Service provider empowered to determine amount of revenue sharing payments subject to liability as functional fiduciary

A service provider that exercised discretion over the amount of revenue sharing payments it received from mutual funds in which plan assets were invested was subject to ERISA liability as a functional fiduciary, according to a federal trial court in Massachusetts.

Revenue sharing determined by service provider

An employer maintained two 401(k) plans for which it also served as the administrator and named fiduciary. Mass Mutual, an insurance company, was retained to provide recordkeeping and investment services to the plan. Specifically, Mass Mutual designed and maintained a menu of investment options (e.g., mutual funds) which were selected by the plans for their participants. Plan participants did not directly invest in a mutual fund, but invested in separate accounts owned by Mass Mutual. The separate accounts were invested in mutual funds or other investment options.

A Group Annuity Contract (GAC) with the employer empowered Mass Mutual with exclusive and absolute ownership and control of the amounts in the separate investment accounts. Mass Mutual further retained the right to add, delete, or substitute investment options offered on its menu. The GAC further authorized Mass Mutual to assess management fees on the separate investment accounts. Fees could be set at a rate of up to 1% of the average daily market value of the account. However, Mass Mutual determined where in the range of 0% to 1% the fee percentage rate would be set. Mass Mutual also entered into participation arrangements with mutual funds included on its investment menu. The arrangements allowed for Mass Mutual to receive revenue sharing payments that were based on the expense ratio charged by the mutual fund for the separate accounts.

Mass Mutual maintained that the revenue sharing payments were used to offset the fees and other payments it would otherwise collect from the plan or its participants as compensation for management of the separate accounts. The plan sponsor, however, denied the existence of such a “dollar-for-dollar offset,” charging that the revenue sharing payments were “kickbacks” made by the mutual funds to gain access to the retirement plans. Specifically, it was alleged that in accepting the revenue sharing “pay-to-play” payments, Mass Mutual engaged in a prohibited transaction and violated its fiduciary duties under ERISA. In moving for summary judgment, Mass Mutual countered that it was not a functional fiduciary with respect to the revenue sharing payments.

Discretion to determine compensation establishes fiduciary status

In addressing whether Mass Mutual was acting as a fiduciary when it received revenue sharing payments in connection with management of the accounts, the court initially explained that persons may be fiduciaries “to the extent” they exercise any discretionary authority or discretionary control respecting management of the plan or exercise any authority or control respecting management or disposition of plan assets (ERISA §3(21)(A)(i)). Pursuant to this definition, the exercise of merely administrative or ministerial functions will not subject a person to fiduciary status. However, persons who are not empowered with discretion or control with respect to the management of a plan may be fiduciaries if they exercise any authority or control with respect to the management or disposition of plan assets, including, for example, the selection of plan investment options.

Individuals may also qualify as fiduciaries “to the extent” they have any discretion or discretionary responsibility in the administration of the plan (ERISA §3(21)(A)(iii)). This provision encompasses individuals who have been granted discretionary authority, regardless of whether such authority is exercised.
Under either ERISA §3(21)(A)(i) or (iii), a party must have been acting as a fiduciary when engaged in the action subject to the ERISA complaint. Focusing on this point, Mass Mutual averred that it was not a fiduciary to the extent it received revenue sharing payments. By contrast, the employer maintained that the ability of Mass Mutual to set the rate of the separate account management fees and to draw them directly from the accounts rendered it a fiduciary with respect to the revenue sharing.

Noting that the discussion of the fees in the record was “impenetrable,” the court concluded that there was a disputable issue of fact as to when and how Mass Mutual determined its compensation for each separate investment account investing in single mutual fund. The court explained that a service provider’s retention of discretion to set its own compensation can create fiduciary duties under ERISA with respect to the compensation. Thus, if a service agreement vests a service provider with control over factors that determine the amount of its compensation, the provider will be a fiduciary with respect to the compensation. The court then stressed that Mass Mutual exercised its discretionary authority to determine its own compensation by setting management fees (up to a maximum) which, in combination with revenue sharing payments, comprised its compensation package. A court could determine that Mass Mutual operated as an ERISA functional fiduciary under ERISA §3(21)(A)(i) to the extent it determined its own compensation, took fees out of the separate accounts, and had the discretion to offset revenue sharing payments against management fees as its compensation. In addition, Mass Mutual qualified as a functional fiduciary under ERISA §3(21)(A)(ii) to the extent it had discretionary control over factors governing its fees after entering into the agreement for the administration of the plan. Accordingly, Mass Mutual was subject to ERISA liability as a functional fiduciary with respect to the receipt of revenue sharing.

Source: Golden Star, Inc. v. Mass Mutual Life Ins. Co. (DC MA).

Visit our News Library to read more news stories.