Spotlight on the Supreme Court

On Monday, December 6, 2021, the U.S. Supreme Court will hear oral argument in an important case titled Hughes v. Northwestern University (S. Ct. Docket No. 19-1401). The case provides the Court with an opportunity to improve the lives of countless retirement savers by giving them a chance to hold those who administer retirement plans accountable when they breach their fiduciary duties. It’s all the more important as the retirement crisis in this country intensifies and Americans increasingly rely on prudent administration of their 401(k)’s to close the gap between their savings and what they’ll need to live in retirement.

Hughes and the other plaintiffs allege that they suffered losses because their retirement plan administrators failed to cull investment options with bloated fees and poor performance. That was a breach of the administrator’s duty to monitor plan investments and remove the imprudent ones. However, the federal district court and the Seventh Circuit tossed them out of court, holding in part that the plan fiduciaries were absolved because the plan included at least some prudent investment options among the bewildering array of 200 available choices.

Better Markets profiled the case in its recent Supreme Court report. We also joined in an amicus brief led by AARP in which we urged the Supreme Court to reverse the lower court’s decision, restore the plaintiffs’ claims, and give them a chance to prove their case. As we said in the brief, the decision below misinterprets the duty to monitor investments and applies an unfair and overly stringent pleading standard. A retirement plan administrator does not satisfy the high fiduciary duty by simply offering up a huge variety of options and leaving it to the participants (who will almost always lack the financial sophistication and expertise of the financial professionals who administer ERISA plans) to fend for themselves as they try to avoid the expensive and poorly performing choices. The Seventh Circuit’s reasoning essentially introduces an element of caveat emptor to ERISA plans that Congress specifically intended to eliminate.

The data shows that such overpriced investments, even with seemingly modest fee rates, can dramatically reduce retirement savings over the long term. The evidence also shows that private lawsuits, expressly authorized under ERISA, have proven to be an effective means of curbing such fiduciary breaches and bringing fees down across the industry.

If the Supreme Court affirms dismissal of the plaintiffs’ complaint in this case, those victims of fiduciary misconduct will suffer irreparable harm. More broadly, other retirement plan participants sustaining similar forms of injury in the future will face higher hurdles to obtain relief. The upshot would be doubly damaging:  It would relax the incentives that are necessary to ensure compliance with the high fiduciary standard embodied in ERISA, and it would thwart Congress’s goal of affording victims of abuse under ERISA ready access to the federal courts to seek relief.

We’ll be listening with interest as the Court hears argument on December 6, and we’ll be watching for the Court’s decision on merits down the road.

Other Cases of Interest in the Federal Courts

We continue to track a number of cases pending in the federal courts that involve key issues in the areas of financial regulation, administrative law, and standing, all of which will affect the financial lives of anyone with a wallet, bank account, credit card, mortgage, car loan, or student loan.

A lawsuit (The Doris Behr Irrevocable Trust v. Johnson & Johnson) attempting to force public company shareholders into mandatory arbitration, a biased, secretive, and anti-consumer forum.

• Why it matters?Mandatory or forced arbitration takes away the rights of consumers and investors to seek relief in open court before unbiased judges when they are ripped off by banks and corporations. These typically fine-print clauses force defrauded investors and other victims into secret, unfair, and biased arbitrations. Those proceedings are generally run by an industry self-regulatory organization which, no surprise, consistently favors the industry. Investors and consumers rarely obtain meaningful recovery.
• In this case, a federal court will decide if a public company can be forced to impose mandatory arbitration not just on its customers but also on any shareholders with claims against the company for fraud, mismanagement, or other breaches of duty. If the court gets this wrong and allows this dramatic—and dramatically bad—legal development, then the toxic effects of mandatory arbitration will be further broadened, incentivizing lawbreaking by limiting the legal rights of investors to stop it.
• Given that shareholders are the owners of public companies, and they rely on legal actions as one important way to protect their investments and police management, such a decision could have a significant and adverse impact on capital formation and allocation.
• In a positive development in June 30, the court granted defendant Johnson & Johnson’s motion to dismiss. However, it also granted the plaintiff “one final opportunity to file an amended complaint.” The third amended complaint and Johnson & Johnson’s motion to dismiss it are now before the court, which is expected to decide the matter soon.

A lawsuit (National Association for Latino Community Builders v. CFPB) challenging the CFPB’s harmful rule that rescinded the underwriting requirements for payday lenders, a commonsense provision that required those lenders to determine whether borrowers could afford to repay their short-term loans. That’s right: the rule merely required lenders to determine at the time a loan was issued that the borrower could afford to repay it. It’s a basic, commonsense, and relatively simple process—unless, of course, the predatory financial firm doesn’t want to make loans that are repaid but instead seeks the legal right to trap desperate borrowers in a never-ending cycle of debt with exorbitant fees and sky-high interest rates, what we call a “debtor’s prison without walls.” (See Dennis’s op-ed on this issue for The Hill).

• Why it matters?Under the Obama administration, after years of substantive and robust analysis, the CFPB crafted important protections for consumers who need short-term or “payday” loans. Among them was the requirement that payday lenders determine a borrower’s ability to repay a loan before extending credit. The purpose was to prevent those lenders from deliberately trapping desperate borrowers in endless cycles of unaffordable debt that saddle them with huge interest payments and fees.
• Under the Trump administration, the CFPB nullified those underwriting requirements in a deplorable example of baseless rulemaking plainly designed to accommodate the payday lending industry and in response to relentless industry lobbying (and, reportedly, campaign contributions). Now a court will have the opportunity to nullify the Trump rule and restore the underwriting requirements for the benefit of millions of vulnerable borrowers living on the economic edge.
• Earlier this year, the CFPB moved to dismiss the action based on the claim that the plaintiff, a nonprofit membership association of organizations that serve Latino communities, has no “standing.” The agency is arguing that neither the plaintiff nor its member organizations face the type of concrete injury from the rule that would entitle them to bring their case in federal court. The doctrine of standing once again figures prominently in an important case, potentially preventing the plaintiff’s claims from being heard on the merits. Briefing is complete on the motion to dismiss, and we await the court’s decision on the threshold standing issue.

An industry challenge (Citadel Securities LLC v. SEC) to the SEC’s approval of a new type of trading order that helps protect investors from predatory trading activity by sophisticated high frequency trading firms.

• The outcome of this case will have a huge impact on the ability of everyday investors to protect their money from being siphoned away by high frequency trading (HFT) firms like Citadel. That’s why we weighed in to help defend a new order type developed by IEX, an investor-friendly exchange that has earned our praise since it was founded in 2016. The SEC rightly approved that order type late last year, but Citadel is fighting to protect its ability to generate near-certain profits—to print money in effect—through privileged data access and sophisticated trading technology. It has asked the D.C. Circuit to invalidate the SEC’s approval of the IEX order.
• HFTs spend enormous sums of money to get a sneak peek at trading activity on the exchanges before the public sees it, and they buy high-speed computer programs capable of acting on that information in microseconds. As retail investors and millions of Americans planning for retirement place their orders, HFT firms can snap them up and skim off near-certain profits because they know where the market is about to head—up or down.
• It’s not just fundamentally unfair, it’s also a plague on our markets. This sort of HFT activity not only bleeds investors, it but also drives away large institutional investors. They are the life blood of our markets, yet because of HFTs’ predatory behavior, they are increasingly turning to alternative trading venues that are safer for them but much less transparent and less regulated than the exchanges. That means less liquidity, transparency, and price discovery on the exchanges, which in turn hurts the market in the long term.
• In our brief, we explained the advantages HFTs enjoy and the harm they inflict on investors. We also showed how the D-Limit Order, which automatically resets its price when HFTs are about to strike, helps neutralize the HFTs’ unfair advantage. Fortunately for investors, the SEC’s mission is to protect investors and the integrity of the markets, not Citadel’s coveted business model, so it approved the IEX order type in accordance with the securities laws and all the requirements surrounding rulemaking. We urged the Court to affirm the SEC’s decision.
• The case was argued before the D.C. Circuit on October 25, 2021, and we’re watching for the Court’s decision on the merits.

A challenge (Alliance for Fair Board Recruitment v. SEC) to the SEC’s approval of a new rule issued by the NASDAQ that would help advance the cause of racial justice.

• Why it matters. Huge societal challenges such as climate change and racial injustice are rightly receiving increasing attention among policymakers, major media outlets, and members of the public. Those engaged in the financial services industry, including the financial market regulators like the SEC and members of the industry like NASDAQ, have key roles to play in solving those problems. Often the first step toward meaningful change on such challenges is public transparency.
• The NASDAQ, a major national stock exchange that lists over 3,000 company stocks, recently took a major step forward on the racial injustice front by issuing a new rule that would require each company listed on the exchange to publicly disclose the self-identified gender, racial, and LGBTQ+ status of each member of the company’s board of directors. The rule also requires each listed company to have, or explain why it does not have, at least two members of its board who are diverse, including at least one director who self-identifies as female and at least one director who self-identifies as an underrepresented minority or LGBTQ+.
• The SEC approved the rule in August and the petitioner, the “Alliance for Fair Board Recruitment,” promptly challenged it in the U.S. Court of Appeals for the Fifth Circuit. The Alliance is based in Texas and its website simply declares that its mission is to “promote the recruitment of corporate board members without regard to race, ethnicity, sex and sexual identity” and further that “The identities of our members are confidential.” Their decision to seek review of the NASDAQ diversity disclosure rule in the Fifth Circuit was clearly a strategic choice because that federal appellate court is widely regarded as ideologically conservative and pro-business. A victory in the case by the Alliance will invalidate an important measure that provides key insights into the composition of thousands of boards of directors, information that would undoubtedly and ultimately lead to greater diversity in America’s board rooms and progress toward bringing minorities into the economic mainstream.
• Briefing in the case is just getting underway. The Alliance is arguing that the rule violates the petitioners’ right to equal protection under the Fifth Amendment to the U.S. Constitution, that it also violates the First Amendment by requiring disclosure of controversial information, and that the SEC lacked authority under the securities laws to approve the rule. We’ll be tracking the case closely.