The FINRA actions may indicate that plan sponsors should not consider the handful of new cases applying Hughes as potentially limiting the open-endedness of the Hughes standard for bringing an ERISA enforcement action. Instead, sponsors may want to carefully consider their documentation of decision-making and speak with their investment managers about the alternative investment options currently offered.
We’ve had our eyes on changing standards for Plan Sponsors around lawsuits on excessive fees and fund choices since September of 2020.[1] We watched as the Supreme Court heard arguments in the Hughes v. Northwestern case, one that (procedural dancing aside) addressed ERISA standards for fund choices and fees. When the Court ruled in September of 2021, we noted that the case could be a bellwether for increasing the duty of prudence for plan sponsors. New developments may indicate that sponsors may need to pay attention to this case.
“At issue in Hughes is whether a defined-contribution plan charged its participants fees higher than would have been charged in alternative investment products…. While the case involves a defined-contribution plan, it’s possible that the Court’s discussion of the case could be more widely read concerning fees and the duty of prudence.”[2] Since then, legal scholars have joined in, advising sponsors on the impact the case may have. “The Supreme Court’s decision… dashes any hopes for a stricter pleading standard in ERISA excessive fees cases… The proximate consequence of the decision is to further raise the compliance bar.”[3] Others noted that the lack of clarity for plan sponsors was concerning. “…[B]ut it still offers lessons for plan sponsors and fiduciaries on executing their responsibilities under ERISA and a sense of how courts may construe such actions going forward.”[4]
The wisdom from those scholars had been to note that plan sponsors and/or retirement committee members should “practice good fiduciary hygiene,” including maintaining documents, hiring outside advisors to assist them, and documenting all decisions in minutes, pay attention to fees and sales loads, as well as administrative charges, and more specifically “Limit, monitor and curate the plan’s menu of investment options.”[5] Many of our recent newsletters and blog posts have addressed some of this guidance, including how to hire new plan administrators and best practices around document retention in work from home circumstances.
Plan Sponsors that offer plan participants a broad range of investment options may want to consider their choices. First, Hughes may indicate that offering investment options that may be niche or suited for a limited number of employees could be troublesome. “Plan fiduciaries must continuously monitor all plan investments and remove those that are imprudent. Because this rule applies irrespective of the number of investment options, it behooves plans to limit that number. There is little agreement on the ideal number of options, and the proper number of options may vary depending on the particular industry or other surrounding circumstances.”[6] Another legal expert stated this more succinctly. “Maintaining an unusually large number of investment options on a plan menu will not absolve a fiduciary of its failure to continually monitor and remove or replace poor- performing, high-cost or otherwise imprudent investments from the menu.”[7]
Since the Hughes decision, a handful of cases have applied it and show little guidance for sponsors. “The pro-defense decision in CommonSpirit … provides a roadmap for district court dismissals in future cases. As a complete defense victory, CommonSpirit is a welcome development in that it carefully scrutinizes the generic allegations made in virtually every fee-and-expense case.” Yet, it also did not provide a clear standard for what a plaintiff must plead. “It shows that the impact of the Supreme Court’s decision in Hughes is still in flux.”[8] Others have noted that additional decisions may continue increasing lawsuits. “Davis v. Salesforce.com, issued April 8, 2022, [and] …Kong v. Trader Joe’s Company, another unpublished opinion decided April 15, 2022 … send the message to Federal District Courts in the Ninth Circuit[9] that many excessive fee cases will have to be heard on the merits and not dismissed at the pleading stage. This means the flood of cases will continue.”[10]
Two new FINRA actions may indicate that investment options offered by member firms will also raise compliance issues. Those actions could portend similar concerns for plan sponsors regarding investment offerings given the heightened scrutiny after Hughes. Professionals should always consult with their legal and compliance counsel before taking any steps. Both FINRA actions involve alternative mutual funds. The first is a new FINRA notice concerning Regulatory Notice 22-11. Regarding that new notice, FINRA stated “[r]ecently, FINRA took enforcement action against several firms for failing to establish or maintain a reasonably designed supervisory system for recommendations of alternative mutual funds, also sometimes referred to as “alt funds” or “liquid alts” (“Alt Funds”). FINRA is continuing to note such deficiencies in its examinations and communications reviews of such products. This Notice reminds member firms of their sales practice and supervisory obligations for such funds.”[11]
Following closely behind, FINRA recently finalized an enforcement action that included a $9M fine for aftermarket sales. In that case, FINRA’s enforcement arm found National Securities Corporation (National) failed its duties in several ways.[12] Among them included prohibited transactions around after-market sales. Additionally, and specifically relevant here, FINRA found that National made omissions in what it told its investors about an alternative investment fund, specifically, that the alternative investment fund had a partnership interest in sub-entities that filed to file their audited financial statements.[13]
The FINRA actions may indicate that plan sponsors should not consider the handful of new cases applying Hughes as potentially limiting the open-endedness of the Hughes standard for bringing an ERISA enforcement action. Instead, sponsors may want to carefully consider their documentation of decision-making and speak with their investment managers about the alternative investment options currently being offered.
[1] https://www.bcgbenefits.com/blog/for-you-or-against-you
[2] https://www.bcgbenefits.com/blog/supreme-court-watch-hughes-v-northwestern-university
[9] Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, Washington, Guam, and the Northern Mariana Islands.
[11] https://www.finra.org/rules-guidance/notices/22-11
[13]https://www.financial-planning.com/news/finra-orders-national-to-pay-9m-over-ipo-aftermarket-sales and https://www.finra.org/sites/default/files/2022-06/finra-letter-of-acceptance-waiver-and-consent-no-2019061652404.pdf at page 12.
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.
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