What If They Are Wrong?: How Court Decisions Impact 401(k) and 403(b) Plan Sponsors’ Fiduciary Risk Management Decisions

As an attorney and a fiduciary risk management consultant, my first thought when SCOTUS announced its decision in Hughes v. Northwestern University1 (Northwestern) was the renewed potential fiduciary risk liability for the plan sponsors. During the oral arguments, SCOTUS was able to get the plan’s own attorney to admit that the Seventh Circuits’ “menu of options” had no legal merit. So, it was a foregone conclusion that the plan would be found to have breached their fiduciary duties by offering both prudent and imprudent investment options within the plan.

Since then, I would argue that we have had a number of questionable decisions in both federal district and federal courts of appeal. In most of these cases, at least one point of contention has been the so-called “apples and oranges” argument.

The “apples and oranges” argument focuses on the use of index funds for benchmarking purposes in evaluating actively managed mutual funds. In one corner, we have the Brotherston2 decision, pointing to the Section 100, comment b of the Restatement (Third) of Trusts (Restatement), which clearly supports the use of index funds as comparators against comparable actively managed funds. Brotherston notes that in the Tibble3 decision, SCOTUS acknowledged that the courts often turn the Restatement for assistance in resolving fiduciary issues.

In the other corner, we have the courts who steadfastly ignore SCOTUS and Brotherson, arguing that actively managed funds can only be compared to similar actively managed funds. These courts argue that the different concepts, approaches, goals and strategies used by these types of funds preclude any meaningful comparison between active and index funds.

The Northwestern decision raises an interesting question. When SCOTUS vacates a decision of a lower court, in effect telling them “you made a mistake,” who pays for the lower court’s mistake? By that, I not only mean the party before SCOTUS, but other plans that may have relied on the lower court’s “mistake.” The lower court suffers no loss. They just take the case up again.

The same question applies to the plan provider who initially recommended the imprudent investments that the plan adviser ultimately chose for the plan. In many cases, the plan sponsor voluntarily agreed to give the plan adviser a fiduciary disclaimer clause, releasing the plan provider from any breach of fiduciary claims in connection with the advice it provided to the plan and its participants.

The importance of the fiduciary disclaimer clause preventing recourse by the plan against the plan adviser’s negligent or fraudulent actions cannot be overstated. As a result, I believe the grant of such a disclaimer should always be set out as a separate breach in any fiduciary breach action against the plan sponsor.

In many cases, the primary or sole reason a plan adviser was hired is because the plan lacked the knowledge and/or experience to independently select prudent investment options and otherwise manage the plan. In such cases, agreeing to a fiduciary disclaimer clause makes absolutely no sense.

So, a plan adviser arguably suffers no harm when SCOTUS or a federal court of appeals reverses a lower court’s adverse decision and reinstates the plan participants’ action. I say “arguably” because SCOTUS has upheld the right of plan sponsors to bring actions against plan providers on common law grounds such as negligence, fraud, and breach of contract.

Every time a court dismisses a 401(k)/403(b) action, the plan adviser industry celebrates on social media sites, often denouncing another “cookie cutter” case. I immediately look to the applicable law to determine if the court has ignored the standards set out in the Restatement and endorsed by SCOTUS. In most cases, I dismiss the erroneous decision and await the plaintiff’s decision as to whether they intend to appeal the decision.

One development we are seeing is more courts ignoring the “costs of discovery” argument as justification for dismissing otherwise meritorious 401(k)/403(b) actions. I have never understood that argument. simply because judges can properly address such concerns through “controlled” discovery, thereby avoiding the inequitable dismissal of an appropriate action. The Sixth Circuit recently provided an excellent analysis of this option in its TriHealth4 decision.

But at the pleading stage, it is too early to make these judgment calls. ‘In the absence of further development of the facts, we have no basis for crediting one set of reasonable inferences over the other. Because either assessment is plausible, the Rules of Civil Procedure entitle [the three employees] to pursue [their imprudence] claim (at least with respect to this theory) to the next stage….’ (citing Fabian, 628 F.3d at 281)

This wait-and-see approach also makes sense given that discovery holds the promise of sharpening this process-based inquiry….In the absence of discovery or some other explanation that would make an inference of imprudence implausible, we cannot dismiss the case on this ground. Nor is this an area in which the runaway costs of discovery necessarily cloud the picture. An attentive district court judge ought to be able to keep discovery within reasonable bounds given that the inquiry is narrow and ought to be readily answerable.

Going Forward
Increasingly, the decision dismissing meritorious 401(k)/403(b) actions eventually turns out to be nothing more than an act providing a plan with a temporary and false sense of security. Fortunately, there are simple risk management steps a plan sponsor can do in designing and maintaining a plan to reduce and/or eliminate a plan sponsor’s potential fiduciary liability exposure, including:

(1) Never agree to a plan advisory contract that contains a fiduciary disclaimer clause.
(2) Always require that a plan adviser provide the plan with an Active Management Value RatioTM (AMVR) forensic analysis for each product recommendation, using only the official AMVR format, as shown throughout this blog site.
(3) Consider having an independent and objective fiduciary risk management audit performed to ensure maximum protection against unnecessary fiduciary liability.
(4) Plan sponsors should learn how to personally prepare and evaluate an AMVR forensic analysis so that they can comply with ERISA’s requirement that a plan sponsor conduct a thorough, objective, and independent investigation and analysis of each investment option offered by a plan.

Fiduciary risk management need not be overly complicated or intimidating. The key is in properly designing a simple, cost-efficient and ERISA compliant fiduciary risk management system so that the plan sponsor can avoid the costs and hassles of litigation.

1. Hughes v. Northwestern University, 953 F.3d 980 (2020).
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 (2018).
3. Tibble v. Edison International, 135 S. Ct. 1823 (2015).
4. Forman v. TriHealth, Inc., 40 F.4th 433, 453 (6th Cir. 2022)

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This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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