Seventh Circuit Finds No Fiduciary Liability for Financial Service Provider Receiving Revenue Sharing
In Leimkuehler v. American United Life Insurance Co., 713 F.3d 905 (7th Cir. 2013), the Seventh Circuit Court of Appeals addressed the receipt by a 401(k) plan’s financial service provider of “revenue sharing” payments from mutual funds. The Seventh Circuit affirmed the district court’s award of summary judgment to the defendant financial service provider, finding that the provider was not a functional fiduciary under ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A). This decision sheds light on the potential liability facing financial service providers in the ongoing 401(k) fee litigation. Moreover, Leimkuehler expanded on the Seventh Circuit’s earlier decision in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), and affirmed that financial service providers are not ERISA fiduciaries when they engage in or make decisions about revenue sharing with the mutual funds offered in a 401(k) plan. However, financial service providers should take heed that this decision hints that the specter of liability still lurks. The Leimkuehler court indicated that financial service providers may be liable as ERISA fiduciaries if they effectively exercise any authority or control over 401(k) plan assets beyond the mere selection or offering of mutual fund options to plan sponsors, or the ministerial administration of plan assets. Thus, while Leimkuehler is a victory for financial service providers, it also serves as a warning and a guide for avoiding possible fiduciary liability.
Leimkuehler, Inc. (the “Company”) is a small Ohio-based company that manufactures prosthetic limbs and braces. Robert Leimkuehler (“Leimkuehler”) is the President of the Company and the only Trustee of the Leimkuehler, Inc. Profit Sharing Plan (the “Plan”). Leimkuehler brought suit on behalf of the Plan against American United Life Insurance Co. (“AUL”) for breach of fiduciary duty under ERISA for engaging in revenue sharing with certain mutual funds included in the Plan’s portfolio.
AUL provides many services to the Plan, including the use of a group variable annuity contract which allows Plan participants to indirectly invest their 401(k) contributions in mutual funds. AUL created a “separate account” for the Plan. The participants’ contributions are deposited in the account and are then invested in the participant selected mutual funds by AUL. After investing the participant’s funds, AUL credits the proceeds of the investments back to the participant.
With the creation of the separate account, AUL eliminated the need for the Plan’s mutual funds to keep track of and service all of the participants’ individual accounts. Instead, AUL performs many of the administrative services that the mutual funds would normally handle. In order to cover the costs of providing the administrative services to the Plan participants, AUL either directly bills the Plan sponsor, or engages in revenue sharing with the mutual funds, whereby the funds pay a portion of the fees they would typically charge investors for the servicing of their accounts as compensation to AUL. Typically, the more a service provider receives in revenue sharing, the less the plan sponsor or participants are charged directly for servicing the accounts.
Claims of Fiduciary Liability
Leimkuehler brought suit against AUL for breach of fiduciary duty, alleging that AUL’s revenue sharing practices caused the Plan to pay excessive fees for the investment and administrative services provided by AUL. AUL is not a named fiduciary under the Plan, and thus the threshold question facing the court was whether a financial service provider acts as a “functional fiduciary” under ERISA in this situation. A person is a functional fiduciary, in relevant part, to the extent he or she “exercises any authority or control respecting management or disposition of [plan] assets.” 29. U.S.C. § 1002(21)(a).
Leimkuehler first argued that AUL’s involvement in selecting the Plan’s investment “menu” involved fiduciary action. AUL created a “menu” of approximately 380 mutual funds that Leimkuehler, as the Trustee, could review for inclusion in the Plan. When creating this menu, AUL also selected the share class of each mutual fund, with each share class having a corresponding level of revenue sharing. From this menu, Leimkuehler selected the mutual funds he wanted to include as the Plan’s investment options. Leimkuehler contended that AUL exercises authority or control over the management or disposition of the Plan’s assets by selecting the mutual fund share classes with their corresponding costs, to include in the “menu.” Essentially, Leimkuehler alleged that by limiting the universe of funds and share classes, AUL acted as a fiduciary. The Seventh Circuit rejected this theory, holding that their prior decision in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), was controlling. The Hecker court held that the mere act of creating a list of mutual funds for inclusion in a plan by a financial service provider was insufficient to create any fiduciary responsibility. Expanding on Hecker, the Leimkuehler court confirmed that “the act of selecting both funds and their share classes for inclusion on a menu of investment options offered to 401(k) plan customers does not transform a provider of annuities into a functional fiduciary.”
Leimkuehler’s second argument was directed at AUL’s control over the separate account. Leimkuehler argued that although the tasks performed by AUL were ministerial in nature, ERISA does not require discretion over plan assets to create fiduciary liability. The court agreed that no discretion is necessary to be a fiduciary, but noted that a person can be a fiduciary only “to the extent” he exercises authority or control over plan assets. Thus, the court concluded, AUL’s control over the separate account could only create fiduciary liability if Leimkuehler was alleging a breach of a duty based upon AUL’s actual management of the separate account. Because Leimkuehler made no allegations that the separate account had been mismanaged by AUL, or that AUL had actually exercised authority or control over the separate account, the court found that AUL was not a fiduciary under the circumstances.
Despite the court’s holding that AUL did not have fiduciary status, the issue of potential liability appears to be specifically limited to the circumstances alleged in the complaint. In this instance, Leimkuehler was seeking liability over AUL’s selection of funds and the corresponding share class, as well as AUL’s maintenance of the separate account. The court noted that the actions of selecting the funds and share classes for the menu of options, and thus making decisions that affect revenue sharing, were all undertaken by AUL well before Plan participants deposited funds into the separate account and allowed AUL to invest their funds.
In an intriguing subplot, the Plan’s contract with AUL granted AUL the continuing right to make substitutions or delete funds from the selections made by Leimkuehler and available to Plan participants. In fact, AUL had exercised this right on two separate occasions. Much to the benefit of AUL, however, one instance fell outside of the statute of limitations, while the other involved a substitution of one fund for another with neither fund offering revenue sharing payments to AUL. Thus, neither instance gave rise to fiduciary status liability under the allegations in the complaint. The court intimated, however, that AUL’s exercise of its right to substitute and/or delete funds after Plan participants deposited money in the separate account may have implicated discretion over the Plan assets and given rise to fiduciary status and potential liability had revenue sharing been implicated.
One final theory of liability was advanced by the Department of Labor (“DOL”) which appeared as amicus curiae on behalf of Leimkuehler. The DOL argued a “non-exercise” theory that AUL’s contractual reservation of the right to substitute or delete mutual funds available to Plan participants is an exercise of authority or control over Plan assets, even if AUL never actually exercised any such authority or control. The court rejected this argument as being at odds with the commonsense understanding of the word “exercise” and refused to hold that an act of omission could satisfy the requirement for liability for a functional fiduciary under ERISA.
The Leimkuehler decision not only reaffirms the financial service provider friendly holding of Hecker, but clarifies the scope of Hecker.; It also clarifies what actions by financial service providers may give rise to fiduciary status and potential liability under ERISA. The Seventh Circuit established that fiduciary status does not arise just from the act of selecting the funds and the share class of each fund for inclusion in a “menu” of options that is offered to a 401(k) plan. Moreover, the court affirmed that providing services and managing participant 401(k) contributions through the “separate account” structure does not necessarily create fiduciary status in a financial services provider.The reaffirmation of these principles is welcome news for financial service providers watchful of their exposure.
The court, however, left open the door for liability to exist where the financial service provider actually exercises control over the funds available to Plan participants.To avoid liability, financial services providers would be wise to pay attention to their agreements with plan clients to ensure that the plan is making the final decision about which mutual funds to offer as investment options, especially once investment in the plan has begun by participants. Any financial service provider that takes too great a role in shaping the plan’s investment options is potentially exposing itself to liability.