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On April 23, 2019, the Ninth Circuit Court of Appeals upheld a lower court ruling in Acosta v. City National that defendant employer-plan sponsor had violated the ERISA prohibition on fiduciary self-dealing “by setting and approving its own fees from Plan assets for serving as its own recordkeeper.”
The case raises the issue of when and how an ERISA plan sponsor may bill the plan for services it provides. In this article we review those rules and then briefly discuss the Ninth Circuit’s decision in City National. Sponsors billing expenses to their plan will want to take careful note of the ruling in this matter.
What services may be billed to a plan?
Some plan sponsors provide services to, e.g., their 401(k) plan, the cost of which they charge to (and are reimbursed for by) the plan. The most obvious of these situations involve financial services firms who provide, for instance, recordkeeping services to their own in-house plans. That is in fact what City National did.
But non-financial services firms may also bill services to their plans, including, e.g., recordkeeping, investment management (where, for instance, the sponsor maintains an in-house managed fund (an “INHAM”)), and the preparation and distribution of certain required plan communications.
There is extensive guidance from the Department of Labor (generally in the form of Advisory Opinions) on what sorts of expenses may be billed to a plan. That guidance generally distinguishes between expenses associated with the“settlor function”(e.g., preparation of the plan document), which are not plan expenses and therefore not chargeable to the plan, and “reasonable plan expenses” (e.g., plan recordkeeping) which may be billed to the plan.
Where services are provided by the sponsor-fiduciary, only direct expenses may be reimbursed
While ERISA provides an exemption for the provision of “services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor,” that exemption is not available where the sponsor fiduciary is, in effect, paying itself for the provision of these services. ERISA’s prohibition against fiduciary self-dealing is not covered by this “service provider” exemption.
DOL regulations do, however, provide that such a fiduciary may receive “reimbursement of direct expenses properly and actually incurred in the performance of such services.” In this regard, a particularly difficult issue is the charge-back of (sponsor) employee compensation, particularly where the employee does work both for the plan and for the sponsor.
Pitfalls
We would identify (at least) three pitfalls – issues that are “easy to miss” – with respect to this rule allowing for the reimbursement of direct expenses to sponsor-fiduciaries:
DOL (and the courts) generally hold sponsors to a strict accounting standard in these cases. DOL has (in Advisory Opinions) emphasized that a sponsor may “seek reimbursement solely for expenses that [the sponsor-fiduciary] would not incur but for its provision of services to the Plan.”
The expenses must still be “reasonable.” Even if the sponsor-fiduciary can establish a direct cost, there is no ERISA exemption available if the cost is unreasonable, e.g., as some plaintiffs have argued, if the same services could have been bought more cheaply from a third party.
As with the in-house plan cases, just because the arrangement satisfies the Prohibited Transaction rules does not mean that it satisfies ERISA’s loyalty and prudence standards.
Reimbursement of direct expenses through revenue sharing
DOL has also stated (in an Advisory Opinion) that, e.g., where a financial services company’s in-house 401(k) plan includes outside funds in its fund menu, revenue sharing from those outside funds may be used to reimburse the sponsor for direct expenses:
[T]o the extent that the Plan and [the plan sponsor]have expressly agreed to and do in fact use [revenue sharing]payments to reduce or eliminate the Plan’s liability for [the plan sponsor’s] documented direct expenses incurred in providing services to the Plan, such payments may be considered “reimbursement” within the meaning of [the applicable DOL regulation].
City National – background
The issues we have been discussing came up both directly and (to some extent) indirectly in Acosta v. City National.
In Acosta v. City National, City National Bank acted as trustee and recordkeeper for its (in-house) City National 401(k) plan. For these services, CNB “was compensated by sharing a portion of the mutual funds’ fees charged to the Plan through a process known as ‘revenue sharing,’ which occurred through a largely automated process.”
During the relevant period, CNB was also recordkeeper for over 200 other plans. It did not, however, “maintain a system for tracking how much time its employees specifically spent servicing the [City National] Plan.” Rather, as the lower court found, “City National … received compensation from the Plan in a mostly automated process without tracking direct expenses or knowing how much direct expenses were required for the Plan’s operation, such that City National could not ensure that it was receiving reimbursement for no more than direct expenses.”
Self-dealing violation
DOL sued City National in 2015, alleging that this fee arrangement violated ERISA’s prohibition on self-dealing. The lower court granted DOL summary judgment on this issue, and the Ninth Circuit affirmed, holding that (as discussed above) ERISA’s prohibited transaction exemption for “reasonable compensation” for the provision of services is not available for fiduciary self-dealing.
Calculation of damages
As noted, CNB had calculated the amount that it charged to the plan for its services simply as a portion of mutual fund revenue sharing payments. The lower court calculated damages based on this amount plus “opportunity costs” – “the money that the Plan would have earned had the Plan, and not City National, received these revenue sharing payments and invested the proceeds.” That total amount (around $8 million) was then reduced by “offsets” for (actual) plan expenses.
In this regard, the Ninth Circuit (affirming the lower court) denied any offset for the compensation of City National employees who provided services to the plan. In support of this conclusion, the court discussed DOL Advisory Opinions on when expenses for employee compensation may be allocated to and reimbursed by the plan. And the court rejected the “speculation” of defendants’ expert that “five or six employee positions would have been eliminated but for their work on the Plan” as inadequate to verify the allocation of expenses.
Tracking allocable employee compensation
In discussing what sort of employee compensation expenses might be offset, the court quoted a DOL Advisory Opinion stating that employee salaries “may be a properly reimbursable expense . . . [1] if the expense would not, in fact, have been sustained had the services not been provided, [2] if it can be properly allocated to the particular services provided, and [3] if the expense does not represent an allocable portion of overhead costs.”
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Payment of expenses to the plan sponsor are typical of the fee cases brought against financial services companies with respect to in-house plans. But they may also be an element of complaints brought against non-financial services companies, where the sponsor charges back certain direct expenses. Certainly, plaintiffs lawyers are going to scrutinize those sorts of charge-back arrangements when they are preparing a fee complaint.
Thus, while there is no question that charging back expenses to the plan is permitted in certain circumstances, there are relatively tight rules about what can be charged back and about how the arrangement should be documented. Sponsors charging back expenses (or considering doing so) will want to consult with counsel concerning compliance with those rules and the risks they present.