In the first edition of this newsletter published in April, we noted the decision in a class action brought on behalf of 401(k) plan participants, Tussey v. ABB, Inc., No. 2:06-CV-04305-NKL, 2012 WL 113291 (W.D. Mo. March 31, 2012). We remarked that the decision could be used as a vehicle for a refresher course about fundamental principles under the Employee Retirement Income Security Act (“ERISA”) that govern the administration of ERISA benefit plans by their employer sponsors. The court found the employer defendant in Tussey had failed to adhere to basic plan fiduciary administration principles that resulted in $37,000,000 in damages. We decided to follow up with an analysis of Tussey that would be useful to ERIC’s members as they review their ERISA plan administrative structures for compliance with those principles and take appropriate actions to avoid a similar fate.
- SUMMARY OF KEY FACTS
In Tussey, the employer, ABB, Inc. (“ABB”), appointed committees consisting of senior officers who controlled all aspects of the administration of two defined contribution plans (collectively, “Plan”), as the designated Plan Administrator with oversight of all employee benefit programs as well as the selection and monitoring of the performance of the Plan’s investment options offered to Plan participants. ABB’s status as Plan Administrator, a fiduciary position by statutory definition, and the fact that its officers exercised direct control of the Plan, was the basis for the Court’s determination that the company was the key plan fiduciary. Consequently, it was exposed to liability for any violation of ERISA arising out of the administration of its Plan. In any case, although it is possible for a plan sponsor to avoid significant aspects of direct fiduciary responsibility for plan operations through appropriate delegations and allocations of such responsibilities, it would be difficult for an employer sponsor to avoid all fiduciary responsibility for an ERISA plan. To maximize insulation from fiduciary liability exposure, a sponsor would have to: (a) contract with an entity to serve explicitly as the statutory Plan Administrator and, (b) also not retain any authority respecting their plan that is exercised by their directors, officers, employees and committees whose membership they control. Even in that circumstance, the selection of the Plan Administrator itself would be a fiduciary decision subject to ERISA.
The following summarizes the primary problems (but by no means all of the problems) that the court found with the administration of the ABB Plan in its 81-page analysis. The opinion painstakingly dissects virtually all of the decisions and practices of the various plan fiduciaries involved in the harsh light of hindsight.
Disclosures: ABB retained the services of a record-keeper (referred to as “RK”) to provide bookkeeping and educational services to both the Plan and the participants. The Plan did not directly pay RK for these services. Rather, as is not uncommon, RK was compensated for the record-keeping services to the Plan through a “revenue sharing” arrangement with the investment companies whose products were offered as investment options to Plan participants. Simply put, RK received a split of the fees those investment vehicles received from Plan participants who invested in their offerings. One of these investment companies was a corporate affiliate of RK (referred to as “RKFund”). While revenue sharing is an appropriate and acceptable practice, the court noted that the disclosures to Plan participants concerning the arrangement were “opaque,” and this was pertinent because, in effect, the participants’ contributions that went to RKFund were paying RK for its services to them. Because the Plan contributions were Plan assets, ABB was subject to fiduciary duties regarding the propriety of such payments. The key concerns here were the amount and the disclosure of such expenses.
Failure to Monitor and Excess Fees: ABB never kept track of the revenue-sharing compensation that RK received from the investment companies for its Plan record-keeping services, nor did it compare RK’s fees with market rates for similar services. Notably, in 2005, a consultant reported to ABB that RK’s compensation for its services to the Plan was well above market rates. The consultant further noted that the Plan had failed to leverage its asset size—$1.4 billion—to negotiate more favorable rates.
Nevertheless, ABB failed to act on that advice. Its assumption seems to have been that, because the Plan itself did not make direct payments to RK, RK was not receiving Plan assets subject to ERISA’s requirements. The court made it clear that if a plan fiduciary is going to use revenue sharing as a means of compensating plan service providers, it must engage in a multi-faceted “deliberative process” to determine why that choice is in the plan’s and its participants’ best interests. In short, among other things, it must determine that the amount of the fees is appropriate.
Self Dealing and Conflict of Interest: The fact that the revenue-sharing payments were not competitive was only one of ABB’s problems. ABB also received corporate record-keeping services from RK, but RK was not paid anything by ABB for these services that were not related to or for the benefit of the Plan. RK was compensated for these services solely from the revenue-sharing payments that were derived from Plan assets. ABB’s status as the employer sponsor of the Plan and a Plan fiduciary made it a party-in-interest (“p.i.i.”) to the Plan. The use of plan assets to benefit a p.i.i. is prohibited by ERISA. The court referred to this arrangement as the Plan subsidizing RK’s services to ABB. Any arrangement involving either multiple plans or a plan and other services to the company sponsor should be scrutinized closely and include clear lines of demarcation so that plan assets cannot be used for non-plan purposes.
Failure to Follow Plan Documents: ABB’s administrators also failed to follow the directions of the Plan’s governing documents that require the Plan’s fiduciaries to pursue rebates for the benefit of the Plan. The court found that, as the consultant had pointed out, the Plan’s fiduciaries could have obtained record-keeping services for the Plan for substantially less than the compensation that was received by RK by using the size of the Plan’s assets to negotiate with service providers for lower rates.
Inadequate/Erroneous Monitoring: The court also focused on the plan’s “Investment Policy Statement” (“IPS”) that mandates a specific process for the evaluation of the performance of a fund that was offered as an investment option to Plan participants before that fund could be removed as an investment option. In 2000, ABB “delisted” a Vanguard fund on the ground that it had “deteriorating performance” as compared to two funds offered by RKFund, but it did not follow the procedure mandated by the IPS. The court found that, if an investigation had been conducted in compliance with the IPS criteria, it would have revealed that the Vanguard fund had not been performing poorly. To the contrary, its performance was significantly better than that of the RKFund’s investment options that ABB selected as replacements. The court also found that the investigation conducted in connection with the selection of the replacement investment options was imprudent because the number of investment vehicles that were investigated was too small to adequately inform ABB about the range of options available in the marketplace. Simply put, ABB failed to obtain sufficient information about the investment options available on the market to prudently select replacement options.
ABB Liability: Because ABB was found to have committed these fiduciary breaches, it was held liable to the Plan for the difference in value between the delisted Vanguard fund and the RKFund that was its replacement, i.e., essentially a highly troubling form of “lost profit” calculation in the amount of $21.8 million. (It did not help ABB that the investment options it selected were offered by an affiliate of a Plan p.i.i. that was a receiving a de facto subsidy from Plan assets for services unrelated to the Plan’s needs that only benefitted ABB.)
The IPS also clearly required that, when a fund selected as an investment option for Plan participants offered different share classes, the Plan’s fiduciaries must select the class of shares with the lowest administrative expenses. The RKFund options selected by ABB had different share classes with varying expense levels, but ABB did not select the share class with the lowest administrative expenses. Moreover, the higher administrative fee level benefitted a Plan p.i.i., RK, because RK had a sharing agreement with the RKFund pursuant to which RK shared in the administrative fees that the RKFund received from Plan participants who invested in its funds. The higher the RKFund’s administrative fees were, the greater the compensation to RK. The court held that this resulted in further breaches of fiduciary duty by ABB: (i) the duty to follow the terms of Plan documents, and (ii) the duty to avoid using Plan assets in “prohibited transactions,” as defined under ERISA.
The core lesson of this case, briefly stated, is that if an employer is going to undertake plan administration and/or investment responsibilities, it must appoint knowledgeable individuals to handle the fiduciary responsibilities and ensure that they devote sufficient time and effort and have the resources to perform those duties properly.
Tussey provides a base for the identification of a series of questions that employers can use as a guide to review the administrative practices of their ERISA employee benefit plans, and to determine the actions that they can take to minimize their risk of exposure to liability for fiduciary breaches and prohibited transactions under ERISA. These questions are as follows:
- Has the employer taken on responsibilities and authority with respect to the administrative and substantive management of its benefit plans?
NOTE: An employer can limit its responsibility for the administration of an ERISA benefit plan. Responsibilities can be delegated to others who are prudently selected by the employer. If so, what are the responsibilities that the employer has retained or assumed? When those responsibilities have been identified, it would be helpful to the employer to consult with ERISA counsel to identify those that may qualify as fiduciary responsibilities as contrasted to settlor responsibilities as a plan sponsor.
It is not the case, however, that the prudent selection of a fiduciary by an employer ends the employer’s responsibilities as a fiduciary. Judicial precedents and DOL criteria establish that employers have an obligation to keep reasonable track of the selected fiduciary’s performance, and to step in and take proper action if that performance is not up to contract standards or otherwise defective. One way to view this obligation is to appreciate that a key fiduciary standard under ERISA is whether the conduct under examination comports with what a “prudent and knowledgeable businessman” would do in a like circumstance. Such a businessman would pay attention to whether the performance of a vendor of services to the business enterprise satisfied contractual obligations and otherwise complied with applicable industry standards. The employer’s supervision of the appointed fiduciary should not be any different.
- What tangible benefits, if any, does the employer achieve by taking on fiduciary responsibilities and possessing or exercising such authority?
- In connection with the preceding question, do any of those benefits derive from the application of plan assets in a manner that may be perceived as benefitting the employer, its affiliates, officers, directors, or certain shareholders, thus giving rise to potential prohibited transactions?
If the answer to the question in the second bullet above is “none,” the proper question for an employer to ask may be, “Why take on this authority and exposure to the risks and liabilities of ERISA fiduciary status?” Even if it only has limited fiduciary responsibilities, the employer also should ask the following relevant questions:
- Have we identified, collected, and organized in a controlled manner all plan documents, and are they compliant with current laws?
- Do we know which individuals are responsible for each activity that must be undertaken to deliver promised benefits in a manner that conforms to the requirements of (i) plan documents, (ii) applicable statutes and regulations, and (iii) applicable judicial precedents? Have we identified all assets that may reasonably be deemed to be plan assets?
- Do we know who the individuals are who have the responsibility for the control and application of plan assets?
- What are our mechanisms and safeguards for assuring that plan assets are applied only to proper purposes and not, by intention or inadvertence, to prohibited uses?
- Who is responsible for an integrated broad spectrum oversight of all of the activities involving plans and plan assets (e.g. senior officer of the company, committee of executives, board or board committee, etc.)?
- Do those persons have the means to identify activities and conduct that cut across multiple areas of oversight and responsibility that may create exposures and potential liabilities because of how they affect multiple areas?
- Are plan administrative, claim and investment decisions well-documented?
The evaluation of the information gathered and the assessment of the actions that may be required based on that information can present complex legal issues. Consultation with your ERISA counsel would be prudent.
The responses you receive for each of the preceding inquiries can serve as a guide to action. Every question for which a clear, complete and appropriate answer is not available may identify an area of potential exposure to liability that should be addressed by appropriate inquiry and remedial action. One critical and perhaps overarching recommendation for plan fiduciaries in this regard is to be proactive in the performance of their obligations.
As noted earlier, employers that offer retirement and other benefit plans, whether or not they undertake broad fiduciary duties as did ABB, would be wise to make periodic comparisons of a diverse selection of service providers as appropriate in view of the size of the plan, the number of participants, the requirements of plan documents, and the exercise of reasonable business judgment. Decisions as to what is offered to participants and the cost for each component of service that are based on weighing multiple potentially applicable factors will tend to insulate employers from liability for breach of fiduciary duty claims (in the absence of p.i.i. self-dealing issues) on the ground that the employer reasonably exercised its discretion.
Judicial decisions in the employee benefit plan areas concerning the selection of vendors of services, covered benefits, and investment options will give some form of deference to a disinterested fiduciary’s judgment calls, provided there is some rational basis for the fiduciary’s selection among competing potential plan providers and with regard to other discretionary decisions. Note, however, that when courts perceive that there may be a conflict of interests that could affect the employer’s judgment, the degree of deference provided may be reduced, and some courts would shift the burden of proof to the employer to show that its interest did not affect its judgment. In Tussey, for example, the circumstance that ABB was receiving services for free from RK, alone, might have caused the Court not to give any deference at all to ABB’s selection of RK as a Plan service provider.”
As a practical matter, in the 401(k) plan context (as in Tussey), a service provider comparison would include identifying qualified service providers evaluating and ranking their plan administration capabilities, fiduciary services, and investment menu platform, and whether a provider is limited to offering TPA services, revenue requirements (pricing), fee transparency and cost structures (including revenue sharing). It is unlikely that one candidate would be at the top of each category, thus allowing for the plan sponsor’s judgment to play a significant role in the selection process. In addition, the evaluation should include whether the provider’s website is “user friendly” in allowing plan participants to obtain investment disclosures, allocate assets among investment options, and determine account status.