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Partial Victories to Two Universities in Their Motions to Dismiss Code Section 403(b) Fee Litigation

Summary

Multiple large, class action lawsuits have been filed against prominent higher education institutions claiming fiduciary breaches under their Code Section 403(b) plans as a result of insufficient oversight of plan investments, which allegedly caused excessive fees to be paid by participants. Last week, district courts in Georgia and North Carolina, respectively, ruled on defendants’ motions under Henderson v. Emory University and Clark v. Duke University. Although the defendants in these cases had some success in eliminating certain causes of action, other causes of action involving the payment of excessive fees and use of multiple record-keepers will continue through litigation.

In Depth

More than 10 large, class action lawsuits have been filed against prominent higher education institutions (e.g., John Hopkins, Yale, Cornell, Vanderbilt) claiming fiduciary breaches under their Internal Revenue Code (Code) Section 403(b) Tax Sheltered Annuity Plans as a result of insufficient oversight of plan investments, which allegedly caused excessive fees to be paid by participants. Last week, district courts in Georgia and North Carolina, respectively, ruled on defendants’ motions to dismiss under Henderson v. Emory University, N.D. Ga., No. 1:16-cv-02920-CAP (5/10/17) and Clark v. Duke University, M.D.N.C., No. 1:16-cv-01044 (8/10/16). Each court granted in part and denied in part portions of the respective motions to dismiss. Although the defendants in these cases had some success in eliminating certain causes of action, other causes of action involving the payment of excessive fees and use of multiple record-keepers will continue through litigation. Code Section 403(b) plan sponsors can glean best practices from the arguments in each of these cases as well as the upcoming cases against Columbia University and New York University.

Summary of the Allegations

The allegations in the original underlying complaints generally fall into eight categories, which plaintiffs argue led to fiduciary breaches:

  1. Funds are too expensive. Alternative funds were available at lower cost and with similar risk/return characteristics.

  2. Failure to offer lower-cost share class. Fiduciaries failed to investigate the availability of lower-cost share classes of mutual funds (e.g., institutional) and continued to offer higher-cost share classes (e.g., retail).

  3. Failure to remove underperforming funds. Fiduciaries failed to adequately monitor investment options and remove those that exhibited poor performance against benchmarks. Further, they argue that the use of investment options that included revenue-sharing arrangements was not appropriate because plan fiduciaries did not compare overall plan fees against a reasonable participant-based recordkeeping fee.

  4. Too many fund options are offered. By providing too many investment options, the fiduciaries created duplicative offerings that charged higher fees and confused participants, preventing them from making educated choices.

  5. Failure to take advantage of “mega plan” economies of scale or to conduct periodic Requests for Proposals for evaluating service providers. The fiduciaries failed to conduct a Request for Proposal (RFP) to ascertain whether a better and less expensive provider was available. The fiduciaries further failed to capitalize on the size of the Code Section 403(b) plan, by potentially combining plans, to secure the best pricing for administrative and investment services.

  6. Too many record-keepers were involved. By utilizing multiple record-keepers, the fiduciaries impeded the plan’s ability to consolidate management of plan investments and negatively impacted the plan’s ability to secure more favorable fee terms or to streamline administration or reduce costs.

  7. Failure to appropriately evaluate revenue sharing funds. Fiduciaries did not compare overall plan fees against a reasonable participant-based recordkeeping fee.

  8. Annuity products offered were too expensive and restrictive. Fiduciaries continued to offer annuity products whose fees were excessive and which “locked in” participants.

Although the rulings did not necessarily provide significant insight into the court’s thinking on each of the above issues, the ultimate decision of each court’s ruling on certain of the above issues is set forth below under the respective case name.

Henderson v. Emory University

In its 26 page decision, the court in the Northern District of Georgia determined the following:

  • Dismissal granted with respect to the issue that defendants acted imprudently by offering too many investment options. The court concluded that “[h]aving too many options does not hurt the Plans’ participants, but instead provides them opportunities to choose the investments that they prefer.”

  • Partial dismissal granted with respect to plaintiffs’ intent to seek any damages that occurred more than six years prior to the complaint being filed caused by imprudence. The court determined that claims of imprudence further back than six years are time barred but plaintiffs could proceed based on revised claim that there is a continuing duty to monitor and remove imprudent options.

  • Partial dismissal granted with respect to any plaintiff allegation that investment in mutual funds offered by a service provider who is a “party-in-interest” is a prohibited transaction. The Employee Retirement Income Security Act of 1974 (ERISA) provides an exception from the prohibited transaction rule for mutual funds.

All other allegations in the complaint are permitted to proceed.

Clark v. Duke University

In its five page decision, the court in the Middle District of North Carolina determined the following:

  • Dismissal granted in full with respect to “locked in” allegations pertaining to certain annuity products and their imprudence. Defendants submitted a 2009 Form 5500 as proof that certain investments with a “locked in” feature had been in place for more than six years. The court determined that plaintiffs’ claim that “Duke’s decision to commit[] the Plan to an imprudent arrangement,” to “allow[] the Plan to be locked into an unreasonable arrangement,” had to consider when the arrangement was entered into. Since the arrangement was entered into prior to 2010, it was barred by the statute of limitations.

  • Partial dismissal granted with respect to any plaintiff allegation that investment in mutual funds offered by a service provider who is a “party-in-interest” is a prohibited transaction. ERISA provides an exception from the prohibited transaction rule for mutual funds.

  • Dismissal granted in full with respect to plaintiffs’ allegation of breach of duty to monitor. Plaintiffs' complaint was devoid of facts of how the monitoring process was deficient.

All other allegations in the complaint are permitted to proceed. 

© 2017 McDermott Will & Emery

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About this Author

Nancy Gerrie, Corporate Attorney, McDermott Law Firm
Partner

Nancy Gerrie is a partner at the law firm of McDermott Will & Emery LLP and the partner-in-charge of the Firm’s Chicago office.  She works with corporations, partnerships, limited liability companies and tax-exempt entities on a variety of retirement plan and other employee benefit plan matters, including the design, amendment, administration and termination of pension, profit sharing, 401(k), employee stock ownership and welfare and benefit plans.

312-984-6936
Mary K. Samsa, Corporate Lawyer, Executive Compensation Attorney, McDermott Will Emery, Law firm
Partner

Mary K. Samsa is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.

Mary has more than 15 years of experience and has represented a wide range of organizations including, but not limited to, Fortune 100 public companies, privately held companies, multinational organizations and not-for-profit hospital systems as well as educational institutions.  Mary’s primary practice focuses on executive compensation (for both taxable and tax-exempt entities) where she regularly advises on nonqualified deferred compensation arrangements, executive employment arrangements (including the rebuttable presumption of reasonableness for tax-exempt entities), equity compensation arrangements, reporting and disclosure of compensatory arrangements, severance arrangements and change in control issues, to name just a few.

Mary is involved in the Tax and International Sections of the American Bar Association, Empowering Women Network (EWN), Founder of the Midwest Chapter of the Global Equity Organization, the Employee Benefits Section   of the Illinois State Bar Association, National Association of Stock Plan Professionals, and the Society for Human Resource Management (SHRM).

312-984-2142
Joseph K. Urwitz, Employee Benefits Lawyer, McDermott Will Emery Law Firm
Associate

Joseph K. Urwitz is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Boston office.  He focuses his practice on employee benefits, executive compensation and ERISA matters.  Joe’s experience includes ERISA fiduciary issues, benefits issues faced by non-profit entities, executive compensation and deferred compensation arrangements, equity award plan design, employment and severance arrangements, qualified plan work and employee benefits matters arising in mergers and acquisitions.

Joe received his J.D. from the University of Chicago Law School...

617-535-3854