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Appellate Court Calls for Another Look at a 403(b) Suit

A university that had won a dismissal of claims in an excessive fee suit will now have to confront some of those charges.
 
Noting that, “at this point, the complaint only needed to give the district court enough to infer from what is alleged that the process was flawed,” the Eighth Circuit Court of Appeals breathed new life into some of the claims brought against fiduciaries of St. Louis-based Washington University’s $3.8 billion 403(b) plan. 
 
Case History
 
The suit (Latasha Davis et al. v. Washington University in St. Louis et al., case number 18-3345)—filed in June 2017 by Latasha Davis and Jennifer Elliott on behalf of the plan’s more than 24,000 participants and beneficiaries—alleged that rather than “leveraging the Plan’s substantial bargaining power to benefit participants and beneficiaries,” the plan fiduciaries:
 
  • Caused the plan to pay unreasonable and excessive fees for investment and administrative services.
  • Selected and retained investment options for the plan that historically and consistently underperformed their benchmarks and charged excessive investment management fees.
  • Paid an asset-based fee for administrative services “that continued to increase with the increase in the value of a participant’s account even though no additional services were being provided.”
  • Selected as the plan’s principal capital preservation fund “the TIAA Traditional Annuity, that prohibited participants from re-directing their investment in the Traditional Annuity into other investment choices during employment except in ten annual installments, effectively denying participants the ability to invest in equity funds and other investments as market conditions or participants’ investment objectives changed.”
However, in October 2018, those claims were dismissed by Judge Ronnie L. White of the U.S. District Court for the Eastern District of Missouri, basically holding that the plaintiffs failed to state a claim. More specifically that the suit failed to allege a breach of fiduciary duties, since the “Consolidated Complaint pleads no facts sufficient to raise a plausible inference that Defendants took any of the actions alleged for the purpose of benefitting themselves or a third-party entity with connections to Wash U, at the expense of the Plan participants, or that they acted under any actual or perceived conflict of interest in administering the Plan.”
 
The Appeal
 
In a May 22 ruling, a panel of judges from the Eighth Circuit summed up the plaintiffs’ complaint as two separate breach-of-fiduciary-duty claims. “The first alleges that Wash U allowed both types of fees to get out of control. The second asserts that it kept several underperforming investments in the plan for too long.” 

In considering the claims, the court acknowledge the standard for such review—“accepting as true the allegations ... in the complaint and drawing all reasonable inferences in favor of the nonmoving party,” in this case the plaintiffs. The also explained that, to survive a motion to dismiss, a complaint must contain “sufficient factual matter” to state a facially plausible claim for relief.  
 
“The first claim clears this pleading hurdle,” the panel wrote in alleging that fees were too high and that WashU should have negotiated a better deal. Here they cited Vanguard’s “mixed” lineup of funds—mixed in that there were different share classes with different expenses—and noted that the plaintiffs alleged that the “failure to replace these shares with their lower-cost counterparts breached Wash U’s fiduciary duty” because higher fees led to lower overall returns. The panel here noted that they allowed similar allegations to proceed in another excessive fee case, Braden v. Wal-Mart Stores, Inc.
 
“Taken together, we concluded that these facts were enough to create an inference of a ‘flawed’ process, even if the complaint itself did not ‘directly address’ how the plan made its selections,” they wrote—and concluded the same in this case. They noted that “two inferences of mismanagement are plausible from Wash U’s failure to offer more institutional shares”; either it did not negotiate aggressively enough with Vanguard, or that it failed to pay close enough attention to available lower-cost alternatives. “Either way, a ‘failure of effort [or] competence’ is enough to state a claim for breach of the duty of prudence.” And, while the defendants here argued at least one other plausible inference for their actions, “on a motion to dismiss, we must draw every reasonable inference in favor of the plaintiffs.”
 
‘Meaningful Benchmark’
 
As for the second claim, here the Eighth Circuit drew an important distinction, noting that “for an investment-by-investment challenge like this one, a complaint cannot simply make a bare allegation that costs are too high, or returns are too low. Rather, it “must provide a sound basis for comparison—a meaningful benchmark.” They turned again to the Braden case, where “a combination of a market index and other shares of the same fund met this requirement,” but found those kind of comparisons lacking here. The court contrasted the comparison of the Vanguard REIT Index Fund with the challenged TIAA Real Estate Fund, explaining that the latter actually holds the real estate assets, and is actively managed.
 
The court acknowledged that “some analysts think it is better for investors to put their money in real estate investment trusts rather than real estate itself. And it might even be better still to do so through an index fund rather than an actively managed portfolio. But it is not imprudent for a fiduciary to provide both investment options,” citing the “different aims, different risks, and different potential rewards that cater to different investors.” They concluded that “comparing apples and oranges is not a way to show that one is better or worse than the other.”
 
They drew similar contrasts with the alternatives set forth by the plaintiffs against the CREF Stock Account, and also found them lacking—“closer, but not close enough,” they wrote.
 
“Moreover,” they wrote, “even if one of these other actively managed funds were an appropriate benchmark, the complaint fails to connect the dots in a way that creates an inference of imprudence.” The court noted that “there is no question, as the complaint alleges, that CREF Stock Account performed more poorly than they did over certain periods of time. But fiduciaries are not required to pick 'the best performing fund.' Nor are they required to pick the lowest-cost fund, particularly when the expense-ratio differences are small—here, between just .06 and .11 percentage points.”
 
As for the TIAA Traditional Annuity, the court first cited the advantages they saw with the investment (“TIAA bears any downside risk by guaranteeing a fixed minimum return”), and then turned to the drawback cited by plaintiffs—the difficulty in withdrawing money from the investment. While the plaintiffs alleged that meant that the option should not have been offered, the court faulted the lack of any meaningful benchmark. “It does not identify even one other investment with a similar risk-and-reward profile that offers better terms than TIAA Traditional Annuity,” they wrote. “A unique investment option like this one shows why a meaningful benchmark is so important. Some investors are perfectly willing to trade liquidity and higher returns for reduced risk and guaranteed income. At a minimum, a prudent fiduciary can offer them that choice.”
 
And so, “we affirm in part, reverse in part, and remand for further proceedings.”
 
What This Means
 
Of the roughly 20 universities that have been sued over the fees and investments in their 403(b) plans since 2016, Washington University had been one of a few to prevail (New York University and Northwestern University the other two, as well as the University of Pennsylvania, at least at the district court level, before having it partially overturned by an appellate court last year). Now, there’s a big difference between losing a case outright and having a court decide that there are questions that require trial to resolve (particularly when the standard is to give your opponent’s arguments the benefit of the doubt). 
 
With this decision, Washington University moves back to the undecided part of the ledger at least until the case actually goes to trial or, as many do,[1] move to settle (as eight of these defendants already have).
 
Where will this one wind up? Time will tell.
 
Footnote
 
[1]Of the roughly 20 universities that have been sued over the fees and investment options in their retirement plans since 2016, there have been eight announced settlements; the largest to date with MIT, for $18.1 million, and prior to that Vanderbilt University, which in April 2019 announced a $14,500,000 cash settlement, as well as a long list of process/procedural changes that were, as with the MIT settlement, also to be monitored over a three-year period, and the most recent was a little more than a month ago with Johns Hopkins, which settled for $14,000,000, also alongside a number of plan design/procedural changes. In March, Brown University settled for $3.5 million, as well as “other, structural relief.” In May 2018, the University of Chicago entered into a class action settlement for a $6.5 million cash payment and changes to the university’s $3 billion plan, while earlier that year Duke University announced a $10.65 million settlement. Princeton University announced a settlement just last week, so those terms are not yet known.