The Supreme Court puts fiduciaries on notice - up next, target date funds

The growth of ERISA litigation over the past years has plagued corporate America: it’s expensive, time consuming and a drain on corporate resources. Any hopes that the Supreme Court might have squelched this trend in Hughes v. Northwestern University were surely dashed after the Court’s unanimous decision. The defendant plan sponsor was denied its motion to dismiss, and will be forced to prove that its fiduciary decisions were prudent. The case proceeds, and likely, so will many others.

ERISA litigators will parse the decision because questions were left unanswered concerning pleading standards – the technical domain of ERISA litigators. Practically speaking, the Court spoke with a unified voice. Fiduciaries have an ongoing duty to monitor the prudence of investment options in a 401(k) plan and the determination of prudence will require a “context specific” analysis. The reference to “context specific” determinations is legalese for indicating that a trial will be warranted to assess the context of any fiduciary decision. In effect, plan sponsors are going to have a harder time dismissing these lawsuits.

The Court has put fiduciaries on notice. A central tenet of ERISA remains steadfast: plan fiduciaries must exercise prudence.

While the Hughes case involved a challenge to the fees and expenses incurred by qualified plans, it behooves plan fiduciaries to cast a wide net of prudence with respect to the plans they oversee and monitor. Chances are high that the next wave of ERISA litigation will be focused on target date funds: the fastest growing and largest category (approximately $ 3 trillion, as of March, 2021) of investment options held by qualified plans.

TDFs allow participants to select a fund targeted to a date in the future (either tied to retirement or beyond) and authorize the investment manager to manage the portfolio towards the targeted date. Each fund adopts a “glide path” which dictates a gradual shift in the allocation of assets from equities towards fixed-income as the targeted date approaches; effectively reflecting a participant’s reduced investment risk tolerance as retirement approaches.

Ironically, TDF’s are overwhelmingly marketed on the theme of “select it and forget it.” This marketing strategy hones in on plan participants’ general lack of attention to managing their retirement nest egg over the course of a long and likely varied career. Frankly, many participants are simply overwhelmed by the task. They welcome the message, “Don’t worry about it. Leave the details to us. Forget about it.”

If plan participants can indulge in “forgetting” about their retirement accounts, the Hughes decision suggests that plan fiduciaries aren’t afforded this luxury. To the contrary, plan fiduciaries are well advised to exercise laser-like prudence with respect to the selection and monitoring of TDF’s. Although marketed as a simple solution for retirement investing TDFs are anything but simple. Index funds are simple. TDFs can be extraordinarily complicated.

TDFs are structured in a variety of legal “wrappers” (registered investment funds or collective investment trusts) each presenting its own set of complexities. Glide paths vary from fund to fund and must be analyzed with specificity and importantly should reflect the demographics of the plan participants. Certain TDFs rely exclusively upon indexed funds whereas others incorporate actively managed funds. Given the creativity of the mutual fund industry, pressure is building to include alternative asset classes such as real estate, private equity and hedge funds. Most recently, certain funds are being offered with a life-annuity option.

Simple investment options? Hardly. TDF’s essentially have become the veritable “kitchen-sink” of investment vehicles all marketed under the guise of simplicity.

To be clear, however, the complexity of these vehicles DOES NOT undermine their effectiveness as a tool for retirement savings. In fact, in light of the array of investment options offered to plan participants, TDF’s can be a prudent option. The complexity of these vehicles, coupled with the Supreme Court’s decision in Hughes v. Northwestern University, squarely places the burden on plan fiduciaries to exercise ongoing prudence with respect to these intricate investment vehicles.

We are currently experiencing a period of heightened market volatility. Will this volatility continue?  No one can be sure. However, we can be sure that volatility leading to realized losses can foster continued litigation. The Supreme Court has been clear: prudence determinations will be “context specific.” Retirement plan fiduciaries, take note – you may be forced to prove the prudence of your decisions.

Mitch Shames is the founder and managing director of Harrison Fiduciary.