Brief in University of Pennsylvania 403(b) Lawsuit Points Out Differences From 401(k)s

An amici curiae brief filed by the American Council on Education and other higher education associations details the history of higher education 403(b) plans.

The American Council on Education and other higher education associations have filed a brief of amici curiae in the 3rd U.S. Circuit Court of Appeals in support of the University of Pennsylvania for a case concerning the management of its 403(b) plan.

The Council points out that the retirement system for higher education has always looked different than the system for industrial, corporate America. It says that, whereas American industry preferred a pension system that incentivized a lifelong relationship between employers and their workers, colleges and universities implemented a system of annuities that achieved a similar guarantee of lifelong income without hampering the movement of personnel that it says is essential to academic life.

In its brief, the Council notes that more than a dozen lawsuits have been filed against private universities with generous retirement benefits—arguing essentially that university 403(b) plans should look just like corporate 401(k) plans and that the universities have violated the Employee Retirement Income Security Act (ERISA) by failing to offer plans following corporate norms. “ERISA does not require a one-size-fits-all approach to retirement. Rather, fiduciaries are obligated to act with the diligence ‘under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims,’” the brief says.

The Council argues that university 403(b) plans do not present the same “circumstances” as corporate 401(k) plans—and they are not “enterprise[s] of a like character and with like aims.” It says, “Plaintiffs cannot paper over the historical and present-day differences between corporate and educational retirement plans to require that they all look alike. If the flimsy allegations of plaintiffs’ complaint—which rest on apples-to-oranges comparisons between 403(b) and 401(k) plans—are sufficient to state a claim for breach of fiduciary duty under ERISA, then there is no meaningful way for fiduciaries to protect themselves from being sued.  Such an outcome would discourage thoughtful individuals from serving as fiduciaries in the first instance, which would undermine the good governance that these plaintiffs claim to be pursuing.”

The brief details the history of higher education 403(b) plans, saying they owe their start to Andrew Carnegie, who became concerned about the poverty that seemed the common fate of retired teachers when he was made a trustee of Cornell University in 1890. In 1905, he gave $10 million to fund the pensions of teachers at thirty universities.

Despite Carnegie’s initial contribution (and subsequent contributions made directly by Carnegie and by the Carnegie Corporation of New York), it was clear almost immediately that it would not be enough, the Council says. In 1918, the Carnegie Foundation founded the Teachers Insurance and Annuity Association, which is now known as TIAA. From its founding, TIAA has assured retirement security for university faculty by providing annuities.

According to the Council, studies show that retirees with savings that generate a periodic annuity are better able to enjoy retirement, because they do not face the anxiety entailed in managing a dwindling pool of assets. It also cites a 2016 report by the U.S. Government Accountability Office recommending that the Secretary of Labor “help encourage plan sponsors to offer lifetime income options” as part of their retirement plans.

According to the brief, collegiate annuities were designed to facilitate the “free interchange of professors” between institutions—and, as a result, the free movement of ideas. So they were designed to allocate individual rights to participants (not to institutions) and to be readily portable. The Council notes that the launch of the collegiate retirement system of annuities pre-dates, by decades, enactment of Section 403(b) of the Internal Revenue Code. In 1942, Congress bestowed tax-preferred status to contributions by charitable organizations toward their employees’ annuities. And in 1958, Congress enacted Section 403(b), which defined the amounts that could be contributed to so-called “tax-sheltered annuities.”

In 1974, Congress permitted 403(b) plans to offer investments other than annuities, thus allowing 403(b) plans to include custodial accounts containing mutual funds in addition to annuities. Despite this statutory change, the prominence of annuities remains a defining characteristic of 403(b) plans, the Council notes.

This is for a variety of reasons:

  • University employees are familiar with and trusting of annuities as a key to maintaining a stable retirement income, having viewed the successful retirements of their predecessors;
  • Because the contracting parties to an annuity are frequently the insurer and the plan participant, the plan sponsor lacks the authority to take money out of annuities;
  • Annuity providers typically penalize or restrict withdrawals in exchange for offering the most favorable rates, so plan participants are naturally reluctant to transition away from annuities; and
  • The Internal Revenue Code imposes limitations on the investment options in a 403(b) plan—where only annuities and registered mutual funds are permitted—that do not apply in the 401(k) context.

The Council notes that given their initial role as supplements to pensions, early 401(k) plans were not built around annuities. Although the market for for-profit retirement plans has changed dramatically in the past forty years, 401(k) plans have largely retained their original structures.

“The data reflect the differences between 403(b) and 401(k) plans. Whereas 68% of 403(b) retirement plans offer annuities among the plan investment options—and likely an even greater percentage of university 403(b) plans—only 6% of 401(k) plans do. And because annuities bring administrative and contractual complexities, the differences between 403(b) and 401(k) plans are pervasive” for the arguments in the lawsuit, the Council says.

It argues that the plaintiffs’ expressed intent—to penalize universities for not offering 401(k) plans that typify the for-profit market—is sharply at odds with the obligations that underlie ERISA. ERISA’s fiduciary standards require a fiduciary to act as would a reasonable individual in similar circumstances who is familiar with such matters. In the university context, that standard requires 403(b) fiduciaries to measure themselves by the conduct of fiduciaries to similar plans, not to measure themselves by the conduct of the cohort of 401(k) fiduciaries overseeing different types of plans.

The Council argues that comparing the investment options offered in the average defined contribution (DC) plan to the investment options offered in the University of Pennsylvania’s 403(b) plan, and disparaging the use of two recordkeepers—does not reflect the market in which the University of Pennsylvania’s plan actually operates.

“Plaintiffs make no secret that they want to change the 403(b) market, to make it look more like the 401(k) market. But a claim for breach of fiduciary duty is not the right mechanism for their quest,” the brief states.

The Council also asks the court to be mindful of the effect of its decision on plan fiduciaries. It notes that faculty members volunteering to serve on university committees to represent the interests of their cohort are being subjected to claims for hundreds of millions of dollars. Though they may be covered by insurance or indemnity agreements, the burdens of litigation on defendants are real and could affect the willingness of qualified individuals to serve as fiduciaries. “A system of freewheeling litigation—in which even standard industry practices can be challenged through years of onerous litigation—is anathema to the recruitment of a sound fiduciary committee,” it says.

The Council also argues that, “As in other cases, ERISA class actions should be permitted to proceed to discovery only if a violation of the law is plausible, rather than possible. Any other standard is a recipe for undermining the interests of the individuals who claim to be asking the courts for assistance.”

Chamber of Commerce and ABC challenge hindsight

The Chamber of Commerce and the American Benefits Council (ABC) also filed a brief in the 3rd Circuit in the case. It argues that, “In recent years…, plaintiffs’ attorneys have filed dozens of ERISA class actions containing no allegations about the fiduciaries’ decision-making process and instead asking courts to infer an inadequate process from allegations that a plan underperformed for some (arbitrarily chosen) period of time. Pleading a plausible ERISA claim requires more.”

The brief applauds the district court for examining each of the factual allegations the plaintiffs’ contend were imprudent and finding that the allegations did not plausibly allege imprudence. It also notes that the court recognized that the inferences the plaintiffs asked it to draw were undermined by other allegations in the plaintiffs’ own complaint or documents incorporated by reference in the complaint—for example, the plaintiffs’ allegation that plan fiduciaries failed to adequately consider supposedly lower-fee institutional share class funds overlooked that “nearly half” of the funds “are already these lower-fee funds.” 

The district court also recognized that the practices about which the plaintiffs complained (such as the fee structure for administrative services, and bundling services and investment offerings among one or two providers) were “just as much in line with a wide swath of rational and competitive business strategy in the market as they are with a fiduciary breach.”  

The Chamber and the ABC argue that the plaintiffs’ arguments are made with the benefit of hindsight. But, they say, allowing plaintiffs to plead claims against an ERISA fiduciary merely by alleging poor performance or by second-guessing a fiduciary’s choice “would impose high [fiduciary] costs upon persons who regularly deal with and offer advice to ERISA plans, and hence upon ERISA plans themselves.”  

The brief asks the appellate court to “reject Plaintiffs’ invitation to dilute the pleading standard in ERISA cases and should thus affirm the district court’s judgment.”

TIAA defends its products

In its brief filed in the 3rd Circuit, TIAA notes that this case is one of sixteen lawsuits in which plaintiffs have alleged that universities violated their fiduciary duty under ERISA Section 404(a) by including in their retirement plans certain TIAA investment options, which allegedly performed poorly and charged excessive fees, and using TIAA’s recordkeeping services for TIAA investments. 

“Those claims reflect a misguided characterization of TIAA’s products and services, and are predicated on the flawed assumption that cost is the single determinant of an investment’s prudence,” TIAA states.

TIAA argues that the plaintiffs’ “bundling” allegation overlooks that pairing of CREF Stock, a variable annuity, with TIAA Traditional, a fixed annuity, is designed to provide participants with a choice to invest in those options and that no participant is required to invest in either or both. It says the pairing arrangement is part of TIAA’s integrated approach to secure lifetime income, which substantially reduces the likelihood that retirees will outlive their savings. “The pairing enables that by providing participants with ready access to annuities with complementary characteristics. Moreover, CREF Stock has a record of strong performance, and its fees are reasonable. Plaintiffs’ attack threatens the foundation of two of the most popular TIAA products that have provided retirees with lifetime income for decades,” TIAA says.

The brief also says the plaintiffs’ argument that recordkeeping is a “commodity service” is incorrect, and reflects their one-sided view that cost is the only proper metric in evaluating investment services. TIAA says it offers participants high-quality recordkeeping services, including individualized financial education and fund-level allocation advice at no additional cost. “Those services help participants better understand TIAA’s annuity offerings and investment strategy, and thus better plan for their retirement. TIAA’s recordkeeping fees are reasonable, particularly in light of the value that participants derive from those services,” the brief states.

In addition, TIAA argues that the plaintiffs’ claims regarding the Real Estate Account (REA) are misguided because they compare REA to an inappropriate benchmark, and the expense ratios of the eight mutual funds of TIAA’s are also well within the range that the 3rd Circuit and other courts have deemed reasonable. “In any event ERISA does not require fiduciaries to offer the lowest-cost options possible, irrespective of other considerations.”