Float income retained by service provider was not plan asset

Float income arising from amounts transferred from mutual funds to redemption and disbursement accounts for distribution to plan participants is not a plan asset and may be retained by a service provider to pay administrative fees on the accounts without breaching fiduciary obligations under ERISA, according to a federal trial court in Massachusetts.

Float income incident to multiple step disbursement process

A service provider (Fidelity) was retained by retirement plans to maintain trust accounts for the plans and their participants. The accounts included three Deposit Accounts that held the assets of the trust funds for the benefit of the plans’ participants and beneficiaries. The trust agreements Fidelity negotiated with the plan stipulated that it would charge only 3 types of fees to the plan: asset-based fees based on a percentage of plan assets held in an investment; fixed administrative fees assessed per plan participant; and fees for individual participant services.

The litigation was precipitated by Fidelity’s multiple step disbursement process. When Fidelity received a withdrawal request, it sold mutual fund shares and moved the funds from the relevant investment option account to a redemption bank account. Electronic disbursements were paid to plan participants from the redemption bank account. Overnight, Fidelity would transfer the funds into an interest bearing account owned and controlled by Fidelity. The principal of the funds would be transferred back to the redemption bank account the next day. Any interest earned overnight on the funds (i.e., “float” income), however, was not transferred to the redemption bank account.

For participants who did not elect to receive an electronic disbursement, the withdrawn funds were transferred from the redemption bank account to an interest bearing disbursement account. A check was issued from the account to the participant in the amount of the withdrawn funds, but exclusive of the interest.

Fidelity retained a portion of the float income generated during the disbursement process to pay recordkeeping and administrative expenses associated with the bank accounts. However, these fees were not specified in the trust agreement. The remainder of the float income was not remitted to plan participants, but credited to the mutual funds.

Plan participants brought suit under ERISA charging that Fidelity violated its fiduciary duties by using the float income to defray its own expenses and transferring float belonging to the plan to other Fidelity clients (i.e., mutual funds). In addition, the participants alleged that Fidelity engaged in prohibited transactions by dealing with plan assets for its own interest or account. Fidelity moved to have the action dismissed, maintaining that float is not a plan asset. Alternatively, Fidelity argued that it was not an ERISA fiduciary with respect to the float.

Float income is not plan asset

The plan participants acknowledged that the plans did not own the underlying assets of the mutual funds in which plan assets were invested. However, the participants claimed that, because the plans owned the shares of the mutual funds, the plans were the beneficial owners of the accounts. As the plans owned the cash proceeds from the sale of the mutual fund shares, the participants argued, those proceeds were plan assets.

Fidelity countered that underlying assets of the funds were not “transmogrified” into plan assets when credited to a beneficiary’s account. Applying “ordinary notions of property rights” and relying on the Eighth Circuit’s ruling in Tussey, et al. v. ABB Inc., et al. (CA-8 (2014), 746 F. 3d 327 (cert. denied, 135 S. Ct. 477 (2014)), as well as similar holdings from the First Circuit (Merrimon v. Unum Life Ins. Co., CA-1 (2014), 758 F. 3d 46, and Vander Luitgaren v. Sun Life Assurance Co. of Canada, CA-1 (2014), 765 F. 3d 59), the court agreed with Fidelity that the cash proceeds from the sale of the mutual funds shares were not plan assets once the shares were sold, even though the funds were transferred to accounts for disbursement to participants.

The court noted that the plans could have negotiated an alternative arrangement, pursuant to which benefits would be paid from accounts owned by the plans. However, Fidelity owned the relevant bank accounts, was responsible for the account fees associated with those accounts and was, therefore, the court concluded, free to pay the fees using float income.

Cautioning plan participants, the court explained that the funder of the check owns the funds in the checking account. As with any mutual fund sale, the court added, an investor is not entitled to earn interest while a disbursement check remains uncashed.

Source: In re: Fidelity ERISA Float Litigation (DC MA).

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