Northern Trust Fails to Get Proprietary Fund Suit Dismissed

A federal judge has refused to dismiss a lawsuit against fiduciaries of the Northern Trust Company Thrift-Incentive Plan that alleges that because the defendants failed to remove underperforming funds from the plan or negotiate lower, reasonable fees, participants’ account balances have suffered.

The defendants moved to dismiss the complaint for failure to state a claim, arguing that the plaintiffs’ allegations are insufficient to lead to a finding that they violated their fiduciary duties. Judge Charles Ronald Norgle of the U.S. District Court for the Northern District of Illinois has denied the motion.

Norgle noted in his opinion that the plaintiffs allege that the defendants violated their duty of loyalty by selecting and retaining plan investment options that generated unreasonable management fees for Northern Trust and by paying unreasonable recordkeeping fees. Specifically, the plaintiffs take issue with the defendants’ decision to retain the 11 Northern Trust Focus Funds, a target-date fund suite, despite being able to offer allegedly better-performing TDFs at the same or lesser cost.

According to the court opinion, since 2013, the Focus Funds have been the only target-date retirement investing options in the plan, and they were the default investment option for plan participants. Norgle noted that according to the complaint, even before their selection for the plan in 2013, the Focus Funds had underperformed relative to benchmark indices and comparable TDFs for three years.

The plaintiffs also allege that the defendants failed to conduct an appropriately competitive bidding process to negotiate low prices and imprudently selected and retained the higher-cost shares of investment options, when the “only difference between the shares classes is the amount of fees.”

Norgle pointed out that in their motion to dismiss, the defendants largely relied on a 2020 decision in Divane v. Northwestern University, in which the 7th U.S. Circuit Court of Appeals emphasized that “any participant could avoid . . . excessive recordkeeping fees and underperformance . . . simply by choosing from hundreds of other options.” However, he added, in a unanimous opinion, the Supreme Court vacated and remanded that decision in the case now known as Hughes v. Northwestern University. The high court held that the 7th Circuit’s reliance and “exclusive focus on investor choice” was flawed reasoning.

The defendants also cited wording in the 7th Circuit’s opinion in Divane to emphasize that the Employee Retirement Income Security Act does not “mandate what kind of benefits employers must provide” in an employee benefits plan. Norgle agreed that ERISA does not require that a plan offer TDFs, for example, but he pointed out that the plaintiffs are not arguing that it does. “They assert that a failure of adequate fiduciary process can be reasonably inferred from the totality of their allegations,” he noted. Norgle agreed with the plaintiffs’ assertion.

According to the court opinion, in a supplement to their motion to dismiss, the defendants compared their case to Smith v. CommonSpirit Health, in which the 6th U.S. Circuit Court of Appeals opined that “merely pointing to another investment that has performed better in a five-year snapshot of the lifespan of a fund that is supposed to grow for fifty years does not suffice to plausibly plead an imprudent decision.” Norgle noted that in contrast to the CommonSpirit case, the plaintiffs in the Northern Trust case “plead consistent, chronic underperformance for a decade.” In addition, he said that the CommonSpirit plaintiffs compared actively managed funds to passively managed funds, which the court described as “comparing apples and oranges,” while the plaintiffs in the Northern Trust case compare the Focus Funds to similar TDFs. “The court is not persuaded that this case is comparable to Smith, and the motion is denied,” Norgle wrote in his opinion.