A federal district court has found the plan sponsor, employee fiduciaries and a recordkeeper of 401(k) plans liable for more than $35 million in damages under ERISA for failing to control costs, permitting the plans to pay excessive revenue-sharing compensation to service providers and imprudently selecting investment options. Tussey v. ABB, Inc., 2008 U.S. Dist LEXIS 45240 (W.D. Mo. Mar. 31, 2012).
The court's decision will heighten the already intense scrutiny of 401(k) plan fees and will put additional pressure on fiduciaries to monitor and control revenue-sharing payments. In addition, the court's use of a plan's investment policy statement (IPS) against the plan's fiduciaries may prompt fiduciaries to reevaluate the contents and usage of the IPS.
Background
The Tussey suit was one of more than a dozen class actions filed against Fortune 200 companies by a Missouri law firm beginning in 2006. Although each complaint varies, all contain similar core allegations that employers and fiduciaries permitted 401(k) plans to charge excessive fees to plan participants for plan investment options.
In particular, the complaints generally allege that revenue-sharing compensation paid to plan service providers was excessive. "Revenue-sharing" is the practice of allocating to a service provider a portion of the management fees collected by a mutual fund (or a similar investment vehicle). It is a common practice among 401(k) plans, which often use revenue-sharing to pay for plan recordkeeping and other services. ERISA does not prohibit revenue-sharing, but it does require plan fiduciaries to act solely in the interest of plan participants. The complaints allege that the process of allocating revenue-sharing payments was not in the best interests of participants because it provided excessive compensation to service providers from fees that were ultimately paid by plan participants.
The complaint against ABB followed the general pattern of the other class actions. Among other things, it alleged that:
- ABB (including individual employees who acted on behalf of ABB) breached its fiduciary duty to two 401(k) plans (the Plans) because it did not monitor recordkeeping costs and failed to negotiate rebates;
- ABB's decisions concerning the selection of investments for the Plans were improperly influenced by conflicts of interest;
- ABB violated its duty of prudence when it failed to offer separate accounts (rather than mutual funds) under the Plans; and
- ABB permitted the recordkeeper of the Plans — Fidelity — to improperly retain float income.
ABB and Fidelity denied the allegations of the complaint, leading to a bench trial that concluded in January 2010.
The Court's Decision
The court found that ABB violated its ERISA fiduciary duties by failing to monitor and control recordkeeping costs and revenue-sharing payments and by selecting more-expensive investment options when less-expensive options were available. The court also found that Fidelity, rather than ABB, was liable for violating ERISA's fiduciary duties by capturing float income. The court rejected the claim that ABB had any duty to offer separate accounts as investment options.
Failure to Monitor Recordkeeping Costs and to Negotiate Rebates
The court found that ABB had failed to monitor the recordkeeping costs of the Plans because it did not attempt to calculate the actual dollar amount received by the recordkeeper through revenue-sharing. Therefore, the court concluded, ABB was unable to make a prudent decision because it did not have the facts necessary to assess whether reasonable compensation to service providers was being paid by the Plans.
ABB argued in its defense that it had monitored the expense ratio of each mutual fund, which is the total cost charged to participants and necessarily includes all revenue-sharing payments. The court rejected this argument and asserted that the conduct of ABB showed that it was "not concerned about the cost of recordkeeping unless it increased ABB expenses."
Notably, the court concluded as a matter of law that the IPS of the Plans was a governing plan document for ERISA purposes. After quoting a statement from the IPS that "rebates will be used to offset or reduce the cost of providing administrative services to plan participants," the court then concluded that ABB's failure to monitor revenue-sharing meant that it had breached its ERISA fiduciary duty to act in accord with plan documents. Equating "rebates" with revenue-sharing, the court reasoned that ABB could not have used the revenue-sharing payments generated by the Plans to reduce or offset recordkeeping costs if it did not know the amount of such payments.
Selection of Investment Options
While rejecting the claim that the selection of all investment options of the Plans was tainted by conflicts of interest, the court found problems with the selection of specific funds, as well as a broad conflict of interest due to cross-subsidization.
- The court concluded that the replacement of a balanced mutual fund with a family of target-date funds was imprudent. Again relying heavily on the IPS, the court reasoned that ABB violated its duty of prudence by removing the mutual fund without going through the "de-selection" process described by the IPS and by adding the target-date funds without evaluating their merits within the parameters set by the IPS.
- The court found that ABB breached its fiduciary duties by choosing mutual fund share classes with higher expense ratios when share classes with lower expense ratios were available. ABB argued unsuccessfully that the selection of the share classes with higher expense ratios was beneficial to participants because it maintained a neutral level of revenue-sharing payments to Fidelity. Under the terms of the agreement between ABB and Fidelity, the latter's fees could be increased if revenue-sharing payments decreased. According to ABB, such increased fees might result in recordkeeping charges deducted from participants' accounts. However, the court rejected this argument and again cited language in the IPS that the court interpreted to require selection of the share class with the lowest expense ratio.
- The court accepted arguments that ABB's selection of investments and control of revenue-sharing were influenced by its receipt of "free" or discounted services from Fidelity that were unrelated to the Plans, such as payroll administration and recordkeeping for other benefit plans. The court found that some, but not all, of the ABB defendants had violated their ERISA duty of loyalty to the Plans once they became aware of the cross-subsidization and failed to act.
Float Income
The court also found that Fidelity, but not ABB, had violated its ERISA fiduciary duties by capturing float income on Plan assets. "Float income" is interest earned from funds temporarily held before being transferred to or from mutual funds (or other investment options). Fidelity's float program was used first to pay bank fees incurred by Fidelity, with the remainder distributed pro rata to the mutual funds. The court concluded that by distributing float income in this way, Fidelity benefited both itself (through reimbursement of bank fees) and nonparticipants (by benefiting all the shareholders of the mutual funds, not just Plan participants) in violation of Fidelity's ERISA fiduciary duty to use plan assets for the exclusive benefit of plan participants.
Separate Accounts and Comingled Funds
The court rejected arguments by the plaintiffs that ABB was imprudent not to offer separately managed investment accounts or comingled funds because such investment options can have lower expenses than mutual funds. The court found that ABB had engaged in a prudent process to consider the merits of separate accounts and comingled funds, and specifically cited a number of advantages that ABB had concluded mutual funds possessed, including Securities and Exchange Commission oversight and daily valuation. In reaching this conclusion, the court again relied on the terms of the IPS, which the court believed did not prohibit the use of retail mutual funds.
Conclusions
One lesson to take away from the decision in ABB is that plan fiduciaries need to think of their plan's IPS in offensive as well as defensive terms. An IPS is an important part of documenting a prudent fiduciary process and can therefore be a key defense against allegations that investment options were imprudently selected. However, the ABB decision shows that an IPS can also be used as an offensive weapon by plaintiffs when a court determines that the terms of the IPS were not followed. The court concluded that the IPS of the ABB Plans was an integral part of the plan document, and therefore needed to be followed as if its provisions were terms of the Plans. Instead of protecting ABB, the IPS was repeatedly used by the court to establish violations of ERISA fiduciary duties. In light of this result, a plan fiduciary should consider whether its IPS explains and protects its fiduciary process. An IPS with inflexible terms (such as ABB's) that do not reflect real-world considerations may do more harm than good.
Another lesson is the need to separate the roles and compensation for third parties who provide both plan-related and other services to a plan sponsor. The court focused heavily on a statement from Fidelity that services to ABB's health and welfare plan and its nonqualified plans were priced below market based on the revenue from the 401(k) Plans. The court concluded that ABB was unjustly enriched by this "subsidization" for services that it would otherwise have paid for from corporate assets.
Whether or not plaintiffs ultimately succeed, it is certain that the 401(k) plan environment has drastically changed since these suits began in 2006. New Department of Labor regulations that require regular disclosure of fees to participants and of revenue-sharing and other indirect payments to plan fiduciaries have greatly increased the availability of information regarding plan fees and revenue-sharing. The ABB case points to the importance of plan fiduciaries incorporating that new information in their decision-making processes concerning plan operations.
Until ABB, the suits challenging 401(k) fees and revenue-sharing payments had yielded mixed results for plaintiffs, including a notable defeat in the Court of Appeals for the Seventh Circuit. The decision in ABB is the major victory on the merits that has long eluded the instigators of these suits. However, the case is far from over. ABB and various other defendants have appealed the decision to the Eighth Circuit. While the court of appeals will undoubtedly give substantial deference to the district court's factual findings, its treatment of the lower court's legal reasoning cannot be predicted.
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