Favorable ruling for Fidelity in self-directed brokerage, Financial Engines case

October 05, 2017

On September 22, 2017, the United States District Court for the District of Massachusetts found for defendant in Fleming v. Fidelity. The case involves two emerging issues in 401(k) plan litigation – the status under ERISA of self-directed brokerage (SDB) arrangements and of Financial Engines fee-sharing arrangements. In this article we briefly review the court’s decision.


Plaintiffs, participants in the Delta Family-Care Savings Plan, a 401(k) plan, alleged that Fidelity was a fiduciary and that it violated ERISA’s duty of loyalty when it structured its BrokerageLink self-directed brokerage SDB service by “selecting share classes that charged higher fees than share classes otherwise available for investment” and “receiv[ed] revenue-sharing payments from [Financial Engines] at the expense of the Plan and Plan participants, and by charging unreasonable and excessive fees for the services … provided to FE.”

Fidelity not a fiduciary

Plaintiffs based its claim that Fidelity was a fiduciary on Fidelity’s “discretionary authority to select the share classes of mutual funds to purchase for Plaintiffs and the Plans through BrokerageLink.” The court, however, characterized this decision by Fidelity as a “product design decision … that is wholly distinct from the decision to make BrokerageLink available to individual Plan participants.” (Emphasis added.) The decision to offer BrokerageLink to Delta plan participants “rested solely with Delta, either as the Plan sponsor or through its benefits committee.” Thus, Delta or the Delta plan committee, neither of which were parties to this lawsuit, was a fiduciary. Fidelity was not.

The court came to a similar conclusion with respect to the FE claim. That is, that the decision to retain FE, and the amount of fees FE would be paid, was made by plan fiduciaries, not Fidelity.

Prohibited transaction claim

Plaintiffs also claimed that the arrangement between Fidelity and FE constituted a prohibited transaction. The argument here is more complicated.

Oversimplifying somewhat, it is generally a prohibited transaction under ERISA for a fiduciary to cause a plan to enter into services arrangement with a party in interest in which the party in interest receives more than “reasonable compensation.” Plaintiffs alleged that, as a result of this fee-sharing arrangement, the fees for FE’s advice were “artificially inflate[d].” Thus, they exceeded “reasonable compensation,” triggering a prohibited transaction.

The court did find that Fidelity became a party in interest “upon agreeing to provide administrative and trustee services [to the plan].” But it found that the arrangements between Fidelity and FE preceded, and in effect did not relate to, the arrangement between FE and the plan: “the conduct complained of [the fee sharing arrangement between FE and Fidelity] involves earlier transactions between Defendants [Fidelity] and mutual funds, or Defendants and FE, in which Delta, as the only relevant Plan fiduciary, had no part.” The court went on to point out that the fiduciary (Delta) didn’t even know about the arrangement.

Thus, because the fiduciary did not cause the fee sharing arrangement, that arrangement is not a prohibited transaction.

Let’s just note the claim that plaintiffs did not make – that the plan fiduciary committed a prohibited transaction by retaining FE because the compensation paid FE was “unreasonable.” Neither Delta nor FE were parties to this lawsuit. It is certainly arguable that, just because FE had a fee-sharing arrangement with Fidelity does not mean that its fees were unreasonable, and that that issue should be determined based on the market for advice services and the cost of available alternatives.

Takeaways for plan fiduciaries

The court decided this case for defendant based on a tight reading of the statute. In these sorts of decisions it’s worth asking, “But – does this reading reflect common notions about how the statute ought to work?” The answer would seem to be, pretty clearly, yes. A financial services company ‘ought’ to have the right to design (and price) its product any way it wants to, and to leave it to the market – that is, the decisions of plan fiduciaries like Delta – to decide whether its product is viable/appropriately structured and priced. There is no need to litigate product design under ERISA.

But plaintiffs’ complaint may raise an issue for plan fiduciaries – who were, as we’ve noted – not defendants in this case.

Do self-directed brokerage accounts present any issues for plan fiduciaries? This is a disputed area. In 2012, Obama Department of Labor published an FAQ that some believed “rais[ed] the possibility that plan fiduciaries could be responsible under ERISA for the underlying investments into which participants invest through a brokerage window.” That FAQ was, after considerable controversy, subsequently withdrawn.

It’s certainly possible to conceive of a badly constructed SDB, the selection of which by a plan fiduciary for inclusion in a plan might be a breach of her ERISA duty of prudence. The best defense here – as (nearly) always – is a strong fiduciary process. If sued, the fiduciary will want to present, e.g., committee minutes showing that with respect to the plan’s SDB it considered available, appropriate alternatives and came to a reasoned and reasonable conclusion.

In the end, that is, and has been for 40-plus years, basic fiduciary best practice. It is the same for consideration of an investment advice provider for plan participants.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

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