The Supreme Court's April 17 decision in Cunningham v. Cornell Univ. "has fundamentally altered the litigation framework for 401(k) excessive fee claims," finance professor Ron Rhoades says.
The case involved Cornell University employees who alleged that the university violated the Employee Retirement Income Security Act by causing “two retirement plans to engage in prohibited transactions with third-party service providers that delivered retirement plan investment options, platform access and recordkeeping services by paying allegedly excessive fees,” according to an alert released Tuesday by Holland & Knight.
The decision, a victory for the plaintiffs, “highlights the importance to plan sponsors and fiduciaries of having a process in place to review service provider agreements,” the law firm states.
As the ruling states, the employees participated in two of Cornell’s defined contribution retirement plans from 2010 to 2016. In 2017, they sued Cornell and other plan fiduciaries for allegedly causing the plans to engage in prohibited transactions for recordkeeping services with the Teachers Insurance and Annuity Association of America-College Retirement Equities Fund and Fidelity Investments.
The plans, according to the plaintiffs, also paid TIAA and Fidelity more than a reasonable recordkeeping fee, the ruling states.
“A reasonable fee (petitioners allege) would be approximately $35 per participant per year, but instead the plans paid between $115 to $183 per participant for one plan and $145 to $200 per participant for the other.”
The ruling “means that complaints for excessive fees are much more likely to survive the Motion to Dismiss stage of the proceedings,” Rhoades, associate professor of finance at Western Kentucky University and director of its personal financial planning program, told ThinkAdvisor in an email.
“Since the discovery phase of litigation is cost-intensive, cases often settle at this stage,” he said. “This means more recoveries by plan participants of excessive fees paid — whether to third-party administrators/recordkeepers, or due to mutual fund fees that are excessive.”
The pivotal ruling, Rhoades wrote on LinkedIn, "establishes that plaintiffs need only demonstrate the existence of a prohibited transaction and resulting harm, without bearing the burden of proving fiduciaries' failure to qualify for service provider exemptions. Instead, defendants must now affirmatively demonstrate their compliance with exemption requirements."
While the underlying case “involved allegations of excessive mutual fund fees, including the use of higher-cost retail share classes instead of lower-cost institutional ones, the Court did not issue any ruling on the validity of those claims or on the substantive question of fee reasonableness,” said Tim Rouse, executive director of The SPARK Institute, in an email.
“However, the ruling does lower the bar for such claims to proceed, without providing any judgment on mutual fund fee practices,” Rouse said.
New Wave of Litigation
"The expanded liability exposure has democratized risk across the 401(k) landscape, extending beyond traditionally vulnerable large plans ($1 billion+) to encompass mid-sized ($100 million+), and to even smaller plans," Rhoades wrote.
The ruling "effectively invites a new wave of litigation that could burden plan fiduciaries for doing what ERISA expressly permits — engaging necessary service providers at reasonable fees,” Rouse said in the statement. “The decision rewards legal technicalities over practical realities and will ultimately harm plan participants by increasing costs and discouraging plan innovation.”
"While the Court acknowledged concerns that this decision may lead to an 'avalanche of meritless litigation,' it deferred to Congress to address those policy outcomes," Rouse added.
Heightened Fee Scrutiny
ERISA attorney Fred Reish, partner at Faegre Drinker, sees the decision increasing "the scrutiny of fees and costs by plan sponsors. It also elevates the importance of having good comparative data."
For example, "a recordkeeper might be directly paid by a plan but might also receive indirect compensation (e.g., revenue sharing from the investments)," Reish added. "The total of that compensation should be compared to data that is sufficient to determine if the compensation is reasonable. The industry data can be obtained, for example, by [requests for proposals] or by benchmarking data."
Smaller Plans Targeted
Rhoades said that he fears "not much will change in the very near future. Most investment advisers to 401(k) plans that choose higher-cost mutual funds will likely continue to do so. At least until the lawsuits pile up, and fear of liability results."
"Most advisors to smaller plans — under $500 [million] in assets — have not really feared lawsuits in the past, as the law firms have been going after the larger plans (as the potential damages, in a class action suit, can be quite large)," Rhoades said.
With the Supreme Court decision, "I anticipate smaller plans will be targeted, as the costs and risks law firms take on to get to the discovery phase (where cases often settle) will be lower," Rhoades added. "Over several years’ time the impacts will begin to be felt, and the Cornell decision will then possess a broader impact."
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