The Supreme Court on mutual-fund fees: fiduciaries have a continuing duty to monitor

Tibble v. Edison Int’l, No. 13-550 (U.S. May 18, 2015).

Defined-benefit pensions guarantee participants a certain periodic payment once they retire. This traditional kind of pension is slowly fading away. It has been replaced by the defined-contribution pension, under which participants—and often their employers—contribute a certain amount of money to a retirement account each year, without guaranteeing what the participant will actually receive once retirement comes.

Defined-contribution pensions, of which the 401(k) is the commonest kind, typically give participants a menu of mutual funds to choose from. This is where mutual-fund fees become important. High mutual-fund fees have a large cumulative effect. Because the fees are taken out of holdings that would otherwise be appreciating, the fees act as a kind of reverse compound interest. 

For example, assume an initial investment of $10,000 that earns 7% per year, which, in turn, is reinvested over 50 years. With no fees, this investment would grow to about $294,570. With a low mutual-fund fee of fourteen basis points, it would grow to $275,904. With a higher—but sadly common—fee of 64 basis points, you’d end up with $218,231. With a yet higher—but not uncommon—fee of 119 basis points, you’d only have $168,398.

Now, there is a line of defense against excessive pension fees. ERISA, the federal law governing employer-provided pensions, requires those who run pensions to do so prudently and in the best interest of the pension participants. Necessarily, then, ERISA requires pension fiduciaries to select mutual funds prudently—which means, among other things, that the mutual-fund fees must not be excessive. 

In this case, 401(k) participants sued under ERISA, claiming certain mutual-fund fees were excessive. The case was filed in 2007. Three of the mutual funds the plaintiffs challenged were initially added to the pension’s mutual-fund menu in 1999. ERISA’s relevant statute of limitations is six years, however, so the defendants argued that the plaintiffs’ claims against those three mutual funds were time-barred.

The Ninth Circuit, speaking through Judge O’Scannlain, agreed with defendants: the claims against the three mutual funds were time-barred because the funds had initially been selected in 1999, more than six years before the plaintiffs filed suit in 2007. The court said that it declined to apply the “continuing violation” doctrine. Continuing to offer an imprudently selected mutual fund does not continue the violation of selecting it. 

The Ninth Circuit committed a category mistake, as the Supreme Court confirms today. This case isn’t about a continuing violation. It’s about pension fiduciaries’ continuing duty to monitor mutual funds to ensure that their fees are not excessive. So long as plaintiffs allege that the breach of that duty happened within the six years preceding the lawsuit, the plaintiffs’ claim is timely. The Ninth Circuit’s judgment is vacated and the case is remanded to determine whether the fiduciaries committed that kind of breach here.

A shameless plug: Two colleagues of mine, Grechen Obrist and Erin Riley, submitted an amicus brief in this case on behalf of eight professors who teach ERISA. Congratulations to them for their fine work.