In a lawsuit regarding two 403(b) plans offered by New York University, a federal judge has found that while plaintiffs have adequately pleaded certain claims, a number of the bases upon which they rely as support for other claims could not—even if proven—result in a favorable judgment.

U.S. District Judge Katherine B. Forrest of the U.S. District Court for the Southern District of New York only moved forward certain claims of breaches of fiduciary duty of prudence under the Employee Retirement Income Security Act (ERISA).

The complaint, filed last year, alleges that the university breached its fiduciary duties by selecting and retaining high-cost and poor performing investment options compared to available alternatives. In addition, the complaint states that in contrast to actions by prudent fiduciaries of other similarly sized defined contribution plans, the university used multiple recordkeepers, rather than a single provider.

As of December 31, 2014, the NYU’s Faculty Plan offered 103 total investment options—25 TIAA-CREF investment options and 78 Vanguard options. As of that same date, NYU’s Medical Plan offered 11 TIAA-CREF investment options and 73 Vanguard options, for a total of 84 options. Both plans offered the TIAA Traditional Annuity, which is a fixed annuity contract that returns a contractually specified minimum interest rate. TIAA-CREF requires plans that offer the TIAA Traditional Annuity to also offer the CREF Stock and Money Market accounts and to use TIAA as a recordkeeper for its proprietary products.

Both TIAA-CREF and Vanguard are recordkeepers for the Faculty Plan, and NYU did not consolidate the Medical Plan to a single recordkeeper (TIAA-CREF) until late 2012. Plaintiffs in the case point to three other plans, as well as industry reports, to support their assertions that many other plans have implemented systems with single recordkeepers.

Forrest dismissed all of the plaintiffs’ loyalty claims. Forrest found that the plaintiffs failed to plead sufficient facts to support the loyalty-based claims. “A plaintiff does not adequately plead a claim simply by making a conclusory assertion that a defendant failed to act ‘“for the exclusive purpose of’ providing benefits to participants and defraying reasonable administration expenses; instead, to implicate the concept of ‘loyalty,’ a plaintiff must allege plausible facts supporting an inference that the defendant acted for the purpose of providing benefits to itself or someone else,” she wrote in her opinion. She noted that plaintiffs’ allegations are principally based on NYU purportedly allowing TIAA-CREF and Vanguard to include their proprietary investments in the plans without considering potential conflicts, which favored TIAA-CREF’s and Vanguard’s own interests through the provision of allegedly bundled services. “As pled, these allegations do not include facts suggesting that defendant entered into the transaction for the purpose of (rather than merely having the effect of) benefitting TIAA-CREF,” Forrest wrote in her opinion.

The plaintiffs in the case relied on the 8th U.S. Circuit Court of Appeals decision in Braden v. Wal-Mart Stores, Inc. But, Forrest noted that the Braden plaintiffs—unlike the current plaintiffs—alleged facts indicating that the defendant had failed to disclose material information regarding the funds’ performance and fees, including the fact that funds purportedly made revenue sharing payments (of concealed amounts) to the trustee in exchange for inclusion in the plan.

Duty of Prudence

The plaintiffs allege that NYU plan fiduciaries breached their duty of prudence under ERISA by entering into an arrangement that required the plans to include and retain particular investment options (specifically, the CREF Stock Account and Money Market Account) regardless of their prudence; and by retaining TIAA-CREF as a recordkeeper, regardless of its cost-effectiveness and quality of service.

Plaintiffs refer to both of these as “lock-in” arrangements and assert that they singly or together constitute a breach of ERISA because they prevented NYU from fulfilling its ongoing duty to independently assess the prudence of each investment option in the plans and to remove any investments that became, for whatever reason, imprudent.

Forrest noted that the 2nd U.S. Circuit Court of Appeals requires that, in order to state a claim for breach of the duty of prudence connected to the retention of certain investment options, plaintiffs must raise a plausible inference that “the investments at issue were so plainly risky at the relevant times that an adequate investigation would have revealed their imprudence, or that a superior alternative investment was readily apparent such that an adequate investigation would have uncovered that alternative”; that is, that “a prudent fiduciary in like circumstances would have acted differently.” Defendant’s contractual agreement to include certain investment options does not, by itself, demonstrate imprudence—plaintiffs have not demonstrated that this arrangement resulted in the plans’ inclusion of “plainly risky” options, she said. “In other words, plaintiffs have not plausibly alleged that defendant engaged in a transaction that in fact (versus in theory) contractually precluded the Plans’ fiduciaries from fulfilling their broad duties of prudence to monitor and review investments under this standard,” she wrote.

In addition, Forrest found that merely having a contractual arrangement for recordkeeping services does not, as a matter of law, constitute a breach of the duty of prudence—to support a claim on this basis, plaintiff must make a plausible factual allegation that the arrangement is otherwise infirm. The plaintiffs attempt to support their claim by adding a series of assertions that alternative recordkeepers—with whom NYU was allegedly precluded from contracting—could have provided “superior services at a lower cost.” But, Forrest said if this fact alone supported imprudence, the mere entry into the market of a lower-cost and superior provider would lead to a breach of fiduciary duty. “This is not the law,” she wrote.

However, Forrest found support for other allegations for breach of duty of prudence. NYU argued, based on the 2nd Circuit’s decision in Young v. Gen. Motors Inv. Mgmt. Corp., that whether fees are excessive or not is relative to the quality of services provided. In other words, under Young, in certain circumstances, paying more for superior services might be more prudent than paying less for inferior ones. But, Forrest noted that the NYU plaintiffs allege more—they allege several forms of procedural deficiencies with regard to recordkeeping which both individually and combined are sufficient to separate the case from Young. For example, they claim that defendant failed to seek bids from other recordkeepers and to ensure that participants were not being overcharged for services. “While ERISA does not dictate ‘any particular course of action,’ it does require a ‘fiduciary . . . to exercise care prudently and with diligence,’” she wrote. Forrest ruled that the series of allegations on the “failure to get bids” claim is sufficient to support allegations for breach of duty of prudence.

In addition, Forrest said case law also supports claims for imprudence based on specific allegations of the level of fees and why such fees were/are unreasonable. The plaintiffs allege that “[e]xperts in the recordkeeping industry” determined that the “market rate” for administrative fees for plans like those at issue in this case was $35 per participant, and that the plans’ recordkeeping fees far exceeded that amount. The judge found the “excessive recordkeeping fees” claim is sufficient to support claims for imprudence.

Additionally, Forrest said that while revenue sharing is a “common industry practice,” a fiduciary’s failure to ensure that “recordkeepers charged appropriate fees and did not receive overpayments for their services” may be a violation of ERISA. Accordingly, she found plaintiffs’ “revenue-sharing” allegations are sufficient to support their claims.

Notably, Forrest found that having a single recordkeeper is not required as a matter of law, and based on the facts alleged (for instance, that NYU consolidated recordkeeping for one plan but not the other), the allegation that a prudent fiduciary would have chosen fewer recordkeepers and thus reduced costs for plan participants—the “recordkeeping consolidation” allegation—is sufficient at this stage to support plaintiffs’ claims.

“More broadly, when plaintiffs’ prudence allegations in Count III are viewed as a whole, they plausibly support an assertion that the Plan fiduciaries failed to diligently investigate and monitor recordkeeping costs. Such a holistic approach was applied in Tussey v. ABB, Inc., in which the Eighth Circuit determined that a host of allegations, viewed together, amounted to a breach of the duty of prudence,” Forrest wrote.

Selecting and Monitoring Investments

Plaintiffs’ allegations that NYU failed to prudently select and evaluate plan investment options may stand as long as any portion of plaintiff’s allegations suffice to support the proposition that defendant failed to “employ[] the appropriate methods” in making investment decisions, Forrest asserted.

First, plaintiffs plausibly allege that NYU imprudently maintained investments in the CREF Stock Account and TIAA Real Estate Account. Plaintiffs allege that these particular funds underperformed comparable lower-cost alternatives over the preceding one-, five-, and ten-year periods, and that other industry players had recommended removing at least the CREF Stock Account from client plans. Plaintiffs’ “specific comparisons” to “allegedly similar but more cost effective fund[s]” support a claim of imprudence. “While it is true that a decline in price indicates only that, in hindsight, the investment may have been a poor one (rather than a continuing breach of a fiduciary duty), here there is the additional allegation of a ten-year record of consistent underperformance. Such an allegation, combined with an allegation of inaction, plausibly supports a claim,” Forrest wrote.

She also found plaintiffs’ allegations that NYU breached its fiduciary duties by offering actively managed funds that did not have a “realistic expectation of higher returns” also plausibly support a prudence claim at this stage in the court proceedings.

However, Forrest said the plaintiffs’ identification of funds for which NYU included a higher-cost share class in the plans instead of an identified available lower-cost share class of the “exact same mutual fund option” does not constitute evidence of imprudence. As the court noted in Loomis v. Exelon Corp., prudent fiduciaries may very well choose to offer retail class shares over institutional class shares because retail class shares necessarily offer higher liquidity than institutional investment vehicles. Participants can move their money from one vehicle to another whenever they wish, without paying a fee. In retirement, they can withdraw money daily. Institutional trusts and pools do not offer that choice. It is not clear that participants would gain from lower expense ratios at the cost of lower liquidity. “Thus, as the inclusion of retail options does not, on its own, suggest imprudence, the low fees associated with these particular retail options indicates that their inclusion in the range of options does not demonstrate an unwise choice.”

Likewise, Forrest found that plaintiffs’ allegations regarding unnecessary and excessive fee layers are insufficient (as pled) to support a prudence claim. In a series of paragraphs, plaintiffs assert that certain administrative and investment advisory fees are unreasonable in terms of the actual services provided to plan participants, and that the distribution fees and mortality and expense risk charges provide no benefit to participants. However, plaintiffs have not alleged that the inclusion of investment products with these fees led to higher fees overall. Without such an allegation, it is not clear that plaintiffs have plausibly alleged that the overall fee structure was unreasonable.

Finally, Forrest agreed with NYU that plaintiffs’ allegations regarding NYU’s purportedly “dizzying array” of investments in the same “investment style” do not support a prudence claim. Plaintiffs allege that NYU breached its fiduciary duty by failing to whittle down the investment options available to class participants, thereby diluting the plans’ bargaining power and confusing participants, but they do not allege that any participants were, in fact, confused or overwhelmed. In effect, then, plaintiffs’ theory boils down to a claim that having too many investments limited the plans’ “ability to qualify for lower cost share classes of certain investments.” But, Forrest said, while ERISA requires fiduciaries to “monitor and remove imprudent investments,” nothing in ERISA requires fiduciaries to limit plan participants’ investment options in order to increase the plan’s ability to offer a particular type of investment (such as funds offering institutional share classes).

Prohibited Transaction Claims

Forrest ruled that plaintiffs’ prohibited transactions claims fail as a matter of law. As an initial matter, any revenue sharing payments or other fee payments drawn from mutual funds’ assets and paid to Vanguard and TIAA-CREF are not “transactions” involving plan assets. Payments drawn from plan assets for administrative purposes do not become “transactions” involving plan assets when they are transferred to the service provider.

Plaintiffs have similarly failed to state a claim under ERISA § 406(a)(1)(A). Though this provision does not necessarily require the transfer of “plan assets” between the plan and a party in interest, it does require plaintiffs to have plausibly alleged that NYU caused the “sale or exchange, or leasing, of any property between the plan and a party in interest.” as commonly and reasonably understood, the statute is not equating “property” with compensation payments simply paid by plan investments to plan recordkeepers for workaday recordkeeping transactions. Indeed, payment of a fee for services rendered is a core aspect of a pension plan under ERISA—and most retirement savings plans. Depending on the circumstances, overpayment of fees may be an issue under other provisions of ERISA, but a payment for services rendered cannot be a “prohibited transaction.”

Finally, ERISA § 406(a)(1)(C) does not provide a viable hook for plaintiffs’ claim of prohibited transactions. Forrest said it is circular to suggest that an entity which becomes a party in interest by providing services to the plans has engaged in a prohibited transaction simply because the plans have paid for those services. plaintiffs have offered only conclusory allegations suggesting self-dealing or disloyal conduct. Accordingly, allegations that the Plans violated § 406(a) by paying Vanguard and TIAA-CREF for recordkeeping services—even allegations that the plans paid too much for those services—do not, without more, state a claim.

Finally, Forrest addressed the allegations that NYU failed to monitor its delegates. “With regard to this claim, plaintiff claims only that defendant is in exclusive possession of information as to whether NYU delegated its fiduciary duties and responsibilities. This on its own does not sufficiently support a claim that the defendant failed to monitor the Plans,” she wrote.