By Pension and Benefits Editorial Staff
Administrators of a university’s 403(b) plans did not breach their fiduciary duties by retaining a relatively high cost TIAA-CREF fund and retaining TIAA as the recordkeeper, according to U.S. Court of Appeals in Chicago (CA-7). In affirming the trial court, the Seventh Circuit explained that plan participants were afforded multiple alternative lower cost investment options (including low-cost index funds) and were not required to invest in the TIAA-CREF fund.
High-cost, low-performing investment option. Northwestern University maintained two 403(b) plans (a retirement plan and a voluntary plan) both of which allowed participants to select options for the investment of their personal accounts. Included among the investment options was the TIAA-CREF Traditional Annuity, a fixed annuity contract that returns a guaranteed, contractually-specified minimum interest rate. While a valuable feature, the Traditional Annuity also carried restrictions and penalties for withdrawal, including a 2.5% surrender charge for participants who withdraw an investment in a lump-sum earlier than 120 days after the termination of employment. In addition, TIAA-CREF required a plan offering the Traditional Annuity to: (1) offer the CREF Stock Account and (2) use TIAA as the recordkeeper for its products.
The Retirement Plan had two recordkeepers (TIAA-CREF and Fidelity). Recordkeeping fees were not assessed as a flat annual fee, based on the number of participants in each plan. Rather, some of the plans charged retail-rate expense ratios, instead of lower institutional rate expense ratios.
Focusing on the low performing CREF Stock Account, the recordkeeping fee arrangements, the allegedly excessive revenue sharing fees, and the broad range of investment options, plan participants brought suit under ERISA against plan fiduciaries. The complaint alleged breaches of fiduciary duty and mirror image counts for breach of fiduciary duty based on prohibited transactions.
A federal trial court ruled that the university’s retention of the high cost TIAA-CREF fund and recordkeeping services for its plans did not violate ERISA. In dismissing the complaint, the court stressed that plan participants were offered alternative low-cost investment options and were not required to participate in the TIAA-CREF funds.
The participants moved to file an amended complaint, alleging that: Northwestern should have offered investment options at below retail prices; the plan investment committee violated it investment policy statement; and Northwestern should not have allowed TIAA to improperly access and use participant data. The court rejected the motion and further denied the participants’ motion for a jury trial.
The participants appealed. The appeals court affirmed the dismissal of the complaint on all counts and further affirmed the denial of a request for leave to further amend the complaint and for a jury trial.
Prudent retention of CREF Stock Account. The participants charged that the fiduciaries breached their duties under ERISA by allowing TIAA-CREF to “mandate” the inclusion of the low performing high cost CREF Stock Account in the plan and by further allowing TIAA-CREF to require the plan to use TIAA as the recordkeeper for its proprietary funds. The participants, however, did not allege that offering the Traditional Annuity was imprudent.
The appeals court agreed with the trial court that the participants’ allegations did not state an ERISA claim, primarily because no plan participant was required to invest in the CREF Stock Account or any other TIAA-CREF product. Participants, the court explained, could avoid the excess recordkeeping fees and low performance of the Stock Account by electing any of the other multiple options within the multi-fund system.
Following the trial court, the appeals court further reasoned that the plan had valid reasons to enlist TIAA as the recordkeeper for its products and adopt the Stock Account as a plan investment option. The most valid reason, according to the court, was that the availability of the TIAA-CREF Traditional Annuity was conditioned on the offering of the Stock Account and the retention of TIAA as the recordkeeper. It was especially prudent to retain the Stock Account and TIAA as the recordkeeper for its funds, the court noted, to shield participants from the Traditional Annuity’s 2.5% surrender charge.
The appellate court also affirmed the view of the trial court that the participants’ belief, that index funds are a better long-term investment than the Stock Account, did not state a fiduciary breach. According to the appeals court, it would be beyond the court’s role for it to paternalistically “seize ERISA” for the purpose of guaranteeing individual litigants their own preferred investment options.
Revenue sharing and flat fees. The participants next alleged that the fiduciaries breached their duties under ERISA by allowing the plan to pay recordkeeping expenses through revenue sharing and by failing to prevent the fees from being excessive. The participants maintained that Northwestern should have implemented and negotiated total fees based on a flat recordkeeping fee.
The trial court dismissed the claim, noting that the validity of revenue sharing under ERISA has been firmly established (Hecker v. Deere & Co., CA-7). With reference to the flat fee issues, the appeals court further explained that, while recordkeeping fees must be disclosed to participants, ERISA does not require fees to be individually allocated or based of flat-fee or other specific structure. Nor does ERISA require a sole recordkeeper or mandate any specific recordkeeping arrangement at all.
The court forcefully rejected the argument that a flat-fee recordkeeping rate is always prudent, noting that such arrangement could work to the detriment of participants with small account balances. Even if the participants could explain how a hypothetical lower cost recordkeeper would be in their best interest, Northwestern, the court stated, was not required to search for a recordkeeper willing to take $35 per participant (or a lower fee). Accordingly, Northwestern’s recordkeeping arrangement did not violate ERISA.
Retention of retail funds not imprudent. The participants charged that the range of investment options under the plans were too numerous, as well as being too expensive and underperforming. In addition, the participants claimed that the fees charged by some funds were too high because they were retail funds, contained unnecessary layers of fees, or were the result of the fiduciaries’ failure to negotiate lower fees.
The trial court found the charges to be inadequate to constitute a breach of fiduciary duty, as low-cost index funds were available to the participants. The appeals court agreed, further stressing that the fact that the plan offered retail funds did not negate the fact that index funds were available under plan.
The participants, relying on Braden v. Wal-Mart Stores, countered that retail share class funds are an imprudent plan investment option. The appeals court, however, found Braden (which involved a limited number of investment options) inapposite of the Northwestern funds which featured a wider range of investment options and fee structures.
Source: Divane v. Northwestern University (CA-7).
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