Plan Fiduciaries Selection of Funds Observed in Smith v. CommonSpirit Health

By Anthony L. Scialabba IV, Esq., QKA

Do plan fiduciaries have any discretion in the selection of funds?

In Smith v. CommonSpirit Health, No. 21-5964 (6th Cir. Jun. 21, 2022), the investment lineup in the Catholic Health Initiatives 401(k) Plan (“Plan”) consisted of several index funds and several actively managed funds (including, Fidelity Freedom Funds, American Beacon Fund, and AllianzGI Fund). The Plaintiffs, participants of the Plan, claimed that the Plan’s fiduciaries violated their various duties under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), through offering several actively managed funds while there were index funds available on the market offering higher returns and lower fees. The Court of Appeals for the Sixth Circuit upheld the district court’s decision to grant a motion to dismiss in favor of CommonSpirit Health.

It has become increasingly popular for plan participants to contend that a more favorable outcome could be accomplished if plan fiduciaries adhered to their preferences rather than utilizing their own preferences. The Smith case serves as another example of this trend. In this regard, the district court emphasized that simply pointing to funds with a better performance is insufficient evidence to prove a violation under ERISA.

In affirming the judgment of the district court, the Court of Appeals noted that it could be imprudent for a retirement plan to not offer actively managed funds. In this regard, the Court of Appeals stated that “[a]actively managed funds […] provide plan participants with the opportunity to take on more risk and pay higher fees in the hope of beating the market. Other investors […] may prefer lower-cost index funds that offer a market-rate return. In judging the success or failure of these funds, it would seem logical to compare their performance to that of funds with similar risk profiles and fee structures.”

Further, the Court of Appeals stated “[ERISA] […] does not give the federal courts a broad license to second-guess the investment decisions of retirement plans. It instead supplies a cause of action only when retirement plan administrators breach a fiduciary duty by, say, offering imprudent investment options.” The Smith case illustrates that plan fiduciaries have discretion to select the investment lineup of a retirement plan, but funds that should not be included in the investment lineup are those which are imprudent.