401(k) Plan Fees in Turmoil: District Court in Tussey Finds Fiduciary Breaches but Third Circuit in Renfro Holds There Are None

There have been several recent court decisions of interest in some of the well-publicized lawsuits contesting the investment selections and the fees charged in a number of large corporate 401(k) plans. Sometimes reaching very different outcomes, these decisions concern the use of retail mutual funds in large plans, alleged breach of fiduciary duties in the selection and monitoring of investments and plan fees, and the scope of protection available to fiduciaries under ERISA Section 404 (c). As these cases progress, the choice of defendants, theories of liability and defenses evolve and certain key issues remain unresolved. Two recent decisions in Tussey v. ABB, Inc. and Renfro v. Unisys Corp. highlight how courts have reached vastly different outcomes on somewhat similar issues.

Tussey v. ABB, Inc.
On March 31, 2012, the District Court of the Western District of Missouri in Tussey v. ABB, Inc. held in a lengthy 81-page decision that ABB, Inc.’s plan fiduciaries breached their fiduciary duties to ABB’s 401(k) plans by failing to monitor recordkeeping expenses, negotiate rebates, and prudently select investment options. As a result of these breaches, the Court awarded the plan participant plaintiffs $36.9 million in damages.

Participants in the Personal Retirement Investment Savings Management Plan (the “Main PRISM Plan”) and the Personal Retirement Investment and Savings Management Plan for Represented Employees of ABB, Inc. (the “Union PRISM Plan”) (collectively, “PRISM Plan” or “PRISM Plans”) brought this action against the following parties:

  • ABB, Inc., the plan sponsor of the PRISM Plans
  • The Employee Benefits Committee of ABB, Inc., a three-member committee that oversees all of ABB’s employee benefit programs and the named administrator of the PRISM Plans;
  • The Pension Review Committee of ABB, Inc., a named fiduciary of the PRISM Plans and responsible for selecting and monitoring the Plan’s investment options
  • Fidelity Management Trust Company (“Fidelity Trust”), the recordkeeper and trust provider for the PRISM Plans
  • Fidelity Management & Research Company (“Fidelity Research”), the investment adviser to the Fidelity mutual funds that are offered through the PRISM Plans

Through the duration of its relationship with ABB, Inc., Fidelity Trust was paid in two different ways. First, Fidelity Trust was paid a per participant, hard dollar fee. By April 2001, however, Fidelity Trust was primarily paid with revenue sharing. The court described revenue sharing as an arrangement by which a recordkeeper is paid a percentage of the revenue a mutual fund makes from plan participants who choose the mutual fund. Under the revenue sharing arrangement, Fidelity Trust’s fees grew as the assets of the PRISM Plans grew, regardless of whether any additional services were provided by Fidelity Trust. In addition, when there was concern that the revenue would decline, Fidelity Trust would ask for hard dollars to make up the difference.

Fidelity’s relationship with ABB was not limited to the PRISM Plans. Fidelity also handled ABB’s payroll, and recordkeeping for ABB’s health and welfare plans and other retirement vehicles for highly compensated employees.

Plaintiffs brought the following claims for breach of fiduciary duty against the defendants:

  • Failure to monitor recordkeeping fees and revenue sharing
  • Failure to prudently select and de-select investments
  • Improper subsidization of administrative expenses through excessive revenue sharing
  • Failure to provide sufficient separate accounts and co-mingled funds
  • Improper use of float income

The key findings of each of these claims are discussed in turn below.

Key Findings
Failure to Monitor Recordkeeping Fees and Revenue Sharing

The Court began by finding that the ABB defendants breached their fiduciary duty to the PRISM Plans by failing to monitor recordkeeping costs and by failing to comply with the Investment Policy Statement that stated that “at all times…rebates will be used to offset or reduce the cost of providing administrative expenses to plan participants.”

Beginning in April 2002, Fidelity Trust was solely compensated for its services to the Main PRISM Plan through revenue sharing and was compensated for its services to the Union PRISM Plan through revenue sharing and an $8 per-participant fee. While the Court was careful to acknowledge that the use of revenue sharing arrangements to pay for plan costs and fees is generally an acceptable practice in the investment industry, the Court found, in this instance, that ABB breached its fiduciary duties with respect to the revenue sharing arrangement because ABB’s primary motivation to use revenue sharing was to decrease ABB’s fee obligations, which the Court determined was not in the best interest of plan participants.

In reaching this holding, the Court relied on the fact that ABB never calculated the dollar amount of the fees the PRISM Plans paid to Fidelity Trust nor did it consider how the Plan’s size could be leveraged to reduce costs. Also, ABB did not get a benchmark of costs for Fidelity’s services before choosing the revenue sharing arrangement, and failed to advocate for a better arrangement even after a third-party consultant told ABB that it was overpaying for its recordkeeping services.

The Court rejected ABB’s argument that the revenue sharing arrangement was prudent because such arrangements permit risk sharing between Fidelity and the PRISM Plans.

The Court found that the risk in this case was borne by ABB alone because while Fidelity reduced its exposure when revenue sharing declined by requesting hard-dollar fees, ABB never determined how much revenue sharing was collected and, because of that, was never in the position to ask for a rebate from Fidelity when the value of the revenue sharing exceeded the cost of the recordkeeping services provided.

The Court also rejected ABB’s argument that its monitoring of the overall expense ratio of the funds was sufficient because this monitoring did not show how much revenue Fidelity Trust was receiving or provide a basis for ABB to compare its revenue sharing arrangement to the market. The Court found that this basic understanding of the revenue sharing was critical because the Investment Policy Statement provided that at “all times…rebates will be used to offset or reduce the cost of providing administrative expenses to plan participants.” Accordingly, the Court also held that ABB violated its Investment Policy Statement because it did not use rebates or revenue sharing to offset the cost of the Plan’s administrative expenses. Nor could it do so because ABB did not calculate the dollar amount of the recordkeeping fees and, therefore, could not know whether the revenue to Fidelity exceeded the costs of its services.

In reaching its conclusions with respect to revenue sharing and recordkeeping fees, the Court emphasized that “if a plan sponsor opts for revenue sharing as its method for paying for recordkeeping services, it must not only comply with its governing documents, it must have gone through a deliberative process for determining why such choice is in the Plan’s and participants’ best interest” (emphasis added).

Selectction and De-selection of Investments
Next, the Court found that ABB’s decisions regarding the selection and de-selection of investments in the PRISM Plans were improperly influenced by conflicts of interest. Specifically, the Court found that ABB defendants breached their fiduciary duties in:

  • the de-selection of the Vanguard Wellington Fund and the selection of the Fidelity Freedom Funds; and
  • the decision to select or keep more costly classes of investments on the Plan’s investment platform when less expensive classes of those same investments were available.

The Court determined that ABB’s decision to remove the Vanguard Wellington Fund from the investment platform violated the Investment Policy Statement, which specifically outlined the process for de-selection of a fund. The process required ABB to examine the fund’s performance over a three to five-year period to determine if the fund was underperforming and, if so, to place the fund on a watch list and remove the fund in six months if the performance did not improve. The Court found that ABB did not follow these procedures but instead relied on the recommendation of one Committee member who failed to present any evidence to support his position to remove the Vanguard Wellington Fund.

In addition, the Court also found that ABB breached its fiduciary duties to the PRISM Plans in its selection of the Fidelity Freedom Funds to replace the Vanguard Wellington Fund. The Investment Policy Statement also sets forth a detailed process for selection of funds. However, ABB conducted only scant research on the Fidelity Freedom Funds. Moreover, the Court found that ABB’s decision to select the Fidelity Freedom Funds appeared to be more motivated by the desire to reduce ABB’s recordkeeping fees than out of concern for the best interests of the PRISM Plans and their participants. Under the collective bargaining agreement, ABB paid the difference between the hard-dollar fees charged to the Union PRISM Plan and the Main PRISM Plan. Therefore, it was in ABB’s interest to maintain low hard-dollar costs for the Union PRISM Plan because any difference in fees was paid by ABB. By switching from the Vanguard Wellington Fund to the Fidelity Freedom Funds, ABB could reduce its hard-dollar costs. However, the desire to reduce hard-dollar costs was in direct conflict with the vast discrepancy in expense ratios between the Vanguard Wellington Fund, which had a competitive expense ratio and charged only 15 basis points in revenue sharing, and the Fidelity Freedom Funds, which charged 35 basis points.

The Court also found that ABB’s selection of more expensive share classes for the Plan’s investment platform, when less expensive shares were available, also resulted in a breach of fiduciary duty. The Investment Policy Statement stated that “[w]hen a selected mutual fund offers ABB a choice of share classes, ABB will select that share class that provides Plan participants with the lowest cost of participation.” The Court found that ABB failed to follow its Investment Policy Statement because ABB’s selection of funds was motivated primarily by the method of compensation of revenue sharing proceeds and not by what was in the best interest of participants, and, therefore, was a breach of fiduciary duty.

Subsbsidizatation of Admdministstratative Expensnses with Excessive Revenue Sharing
Next, the Court held that the ABB defendants breached their fiduciary duty to the PRISM Plans by knowingly overpaying Fidelity Trust for its recordkeeping services via a revenue sharing arrangement as a means to subsidize services to ABB’s corporate plans. The Court found that ABB was on notice of this excessive revenue sharing because Fidelity Trust had informed them that they would not charge fees for ABB’s corporate plans so long as the revenue generated by recordkeeping the PRISM Plans remained constant, and because ABB received a report from a third party consultant that opined that the PRISM Plans were subsidizing ABB’s corporate services. Despite this knowledge, ABB continued to receive discounted services on its corporate plans and made no effort to investigate.

Use of Separate Accounts and Commingled Funds
Plaintiffs argued that ABB violated its fiduciary duties by failing to offer more separate accounts or commingled funds on the PRISM Plans’ platforms. The Court, however, rejected this argument, holding that ABB’s decision to limit the number of commingled and separate accounts was prudent and did not violate the Investment Policy Statement. Unlike other instances, the Court found that ABB undertook a deliberate decision-making process in choosing not to offer additional separate accounts and commingled funds. In addition, the Investment Policy Statement only required the PRISM Plans to have commingled funds and not separate accounts.

Use of Float
Finally, the Court, in its only finding against Fidelity Trust and Fidelity Research, found that both breached their duty to the PRISM Plans by failing to use float income exclusively for the benefit of participants and beneficiaries or to defray the cost of plan administration. Float income is the interest earned during the transfer process when contributions are held in a temporary account pending transfer. Here, Fidelity Research managed the Plan assets that were held in temporary overnight accounts that were then transferred to a separate account with Fidelity Operations. The float income that was earned in the temporary account was then used to pay Fidelity Trust’s operating expenses for recordkeeping and administering the PRISM Plans, and the remainder was distributed pro rata to all shareholders of that particular investment option and not solely to participants in the PRISM Plans. As a result, the Court found that Fidelity Trust was earning more income than was provided for by the Trust Agreement. Also, because float income is a plan asset, the Court found that Fidelity Trust and Fidelity Research breached their fiduciaries duty by distributing the float income to non-plan participants instead of PRISM Plan participants only.

Renfro v. Unisys
In stark contrast to the result in Tussey, the Third Circuit Court of Appeals in Renfro v. Unisys found that the plan sponsor, Unisys Corporation, did not violate its fiduciary duty in its selection of investment options for the Unisys plan. Here, the plaintiffs sued Unisys Corporation and Fidelity Management Trust Company, the recordkeeper and directed trustee for the Unisys 401(k) plan, alleging, in general, that the defendants had inadequately selected a mix and range of investment options offered to participants under the plan. The aspect of the choice of investment options in the Unisys plan that was a focus of the claims in this case was the use by the plan of retail mutual funds. At the time of the filing of the complaint, there were 73 investment options available under the plan, including a stable value fund, an employer stock fund, four commingled funds through Fidelity and 67 Fidelity mutual funds. The plan’s trust agreement with Fidelity provided that the mutual funds in the plan had to be Fidelity funds unless they were to be administered by Unisys or another recordkeeper. The funds had a variety of risk factors and the expense ratios for the funds ranged from 0.1% to 1.21%. All of the fund fees were disclosed in communications to the plan participants and about $1.9 billion of the plan’s approximately $2.0 billion in assets were invested in the Fidelity mutual funds.

The operative complaint in the case alleged that the defendants had breached their fiduciary duties of loyalty and prudence under ERISA by including retail mutual funds as investment options under the plan. The assertions included that the fees charged by the retail mutual funds, which are available to small individual investors as well as to investors such as large 401(k) plans, were excessive compared to other investments available to large investors. The plaintiffs contended that Unisys could have selected investment vehicles with lower costs than the retail funds, or negotiated lower expense ratios on the funds due to the size of the plan’s assets.

The defendants moved the District Court to dismiss the complaint under the heightened pleadings standards set out by the Supreme Court in the Twombly and Iqbal cases. The defendants argued that the plaintiffs had not plausibly alleged a breach of fiduciary duty, citing the decision of the Seventh Circuit Court of Appeals in Hecker v. Deere & Co. See our March 2009 issue. The Fidelity defendants also moved to dismiss the complaint on the grounds that they were not fiduciaries with respect to the conduct at issue. The District Court granted the motions to dismiss finding that:

  • the Fidelity entities were not fiduciaries as to the challenged actions as Fidelity did not exercise control over the choice of investment options in the plan; and
  • the complaint failed to state a claim for relief because the plan offered a sufficient mix of investments such that no rational finder of fact could find that the defendants breached their ERISA fiduciaries by providing the particular array of investment vehicles in the plan.

The Third Circuit upheld the dismissal of Fidelity finding that, as a directed trustee under the terms of the trust agreement, it did not function as a fiduciary as to selecting and maintaining the investment options under the plan. The appeals court also rejected the plaintiffs’ claim that Fidelity was liable on the basis that Fidelity did not owe a fiduciary duty with respect to the negotiation of its fees with Unisys, and that Fidelity was not a plan fiduciary when it negotiated the trust agreement with Unisys. With respect to an allegation of co-fiduciary breach, the court found that the complaint did not plead that Fidelity had actual knowledge of the alleged breach of fiduciary duty by Unisys in the decision making process as to which investment options were to be included under the plan. Finally, the Court considered a claim by the plaintiffs against Fidelity for restitution under ERISA Section 502(a)(3), but it found that Section 502(a)(3) does not authorize suits against non-fiduciaries charged solely with participating in a fiduciary breach. As the Court had previously held that Fidelity and its related entities did not act as fiduciaries concerning the challenged investment choices, it ruled that they could not be sued under Section 502(a)(3) for acts taken in a non-fiduciary role.

The Third Circuit then examined the plaintiffs’ allegations to Unisys’ selection and periodic evaluation of the “mix and range” of the plan’s investment menu. There was no claim that any particular investment option was an imprudent investment selection for the plan. Instead, the plaintiffs challenged the general use of retail mutual funds that were available on the same terms to individual investors on the open market. There were also allegations that the mutual fund fees were excessive in relation to the value of the services rendered compared to other mutual funds and other available types of investment vehicles. The plaintiffs, in particular, challenged the expense ratio nature of the mutual fund fee structure under which the fees are determined as a percentage of the total assets in the fund. They asserted the services necessary to service a mutual fund do not vary with the amount of the assets under management and that the fees should have been calculated on a per-participant basis. Finally, the plaintiffs argued that the use by the plan of other types of investment vehicles, such as the commingled funds, demonstrated that the mix and range of investment options that mainly included mutual funds was imprudent.

The Court framed its analysis of the plaintiffs’ claims as to the choice of plan investments by Unisys as whether the plaintiffs had “plausibly pleaded a breach of fiduciary duty” in light of the composition of the mix and range of investment options under the plan. The Court noted that other U.S. Circuit Courts of Appeal had previously considered the same issue using a similar analysis. For instance, the Seventh Circuit in Hecker and the Eighth Circuit in Braden v. Walmart both examined the mix and range of investment options and then evaluated the plausibility of the claims challenging fund selection, with the Hecker court ultimately holding that the plan fiduciaries had not breached their fiduciary duties with respect to fund selection. Similarly here, the Third Circuit held that “[i]n light of the reasonable mix and range of investment options in the Unisys Plan, plaintiff’s factual allegations about Unisys’s conduct do not plausibly support their claims.”

The Third Circuit did not resolve a dispute as to whether Section 404(c) of ERISA can insulate a fiduciary from liability for its investment selections. Section 404(c) states:

(A) In the case of a pension plan which provides for individual accounts and permits a participant or beneficiary to exercise control over the assets in his account (as determined under regulations of the Secretary) —


(ii) no person who is otherwise a fiduciary shall be liable under this part for any loss, or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control…

There is an ongoing conflict between some federal courts and the U.S. Department of Labor (“DOL”) regarding whether Section 404(c) can protect a fiduciary from liability for its investment selections. For example, the Fifth Circuit in Langbecker v. Electronic Data Systems Corp. determined that Section 404(c) could be a defense to claims of imprudent investment selections, whereas the DOL has published regulations stating that Section 404(c) is not such a defense. The Third Circuit opted not to opine on the matter because the complaint was dismissed.

Plan Implications Following Tussey and Renfro

Overall, the courts’ decision in Tussey and Renfro appear to show that the court’s outcome is less dictated by the choices made by plan fiduciaries than by the thoroughness and care by which the plan fiduciaries investigated, considered and compared their investment selections and fees. Accordingly, as these cases demonstrate, it is critical for plan sponsors to understand and follow their plan’s investment policy procedures and guidelines, to understand their plan’s fees and compare them to the marketplace, to document all actions taken with respect to investment selections and plan fees, and to act for the exclusive benefit of plan participants and beneficiaries.