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Important 401(k) Fee Rulings on the Horizon

Many of the lawsuits that challenge retirement plan fee practices are nearing critical decision points.  After languishing for months in what were often heated procedural battles, several of these cases are fast approaching discovery cutoffs and summary judgment deadlines.  Rulings on those summary judgment motions could widen the existing schism among the courts about the extent to which ERISA governs the inner workings of the 401(k) industry.  We are likely to learn whether “revenue sharing” payments among service providers are plan assets subject to regulation, whether minimal involvement in fund selection makes service providers ERISA fiduciaries, and how plan sponsors should determine whether fees are excessive.  One thing is certain: these rulings will determine whether more lawsuits will be filed in the coming months.

Old Cases Attack Service Provider Arrangements

At last count, there were at least 29 separate actions pending in federal district and appellate courts attacking various methods of assessing administrative fees to defined contribution plans (typically 401(k) or 403(b) arrangements).  Of those, most are claims by plan participants against their employers and named plan fiduciaries.  In at least six, participants have added claims against plan service providers such as Fidelity, ING, Security Benefit, and AG Edwards.  Seven of the lawsuits were filed by plan sponsors themselves (or by named fiduciaries acting on behalf of the plan) against the plan’s service providers.  Service provider defendants in these cases include Nationwide, Principal, Fidelity, John Hancock, The Hartford, and Paychex.  Class certification motions have been granted in four cases, denied in three, and are pending in many others.  (For a summary of these cases, click here.)

At issue in many of these lawsuits are alleged “pay to play” arrangements, which purportedly violate ERISA’s exclusive benefit and prohibited transaction rules.  These are arrangements in which service providers allegedly agree to include investment companies on their lists of “approved” fund options from which plan sponsors may select only if those investment companies agree to funnel undisclosed fees – often referred to as “revenue sharing” payments – to the service providers.  For instance, in Phones Plus, Inc. v. The Hartford, a Connecticut case that was filed in late 2006, a 401(k) plan sponsor filed what purports to be a nationwide class action suit on behalf of all other employers that have engaged The Hartford as a service provider.  The sponsor contends that The Hartford breached its fiduciary duties to the plans under ERISA, and engaged in prohibited transactions, by keeping for its own use revenue sharing payments made by investment companies with respect to plan assets invested with those companies.

Many of the pending fee challenges were filed in late 2006 and early 2007 by the St. Louis-based Schlicter, Bogard & Denton law firm.  Plaintiffs in most of those cases have since filed amended complaints, apparently in search of theories that will stick.  The complaints now focus on the alleged impropriety of using any actively managed investment vehicles (as opposed to passive index funds), claiming that it is inherently imprudent under ERISA to do so.  They also challenge the use of mutual fund investment vehicles by very large plans, on the theory that fiduciaries of those plans should have used their bargaining power to purchase customized “separate account” investments, which have a lower cost structure.

In addition, the Schlicter plaintiffs have recently alleged in two cases that plan fiduciaries engaged in prohibited self-dealing when hiring service providers.  For instance, plaintiffs in the United Technologies case contend that the plan sponsor received a “corporate benefit” by engaging Fidelity and offering Fidelity mutual funds, because Fidelity is allegedly a large investor in United Technologies.  Similarly, in an amended complaint filed May 1, 2008, the International Paper plaintiffs argued that plan fiduciaries engaged in prohibited transactions by entering into service arrangements that were primarily intended to convey a corporate benefit to International Paper, rather than a benefit to the plan.

New in 2008

Two new fee challenges were filed in 2008.  Zang v. Paychex, filed in New York on January 30, 2008, alleges that Paychex orchestrated a “pay to play” arrangement designed to steer small plans to vendors with whom Paychex had revenue sharing deals.  Plaintiffs claim that Paychex was an ERISA fiduciary of the nationwide class of plans they seek to represent because it exercised control over the menu of investment vehicles made available to the plans.

On July 2, 2008, the Schlicter firm filed a second ERISA suit against Kraft foods, George v. Kraft, No. 1:08-cv-03799 (Kraft II).  This suit appears to be nearly identical to the case filed almost two years ago against Kraft in the same court, except that Kraft II adds various Altria-related defendants, and it includes allegations that the plan’s fiduciaries operated under conflicts of interest in selecting the investment funds offered to participants.

Key Issues for Service Providers

Although the theories of recovery in these cases have evolved as the plaintiffs attempt to survive motions to dismiss, a recent development is potentially troubling for 401(k) service providers.  To succeed on their ERISA claims against such service providers, the plaintiffs first must establish that the providers acted as ERISA “fiduciaries” with respect to the plans, rather than merely as ministerial agents.  One of the underlying arguments that plaintiffs have made in these suits – especially those involving “pay to play” arrangements – is that service providers are ERISA fiduciaries if they exercise any control over the global list of investment funds from which plan sponsors may select a plan-specific lineup. 

Retirement plan vendors often select a subset of investment funds from the universe of all available funds, and allow plan sponsors to choose the funds they want to make available under their plan from that subset.  According to the plaintiffs, this discretionary authority to narrow the universe of available investment options is sufficient to make ERISA fiduciaries out of the service providers, ostensibly because it amounts to exercising control over plan assets.  That, in turn, could subject these vendors – almost all of whom have developed business models and patterns of practice based on the long-held belief that they are not ERISA fiduciaries – to substantial risk.

It is unclear whether the plaintiffs’ theory ultimately will be accepted.  Taken to its extreme, their argument would mean that if a vendor omits any potential investment vehicle from the “approved” list, it could be deemed to be an ERISA fiduciary.  Moreover, the argument appears to fail under its own weight.  It assumes that a vendor’s exercise of discretion to exclude a fund, so that the fund will never become part of the plan, is also equivalent to the exercise of authority over a plan asset, making the service provider an ERISA fiduciary.

Significantly, however, several courts appear to have accepted the plaintiffs’ reasoning.  In her decision denying the defendants’ motions to dismiss in Tussey v. ABB, a judge in the Western District of Missouri concluded that Fidelity Trust could be a fiduciary of the ABB plan because it conducted a first-cut screening of available investment options. 

Similarly, in denying a motion to dismiss in Phones Plus, Inc. v. The Hartford, the court rejected the service provider’s reliance on an important Department of Labor Advisory Opinion on the issue of fiduciary status.  The Hartford pointed to Advisory Opinion 97-16A (known as the “Aetna Opinion”) to support its argument that a vendor’s authority to cull the universe of investment vehicles to a manageable list does not make it an ERISA fiduciary.  The DOL had reached this conclusion in 1997 when evaluating a similar arrangement between Aetna and its affiliates.  The Aetna Opinion provided a degree of comfort to many service providers who wish to avoid being labeled ERISA fiduciaries.  The Phones Plus court refused to place any weight on the Advisory Opinion, however, because The Hartford had not made the same kinds of disclosures that Aetna had made, and because in the court’s view Advisory Opinions are, at best, merely persuasive authority.  Service providers will be closely monitoring whether other courts adopt a similarly narrow interpretation of the Aetna Opinion.

In a hopeful sign to defendants, however, a New York court dismissed two fee cases against General Motors (Young and Brewer) because participants filed their claims outside of ERISA’s statute of limitations period.  The court ruled that all of the investment funds at issue had been made available more than three years before the lawsuits were filed, and that documents accurately describing those investment funds and their fees had been given to participants more than three years earlier.  The plaintiffs have appealed those rulings to the Second Circuit.

If you would like to keep up with developments on the fee litigation, please register to receive our periodic updates by sending us an email directly.  

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

Gregory L. Ash, Chair of Spencer Fane’s ERISA Litigation Group