the appeals court that heard the case previously, according to The Wall Street Journal.

The History

Three current and former Northwestern University employees started the litigation in 2016 that led to the Hughes ruling by suing the university and its retirement investment committee over concerns about the university’s retirement and savings plans.

The employees argued that Northwestern, the investment committee and the committee members had violated their duty under ERISA fiduciary rules to exercise prudence.

The employees accused the fiduciaries of acting in an imprudent manner by offering plans with high record-keeping costs; retail mutual fund and variable annuity share classes with high, retail-level fees; and, in the beginning, an investment option menu that was too long and could have led to poor participant investment choices.

In October 2016, Northwestern cut the investment option menu to about 40 options. The university employees argued that the move was evidence that the original menu was too big to be prudent, and that the withdrawal penalties and restrictions built in to a fixed annuity left on the shorter investment option menu were too high.

A federal district judge ruled in favor of the sponsor, Northwestern University, in 2018.

In 2020, a three-judge panel at the 7th U.S. Circuit Court of Appeals upheld the district court ruling.

The Friends of the Court

At the Supreme Court, the U.S. Department of Justice supported the current and former employees.

AARP argued, in a “friend of the court” brief, that blocking the employees would thwart ERISA’s core purpose, which is to protect plan participants from an administrator’s failure to perform its fiduciary duties.

“Congress intended ERISA’s fiduciary duties to be broadly construed,” AARP said. “ERISA’s fiduciary duties are more important than ever, because most employers offer only defined contribution plans, participants rely heavily on the quality of their investments, and the retirement savings crisis has escalated.”

The American Benefits Council and the Investment Council Institute asserted that ruling in favor of the employees would hurt retirement plan participants by exposing prudent plan sponsors that have made reasonable choices to the threat of costly litigation based on the premise that the sponsors could have made other choices.

The Teachers Insurance and Annuity Association of America, which sold the tax-sheltered annuities in Northwestern’s retirement plans, asserted in a separate brief that one challenge is that the plaintiffs in the cases have failed to acknowledge that offering a vehicle that can provide a guaranteed stream of retirement income is different and more expensive from simply offering a worker a chance to build wealth through an ordinary, non-guaranteed 401(k) plan.

A 403(b) backed by TIAA annuities is also different from, and somewhat more expensive to run than, a 401(k) plan, because each employee owns a separate annuity contract, TIAA told the court.

“Because each plan participant holds his or her own annuity contract, the recordkeeper must determine account values, minimum guarantees, and any additional returns individually for each annuitant rather than simply execute a pro rata allocation of plan assets as in the 401(k) context,” TIAA wrote.

As an annuity issuer, TIAA must also spend money to comply with state annuity regulations, TIAA said.

Reactions to the New Ruling

TIAA declined to comment on the ruling.

Northwestern said in a comment that it is disappointed by the court’s disagreement with the reasoning adopted by the 7th Circuit.

“We are pleased that the court has asked the 7th Circuit to reconsider whether plaintiffs’ allegations fail to state a claim,” the university said. “As Northwestern has explained, the university did not violate its fiduciary duty with regard to the recordkeeping or the investment fees related to its retirement plans, and nothing in the court’s decision today prevents the 7th Circuit from reaching that conclusion in reexamining the allegations on remand.”

Nancy Ross and Jed Glickstein, lawyers with Mayer Brown who helped 18 colleges and universities file a brief supporting Northwestern, have noted that many current and former employees of private universities have filed suits challenging the administration of 403(b) plans, and that the Supreme Court’s opinion seems likely to affect how universities and their fiduciaries approach 403(b) plan administration.

Fred Reish, partner at Faegre Drinker, said in a comment on the ruling that the essential issue is whether it was the participants’ obligation to find the low-cost, high quality investments that they prefer or whether the plan fiduciaries were obligated to offer only prudent investments.

“The Supreme Court held that the duty to monitor required that all imprudent investments be removed, leaving only prudent investments,” Reish said. “The focus on the duty to monitor was at least partially attributable to the fact that some of the investments had been selected years before and that the statute of limitations had run on the issue of prudent selection.”

– Melanie Waddell contributed to this report. 

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Pictured: Associate Justice Sonia Sotomayor. (Photo: Erin Schaff/Bloomberg)