The Employee Retirement Income Security Act does not require plan sponsors or service providers to disclose revenue sharing fee information to participants, according to the U.S. District Court for the Western District of Wisconsin. In a June 20 memorandum opinion dismissing a lawsuit against John Deere, Inc. and two subsidiaries of Fidelity Investments, the court held that ERISA's statutory provisions contain limited and finite disclosure requirements that are not supplemented by ERISA's general fiduciary mandates. The court also held that the defendants could not be liable for allegedly excessive fees charged by Fidelity's mutual funds. The ruling is the first to dismiss one of the recent spate of ERISA lawsuits filed across the country challenging the common practice of revenue sharing.
The full text of the court's opinion is available here.
The thrust of the lawsuits is that revenue sharing results in the payment of excessive and undisclosed fees, both of which are alleged to violate ERISA. Revenue sharing is not a defined term in ERISA, but it generally refers to a compensation practice in which 401(k) plan investment providers allocate—or "share"—a portion of their asset-based fees to other plan service providers. This has become an increasingly common practice, especially among so-called "bundled" service providers, like Fidelity, that offer a range of investment and administrative services to plans through more than one corporate sibling. In the John Deere case, the investment management arm of Fidelity (Fidelity Management and Research Company) provided investment vehicles to the John Deere plan, while Fidelity Management and Trust Company acted as plan trustee and recordkeeper. In order to offset some of the cost of providing trust and recordkeeping services, Fidelity Management and Research allocated a portion of its asset-based fees to Fidelity Trust. As indicated in the court's decision, Fidelity disclosed to the plan and its participants neither the existence nor the amount of that revenue sharing.
The court easily rejected plaintiffs’ claims that the lack of revenue sharing disclosure violated ERISA. Rather, noting that the Department of Labor is currently engaged in a regulatory effort to require revenue sharing disclosure, the court held that nothing in the current statute or regulations directly requires such disclosure. "Whether, as a policy matter, additional reporting of revenue sharing arrangements should be required" was not for the court to decide. Instead, the very existence of the regulatory initiative "unequivocally confirms" that the lack of such disclosure does not violate current ERISA standards. The court also refused to expand ERISA's general fiduciary obligations to include a separate duty to disclose fee information. Rather, disclosure requirements are "generally limited to those expressly prescribed by the statutory language" of ERISA.
The court then turned to the plaintiffs' contention that John Deere and Fidelity breached their fiduciary duties because the investment options offered by the plan all charged excessive fees. The court first held that defendants could not be liable for any losses because the plan fit into the safe harbor of ERISA section 404(c). Although typically raised as an affirmative defense, plaintiffs suggested in their complaint that defendants did not meet the disclosure requirements in the Department of Labor's 404(c) regulations, apparently attempting to preemptively take away the defense. The defendants, in their motion to dismiss, argued that the 404(c) defense does apply, and that it shields them from any liability that occurred as a result of participants' exercise of control over their individual accounts.
The court agreed with defendants. According to the court, the only component of the 404(c) safe harbor that was in dispute was the regulations' disclosure requirements. The court appeared to assume that the plan met the balance of the extensive safe harbor conditions. Examining the plan documents that were part of the record, the court then found that on "their face it appears that the disclosures provide precisely" the information required by the regulations. As is the case with the statutory disclosure requirements of ERISA, the section 404(c) regulations do not expressly require disclosure of revenue sharing information. In addition, according to the court: "There is nothing to suggest that receiving this additional nonprescribed information would effectively enhance investment decisions."
In what ultimately may be the most controversial portion of the opinion, the court next held that defendants were insulated from fiduciary liability because, even if the revenue sharing arrangements caused the plan and participants to pay excessive fees, the payments resulted from the participants’ exercise of control over the investments. Noting that the plan provided, as an investment option, an open brokerage window that made available more than 2,500 mutual funds to participants, the court opined that is "untenable to suggest" that all of the funds charged excessive expense ratios. "The only possible conclusion," the court said, "is that to the extent participants incurred excessive expenses, those losses were the result of participants exercising control over their investments within the meaning of the safe harbor provision" of section 404(c). Even assuming that defendants had "failed to satisfy their fiduciary obligation to consider expenses when selecting mutual fund investment options, they are nevertheless insulated from liability by the safe harbor provision because of the nature and breadth of funds made available to participants under the plans."
The court's holding appears to be at odds with the Department of Labor's interpretation of section 404(c)—generally shared by ERISA practitioners—that plan fiduciaries remain responsible for prudently selecting and monitoring a plan's investment options. Plan fiduciaries are not liable for the individual investment choices of participants, but are generally understood to remain liable if they permit imprudent investment options to be among the choices available for participants. For this reason, there has always been a healthy skepticism among plan sponsors toward the value of section 404(c)'s protection. The court's holding on this issue represents a significant departure from the current understanding of the safe harbor provision, and if it is allowed to stand or be upheld on appeal, it will dramatically enhance the value of section 404(c) liability protection.
Finally, in two short paragraphs, the court dismissed the Fidelity defendants for the same reasons John Deere was dismissed. In addition, because the trust agreements between John Deere and Fidelity Trust "unequivocally provide" that John Deere has "sole responsibility for selection of plan investment options," neither of the Fidelity defendants could be fiduciaries with respect to the plan's investment decisions, and "accordingly could not be liable for breach of fiduciary duty on the claims."
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