On March 19, 2018, the District Court for the Northern District of Illinois, in Scott v. Aon Hewitt Financial Advisors, et al., dismissed plaintiff’s claims against Aon Hewitt (Hewitt) and Aon Hewitt Financial Advisors (AFA) that investment advice arrangements between Hewitt, AFA and Financial Engines violated ERISA’s fiduciary and prohibited transaction rules.
In this article we review the court’s decision.
The decision is complicated and a little unclear in places. Before getting into the details, we begin with the key points:
The case is one of a series of lawsuits involving the same plaintiffs’ law firm (see, e.g., Fleming v. Fidelity which we wrote about in 2017) challenging arrangements between recordkeeping platform providers (in this case, Hewitt) and Financial Engines. Under these arrangements, generally, FE pays a fee to the recordkeeper, and plaintiffs in these suits are claiming that payment of that fee violates ERISA.
Plaintiffs have lost all the cases decided thus far. Generally, the courts have found (1) that the recordkeeper (and where relevant its affiliates) were not fiduciaries, at least not with respect to the receipt of payments from FE, and (2) that the terms of the FE arrangement were ultimately approved by the plan fiduciary.
Plaintiffs’ prohibited transaction claims generally fail because (1) there is no fiduciary (with respect to the recordkeeper/FE arrangement), (2) the payments do not involve plan assets, (3) the arrangement (as in this case) is structured so that payments are made by the recordkeeper to FE rather than the other way around and/or (4) no proper allegation was made that the compensation paid by the plan to FE for advice services was unreasonable.
One of the most interesting aspects of Scott v. Aon Hewitt is the court’s articulation of the standard for “reasonable compensation”: the court held that reasonableness of compensation is a “fair market standard,” and that it is applied to the services as bundle – “there is no requirement to allocate specific compensation to specific services.” Thus, how two service providers divide up fees for a bundle of services is irrelevant. What matters is whether “the total compensation paid by the Plan for the bundle of investment advisory services” (emphasis added) exceeds their fair market value.
None of the foregoing means that there cannot be unreasonably priced investment advisory services that flunk ERISA’s fiduciary rules. But, with the courts rejecting claims against providers, plaintiffs’ lawyers may target plan fiduciaries in subsequent lawsuits.
In what follows we review the case in detail.
Plaintiff is a participant (as a retired former employee) in the Caterpillar 401(k) Retirement Plan. According to the court, Financial Engines (FE) provided “investment advisory services” to plan participants (including plaintiff) through two different arrangements
Arrangement 1: From 2012 to 2014, Caterpillar hired FE to provide participant investment advice services directly and paid a portion of the fees that it received from the plan to Hewitt. To be clear: under this arrangement the plan paid fees to FE, and then FE paid fees to Hewitt.
Arrangement 2: Beginning in 2014, Caterpillar contracted with AFA to provide investment advice services, and then AFA subcontracted with FE to provide them. Under this arrangement the fee flow reversed: the plan paid fees to AFA, and then AFA paid fees to FE.
According to the court (citing plaintiff’s complaint), under both of these arrangements, FE “needed access to the participants’ 401(k) accounts to obtain investment related information and to implement the participants’ chosen investment strategies. … Hewitt provided and facilitated that access so that Financial Engines, AFA, and the Plan participants had secure access to the necessary information to make contribution allocations and investment elections and to process the participants’ investment choices.”
According to plaintiff’s complaint, Hewitt and AFA breached their ERISA fiduciary duty of loyalty by “(a) devising an arrangement with Financial Engines for the purpose of collecting and paying to Defendants unreasonable and excessive fees for services provided by Financial Engines, at the expense of [the plaintiff] and participants and the Plan and Plans generally, and concealing the true arrangement from [the plaintiff], the Plan and Plans; and (b) charging unreasonable and excessive fees for the services provided to Financial Engines in connection with Financial Engines’ investment advice program.”
Plaintiff also claimed that these arrangements violated ERISA’s prohibited transaction rules in several respects.
The court’s decision – fiduciary breach
Plaintiff claimed that Hewitt and AFA were fiduciaries because they: (1) purported to provide investment advice for a fee; (2) hired FE and controlled the negotiation of FE’s contract; and (3) selected FE as an advice provider.
With respect to the claim that Hewitt was an “advice fiduciary,” the court applied the pre-Fiduciary Rule 5-part test. The court found that plaintiff’s complaint did not allege that Hewitt provided “individualized investment advice to the Plan on a regular basis pursuant to a mutual agreement that its advice would serve as a primary basis for the Plan’s investment decisions,” and that therefore Hewitt was not an advice fiduciary.
With respect to the claim that Hewitt controlled the plan’s relationship with FE, the court found that plaintiff’s “conclusory allegations that Hewitt controlled Caterpillar’s decision to engage Financial Engines are contradicted by the Hewitt/Financial Engines Master Service Agreement.” That agreement “provides that ‘[t]he decision to engage Financial Engines … shall be made independently by the [plan sponsor] and each participant,’ and it strictly prohibits Hewitt from ‘negotiat[ing] the terms of any agreement between Financial Engines and a plan sponsor or participant.’”
The court acknowledged that AFA was an advice fiduciary but found that it was not a fiduciary with respect to its arrangement with FE. The decision is a little unclear at this point, but the court does hold both that (1) “a fiduciary’s negotiation of its own compensation is a nonfiduciary act as a matter of law” (citing Hecker v. Deere), and (2) that “a decision which is strictly a corporate management business decision [in this case, “AFA’s hiring of Financial Engines to provide subadvisory services”] … impose[s] no fiduciary duties.”
Thus the court concluded:
In this case, AFA is a fiduciary only for the purpose of providing investment advice. AFA, therefore, only can be liable for breach of fiduciary duty to the extent that it engaged in misconduct in carrying out its sole fiduciary function, which is rendering investment advice. … AFA did not have any fiduciary duty to Plan participants during its arms length negotiations with Caterpillar regarding its compensation or when AFA hired Financial Engines as a subadvisor.
The court did seem to indicate, however, that if plaintiff could amend her complaint to show facts supporting her allegation that Hewitt “controlled Caterpillar’s decision to engage Financial Engines,” her claim might possibly be revived.
Prohibited transaction claims
Plaintiff alleged several breaches of ERISA’s prohibited transaction rules. These claims and the arguments with respect to them are technical. Reviewing them very briefly:
Receiving unreasonable compensation with respect to services: Generally, under ERISA’s prohibited transaction rules, plan-service provider arrangements are subject to a “reasonable compensation” standard.
With respect to Arrangement 1, the court found that the transaction (between Hewitt and FE) could not be a prohibited transaction because it was not caused by a fiduciary (since Hewitt was not a fiduciary). Moreover, it did not involve the plan – it was between Hewitt and FE.
With respect to Arrangement 2, the court, citing DOL’s Best Interest Contract Exemption under the Fiduciary Rule, held that reasonableness of compensation “is a fair market standard,” and that “there is no requirement to allocate specific compensation to specific services.” Thus, allegations that the payments from FE to Hewitt were unreasonable are irrelevant, and the court dismissed this claim because plaintiff did not “allege that the fees paid exceeded the fair market value of the services [that is, the participant advice services] provided.”
Fiduciary kickback: Generally, under ERISA’s prohibited transaction rules, a fiduciary may not receive “consideration for his own personal account” from someone dealing with a plan (in effect, a kickback). With respect to Arrangement 1, the court dismissed this claim because Hewitt was not a fiduciary. With respect to Arrangement 2, the court dismissed this claim because (as noted above), there were no kickbacks: under Arrangement 2, the plan paid AFA, and then AFA paid FE, not the other way around.
Significance for sponsors
To repeat what we said at the beginning of this article, the fact that courts are dismissing these cases against providers does not mean that a participant advice arrangement cannot violate ERISA. Indeed, it is certainly possible that such an arrangement could be unreasonably priced.
In this regard perhaps the most interesting language in the decision was the court’s explanation of the “reasonableness” standard in this context: (1) The analysis is to focus on the fair market value of the (2) the services as a bundle, (3) not on how the two service providers – the recordkeeping platform provider and the advice provider – divide up the total fee.
Moreover, where sponsor fiduciaries authorize an arrangement that does involve unreasonable fees, they may be held responsible for the fiduciary breach – imprudently causing the plan to enter into an arrangement with unreasonable fees.