Review of Oral Arguments in Northwestern University ERISA Case

Two attorneys say things so far look good for Northwestern University, meaning the court could raise pleading standards for plaintiffs in excessive fee lawsuits.

This week, the U.S. Supreme Court heard oral arguments in an Employee Retirement Income Security Act (ERISA) excessive fee lawsuit known as Hughes v. Northwestern University.

The question before the high court is whether participants in a defined contribution (DC) ERISA plan stated a plausible claim for relief against plan fiduciaries for breach of the duty of prudence by alleging that the fiduciaries caused the participants to pay investment management and administrative fees higher than those available for other materially identical investment products or services.

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Prior to the Supreme Court agreeing to take up the case, U.S. federal government attorneys asked the Supreme Court to grant a petition for a writ of certiorari requested by participants of two Northwestern University 403(b) retirement plans. A writ of certiorari is a request that the Supreme Court order a lower court to send up the record of the case for review. In their writ, the attorneys said the plaintiffs state at least two plausible claims for breach of ERISA’s duty of prudence. They argued the 7th U.S. Circuit Court of Appeals’ decision in favor of the university is incorrect and conflicts with decisions made by the 3rd and 8th Circuits in similar cases.

Following the oral arguments, PLANSPONSOR engaged in the following Q&A discussion with a pair of expert ERISA attorneys from the law firm Mayer Brown. The attorneys are Nancy Ross, a Chicago-based partner and co-chair of the firm’s ERISA litigation practice, and Jed Glickstein, Chicago-based counsel in the firm’s litigation and dispute resolution practice. The pair had submitted an amicus brief to the Supreme Court in the case, calling on the high court to answer—in favor of Northwestern University and in support of the 7th Circuit ruling—the question of what qualifies as a plausible claim for relief in DC plan excessive investment and recordkeeping fee suits.

In sum, the pair say the questions and argumentations coming from the bench showed a preference for the position of Northwestern University, such that the pair would “rather be in their shoes than the plaintiffs’ shoes.” However, they warned that the Supreme Court could still certainly rule in a surprising or unexpected way, and it has the leeway to either publish a sweeping or a highly limited ruling, so caution and patience are warranted. They expect a ruling to be filed by late Spring 2022, but even that timing is uncertain at this juncture.

PLANSPONSOR: Can you please remind our readers what is at stake in this case and why some parties have suggested it could result in a Supreme Court decision that sets important precedents that could shape the future of retirement plan excessive fee lawsuits?

Ross: I think the best place to start is by making the point that some attorneys, myself included, felt this was an interesting and frankly surprising case for the Supreme Court to agree to review—this one out of the hundreds of excessive fee cases that have been filed across the United States.

Why do I say that? It is because the justices have latched onto a case that, on its face, involves a pretty narrow, niche type of defined contribution plan—a 403(b) plan run in ways that are unique to higher education institutions. The investment options that are the central feature in the case are TIAA annuities of a type that are more or less unique to higher education institutions and which do not commonly appear in the typical corporate 401(k) plan.

So, the question is, how broad is the opinion going to be? Will it really provide useful instruction and guidance to corporate 401(k) plan fiduciaries, as opposed to just these university-type plans? The answer could be yes, certainly, and we could get a ruling that provides guidelines and instructions to all types of DC plans regarding the pleading standards that would-be plaintiffs must meet in future excessive fee cases, but it is also possible that the ruling will be more limited.

Glickstein: I agree, but I also think the Supreme Court, given its limited time and resources, likely would not have taken up this case if it was just going to make a ruling on the pleading standards that only apply to these plans—this specific type of university-operated 403(b) plan. My expectation is that they are likely going to say something about the pleading standards under ERISA as a broader and more general matter.

Now, on the question of why the Supreme Court chose this case, I think one answer is that it is representative of the very cookie-cutter nature of many of these excessive fee lawsuits. The cases that have been filed against Northwestern University and other big-name schools are remarkably similar—they are true cookie-cutter cases. This is meaningful because we have a real circuit split in these cases, with different lower courts reaching different conclusions on what are in essence the exact same pleadings. So, that’s an interesting dynamic playing out here and it opens up a lane for a potentially sweeping decision.

Ross: Good point. We have a very defined group of targeted defendants here—the 20 or so educational institutions fighting ERISA cases that all look so similar. It is probably fair to say that, if there had been a similar number of cookie-cutter lawsuits against a different industry or sector, we very well might have seen a different case elevated to the Supreme Court.

I believe another factor involved is the fact that the 7th U.S. Circuit Court of Appeals is very well respected, and it is a circuit in which rulings have been filed based on the determination that ERISA retirement plan fiduciaries should not be overly paternalistic.

PLANSPONSOR: Regarding the potential outcome of the case, did you get a clear sense of where some or all of the justices seem to be settling on the important question underpinning the lawsuit?

Glickstein: I felt cautiously optimistic, based on the tenor of the questions, that this ruling will come down in favor of the Northwestern University defendants, meaning it will in some way raise and strengthen the pleading standards over which plaintiffs must jump in order to state a plausible claim for relief under ERISA.

It seems to me that the justices understand the broader context here—that is, they appreciate the immense settlement pressures that have come to be in the ERISA litigation landscape. They seem to appreciate the fact that plaintiffs’ attorneys now see getting past the motion to dismiss stage as the real goal of their efforts, thereby wining settlements from defendants who don’t want to engage in potentially costly and lengthy litigation. The justices were all engaged in the question of how they could help to ensure that frivolous lawsuits are not allowed to proceed while also ensuring meritorious claims have an adequate path forward. Of course, that’s a very difficult question to answer in practice.

Ross: That is my sense as well. I will note that I have already had a number of calls from plan sponsors asking whether or not they should make changes to their plan lineup or plan administration in light of how the oral arguments went. Really it is too early to do so, because even a decision that is held in favor of Northwestern University could be structured in so many different potential ways. Many of my colleagues in the defense bar think the 7th Circuit’s decision will be affirmed.

Another interesting point to make is that Northwestern University is a very sympathetic defendant. There is a perception, and I think an accurate one, that U.S. universities are much more democratic and horizontal in their leadership and management structures. This is very different from the hierarchies and leadership styles that you tend to have in corporate America.

Jed and I were happy to hear that one of the justices picked up on a point we made in our amicus brief, where we noted that these cases don’t just target large institutions or companies—they directly target individuals. I think the justices appreciated our point that, for ERISA fiduciaries operating plans in this litigious environment, no good deed goes unpunished.

PLANSPONSOR: Any thoughts about how the current structure of the court, with its substantial conservative majority, might impact the outcome?

Glickstein: You know, in this case, as in other ERISA cases before, the questions and arguments coming from the justices did not seem to break down cleanly on liberal versus conservative lines. My view is that all of the justices were grappling with the exact question we all have posed: How do we get rid of frivolous cases while also allowing meritorious cases to proceed? All of them in their own way were coming to this key, central question. That’s the core of the case, and I think the majority of the justices feel the balance is out of whack today. Again, I would rather be the defendant than the plaintiff, at this point.

Ross: Yes, but I would like to add that I thought the arguments and questions from the justices, in some regards, were misdirected, as there was less direct discussion of the pleading standard itself than I would have liked to hear. There were far more questions being asked that went straight into the merits of this particular case, and there was virtually no discussion of ERISA’s actual statutory intent or language. This makes me wonder whether we aren’t in store for a fairly narrow decision that ultimately does not give fiduciaries much comfort or guidance, even if the 7th Circuit ruling is upheld.

Factors That Determine Whether the Time Is Right for PRT

Pension risk transfer activity is picking up, and plan sponsors have several considerations when implementing transactions.

The stage is set for a record year for pension risk transfer (PRT) transactions. Legal & General Retirement America (LGRA)’s third quarter Pension Risk Transfer Monitor estimated that more than $16 billion in sales occurred in the third quarter. Fueled by strong equity returns and rising interest rates, third quarter transaction volume was nearly twice the combined $8.8 billion recorded during the first two quarters of 2021.

The third quarter was also reported to be the second highest single quarter to date, behind only the fourth quarter of 2012, when General Motors completed a transaction of $26 billion. With Q4 2021 transactions projected to be between $10 billion to $15 billion, total annual market volume could be between $35 billion to $40 billion, potentially surpassing its previous high set in 2012 at $36 billion.

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“We’ve seen secular behavior with de-risking this year eclipsing 2012, which included the GM and Verizon deals, which have been the biggest deals in the PRT market,” says George Palms, president of LGRA in Stamford, Connecticut. “Also unusual this year is there have been 10 transactions of over $1 billion in assets.”

He says the PRT market skews toward high-dollar transactions, but in the years that follow big deals, smaller plan sponsors tend to follow that trend. “That’s what we’re likely to see in coming years,” Palms says.

In the height of the COVID-19 pandemic in spring2020, plan sponsors were seeing a big deterioration in funded status as the markets and interest rates fell, but the market has rallied since then, notes Sean Kurian, head of institutional solutions at Conning in New York City. Plans that have maintained their equity allocations have benefited from the rally and are now more funded than they were even before the crisis of the pandemic.

“So the ability to think about implementing a PRT transaction is more of a reality now,” he says. “If funded status is in the high 90s percentage range, plan sponsors can start to think about implementing PRT.”

Kurian adds that there seems to be a bigger appetite for PRT than there was during the pandemic. There was a slowdown in PRT activity in 2020, but that has reversed this year.

Is Now a Good Time for a PRT Transaction?

Kurian notes that when plan sponsors make an annuity purchase, they pay an insurance company to take responsibility for taking the payments to participants and beneficiaries off plan sponsors’ hands. The premium could include all or some assets in plan, depending on whether the plan sponsor is transferring liabilities for a specific group of employees or all of them.

A main component to consider is the difference between what assets the plan already has versus the premium the insurance company will charge, says Kurian. There are different methodologies to evaluate pension obligations. The basis plan sponsors use for reporting is usually discounted on a corporate bond basis, but insurance companies are usually more conservative, so the value of obligations might not be the same. Kurian says, generally, liabilities calculated for insuring purposes are more than for plan reporting, so a plan might be 100% funded on an accounting basis, but an insurance company might require 105% of liabilities as a premium.

“This is the first disconnect worth understanding. Plan sponsors might need to get to up to 110% funded to insure through a PRT,” he says. “The plan sponsor must determine whether it has enough money to fund for that or whether it will need to set up an investment strategy to get to that amount in the future.”

When considering transferring pension risk to an insurer, plan sponsors must first look at their funded status and consider whether they have the financial capability to move forward, Palms says.

Palms notes that LGRA’s sister company, Legal & General Investment Management America (LGIMA), is seeing funded status oscillate from quarter to quarter. However, most plans are in a good place with funded status, which will be a factor leading to a record year for PRT activity.

Insurance market competitive pressures will help set premiums, but plan sponsors need to determine what assets they have to meet the premium obligation and how to close any gap, Kurian adds.

“Plan sponsors can’t just put all their assets in risky strategies; if bets don’t pay off, they may lose funding,” he says. “So they have to consider the equity market as well as interest rates for bond investing. If they are not fully hedged and interest rates fall, the amount of pension obligations might increase. If they are hedged, they can worry less about the interest rate component and rely more on contributions to fund obligations.”

Kurian says Conning tells clients to think of a journey plan. If the plan is 95% funded on an accounting basis, how does the plan sponsor need to balance risk and return to get to where it needs to be? He suggests plan sponsors set appropriate risk tolerance as they step along the investment glide path.

While the high degree of volatility in interest rates could affect the pricing of annuities for PRTs, Palms says LGRA is seeing insurers not only using public fixed income but private fixed income and alternatives to back PRT deals. He also says many insurers are owned by private equity organizations whose investments are used to insure transactions.

“When plan sponsors see public bond rates going down, that doesn’t mean the other things backing PRT deals are going down,” he says. “In the fourth quarter, we are seeing very competitive prices.”

Considerations for Implementing a PRT Transaction

In addition to getting the plan’s funded level equal to the premium amount, when a plan sponsor has decided to implement a PRT transaction, it should engage a fiduciary adviser to move forward and consider implementing a lump-sum distribution window first to get pension obligation amounts off their books, Kurian suggests.

Palms says Pension Benefit Guaranty Corporation (PBGC) premiums are a motivator for some companies to do what LGRA calls “lower-benefit traunch transactions.”

“Plan sponsors get lower-benefit participants out of the plan to lower PBGC premiums,” he says. This could be in the form of a lump-sum distribution window, for example.

When preparing to implement a PRT transaction, plan sponsors should consider whether their funded status will allow them to move forward, says Palms. They should also understand the impact the transaction will have on their balance sheets—in other words, the effect of PRT costs should be weighed against the reduction in PBGC premiums and reduction in risk.

Plan sponsors also want to have a sense of what annuity pricing looks like in relation to their pension benefit obligation (PBO), Palms adds. “We’re seeing all retiree deals transact at moderate premiums, with some actually less than PBO,” he says.

Plan sponsors should go to the marketplace to see how insurers are priced, work out a timeline with considerations of different regulatory requirements for PRT transactions and continue to manage assets to maintain a funded status equal to the insurance premium.

Then there is the process of getting ready to implement transactions. Palms says plan sponsors need to have their data in good order—they don’t want the pricing to include retirees that might have already died, for example.

PRT Timelines

From a timing perspective, Palms says it is generally better to implement PRT transactions in the first half or first three quarters of the year. The fourth quarter is a time of peak activity, and plan sponsors won’t get as many competitors when PRT activity is high.

For a lump-sum distribution window, the timeline depends on how long it takes a plan sponsor to prepare for the strategy. Palms says this includes calculating lump-sum values based on prescribed interest rates to make sure enough funding is in place, as well as distributing communications to participants and beneficiaries. “It could take from three up to nine months from conceptualizing to delivering,” he says.

For an annuity purchase, the timeline can depend on which group of participants is being insured, with all-retiree transactions the most straightforward, Palms says. “From what we hear from brokers and intermediaries, initial conversations to set expectations start four to five months out from the transaction,” he says. “If there is a lot of data to clean up, preparation could take nine to 12 months.”

When plan sponsors go to market to select an insurer, the transaction timeline could be about three months, Palms says. However, it depends on the size of the transaction. “Plan sponsors should get bids two to three weeks out from when they want to implement the annuity purchase, then select and insurer and sign the contract,” he says.

One thing to keep in mind, according to Kurian, is that, ultimately, as more plans undertake PRT activities, the ability of insurers to take them on will be reduced. “The competitive landscape will decline,” he explains. “The million-dollar question is whether there is a limitless supply of resources out there, when will the supply change and how should plan sponsors react—how long should they wait.”

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