The United States Supreme Court’s first ERISA ruling since 2020 was a unanimous win for employees. In Hughes, et al. v. Northwestern University, the Court held that ERISA gives employees the right to sue their employer for overcharges on investments in the company’s retirement plan. This ruling means employers who offer their employees overpriced retirement plan investment options may violate their duties to their employees under ERISA. It is also a fascinating peek at how ordinary investors can get price-gouged with the assistance of the very fiduciaries who are supposed to be protecting them.
The plaintiffs worked for Northwestern University. Like many Americans, they had the option to invest pre-tax wages into a retirement account maintained by their employer (e.g., a 401(k)). Northwestern chose which funds the employees could invest in, but the employees were free to choose whichever investments they preferred from this “menu” prepared by Northwestern.
The plaintiffs sued Northwestern alleging some of these investment options were needlessly overpriced. In investment parlance, the funds had an unnecessarily high “expense ratio” because Northwestern offered the employees “retail” shares rather than the cheaper “institutional” shares.
This particular allegation is a big deal. Large employers like Northwestern have the leverage to offer their employees funds that are extra cheap. This is because you can get a better deal from a fund if you’re buying on behalf of a thousand investors rather than just yourself. Many mutual funds or ETFs are available to retail investors in the regular “retail” class with the typical expense ratio, but also available in the special “institutional” class with a much cheaper fee.
For a huge employer like Northwestern to say “hey Mr. Mutual Fund, we know we could get our employees the cheap funds because we’re a big bad university with lots of leverage, but go ahead and charge our employees extra” would be egregious. It’s like buying a thousand cars at the sticker price rather than negotiating a volume discount.
The lower courts had dismissed the case. Northwestern’s “menu” of investments included reasonably priced funds in addition to the overpriced funds. On the basis that the employees were free to choose not to be price-gouged on their investments (assuming they could figure out they were being overcharged), the lower courts reasoned that this amounted to “no harm, no foul”.
The Supreme Court disagreed. It criticized the lower courts for failing to consider Northwestern’s duty under ERISA to “monitor all plan investments and remove any imprudent ones.” ERISA requires that employers managing retirement plans act with “care, skill, prudence, and diligence” when handling their employees’ benefits. This basically means employers should treat their workers’ money with the same degree of care the employer would treat their own money.
Obviously, no prudent person would pay the retail price over the volume discount–unless they were paying with somebody else’s money.
The Hughes case is a good reminder that ERISA doesn’t let employers off the hook for price-gouging their workers’ retirement savings merely because the workers might have figured out that they were being price-gouged and chosen the cheaper investments.