Northwestern’s retention of high-cost TIAA-CREF Funds and recordkeeping services did not breach fiduciary duty

A university’s retention of allegedly high cost TIAA-CREF funds and recordkeeping services for its 403(b) plans did not violate ERISA, according to a federal trial court in Illinois. In dismissing the complaint with prejudice, the court stressed that plan participants were afforded alternative lower cost investment options and were not required to participate in the TIAA-CREF funds.

High cost, low performing fund as plan investment option

Northwestern University maintained two 403(b) plans, both of which allowed participants to select options for the investment of their personal accounts. Included among the investment options was the TIAA-CREF Traditional Annuity, a fixed annuity contract that returns a guaranteed, contractually-specified minimum interest rate. While a valuable feature, the Traditional Annuity also carried restrictions and penalties for withdrawal, including a 2.5% surrender charge for participants who withdraw an investment in a lump-sum earlier than 120 days after the termination of employment. In addition, TIAA-CREF required a plan offering the Traditional Annuity to: (1) offer the CREF Stock Account and (2) use TIAA as the recordkeeper for its products.

The Retirement Plan had two recordkeepers (TIAA-CREF and Fidelity). The Voluntary Plan had one recordkeeper (TIAA-CREF). The recordkeepers were paid via expense ratios. The plans featured funds that assessed institutional rate expense ratios. However, the Fidelity funds in the plan charged higher retail expense ratios to cover recordkeeping.

Of particular concern to plan participants, the CREF Stock Account charged an expense ratio of .46% (compared to other funds, such as the TIAA-CREF S&P 500 Index which had an expense ratio of .06%). Of that expense ratio, nearly one-half was paid from the CREF Stock Account to TIAA-CREF for recordkeeping.

Focusing on the low performing CREF Stock Account, the recordkeeping fee arrangements, the allegedly excessive revenue sharing fees, and the broad range of investment options, plan participants brought suit under ERISA against plan fiduciaries. The complaint alleged breaches of fiduciary duty and mirror image counts for breach of fiduciary duty based on prohibited transactions.

CREF Stock Account

Initially, the participants charged that the fiduciaries breached their duties under ERISA by allowing TIAA-CREF to “mandate” the inclusion of the low performing high cost CREF Stock Account in the plan and by further allowing TIAA-CREF to require the plan to use TIAA-CREF as the recordkeeper for its proprietary funds. Objecting to the inclusion of the Stock Account, the participants maintained, generally, index funds were a less expensive and better long-term investment.

In dismissing the participants’ claim, the court first stressed that no plan participant was required to invest in the CREF Stock Account or any other TIAA-CREF product. Thus, participants could avoid the excess recordkeeping fees and low performance of the Stock Account by electing another option.

Next, the court stressed that the mere fact that the participants believe index funds are a better long-term investment than the Stock Account “does not a fiduciary breach make.” Individual plan participants remained free to elect low cost options. Further precluding plan fiduciaries from offering riskier investment options, the court opined, was “paternalistic.”

Revenue sharing

The participants next alleged that the fiduciaries breached their duties under ERISA by allowing the plan to pay recordkeeping expenses through revenue sharing and by failing to prevent the fees from being excessive. The participants maintained that the funds should have used their bargaining power to solicit bids for recordkeeping services that would assess fees on a per capita basis (instead of as an expense ratio) or at least limit the plans to a single recordkeeper.

The court dismissed the claim, noting that the validity of revenue sharing under ERISA has been firmly established in the Seventh Circuit (see Hecker v. Deere & Co., CA-7 (2009), 556 F. 3d 575). In addition, the fiduciaries were not required to find a recordkeeper that would provide services at the rate recommended by the participants of $35 per participant. Returning to its central point, the court again emphasized that the participants had the power to keep expense ratios (and recordkeeping expenses) low by investing in the available alternative funds.

Broad range of investment options

Finally, the participants charged that the range of investment options under the plans was so broad as to impose a “virtually impossible burden” on them of deciding where to invest their money. In addition, the participants claimed that the fees charged by some funds were too high because they were retail funds, contained unnecessary layers of fees, or were the result of the fiduciaries’ failure to negotiate lower fees.

Finding the charges to be inadequate to constitute a breach of fiduciary duty, the court stressed that low-cost index funds were (and remain) available to the participants. The fact that the plan offered retail funds did not, the court stressed, negate the fact that index funds were available under the plan.

Prohibited transactions

The participants also repackaged the fiduciary breach claims as prohibited transaction claims. Essentially, as framed by the court, the participants maintained that the fiduciaries engaged in a prohibited transaction every time the plan paid fees to TIAA-CREF or Fidelity.

Initially, the court explained revenue sharing is not a prohibited transfer of plan assets, as the amount of the expense ratio once collected is actually the property of the fund. Moreover, the court concluded that the fees were reasonable as a matter of law and were under the control of the participants, who were fully empowered to choose the funds in which to invest money in their accounts.

Source: Divane v. Northwestern University (DC IL).
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