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Guest Article

(From the March 9, 2009 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

ERISA Fiduciaries Have No Affirmative Duty to Disclose Revenue Sharing, Seventh Circuit Rules

A recent 7th Circuit decision may stem the tide of "excessive fee" and "imprudent selection of investment" suits being brought against ERISA plan fiduciaries. The Court of Appeals upheld a lower court ruling that ERISA's fiduciary standards do not require disclosure of revenue sharing arrangements among the service providers. Disclosure of total fund-level fees is "enough" according to the Court - and compliance with ERISA § 404(c) coupled with a "brokerage window" is sufficient to quell claims that the fiduciary's selection of investment is imprudent.

The decision in Hecker v. ________, No. 07-3605 & 08-1224 (2/12/09), is being noted by ERISA plan sponsors and service providers with cautious optimism and a sigh of relief. The Court of Appeals seems to have drawn a bright line for ERISA plan participants seeking to sue because of dissatisfaction with the investment performance of their accounts. The Court upheld the lower court's dismissal of the case, and upheld the assessment of over $219,000 in fees against the participants.

Investment Options / Fee Arrangements Challenged

In Hecker, three employees who participated in the employer's two 401(k) plans sought to sue on their own behalf and for a class of participants. Dissatisfied with the fees that were being charged by the investment funds, they alleged violation of ERISA because: (1) revenue sharing arrangements between the fund provider and trustee had not been disclosed, and (2) the selection of the plan's investment funds was imprudent because of the high fees.

The plans offered a wide range of investment options: 25 designated investment funds, plus an employer stock fund and an "open brokerage" window. Of the 25 designated investment funds, 23 consisted of publicly-traded mutual funds offered by one mutual fund provider ("Research Company") and two consisted of plan-specific investment funds managed by the mutual fund provider's related trust company ("Trust Company"). Trust Company also served as the plans' directed trustee and third-party administrator. Under the 25 designated investment funds, fees were paid on the fund level as a percentage of assets. The asset-based fees ranged from "just over 1% to as low as 0.07%." Trust Company's third-party administrative fees were paid out of the fees it received from the plan-specific funds it managed, and from fees it "shared" with Research Company from the 23 mutual funds. Through an open-brokerage window, the participants had the option of investing in more than 2500 other mutual funds.

A substantial amount of assets were involved in the suit. Together, the plans held over $ 2.5 billion in assets, of which $1.5 was invested in Research Company's 23 publicly-traded mutual funds.

The participants filed suit against the employer, Research Company, and Trust Company, claiming breach of ERISA fiduciary duty. Three key allegations were made.

Functional Fiduciaries. Research Company and Trust Company were "functional fiduciaries" in the selection of the investment options, the structuring of fees and the disclosure of information to plan participants. Although not explicitly retained as fiduciaries in that regard, they exercised control over the selection, fee structuring and disclosure of information such that they constituted fiduciaries for that purpose, and were liable for the ERISA breaches in that regard.
Duty to Disclose. The fiduciaries had an obligation to disclose the fee sharing arrangements between Research Company and Trust Company
Imprudent Selection. The selection of the plans' investment options was imprudent because of their high fees.

The trial court dismissed the case for failure to state a claim, and ordered the plaintiffs to pay the defendants' costs in responding to the suit. Over $54,000 was ordered to be paid to the employer, and over $164,000 to Research Company and Trust Company combined.

Seventh Circuit Upholds

On appeal, the Seventh Circuit agreed with the trial court. Expounding on the lower court's analysis, it reasoned as follows:

Documents Control / Functional Fiduciary. Participants argued that the structural requirement imposed by Trust Company - that a plan's designated investment options be limited to Research Company's mutual funds and funds managed by Trust Company - amounted to "discretionary authority" over the management of the plans, making Trust Company and Research Company ERISA fiduciaries with regard to those matters. The Court summarily dismissed this contention:
In any event, the Trust Agreement gives [the employer], not [Trust Company], the final say on which investment options will be included. The fact that [the employer] may have discussed this decision, or negotiated about it, with [Trust Company] does not mean that [Trust Company] had discretion to select the funds for the Plans.

The Court made clear that playing a role or providing advice does not transform a company into a fiduciary. Many professionals help to develop a plan but, despite their influence, they are not considered fiduciaries.
No Affirmative Duty to Disclose Revenue Sharing. The Court ruled that revenue sharing, as structured in this case, did not violate ERISA and was not required to be disclosed to plan participants. Under the facts, the employer disclosed the total fees to be charged on the fund level - and that was "enough," according to the Court. The later distribution of the fees among the service providers was not material information a participant needed in making investment decisions.
The total fee, not the internal, post-collection distribution of the fee, is the critical figure for someone interested in the cost of including a certain investment in her portfolio and the net value of that investment. ... The later distribution of fees by [Research Company] is not information that the participants needed to know to keep from acting to their detriment. ...The information is thus not material, and its omission is not a breach of [the employer's] fiduciary duty.

Participants argued that the Summary Plan Description gave the misimpression that the employer was paying the administrative costs of the plan - when, in fact, the participants were paying those costs through fees disclosed and taken on the fund level. However, for the non-disclosure of revenue sharing to constitute an ERISA fiduciary violation in that circumstance, the Court explained that there must be either an intentionally misleading statement or a material omission - and the participants alleged neither. The employer, it appeared under the facts submitted, apparently understood Trust Company's administrative services to be free of charge.
ERISA § 404(c) Compliance & Brokerage Window. The Court held that compliance with ERISA § 404(c) - when coupled with a "sufficient range of options so that the participants have control over the risk of loss" - shields a fiduciary from claims of imprudent selection of funds. As such it dismissed the claim that the fiduciaries' selection of the plan investment options was imprudent. The Court noted that there was "no plausible allegation" that the employer failed to comply with ERISA § 404(c) and its requirements - for example, the requirements to describe the investment alternatives, explain how to give investment direction, describe fees and expenses, etc. The Court also noted that there "was no room for doubt" that the plan offered a sufficient mix of investment options, with the 25 designated investment options and a brokerage window through which some 2500 additional mutual funds were available.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.