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In this article we review the areas of 401(k) sponsor-fiduciary practice that are current or emerging targets for plaintiffs’ litigators. We include in our discussion 401(k) fee suits recently filed against BB&T (Smith v. BB&T Corporation) and Fidelity (Fleming v. Fidelity Management Trust Company).
Typically, claims with respect to recordkeeping and administrative fees are brought where the fees were paid out of revenue sharing based on assets-under-management fees. While courts (and even plaintiffs’ lawyers) acknowledge that the use of revenue sharing and payment of administrative costs based in part on assets-under-management fees do not in themselves violate ERISA, plaintiffs’ claim (and courts seem to be agreeing) that the reasonableness of fees should be determined on the basis of a flat fee per participant. Quoting the case recently filed against BB&T Corporation (Smith v. BB&T Corporation):
The cost of providing recordkeeping services depends on the number of participants, not on the amount of money in participants’ accounts. … For this reason, prudent fiduciaries set recordkeeping fees on the basis of a fixed dollar amount for each participant in the plan, instead of a percentage of plan assets. Otherwise, as plan assets increase (such as through participant contributions and gain on investments), recordkeeping compensation increases without any change in recordkeeping services.
In this context, plaintiffs’ claim that plan fiduciaries violate ERISA when they:
Fail to monitor the amount of fees being paid for recordkeeping and administration and do not know how much, from year to year, is in fact being paid.
Do not solicit competitive bids – again quoting BB&T: “prudent fiduciaries of large 401(k) plans … put plan recordkeeping and administrative services out for competitive bidding at regular intervals of around 3 years.”
Allow the plan to overpay – typically plaintiffs compare fees paid by the defendants’ plan to those paid by other, similarly situated plans.
Claims with respect to investment fees are somewhat more problematic – the court of appeals in Tussey v. ABB reversed the lower court decision in favor of plaintiffs on this issue. That is because, generally, it’s harder to compare actively managed funds. In that context, plaintiffs have claimed that fiduciaries violate ERISA when they include a fund in the fund menu:
When there is an identical lower-priced fund available. Plaintiffs have had success with this claim where a retail fund share class is used and a lower-priced institutional share class is available. They are seeking to extend this theory of liability to the use of higher-priced institutional share classes (where a lower-priced institutional share class is available) and the use of mutual funds (where, allegedly, a lower-priced collective trust or separate account could have been used).
That both (i) is overpriced relative to other funds using a similar style and (ii) underperforms its benchmark.
Some elements of 401(k) fee litigation involve claims with respect to what funds (or what sorts of funds) are included in the plan’s fund menu. Ultimately, these claims are based on the plan fiduciary’s obligation, in a plan where participants are expected to choose their own investments, to create a fund menu that (quoting the Department of Labor’s 404(c) regulation) “in the aggregate enable[s] the participant … by choosing among [funds in the fund menu] to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant.”
Just what the plan fiduciary’s duty is here is still unclear. For instance, if a plan’s fund menu includes a set of low-/efficiently-priced options, may it also include options that are not the lowest-price-in-their-class but are nevertheless popular with participants? The John Deere 401(k) fee litigation (in 2009) raised this issue but did not satisfactorily resolve it. Two areas to watch:
Stable value vs. money market: Plaintiffs have, in several cases, claimed that it is an ERISA fiduciary breach to include a money market fund and not a stable value fund in the plan’s fund menu. As we have said before, whether a court will buy this argument remains to be seen – money market funds and stable value funds are investing in different slices of the investment frontier/yield curve. Neither investment strategy is per se imprudent. Why, under ERISA, one must be preferred over the other in a 401(k) plan fund lineup is not clear.
Brokerage window practice: While sponsor policy with respect to brokerage windows has not been an element of typical 401(k) fee litigation, issues raised in the case recently filed against Fidelity (as a provider, not as a sponsor-fiduciary) (Fleming v. Fidelity Management Trust Company) with respect to brokerage window fee practice may be of concern to sponsors. In that case, plaintiffs claimed, among other things, that Fidelity got an unreasonable amount of revenue sharing from, and favored higher-priced vs. lower-priced share classes of funds offered in, its brokerage window product.
To what extent does a plan sponsor have an obligation to review the pricing of window investments? We do not know, but sponsors will want to watch the development of the Fidelity case in this regard.
While company stock provides its own sub-area of defined contribution plan fiduciary litigation (stock-drop and reverse stock-drop cases), it also is a feature of some 401(k) fee litigation. Thus, the case recently filed against BB&T (Smith v. BB&T Corporation) includes allegations that cash drag and excessive fees (e.g., with respect to the money market fund used for un-invested cash) resulted in the plan’s (unitized) company stock fund underperforming BB&T stock “over one, five, and ten-year periods.”
Company stock cash drag was a focus of some of the early 401(k) fee cases. Especially where participant investments in company stock are significant, the performance of the plan’s company stock fund vs. actual company stock will be a focus of participants and, where the plan’s fund consistently underperforms, a litigation target.
With the finalization of DOL’s Conflict of Interest regulation, fiduciary investment advice is, obviously, a significant focus of providers, sponsors and even participants. It is as yet unclear how the new regulation will change plan practice and the economics of advice. But the case recently filed against Fidelity (noted above) raises certain issues that may ultimately be of concern to sponsors. That case alleges that:
[I]n order to be included as the investment advice service provider on Fidelity’s platform, [Financial Engines] agreed to pay – and is paying – Fidelity a significant percentage of the fees it collects from 401(k) plan investors …. These fees are not being paid for any substantial services being provided by Fidelity to FE or to participants of the Plans, but are instead being paid as part of a so-called “pay-to-play” arrangement; better described in the pejorative as a kick-back.
This is a lawsuit against Fidelity as a provider, not as a sponsor-fiduciary. But allegations that the assets-under-management fees Fidelity is being paid (with respect to the advice Financial Engines is providing) are unreasonable may present an issue for sponsors.
Cannot the same questions that are being asked with respect to the cost of recordkeeping services be asked about the cost of advice? Do sponsors know how much those fees are, who is receiving them and for what services? Should the portion of those fees that do not pay directly for advice (that is, e.g., the portion that FE is allegedly paying to Fidelity) be based on assets-under-management?
For sponsor-fiduciaries, the themes in current 401(k) fee litigation are:
Know how much the plan is paying.
Take steps to make sure that fees are competitive – know what similarly situated plans are paying and consider re-bidding on a regular basis.
Focus especially on revenue sharing and assets-under-management arrangements. Is there a rational basis for linking the amount of fees to the amount of assets?
The first round of 401(k) fee cases was brought in 2006, by the same law firm that is now suing BB&T in the case discussed in this article. In the 10 years since those first cases, plaintiffs’ lawyers have been relentless in identifying sponsor-fiduciary vulnerabilities. And they show no signs of letting up.
Bottom line: sponsors are going to have to be just as relentless in getting the best deal for their plan and for plan participants.
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We will continue to follow these issues.