This may be the clearest sign about the responsibilities of plan trustees we have seen... Reeve
Tussey v. ABB, Inc.: Another Example of the Importance of Engaging in Prudent Decision-Making Process and Following Plan Documents
On March 31, 2012, a court in the Western District of Missouri finally issued its decision in Tussey v. ABB, Inc., No. 2:06-CV-04305, 2010 U.S. Dist. LEXIS 45240 (W.D. Mo. Mar. 31, 2012) and determined that the plans’ fiduciaries were jointly and severally liable for $35.2 million. This is one of a series of cases filed in 2006 by the Schlichter law firm alleging that ERISA covered 401(k) plans were paying their vendors excessive compensation. The court, after a four-week bench trial that concluded a little over two years ago, held that the ABB, Inc. plans’ fiduciaries violated ERISA’s fiduciary standards of conduct when they:
(1) Failed to monitor recordkeeping costs paid through revenue sharing and hard dollars, and to negotiate rebates for the plans;
(2) Failed to prudently deliberate prior to deselecting and replacing investment options in the 401(k) line-up;
(3) Selected more expensive share classes for the plans’ investment line-up when less expense share classes were available; and
(4) Permitted revenue sharing for the purpose of subsidizing corporate expenses unrelated to the administration of the 401(k) plans from which the revenue sharing was generated.
The court also found that certain Fidelity affiliates were fiduciaries because they exercised discretionary authority and that, in this capacity, they violated their fiduciary duties when they retained float income for their own benefit (and for the benefit of Fidelity investment options), instead of passing that income on to the plans.
As noted below, revenue sharing played a large role in this case, and although the court found the plans’ fiduciaries had breached their duties with respect to the use of revenue sharing to compensate the plans’ recordkeeper, the court did not conclude that the use of revenue sharing was itself a violation of ERISA’s fiduciary standards of conduct. To the contrary, the court recognized that revenue sharing was an accepted way to compensate vendors in the industry. The plans’ fiduciaries’ problem in this instance, according to the court, was that they failed to administer the revenue sharing arrangement in a prudent manner.
ABB, Inc. sponsored two employee benefit pension plans: the Personal Retirement Investment and Savings Management Plan and the Personal Retirement Investment and Savings Management Plan for Represented Employees of ABB, Inc. (collectively the “Plans”). Both are ERISA governed 401(k) defined contribution benefit plans that offered nearly identical benefits. One Plan was offered to ABB’s unionized employees and the other Plan to its non-union employees. At the time the opinion was issued, the Plans were governed by a variety of committees some of which were appointed by the board of directors and at least one of the committees served as the Plans’ administrator. The committees and one individual were the named defendants and hereafter will be referred to as the ABB defendants.
The Plans included mutual funds offered by Fidelity Investments. Fidelity Research was the investment adviser to these mutual funds. Fidelity Trust was the Plans’ recordkeeper. As the recordkeeper, Fidelity Trust provided educational information, bookkeeping, and other services to the Plans. According to the court, during its relationship with the Plans, Fidelity Trust has been paid two different ways. Originally, it was paid in hard dollars based on a per-participant per month fee. Over time, Fidelity Trust was primarily paid through revenue sharing. Fidelity Research and Fidelity Trust are hereafter sometimes referred to as the Fidelity defendants.
Findings With Respect to the Plans’ Fiduciaries
Claim One: The failure of the ABB defendants to monitor recordkeeping costs and to negotiate rebates for the Plans.
The court found that by April 2001 the non-union Plan paid Fidelity Trust for its recordkeeping services solely through revenue sharing and that the union Plan compensated Fidelity through a combination of revenue sharing plus an $8 per-participant fee. It further found that, with the exception of one mutual fund, revenue sharing fees were paid to Fidelity Trust directly from the mutual funds offered through the Plans, many of which were Fidelity proprietary funds. With respect to the fiduciary oversight of these fees, the court found that the Plan fiduciaries (1) never calculated the dollar amount of the recordkeeping fees the Plan paid to Fidelity Trust through revenue sharing; (2) did not consider how the Plan size might be used to leverage lower fees; and (3) did not benchmark the expenses before they chose to pay the recordkeeping fees through revenue sharing.
Apparently, the Plan fiduciaries took no action with respect to the fees Fidelity Trust was paid even after their consultant, Mercer, reported to them in 2005 that they were overpaying Fidelity Trust for recordkeeping services and that it appeared that the Plans were subsidizing other corporate (i.e., non-Plan) services that Fidelity provided ABB. Based on these facts, the court specifically concluded that the “ABB fiduciaries were not concerned about the cost of recordkeeping unless it increased ABB expenses or caused the … Plans to be less attractive to its employees as a result of hard-dollar, per-participant fees being charged.” Tussey, 2010 U.S. Dist. LEXIS at *31.
In addition, the court found that in these circumstances the ABB defendants failed to comply with the terms of the Plan’s Investment Policy Statement (IPS) which required that revenue sharing be used to offset or reduce the cost of providing administrative services to Plans’ participants. Id. at *39-*40. Based on expert witness testimony, the court concluded that the Plans had overpaid for their recordkeeping services by significant amounts. Id. at *33.
The court observed that while revenue sharing is commonly used in the industry, if a plan sponsor opts for revenue sharing as its method of paying for recordkeeping services, it must not only comply with its governing plan documents, it must also through a deliberative process to determine why such choice is in the plan’s and the plan participants’ “best” interest. Id. at *46.
Claim Two: The failure of the ABB defendants to prudently select and de-select an investment options.
The plaintiffs in this case had argued that the ABB defendants’ decisions concerning the selection and de-selection of investments for the Plans’ line-up was improperly influenced by conflicts of interests due to the relationship of ABB and Fidelity Trust (and the potential for enhanced revenue sharing attributable to the inclusion of certain funds on the Plans’ investment platform). The court found such conflicts existed in two specific situations — one involving the replacement of the Vanguard Wellington mutual fund with a Fidelity target-date fund, and the second involving the decision to select or retain more costly classes of investments on the Plans’ investment line-up when other less expensive classes of the same investments were available. Id. at *47-*48.
In 2000, the Plans’ fiduciaries swapped the Vanguard Wellington Fund for a Fidelity target-date or lifestyle fund. The court determined that the ABB defendants violated their duty of prudence when they failed to follow in this instance the specific IPS requirements applicable to the selection and de-selection of an investment fund, and more generally failed to engage in a deliberative assessment of the merits in determining which investment option to choose. Id. at *65. The court held, based on the evidence presented at trial, that the recommendation of the Fidelity target-date fund to replace the Vanguard fund was a breach of one of the ABB defendant’s duty of loyalty in that the defendant, the head of one of the Plans’ fiduciary committees, knew that the recommendation would generate more revenue sharing for Fidelity Trust and reduce the Plan’s hard-dollar costs, and because of the potential benefit to ABB, the court viewed this as a prohibited transaction. Id. at *69.
The court also found as a general matter that, in 2005, after the Plan fiduciaries removed the Fidelity Magellan Fund from the Plans’ investment line-up, the fiduciaries chose share classes that provided more basis points for revenue sharing in order to prevent the imposition of hard-dollar per participant monthly fees without making a determination that the selection was prudent for the Plans participants. Id. at *82.
The court found that this decision was contrary to the Plans’ governing documents which provided that “[w]hen a selected mutual fund offers ABB a choice of share classes, ABB will select the share class that provides Plan participants with the lowest cost of participation.” Id. at *79. The court rejected the ABB defendants’ argument that this language should be interpreted to mean that the Plans’ fiduciaries, when making an investment decisions, should take into account how the choice of the investment option might affect the recordkeeping costs to the Plans’ participants rather than interpreted to mean that the Plans’ fiduciaries are required to consistently select investment options with the lowest expense ratio. Id. at *79. The court stated that in this case the hard-dollar costs would not have shifted to participants because ABB intended to pay all hard-dollar recordkeeping costs that resulted from negotiations with Fidelity Trust. In addition, the court noted that the ABB defendants had failed “to explain how it is prudent to require participants choosing managed funds, those that produce revenue sharing, to pay for the recordkeeping expenses of the participants who chose more conservative investments that did not produce revenue sharing.” Id. at *79-*80.
Claim Three: The use of revenue sharing for the purpose of subsidizing corporate expenses unrelated to the administration of the Plans.
In connection with the de-selection of the Magellan Fund and selection of funds that provided more basis points for revenue sharing, the court found that the ABB defendants had been informed by Fidelity as to the revenue and cost information as to all of its services to ABB (including recordkeeping for the company’s defined benefit plan, its deferred compensation plan, its health benefits, and its payroll). The court also noted that the 2005 report by the ABB consultant, Mercer, had indicated that the Plans’ recordkeeping payments via revenue sharing appeared to be subsidizing the cost of administration for ABB’s other employee benefit plans and non-qualified plans. The court determined that once ABB was aware of the cross-subsidy inherent in the Plans’ revenue sharing arrangement, it nonetheless continued to maintain the current arrangement, and further concluded that the decisions and actions taken by ABB in negotiating a recordkeeping fee on behalf of the Plans was motivated by the discounts ABB received for its corporate services. The court found that this evidence supported a finding that the overpayment of revenue sharing fees was used to subsidize the administration of non-related plans and that the fiduciaries “failed to make a good faith effort to prevent the subsidization of administration costs” for these other unrelated plans. Id. at *85-*86. This, the court concluded, violated ERISA’s duty of loyalty. Id. at *88.
Findings With Respect to Fidelity Defendants
Before the Plans’ assets were allocated to their proper investments based on participant directions, the assets were parked in interest earning accounts for short periods. The interest earned during this period is known as “float income” or “float.” The court noted that the interest that was earned in the accounts was credited against any bank expenses incurred in maintaining the accounts, and that because maintaining the accounts was integral to the trust services rendered by Fidelity Trust, the float income was effectively being used to pay Fidelity Trust’s operating expenses for recordkeeping and administering the Plan. This was so even though the applicable trust agreement provided that Fidelity Trust would be paid only through revenue sharing. Id. at *99. In other words, it appears, from the court’s conclusions, that Fidelity’s retention of the float income was not disclosed to the ABB defendants. Id.at *103. The court found that Fidelity Research decided that any remaining float income would be distributed on a pro-rata basis to the mutual funds in the Plans’ investment line-up and thus benefit all shareholders of the mutual funds, not just the Plans’ participants. Id. at *99-*100.
The court held that since float income was generated from assets of the Plans, any float income generated from those assets was itself an asset of the Plans. Id. at *100-*101. The court then concluded that since Fidelity Trust and Fidelity Research decided how to use the float income they were fiduciaries because they exercised discretionary authority and control over assets of the Plans. Id. at *100-*103. The court further concluded that since the Fidelity defendants had decided to use the assets of the Plans to benefit entities other than Plan participants or beneficiaries, the Fidelity defendants violated ERISA’s duty of loyalty. Id. at *103.
By way of relief, the court concluded that the ABB defendants owed the Plans $13.4 million for their failure to monitor recordkeeping expenses; and $21.8 million for the imprudent selection of the Fidelity target-date funds and the removal of the Vanguard Wellington fund, which resulted in lower returns to participants. Id. at *107- *109. With respect to the other claims against the fiduciaries, the court concluded that the total of $35.2 million already assessed against the ABB defendants included compensation for losses attributed to the other allegations (e.g., the selection of classes of investments with higher expenses). Id. at *110-*111. The Fidelity defendants were ordered to pay the Plans $1.7 million for improper use of the float. Id. at *113.
This case is not ground-breaking. Assuming the court’s finding of facts are true, this case is yet another example of the pitfalls fiduciaries face if they fail to engage in a prudent process when making decisions for employee benefits plans and fail to follow the governing plan documents. The court concluded that the fiduciaries, even when faced with a report from their consultants – Mercer – concluding that Fidelity Trust was being overpaid and that the excess payments were effectively cross-subsidizing corporate (non-Plan) expenses, still did not respond and take appropriate steps to protect the Plans from unnecessary losses.
It is important to underscore that at no time did the court condemn the use of revenue sharing as a means of compensating service providers. Indeed, the court explained “that it was not ‘stating that revenue sharing was an imprudent method for compensating a plan’s recordkeeper. . . .'” Id. at *45-*46. As noted above, the court did caution, however, that if revenue sharing was selected as a method of compensating a recordkeeper, then the fiduciaries must go “through a deliberative process for determining why such a choice is in the plan’s and participants’ best interest.” Id. at *46.
This case serves as a reminder to fiduciaries wrestling with decisions that may impact the use of plan assets of the importance of ensuring that they go through a documented process of determining whether the fees incurred by their plan are reasonable. Ensuring that a fiduciary has engaged in a prudent process with respect to fees paid to plan vendors will become even more important when the Department of Labor’s revised Section 408(b)(2) regulations become effective July 1, 2012. The revised regulations impose new fee disclosure requirements that fiduciaries must consider in determining whether a service provider’s fees are reasonable. Failure to demonstrate that direct and indirect compensation has been considered in the process of deciding whether a vendor’s compensation is reasonable may increase a fiduciary’s exposure to an allegation that the fiduciary has breached its fiduciary duties and that the agreement with the vendor is a prohibited transaction under ERISA.
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Tess Ferrera, firstname.lastname@example.org, 202-626-1470
Eva McComas, email@example.com, 650-384-4090
Fred Oliphant, firstname.lastname@example.org, 202-626-5834
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