The University of Pennsylvania suffered a setback in the first ERISA fee case against a university to be decided by a U.S. Court of Appeals. In Sweda v. the University of Pennsylvania, a divided panel of the Third Circuit ruled 2-1 that the district court had erred in granting the university’s motion to dismiss.  A copy of the opinion is attached here.

The plaintiffs alleged that, among other things, the fiduciaries of the university’s 403(b) plan failed to use prudent and loyal decision making processes regarding investments and administration, overpaid certain fees by up to 600%, and failed to remove underperforming investment offerings. At times the plan offered as many as 118 investment offerings, including mutual funds, fixed and variable annuities, and an insurance company separate account, as well as a self-directed brokerage window. As in several other university fee cases (e.g., Georgetown University and Northwestern University), the district court had found that dismissal was appropriate. But unlike those cases, the appellate court in Sweda reversed on appeal.

The majority opinion in Sweda is a textbook example of giving ERISA plaintiffs the benefit of the doubt at early stages of a case. In reversing the dismissal, the panel cited many of the plaintiff-friendly soundbites from ERISA case law: “pure heart, empty head” and “highest duty known to law,” etc. The majority panel held that “[t]o the extent that the District Court required Sweda to rule out lawful explanations for [the fiduciaries’] conduct, it erred.”

Pleading Standard in ERISA Cases

The real focus of the majority’s decision was on the proper pleading standard in ERISA cases. In most ERISA prudence cases, the plaintiffs are relatively information-poor at the outset of the case, as they are not usually privy to the inner-workings of the process employed by the plan fiduciaries.   Therefore, they face challenges when trying to plead specific and compelling facts in their complaints, before taking any discovery. Thus, in their fee complaints, plaintiffs usually resort to discussing results (e.g., performance against known benchmarks) more than process (e.g., what the fiduciaries did and relied on).

The Sweda case is more about the pleading standard in court, than the standard of conduct a prudent fiduciary must employ under ERISA. Of course, the two are related because ERISA litigation is very costly and disruptive, and most prudent fiduciaries want to conduct themselves in a way that maximizes the chances that they can file a successful motion to dismiss.

Thus, this case doesn’t say whether the Univ. of Pennsylvania fiduciaries actually breached their fiduciary duties –only that discovery must go forward before that decision can be made. Other fiduciaries have been in this position, and ultimately prevailed. For example, NYU and American Century did not win motions to dismiss in their ERISA fee cases, but they did later prevail at trial.

The majority in Sweda distinguished Hecker v. Deere, an early defense victory in the ERISA fee litigation, by noting that in Hecker the defendants could rely on their § 404(c) defense in a motion to dismiss because the plaintiffs’ complaint “thoroughly anticipated” the safe harbor defense. In Sweda, by contrast, the plaintiff did not put the safe harbor defense for self-directed investing activity in play at the pleading stage. Therefore, the Penn fiduciaries must wait until a later stage of the case to raise their 404(c) defense.

The precedential impact of Sweda is somewhat lessened by the fact that it is a 2-1 decision. The dissent makes a good case that the majority departs from earlier precedents.

In my view, the real rub is that standards like “prudent” and “reasonable” – bedrock ERISA principles – are broad and inherently devoid of specific, bright-line rules. The opinion says such bright line rules would “hinder” courts’ evaluation of fiduciaries, but of course, the absence of a bright line rule makes it difficult for fiduciaries to know in advance what conduct will insulate them from liability.

Meaningful Mix of Investments Options

As a factual matter, the University of Pennsylvania’s 403(b) plan featured a large mix of options, including between 78-118 mutual funds, various fixed and variable annuities, and a brokerage window. But the Third Circuit held that a fiduciary cannot win a motion to dismiss merely by arguing that the plan has a meaningful mix of investment options. Such a rule, the Court reasoned, would encourage fiduciaries to stuff plans with hundreds of options, even if they are overpriced or underperforming. So when Sweda alleged that the fiduciaries’ process of selecting and managing options must have been flawed if the plan retained expensive underperformers over better performing, cheaper alternatives, the Court held: “At this stage, her factual allegations must be taken as true, and every reasonable inference from them must be drawn in her favor.”

Bottom Line

The results are mixed in ERISA fee cases, both in university 403(b) plans and business 401(k) plans. Sometimes fiduciaries win motions to dismiss, and sometimes they win at trial. But other times they make multimillion dollar settlement payments to avoid trial.

A similar state of affairs existed in the employer stock cases under ERISA before the Supreme Court brought some semblance of order to the chaos by setting forth a specific pleading standard. Thanks to the Dudenhoeffer decision in 2014, in employer stock cases under ERISA, unlike fee cases, successful motions to dismiss have become the norm (subject to one exception now pending before the Supreme Court, as described here). The defense-side’s path toward arriving at a Dudenhoeffer-like standard that would make successful motions to dismiss the norm in fee cases continues to hit potholes. Maybe one of these “pleading standard” fee cases will get to the Supreme Court someday soon.

Stay tuned to for updates on ERISA fee cases.