Fiduciaries liable for failure to monitor recordkeeping costs, but recordkeeper evades liability for use of float income

The U.S. Court of Appeals in St. Louis (CA-8) has affirmed a trial court ruling that plan fiduciaries violated their duties under ERISA by failing to monitor excessive fees remitted to a recordkeeper that was paid through revenue sharing. However, the court reversed and remanded the issue of whether the fiduciary breached ERISA by replacing a strong performing investment option with higher priced investment funds maintained by the recordkeeper, for determination under the deferential abuse of discretion standard. In addition, the court absolved the recordkeeper of liability for its use of float income retained on plan investments.

ABB, Inc., maintained separate 401(k) plans (collectively “the plan”) for management personnel and rank-and-file employees who were represented by a union. The employer also sponsored defined benefit, nonqualified, and welfare plans. The DC plan’s investment platform included funds offered by Fidelity Investments. Fidelity Research served as an investment adviser to the mutual funds offered by the plan.

Fidelity Trust provided recordkeeping services for the plan and was primarily paid through revenue sharing by the investment companies whose products were selected by the company to be on the plan platform. Fidelity Trust also received revenue sharing from an internal allocation with the interrelated Fidelity companies (i.e., internal revenue sharing). Under the arrangement, in the event revenue sharing was used to pay Fidelity Trust, its fees grew as assets of the plan which provided revenue sharing grew, even if Fidelity Trust provided no services to the plan.

Alleged breaches of fiduciary duty

In a class action suit brought by plan participants, the trial court concluded that the company fiduciaries and Fidelity breached numerous fiduciary duties under ERISA. Specifically, the court determined that: (1) the company fiduciaries failed to monitor recordkeeping costs and negotiate rebates for the plan from either Fidelity or other investment companies on the plan platform when less expensive share classes were available; (2) the company fiduciaries did not follow prescribed procedures in removing a mutual fund offered by another company and replacing it with Fidelity Funds that provided more revenue sharing; (3) the company fiduciaries paid Fidelity fees that exceeded market cost for plan services in order to subsidize corporate services (e.g., payroll and recordkeeping) provided to the company by Fidelity; (4) Fidelity Trust failed to use float income solely in the interest of plan participants; and (5) Fidelity transferred float income to the plan investment options instead of directly to the plan.

The plan empowered the plan administrator and its agents with sole and absolute discretion over the construction and interpretation of plan terms. Under established law, such a broad grant of discretionary authority would allow a fiduciary’s interpretation to be upheld if reasonable. The fiduciaries claimed, however, that the trial court failed to afford the appropriate level of deference to the plan administrators, especially with respect to their interpretation of the plan’s Investment Policy Statement (IPS). The participants countered that deference applied only to discretionary benefits claims determination. The appeals court refused to limit deference to benefit claims and proceeded to review the fiduciaries’ actions for an abuse of discretion.

Failure to monitor recordkeeping costs

The trial court held that the fiduciaries failed to monitor recordkeeping costs and failed to comply with the plan’s IPS, which specifically required that revenue sharing be used to offset or reduce the cost of providing administrative services to the plan. On appeal, the fiduciaries argued that the fact that the plan offered a wide range of investment options from which participants could select low-priced funds barred claims alleging unreasonable recordkeeping fees. The appeals court rejected such a sweeping standard, noting that the case involved significant allegations of wrongdoing with respect to fees.

In concluding that the company fiduciaries breached their duties under ERISA, the trial court expressly did not rule that revenue sharing is an improvident method for compensating plan recordkeepers. Rather, the court stressed that the company fiduciaries never calculated the actual dollar amount of the recordkeeping fees paid to Fidelity via the revenue sharing arrangements and did not consider how the plan’s size could be leveraged to reduce recordkeeping costs. The court found especially incriminating the fact that the company fiduciaries did not obtain a benchmark cost standard for Fidelity’s services, even after being informed by an outside consulting firm that it was overpaying for recordkeeping and that the DC plan was subsidizing the corporate services provided to ABB by Fidelity.

Of particular interest to the court was the fact that the IPS (which it found to be a governing plan document under ERISA) explicitly required revenue sharing to be used to offset or reduce recordkeeping costs. However, the company fiduciaries, by failing to monitor the revenue sharing to determine its prudence (e.g., by determining the governing market rate and baseline) allowed Fidelity to use the revenue sharing to cover recordkeeping costs, without lowering the plan’s administrative costs. While revenue sharing is an appropriate method for compensating plan recordkeepers, the company fiduciaries were bound by the terms of the IPS. Accordingly, the fiduciaries needed to establish a deliberate process to justify the use of revenue sharing that went beyond a raw assessment of the reasonableness of the expense ratios.

Finally, the court concluded that the failure to monitor and benchmark the fees (or rebate excess fees to the plan) resulted in the plan overpaying for the services provided by Fidelity. According to the court, the revenue sharing generated for Fidelity by the plan’s assets far exceeded the market value for recordkeeping and other administrative services provided by Fidelity. Accordingly, the fiduciaries failed to protect the plan and its participants and beneficiaries.

The appeals court found the trial court’s conclusion to be factually supported. The failure of the trial court to afford deference to the plan administrator’s interpretation of the plan with respect to recordkeeping and revenue sharing was harmless, given the factual support of its conclusions.

Selection and deselection of investments

The trial court next determined that the company fiduciaries’ selection and de-selection of specified investment options on the plan’s platform were improperly influenced by conflicts of interest, resulting in the inclusion on the investment platform of more expensive and underperforming investment options.

The fiduciaries replaced an actively managed balanced mutual fund maintained by Vanguard with a lifestyle fund maintained by Fidelity that was comprised of Fidelity retail funds. However, the decision to remove the Vanguard Funds was made without regard to the 3-5 year history of the Fund, in disregard of de-selection procedures specified by the IPS.

The trial court further found that, after the Vanguard Fund was removed from the plan, the company fiduciaries selected share classes with higher expenses than other available share classes. The court concluded that the funds were not selected because of their value to plan participants, but because they provided more revenue sharing and, under the compensation arrangement with Fidelity, reduced the company’s costs. These actions directly contravened the IPS, which required the company to select a share class that provided plan participants with the lowest cost of participation, which the court interpreted to mean the share class with the lowest expense ratio.

Initially, the appeals court affirmed the ruling of the trial court that the company’s imprudent decision to remove the Vanguard Fund and add the Fidelity Funds to the plan’s investment platform occurred within the governing 6-year statute of limitations. The execution of the decision to modify the investment lineup occurred within the limitations period.

With regard to the substantive fiduciary breach claims, however, the appeals court agreed with the fiduciaries that the trial court erroneously substituted its interpretation of the plan and its view of ideal plan investments for that of the fiduciaries authorized to make such judgments. The appeals court was not certain that the trial court would have reached the same conclusions had it employed the appropriate deferential standard of review in evaluating whether the fiduciaries breached their duties in implementing the redesign and evaluating and selecting plan investment options. Accordingly, the trial court’s judgment and award on the claims was reversed and the issues remanded for consideration under the deferential review standard.

Use of float income

Fidelity was not liable as a fiduciary for the failure of the company fiduciaries to comply with the IPS or in advocating for the retention of its higher priced funds, negotiating for lucrative revenue sharing payments, or for assessing excessive fees. Fidelity was entitled to pursue its business interests. However, the trial court determined that Fidelity did breach its fiduciary duties under ERISA when it exercised its discretionary control over plan assets to use, for its purposes, float income that was earned when transferred contributions were invested in overnight secured vehicles. The float income was transferred to a Fidelity account and used to pay bank expenses that should have been borne by Fidelity. Remaining float income was distributed among individual investment options, resulting in plan assets not being disbursed solely to plan participants and beneficiaries. Both instances, the court ruled, constituted the use of plan assets other than for the exclusive purpose of plan participants and beneficiaries.

On appeal, Fidelity maintained that it was not required to credit the plan with income earned on overnight investments of float because float is not a plan asset. The appeals court agreed, finding no evidence that the plan had property rights in in the float or float income. Absent proof of any ownership right to the funds in the redemption account balance, the court explained, the plan had no right to float income from that account. As the float was not a plan asset under the circumstances of the case, the court ruled that Fidelity did not breach a fiduciary duty of loyalty by paying the expenses on the float account and distributing the remaining float to the investment options.

Source: Tussey v. ABB, Inc. (CA-8)

Visit our News Library to read more news stories.