Home Depot court finds for defendants on monitoring of Financial Engines investment advice arrangement

We recently discussed the September 30, 2022, decision in Pizarro v. The Home Depot by the United States District Court for the Northern District of Georgia, in which the court found for defendant plan sponsor/sponsor fiduciaries on cross-motions for summary judgment with respect to all plaintiffs’ claims. Our earlier article discussed the court’s decision on plaintiffs’ claim that the retention in the plan fund menu of the BlackRock Target Date Funds violated ERISA prudence standards (plaintiffs alleged those funds had “underperformed” comparators). In this article we discuss another important issue in the case, plaintiffs’ claim that plan fiduciaries failed to prudently monitor fees under the plan’s advice arrangement with Financial Engines and (subsequently) Alight Financial Advisors. This is one of the few decisions we’ve had on the substance of this issue and includes some significant guidance for 401(k) plan sponsors that include in their plan an advice service for plan participants.

Background

With respect to this element of Pizarro, plaintiffs claimed that “Home Depot Defendants imprudently failed to investigate and monitor unreasonably high fees for Professional Management charged by FE and AFA, and that FE’s and AFA’s collection of a data connectivity fee, which they partially remitted to Aon Hewitt [the plan’s recordkeeper and predecessor to Alight], amounted to a kickback.”

This element of the case is similar to other “pay to play” cases that have been brought with respect to FE management services and fees that FE pays recordkeepers in connection with those services.

Generalizing, under some FE/recordkeeper arrangements, FE is hired by the plan and pays a portion of the fees that it receives to the platform provider. In others, the platform provider contracts directly with the plan and then subcontracts with FE to provide the actual advice services. In Pizarro, at the beginning of the relevant period FE provided direct services to the plan; that arrangement was later reconfigured to one in which AFA had the direct contractual relationship and subcontracted services from FE.

Either way, in these arrangements, some portion of the fee paid for advice services goes (it is alleged) to the platform provider, while all advice services are provided by FE. Plaintiffs (here and in other “pay to play” cases) claim that the fee paid to (or retained by) the recordkeeping platform provider with respect to advice services violates ERISA, typically characterizing it as an illegal “kickback.”

The Home Depot/FE/recordkeeper arrangement

In Pizarro, defendants argued that these fees are not kickbacks at all but instead are necessary “data access” and “data connectivity” fees that allowed FE to integrate plan data (developed by the recordkeeper) about the participant that significantly increased uptake of FE advice services. Under a prior advice arrangement with Merrill Lynch, in which participants had to input relevant personal data, only 1.5% of eligible participants took advantage of Merrill Lynch’s advice service. Under FE’s integrated arrangement with the recordkeeper, FE was able to “implement … its advice in real time without the need for Plan participants to serve as ‘middlemen.’” As a result (defendants claimed), the percentage of participants using advice services increased significantly.

The existence of this FE/recordkeeper fee arrangement, the fact that FE charged an asset-based fee for its services, the (alleged) existence of other advice providers with lower fees, and defendants’ (alleged) failure to implement a formal RFP process in selecting an advice provider, provided the basis for plaintiffs’ claim that the plan fiduciaries failed to prudently monitor the cost of the FE/AFA advice arrangement.

Procedural prudence

The discussion in our prior article of the difference between motions to dismiss (the typical posture of 401(k) prudence litigation) and motions for summary judgment also applies to the court’s decision on this issue. And the court’s conclusion – finding that defendants did breach their duty of “procedural prudence” but granting defendants’ motion for summary judgment on the basis of “objective or substantive prudence/loss causation” – is the similar.

With respect to the plan fiduciaries’ “procedural prudence” – whether they used a prudent process to arrive at the decision to retain FE and AFA and to enter into the fee arrangements with them that they did – the court accepted earlier findings by U.S. District Court Judge William M. Ray, II (who, before he recused himself on March 4, 2022, had been the presiding judge in this case). Judge Ray had found that:

• As to Home Depot Defendants’ ongoing process for monitoring the fees charged by FE and by AFA, Plan Committee meeting minutes suggest: … that the fiduciaries neither investigated nor discussed whether the asset-based fee rate FE or AFA charged was reasonable relative to the services they performed;
• As to the reasonableness of FE’s and AFA’s fees, readily available public documents suggested that FE and AFA operate in a highly competitive market, that other service providers offered comparable investment advisory services at lower rates than those FE and AFA charged, and that FE and AFA charged lower rates to other plans they serviced;
• As to the alleged “kick-back” arrangement between FE and Aon Hewitt, Curcio Webb cautioned Home Depot Defendants that they should monitor the arrangement closely to ensure the fees FE remitted to Aon Hewitt were not “unreasonably high”; and
• Regarding the retention of AFA after the “kick-back” payments were eliminated, evidence that Home Depot Defendants did not engage in a competitive bidding process, conduct a market survey of fees, or inquire into whether the fees charged by AFA were reasonable.

The court found that these facts (as found by Judge Ray) were sufficient to prove a breach of the fiduciaries’ duty of “procedural prudence.”

But (as with respect the BlackRock TDFs), the court emphasized that a finding of summary judgment for plaintiffs also required a showing of “loss causation.” Before we discuss that element of the court’s decision (which was in favor of defendants), however, we want to pause and review the court’s finding on procedural prudence, because it gives some clear guidance as to what exactly courts (or at least this court) believe plan fiduciaries are required to do with respect to advice arrangements.

Guidance for sponsors – standards for fiduciary review of advice arrangements

Unlike the court’s decision with respect to the retention of the BlackRock TDFs, where it found that both parties had demonstrated genuine issues of fact with respect to the prudence of The Home Depot plan fiduciaries’ review/monitoring of those funds, here the court did find that the fiduciaries’ review/monitoring of the FE/AFA advice arrangement was inadequate. Thus, the court’s holding provides some insight for sponsors about what they should be doing when they hire/retain/monitor an advice provider.

Repeating/summarizing the court’s decision in this regard, fiduciaries should:

• Investigate and discuss whether an asset-based or per capita fee is appropriate, “relative to the services … performed” and (we would add) relative to account size (a point defendants raised).
• Compare the fees charged by comparable service providers and ask for information about the fees paid by other, comparable sponsors.
• Monitor any fee arrangement between the advice provider and the recordkeeper to make sure payments to the recordkeeper are not “unreasonably high.”
• Undertake (on some reasonable basis) an RFP/competitive bidding process or survey of market fees or otherwise investigate whether the provider’s fees are reasonable.

Objective or substantive prudence/loss causation

Notwithstanding their procedural imprudence, as we noted at the top, defendants won this case. And they won it on the same basis they won with respect to the BlackRock TDFs: the court found that, even though defendants had not engaged in a prudent process with respect to the advice arrangement, a prudent fiduciary could have (nevertheless) entered into an identical arrangement. That is, the advice arrangement was “objectively prudent.” Briefly the court found (as a matter of fact) that:

Fees for advice both on a per capita- and on a basis points-basis were lower than the fees charged FE’s and AFA’s other clients.

Plaintiffs’ alleged comparators “were not apt for apples-to apples comparison based on the services they provided,” and plaintiffs offered “no evidence that any of these providers were both less expensive and satisfied the Plan’s goals as well as or better than FE and AFA.”

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With respect to the sponsor fiduciary obligation to review/monitor advice arrangements in a 401(k) plan, this case is interesting in two respects. First (and most importantly), it provides some substantive guidance (see above) as to what (practically) that obligation entails. Second, it underlines the point we made in our last article – even where the fiduciary fails to engage in a prudent process, “objective prudence” may be a defense. And, given that the facts developed with respect to this issue are “objective,” this pro-defendant argument may even be suitable for a defendant’s motion to dismiss.

We will continue to follow this issue.

This is a publication of O3 Plan Advisory Services. If you have any comments, or have questions about regulatory developments, please contact your relationship manager or Mike Barry at mbarry@octoberthree.com.    The information, analyses and opinions set out herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. Nothing herein constitutes or should be construed as a legal opinion or advice. You should consult your own attorney, accountant, financial or tax advisor or other planner or consultant with regard to your own situation or that of any entity which you represent or advise.   Information set out or referred to above has been obtained from sources believed to be reliable. However, neither O3 Plan Advisory Services nor any of its affiliates has verified the accuracy or completeness of any such information. All information is provided “as is” and O3 Plan Advisory Services and its affiliates expressly disclaim all express and implied warranties regarding the information. Neither O3 Plan Advisory Services nor any of its affiliates shall have any liability for any use of the information set out or referred to herein.