Early this year, the Hughes vs. Northwestern University Supreme Court case disputed Northwestern’s defined-contribution system, emphasizing the importance of 401(K) plans providing suitable investment options for its participants and fulfilling fiduciary responsibility. Northwestern’s plan included 242 investment options. Some of these funds were not good options, and therefore, the plaintiff sued on these grounds. The defendant responded that participants did not need to own the poor investment options and could instead choose better funds.
In retail investing, brokers are generally free to operate under their jurisdiction, aside from legal requirements prohibiting the sale of only unsuitable investments. Retail investors also have the jurisdiction to make their investment choices, which includes taking their money out if they see investment options as unsuitable.
However, this lawsuit involved an employer-sponsored retirement plan, which is unlike brokerage firms. Although the Seventh Circuit of the U.S. Court of Appeals ruled that Northwestern University did not violate its fiduciary duty by offering a mixed bag of investments, companies that sponsor 401(K) plans must still comply with other regulations under the Employment Retirement Income Security Act of 1974. These regulations hold plan sponsors to a higher standard than brokerage firms, requiring plan sponsors to act in the sole interest of their beneficiaries.
Ultimately, it was ruled in a unanimous opinion (despite Justice Barrett, who recused herself) that the Seventh Circuit was mistaken in relying on the participants’ ultimate choice in their investment decisions to excuse ill-considered decisions by respondents. Furthermore, fiduciaries are breaching their duty if they do not remove imprudent investment options from their plan. It was consensus that the Seventh Circuit’s focus on investor choice neglected the sponsor’s duty of prudence.
The Supreme Court, however, did not provide alternative guidance. If a plan has one poor option among the rest, is it considered imprudent? In sum, the context of the rules for safety given to fiduciaries has not been specifically determined in this case.
A lack of direct guidelines and explicit standards for regulation by federal authorities makes it difficult for plan sponsors to do the right thing in providing efficient retirement plans for their employees. Regulation through emerging lawsuits is not the most efficient way to provide direction but will continue as the norm until straightforward standards for employer-sponsored retirement plans are codified.
Until then, plan sponsors must prioritize the importance of fiduciary responsibilities. Transparency and consistent reviews of defined contribution investment lineups are key to ensuring plan sponsors are working in their participant’s best interests. These reviews should include regulatory and fiduciary issues, cultural and employee demographics, along with research and industry trends. Plan sponsors can also consider partnering with a fiduciary advisor for advice on a plan’s lineup, whether it is a co-fiduciary relationship or outsourcing all evaluation and decision-making responsibility to the advisor. In this, plan sponsors can ensure they are intentional with the number of investment choices, reducing the opportunity of overly concentrated portfolios or overlapping in similar assets and securities.
Streamlining choices, consistently reviewing lineups, and eliminating overlap will allow plan sponsors to significantly reduce unsuitable options within their lineups, prioritizing their participants’ benefit and fulfilling their fiduciary standards. As one of Utah’s most popular 401(K) companies, TrueNorth Retire’s goal is to ensure you achieve yours. We offer fee-only holistic financial and retirement planning services that will work with your circumstance to find the most optimal way to accomplish financial security.
Contact one of the top 401(K) advisors in Utah to learn more or schedule a no-cost consultation by calling (801) 316-1875.