Dismissal of Case Against UPenn Good News for 403(b) Plan Sponsors

Colleges and universities have finally received some encouraging news in the recent spate of class action suits against higher education 403(b) plans. Last week a federal judge dismissed all claims against the University of Pennsylvania, marking the first time that one of these recent law suits has been be dismissed in full. See Sweda v. Univ. of Pa., No. 16-4329 (E.D. Pa. Sept. 21, 2017).

The facts involved in the suit against University of Pennsylvania were not unlike those of many of the other breach of fiduciary duty cases brought against higher education employers. Since 2010 the University of Pennsylvania's 403(b) plan has offered between seventy-six and 118 investment options to its 21,412 participants. At the end of 2014 the plan had $3.8 billion in net assets. Participants in the plan asserted breaches of fiduciary duties arising out of a variety of decisions made by plan fiduciaries at UPenn: locking in the plan to certain TIAA-CREF accounts; allowing TIAA-CREF and Vanguard to serve as their own recordkeepers and use asset-based recordkeeping fees instead of flat, per-person fees; offering some retail class shares, rather than all lower-fee institutional class shares; and permitting some underperforming funds to remain in the plan. The judge dismissed all claims in their entirety.

In reaching his decision the judge relied heavily on Renfro v. Unisys Corp., 671 F.3d 314 (3d Cir. 2011), a Third Circuit decision from 2011 that directs courts to consider the composition of the plan's offerings as a whole, rather than singling out individual underperforming funds. In Renfro the Third Circuit held that in deciding whether to dismiss claims of breach of fiduciary duty, a court must determine whether the claims of a flawed process are plausible based on "the range of investment options and the characteristics of those included options—including the risk profiles, investment strategies, and associated fees." In the University of Pennsylvania decision, the judge said that Renfro "requires plaintiffs to show more than just a single sub-optimality in a given mutual fund. Instead, they must show systemic mismanagement such that individuals are presented with a Hobson's choice between a poorly performing § 401(k) portfolio or no § 401(k) at all," the judge said. Although Renfrodealt with a 401(k) plan, the judge applied it to the University of Pennsylvania's 403(b) plan because of the similarity in the operation of 401(k) and 403(b) plans and the uniformity of ERISA's fiduciary standards.

First, the plaintiffs argued that it was improper for the fiduciaries to "lock in" the plan to TIAA-CREF and allow TIAA-CREF to mandate the inclusion of several accounts that the plaintiffs described as underperforming. The judge, however, concluded that locking in a plan to a particular provider is not a breach of fiduciary duty because this is a common practice used to negotiate lower fees and better terms.

Second, plaintiffs argued that allowing TIAA-CREF and Vanguard to serve as their own recordkeepers unnecessarily increased recordkeeping fees. The judge dismissed this claim because this sort of "bundling" of services is common, likening the bundling of recordkeeping and investment services to cable companies bundling internet, cable TV, and landline telephone services. The judge noted that in such circumstances paying for a service that is not needed is often required to receive a product or service the value of which outweighs the unnecessary or undesired fee. The judge also noted that the fees, which ranged from .04% to .87%, were almost certainly not high enough to be unreasonable.

Third, plaintiffs argued that it was a breach to permit the use of asset-based recordkeeping fees instead of flat, per-person fees. The judge said that whether to assess the fees as a flat, per-person fee or an asset-based fee — a decision that determines where the burden of fees will fall — is up to the discretion of the plan administrator.

Fourth, plaintiffs argued that participants were charged unnecessary fees, principally because some of the investment offerings in the plan were retail class shares, rather than lower-fee institutional class shares. The judge ruled that fiduciaries are not required to "maintain a myopic focus on the singular goal of lower fees." Because providing institutional class shares may come with drawbacks, such as minimum investment levels and less liquidity, the inclusion of retail class shares in the plan does not, by itself, constitute a breach of fiduciary duty.

Fifth, plaintiffs argued that the fiduciaries offered too many investment options, overwhelming participants. In recent years, the plan has offered between seventy-six and 118 investment options, broken into four tiers based on the participants' investment acumen and desire to customize their investments. The plaintiffs failed to allege that any participant was actually confused by the plan's offerings, which the judge said was fatal to this claim. The judge went on to note, however, that even if such harm had been alleged, this claim would still fail. Although the judge appeared to accept the premise that offering too many investment options could constitute a breach of fiduciary duty, the judge said seventy-eight options is reasonable, particularly when organized in a way designed to help guide participants.

Finally, plaintiffs argued that certain funds were outperformed by the market. The judge noted that there is no cause of action in ERISA for underperforming funds, and instead fiduciaries are judged based on whether they exercised prudence under the circumstances that existed when decisions were made. The judge looked to the fact that only slightly more than half of the funds in the plan underperformed their relevant benchmarks, and compared this to what he described as the expected outcome: that half of the funds should underperform and half should outperform. Although the judge noted that this could be consistent with a breach of fiduciary duty, he said it was not sufficient to "nudge their claims across the line from conceivable to plausible."

The University of Pennsylvania decision is good news for 403(b) plan sponsors, but it remains to be seen whether other courts will follow Judge Pratter's approach. Although several courts have denied motions to dismiss filed by schools facing similar class action suits, New York University was granted a partial dismissal last month. See Sacerdote v. N.Y. Univ., 16-cv-6284 (S.D.N.Y. Aug. 25, 2017). As in the University of Pennsylvania case, the court agreed with NYU that locked in investment options and fees related to bundled services are not sufficient to support claims of breach of fiduciary duty. But the court denied NYU's motion to dismiss claims that recordkeeping fees were excessive and NYU failed to obtain bids for alternative recordkeeping services. The court also denied the motion to dismiss as to claims that NYU failed to prudently evaluate the performance of funds and determine whether they should continue to be offered to participants, specifically noting that the plaintiffs alleged a ten-year record of consistent underperformance. Finally, the NYU court dismissed claims that offering too many investment options constitutes a breach of fiduciary duty.

The 403(b) plan fee litigation is far from over, but the University of Pennsylvania's success is an encouraging development for higher education institutions. Verrill Dana continues to monitor this litigation closely and work with our higher education clients to establish and maintain best practices in fiduciary governance.