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U.S. Judge Dismisses Suit Against Fidelity, Deere

(Reuters)—Mutual fund company Fidelity Investments scored a legal victory this week when a federal judge threw out a lawsuit that alleged it had charged unreasonable fees and expenses to manage retirement savings.

Judge John Shabaz, sitting in the U.S. District Court in Wisconsin‘s Western District, dismissed a suit on Wednesday filed by workers at Deere & Co. The workers sued their employer and Fidelity, which acts as trustee and record keeper for the farm equipment maker’s 401(k) retirement savings plan.

A copy of the order was obtained by Reuters on Thursday. The plaintiffs, who sought class action status, alleged that Deere and Fidelity harmed them by charging “excessive and unreasonable fees and costs” and by failing to tell them about a revenue-sharing agreement.

The court ruled that neither Deere nor Fidelity had to tell the workers about these matters.

Filed in December, the lawsuit and about a dozen others like it shed new light on fees, an often overlooked part of the 401(k) retirement savings business.

“In this particular case, Fidelity has won the battle, but the war rages on,” said Gregory Ash, a partner specializing in employee benefits law at Spencer Fane. Fidelity spokesman Vin Loporchio said, “We believe it was the correct ruling.”

Jerome Schlichter, a partner at Schlichter, Bogard & Denton who represents the Deere workers and other plaintiffs in similar suits, said, “It is just one event in a process that will be ongoing and will take considerable time.”

Deere employees charged the company and Fidelity assessed plan participants expenses that “were, or are, unreasonable and/or not incurred solely for the benefit of the Plan participants.”

Arguing that administrative fees and expenses can weigh on participants’ returns, the plaintiffs said even small reductions can significantly reduce long-term savings.

 

The group also charged that Deere and Fidelity did not disclose that the mutual fund firm administering the plans shares some of the fees it charges with its customer.

“In the context of the disclosure of information on investment options, the additional information suggested by plaintiffs, including revenue sharing, is neither required by the regulations nor material to participant investors assessing the investment opportunity,” Judge Shabaz wrote in his ruling.

The ruling is a victory for Fidelity, a powerhouse in the investment management industry, at a time more and more Americans are relying on 401(k) savings plans to finance retirement. But the privately held firm faces other battles in two pending lawsuits that name it as a defendant.

As more Americans rely on 401(k) portfolios for retirement, the focus on fees has sharpened. Congress, the U.S. Department of Labor and the U.S. Securities and Exchange Commission are examining the issue.

The group also charged that Deere and Fidelity did not disclose that the mutual fund firm administering the plans shares some of the fees it charges with its customer.

“In the context of the disclosure of information on investment options, the additional information suggested by plaintiffs, including revenue sharing, is neither required by the regulations nor material to participant investors assessing the investment opportunity,” Judge Shabaz wrote in his ruling.

The ruling is a victory for Fidelity, a powerhouse in the investment management industry, at a time more and more Americans are relying on 401(k) savings plans to finance retirement. But the privately held firm faces other battles in two pending lawsuits that name it as a defendant.

As more Americans rely on 401(k) portfolios for retirement, the focus on fees has sharpened. Congress, the U.S. Department of Labor and the U.S. Securities and Exchange Commission are examining the issue.

401(k) Fee Litigation Proceeds: More Suits, More Attorneys, New Targets

After firing off an initial volley of 14 class action lawsuits against Fortune 100 employers and their retirement plans, the St. Louis-based Schlicter, Bogard & Denton law firm now has plenty of company in the attack on 401(k) plan fee practices.  As the Schlicter cases proceed, new suits are being filed by other plaintiffs’ firms attacking revenue sharing, disclosures to participants, and allegedly excessive fees.  In many of the more recent suits, theories first espoused by Schlicter lawyers have been polished to counter defenses that have been raised in the initial set of lawsuits. Status of Schlicter Cases As we predicted when the first seven suits were filed in September 2006 (see “A Frontal Assault on 401(k) Fee Practices”), defendants have had no luck making these cases go away quickly.  With one notable exception, none of the 13 different judges overseeing the Schlicter cases has granted the defendants’ requests to have the claims dismissed or clarified.  The exception came in a four paragraph order in the Exelon case in which the judge struck the plaintiffs’ claim for investment losses arising out of the defendants’ alleged failure to comply with ERISA Section 404(c).  Even that ruling left the door open for the plaintiffs to reassert this theory of recovery in an amended complaint, so long as they clarified how the defendants’ failure to follow Section 404(c) caused their investment losses.  The plaintiffs apparently have decided not to re-plead that claim. The courts rejected motions to dismiss or clarify the plaintiffs’ complaints in the Kraft and Boeing cases (see “District Court Declines to Dismiss Kraft 401(k) Fee Case”).  In both of those decisions the court also refused to dismiss the plaintiffs’ 404(c)-based claims.  Similar motions to dismiss or clarify are pending in at least nine of the other Schlicter cases. The case against Deere & Company and Fidelity, which is pending in the Western District of Wisconsin, appears to be on a fast track.  Trial in that case has already been preliminarily scheduled for September of this year.  The result is that the

Deere case could significantly affect the others, as this court will be the first to render key legal rulings on issues that are common among all of the complaints. Interlopers Aplenty As if managing 14 class action lawsuits were not enough, the Schlicter attorneys now find themselves fighting not only the legal teams of their Fortune 100 targets, but also a cadre of other plaintiffs’ attorneys seeking to horn in on the action.  In what amounts to a battle for lead class counsel status – and a priority claim to any attorneys’ fees awarded – a separate group of lawyers has filed almost identical claims against two of the Schlicter targets.  Joining in the challenges against

Northrop Grumman and Kraft Foods is the New York-based Squitieri & Fearon firm, working in collaboration with the Keller, Fishback & Jackson firm in California and the Gainy and McKenna firm from New York.  Those firms have filed their own claims in Heidecker v. Northrop Grumman and Pino v. Kraft Foods.  The two cases against Northrop Grumman have already been consolidated (and are now known as In re Northrop Grumman Corporation ERISA Litigation).  Shortly after the Grumman cases were consolidated, however, Schlicter survived Keller Fishback’s motion to be appointed co-lead counsel. In what may be a significant development in the plaintiffs’ favor, attorneys for the AARP were recently granted permission to intervene on behalf of the plaintiffs in the Northrop Grumman litigation.  It remains to be seen what role the AARP will play in that case, or whether it will ask to intervene in any of the other suits. Excessive Fee Claims Abound Aside from the Schlicter lawsuits, claims alleging ERISA violations as a result of excessive fees are finding their way into other cases.  Making good on its promise to “investigate” fee practices, the ERISA powerhouse Keller Rohrback law firm added excessive fee claims to its lawsuit against ING and the New York State Teachers Union in Montoya v. ING Life Insurance and Annuity Company, which was filed in New York on March 28.  That suit is based primarily on the groundwork laid during former New York Attorney General Eliot Spitzer’s state-law investigation of, and settlement with, these parties over an allegedly illegal scheme in which the Union received kickbacks from ING in exchange for endorsing ING’s 403(b) products.  In addition to arguing that ING and the Union breached ERISA-based duties of loyalty and prudence by engaging in the alleged endorsement scheme, the Montoya plaintiffs also contend that the administrative fees paid to ING were excessive, and that revenue sharing payments ING received amounted to plan assets that were improperly used. Adding to the list of cases challenging fee practices, two lawsuits filed against General Motors in April tacked excessive fee claims onto run-of-the-mill prudence attacks on the use of so-called “single equity” stock funds in several GM and Delphi defined contribution plans.  In Brewer v. General Motors Investment Management Corp. and Young v. General Motors Investment Management Corp., the plaintiffs argue that plan fiduciaries imprudently offered participants the ability to invest in Fidelity mutual funds – which charge asset-based fees that are used, in part, to pay for recordkeeping and other administrative services – when the plans already received those services from, and were charged separately for them by, other providers.  The GM and ING cases join similar challenges to retirement plan fee practices asserted against Nationwide, Principal, and The Hartford. Who’s Next? Although it is certainly too early to rule out additional lawsuits against large employers and their 401(k) plans, or copy-cat suits against smaller employers and plans, it appears that sponsors of variable annuity investment products, which are typically offered under Code Section 403(b) arrangements, may be sitting in the hottest of the hot seats.  These products have been heavily criticized for their lack of transparency and high fees.  Critics also contend that annuity providers often engage in various forms of “pay to play” practices.  These include arrangements in which investment companies allegedly pay annuity providers what amounts to a kick-back (in the form of revenue sharing payments) to gain shelf space on the provider’s list of investment products that are made available to 403(b) plans, or in which the annuity provider pays 403(b) plan sponsors (such as teachers unions) to endorse the annuity provider among its members. Keller Rohrback’s website identifies ten variable annuity providers the firm is investigating, including AIG, MetLife, Mutual of Omaha, and Prudential.  That firm also has targeted the National Education Association’s “Valuebuilder” 403(b) program.  This program is alleged to have engaged in the same kind of endorsement scheme as the one at issue in Keller’s lawsuit against ING and the New York State Teachers Union.  To the extent that these unions received payments to endorse the annuity providers, or significantly limited participants’ choices among providers, the 403(b) programs may be subject to ERISA’s fiduciary standards. Plaintiffs’ attorneys also claim to be investigating other 401(k) investment and service provides, including Ameriprise Retirement Services, Automatic Data Processing, and Bisys.  It is conceivable that one or more of those entities will join Fidelity at the defense table.  Moreover, Keller Rohrback has targeted at least eight more plan sponsors for investigation. We can expect to see more lawsuits taking on retirement plan fees in the coming months.  If you would like to keep up with those developments, please register to receive our periodic updates by completing the E-Mail Alert signup, above, checking the Employee Benefits tab, or send us an email directly.  We will also continue to add information to our “401(k) Fee Litigation Update Center” as circumstances warrant.

If you have questions about the matters addressed in this article, please contact:

Gregory L. Ash, Chair of Spencer Fane’s ERISA Litigation Groupgash@spencerfane.comPhone:  (913) 327-5115

 

You Better Be An “Original Source”

The False Claims Act prohibits persons (for example, government contractors) from making false or fraudulent claims for payment to the United States government. The Act allows civil actions to be brought by the Attorney General or a private person in the name of the United States. Private citizens may be awarded 15 – 30% of the damages the government recovers. This reward acts as an incentive for private citizens to find, report, and attempt to alleviate fraud and abuse. To avoid a frenzy of lawsuits being filed following every news report, the FCA bars a private citizen’s lawsuit if the basis for the lawsuit is already publicly known, unless the person was an “original source.” An original source is a person who (1) has direct and independent knowledge of the facts underlying the cause of action and (2) voluntarily provided the information to the government before filing the FCA lawsuit.

James Stone worked for Rockwell International Corp. as an engineer from 1980 to March 1986. Stone worked at the Rocky Flats nuclear weapons plant near Golden, Colorado, pursuant to a government contract. In the early 1980s, Rockwell investigated the possibility of disposing of toxic pond sludge by mixing it with cement to form concrete blocks (“pondcrete”). In 1982, Stone reviewed the proposed “pondcrete” process and advised Rockwell that he believed the process would not work. Stone opined that the pondcrete would be unstable, later deteriorate, and ultimately release toxic waste into the environment. Stone’s prediction was based on what he perceived to be a flaw in the equipment used to create the pondcrete.

The pondcrete process worked well for several years, but as Stone predicted, eventually the pondcrete failed, though not for the reason Stone anticipated. The pondcrete failed when a foreman changed the toxic sludge to cement ratio of the mixture. This change took place long after Stone was employed, and Stone had no personal knowledge of the change.

About one year after Stone’s employment ended, Stone went to the FBI to report various environmental crimes he believed occurred during his employment. The FBI used Stone’s information to obtain a search warrant for the Rocky Flats facility. Three days after the FBI’s search, there was intense media coverage of the environmental violations alleged in the affidavit underlying the search warrant. Shortly thereafter, Stone filed a qui tam lawsuit under the False Claims Act on behalf of himself and the United States. Stone alleged that Rockwell concealed environmental, safety, and health issues from the Department of Energy throughout the 1980s.

Stone went to the FBI with his allegations before the public knew about the Rocky Flats problems. Stone, however, brought his qui tam lawsuit after the media reported the alleged violations to the public. Because the basis for the lawsuit was publicly known when Stone filed, Stone had to prove he was an “original source.”

Stone’s case went to trial. The jury awarded damages of nearly $1.4 million, which was trebled by the trial court. Rockwell challenged the result, stating that Stone’s lawsuit was based on public information and Stone was not an original source. Winding its way up to the Tenth Circuit, back down, and up again, the case finally landed in front of the United States Supreme Court.

The Supreme Court ruled 6-2 that Stone was not an original source. Justice Scalia, writing for the majority, explained that Stone did not have direct and independent knowledge of the information upon which his allegations were based. Scalia noted that Stone’s information was based on his years of employment and his prediction that the pondcrete would fail. The lawsuit and jury’s verdict, however, were based on events occurring between April 1987 and September 1988. Stone did not work for Rockwell during these years. Stone had no personal knowledge of anything happening at Rockwell during these years. And, although Stone predicted the pondcrete would fail, he did not correctly identify the cause of the failure. The pondcrete, in fact, only failed when a foreman changed the ratio of the toxic sludge to cement mixture. This change occurred long after Stone was employed, and was wholly unrelated to Stone’s earlier prediction. The Court was careful to differentiate personal knowledge of a fact from a prediction of a future event. The Court did not decide if a prediction would qualify as direct and independent knowledge. Instead, the Court focused on the cause and effect underlying Stone’s prediction. Stone’s status as an original source failed because his only knowledge was based on a prediction of a future event and that prediction was based on an erroneous cause and effect analysis. The Court emphasized that the private person’s misunderstanding of why a defect occurred would not be problematic when the person actually knew a defect existed. But, Stone neither knew the defect existed, nor did he correctly predict the cause of the failure.

Justice Stevens, in a dissent joined by Justice Ginsburg, noted that a person is an original source when he has knowledge of the information underlying the publicly disclosed allegations, not the information underlying the allegations in the complaint. Justice Breyer did not take part in the case.

Impact

The original source requirement is critical to deter suits by after the fact relators based upon information that has been publicly disclosed . The Rockwell decision mandates that only whistleblowers with actual knowledge can institute qui tam cases based on public information. The ruling is important to government contractors because, in clarifying the meaning of “original source,” the decision should discourage claims by so-called “parasitic relators” − who overstate or fabricate their role in uncovering fraud and waste despite the fact that they do not expose any previously unknown wrongdoing.

Government contractors believe this decision is an important victory that will cause whistleblowers to think twice before they file False Claims Act lawsuits. The whistleblower must truly have information that is independent (not from the press or some other source) and direct (personal knowledge reasonably related to the cause of action). Although not all fishing expeditions will be stopped, this decision helps contractors avoid frivolous lawsuits and thwarts plaintiffs who care more about the reward than the bad act.

On the other hand, the policy question raised by Rockwell is whether “genuine relators” may also be discouraged by the Court’s interpretation of “original source.” In this case, the FBI’s search warrant and subsequent investigation was made possible by the fact that Stone came forward with legitimate information about environmental violations at Rocky Flats. Requiring that the information provided by citizens not only lead to the fraud being uncovered but also ultimately form the basis of the evidence used to reach a jury verdict of fraud is likely to have a chilling effect on potential whistleblowers in the future. An individual who is considered an original source who files a fraud suit on behalf of the government against a company that does business with the government receives a portion of any award. Many commentators believe the Supreme Court’s decision will not affect the result that Rockwell must pay the $4.2 million award, it just means that the whistleblower, Stone, will not receive any monetary compensation for his role in uncovering the fraud and penalizing Rockwell. If legitimate whistleblowers are deterred by this decision, the concern is that it will be easier for government contractors to commit, and get away with, fraud.

401(k) Plans In The Cross-Hairs

To learn more aobut 401(k) fee litigation, visit our 401(k) Fee Litigation Update Center.

A recent spate of litigation involving 401(k) plan fees has drawn the attention of employers, the media, and Congress. At issue in these cases is hundreds of millions of dollars in potential liability, and also the very backbone of the retirement plan industry. Employers can expect more scrutiny of their plans from employees and, in some unfortunate circumstances, from plaintiffs’ attorneys.

Class action attorneys have identified their next target, and it isn’t cigarette manufacturers, pharmaceuticals, or falling stock prices. Instead, they have in their sights something that is much more pervasive in the business community, and potentially more explosive: the 401(k) industry and employers who participate in it. A series of class action lawsuits filed in late 2006 and early 2007 challenges the way that employers pay for the 401(k) plans that they sponsor. At last count at least seventeen cases were pending in federal courts from Maryland to California, each arguing that investment-related fees paid by plans to their service providers were so excessive as to violate the Employee Retirement Income Security Act of 1974 (“ERISA”).

Coming on the heels of the stock-drop cases that continue to plague employers that offer company stock funds in their plans, this new rash of litigation has the potential to affect many more plans and plan sponsors. These lawsuits attack the basic fee structure used by most 401(k) plans. They have received significant media attention, leading to increased scrutiny from legislators and plan participants. And although the courts have not yet considered the merits of the claims, they are already altering the way that plans are administered.

The Substance of the Claims
The current challenges come primarily from participants in employer-sponsored 401(k) plans. Long predicted by benefits prognosticators, this new wave of litigation is largely driven by three factors: demographics; the growing prevalence of 401(k)-type arrangements as the primary source of retirement savings; and the stock market. As the vast majority of American workers face the prospect of retirement without the security of a traditional defined benefit retirement plan, the investment options made available to participants in 401(k) arrangements and the net investment return on those options will increasingly come under scrutiny. Ultimately, these lawsuits can be traced to the convergence of these three factors.

According to the complaints, administrative fees paid by the plans – and indirectly paid by plan participants – were excessive, improperly diluting the returns on participants’ 401(k) investments. The lawsuits seek to recover what could amount to many millions of dollars from plan sponsors and executives who allowed the plans to pay the allegedly excessive fees, and in some cases from the plan service providers who received those fees. Although the employers and plans that have been sued so far are very large, including Kraft, International Paper, Caterpillar, and Boeing, the legal theories advanced by the plaintiffs would apply to almost every 401(k) plan and plan sponsor. With over $2.9 trillion in the 401(k) industry at stake and baby boomers on the cusp of retirement, it’s clear that these issues are not going away soon.

Revenue Sharing Under Fire
The common theme among all of the cases that have been filed to date is an attack on a practice the plaintiffs characterize as “revenue sharing.” That term can have different interpretations depending upon the kind of investments offered under a plan (e.g., annuity contracts, collective trusts, and mutual funds). In the context of mutual funds – perhaps the most common 401(k) investment vehicle – revenue sharing generally refers to a practice in which mutual fund companies carve off a portion of the management fees they receive from investors and then “share” that revenue with other service providers with whom the fund companies sub-contract. Revenue sharing is a practice that is common throughout the 401(k) industry.

One of the allegations in the class complaints is that plan fiduciaries did not understand the complicated fee structures that are common in the 401(k) industry. For a more detailed explanation of those structures, please refer to the discussion found at Understanding 401(k)Fees.

The complaints characterize revenue sharing payments in two ways. First, the plaintiffs claim that these payments amount to “hidden” fees, largely because they are difficult to understand and rarely disclosed to participants. Second, the plaintiffs contend that revenue sharing payments are actually assets of the plans which are improperly used to benefit parties other than plan participants, in violation of ERISA’s “exclusive benefit” and “prohibited transaction” rules. The complaints characterize these payments as “the big secret of the retirement industry.”

The plaintiffs allege that the defendants in these cases breached their fiduciary duties under ERISA by failing to investigate whether the plan’s service providers received revenue sharing payments. They contend that plan expenses could have been reduced – and participants’ investment earnings could have been increased – if the defendants had uncovered these arrangements and used that information to negotiate for lower fees. They also suggest that defendants violated ERISA by failing to disclose the existence of revenue sharing payments to participants.

Other Claims
lthough the attack on revenue sharing is at the core of these suits, the plaintiffs challenge a number of other practices as well. A few of the complaints argue that some direct (or “hard dollar”) payments from the plans to their service providers were not adequately disclosed to participants. For example, they say that this happens when plans participate in master trust arrangements (which are trusts that pool the assets of multiple plans), and payments are made to service providers from the master trust. The lawsuits suggest that fees paid directly from the master trust – rather than from a component plan – were not disclosed to plan participants, making it appear that plan expenses were very low or even nonexistent.

Some of the plans offered participants the ability to invest in mutual funds that charge a fee for active management, but that allegedly behave like passively managed index funds. The complaints assert that the returns participants earned on those funds were virtually identical to the returns they could have obtained from an index fund which has a much lower management fee. They argue that the management fees imposed by these alleged “shadow index funds” were therefore excessive, and that the plans’ fiduciaries should not have accepted them.

In a few of the cases the plaintiffs take aim at practices associated with employer stock funds. These funds allow (and in some cases require) plan participants to invest in the stock of the plan sponsor. The participants contend that the employer stock funds charged improper management and administration fees, when there really was no “management” of the fund at all. They also argue that fiduciaries allowed excessive cash to be held in unitized employer stock funds, thus diluting returns.

End Run on Section 404(c)
Also common to all of the lawsuits is the plan participants’ assertion that they were not fully informed about the expenses associated with their accounts. This, they say, vitiates the protection from liability that plan fiduciaries might otherwise have had under Section 404(c) of ERISA. The implication is that participants whose 401(k) accounts suffered investment losses could seek to recover those losses from the fiduciaries, in addition to the allegedly excessive fees.

Most plans that allow participants to choose how to invest their money do so in reliance on Section 404(c). That statutory provision protects plan sponsors and fiduciaries from liability for any losses participants may incur when making their own investment choices. However, this protection applies only if participants are given sufficient information with which to make investment decisions. According to the participants, by failing to provide adequate information about plan expenses, the fiduciaries did not comply with Section 404(c), and thus they remain responsible for any investment losses the participants may have suffered.

Assessing the Risk
The defendants in the currently pending suits are mounting a vigorous defense, filing a flurry of preliminary motions. Based upon the arguments they have raised to date and recent decisions by courts in the Fourth (LaRue v. DeWolff, Boberg & Assocs.) and Fifth (Langbecker v. EDS Corp.) United States Circuit Courts of Appeal, it appears that the plaintiffs will have an uphill battle. Nevertheless, these cases will be heavily fact-dependent, and are unlikely to be resolved in the early stages of litigation.

Of equal concern may be the possible legislative and regulatory responses to these lawsuits. Already the U.S. House Committee on Education and Labor has held hearings to address 401(k) fees. More hearings are set for later in the year. The Department of Labor also is considering several initiatives to regulate the relationships between plans and their service providers, and to increase the transparency of retirement plan fees. Thus, the changes that emanate from Washington could have a more significant impact on employer-sponsored 401(k) plans than the threat of litigation.

What’s Next?
It is likely that more lawsuits will be filed in the coming months. Although the St. Louis-based Schlicter, Bogard & Denton law firm is primarily responsible for the current wave of litigation, there are indications that other plaintiffs’ firms are poised to join the fray. Internet reports indicate that a large firm with a well-established ERISA practice is “investigating” the fee practices of insurance companies that provide retirement plan services. Moreover, the Schlicter firm has placed newspaper advertisements to solicit potential plaintiffs for lawsuits that target at least 15 additional plans.

More recently, plaintiffs have added plan service providers to the list of those they sue. In each of the last three cases filed by the Schlicter firm, Fidelity Management Trust Co. and Fidelity Management Research Co. have been named directly as defendants. In those cases, Fidelity’s involvement with the investment funds offered under the plans was allegedly so pervasive as to make Fidelity an ERISA fiduciary with respect to the plans. In addition, plan sponsors themselves have sued insurance company providers directly – Nationwide, The Hartford, and Principal – in what purport to be national class actions on behalf of all plans and plan sponsors that have engaged those entities.

Cases are now pending in federal district courts in the Second, Sixth, Seventh, Eighth, and Ninth Circuits. As these matters proceed, it is likely that the courts will render substantive interpretations of ERISA that are not always consistent. Unless Congress intervenes, it will be up to the Supreme Court to explain the extent of the rights and obligations that employers – and employees – have with respect to 401(k) plans. Thus, for some time to come these lawsuits will shape the legal landscape in which retirement plans are administered.

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