The U.S. Court of Appeals for the Seventh Circuit has recently decided a case challenging the amount of fees paid by 401(k) plan participants. Leimkuehler v. Am. United Life Ins. Co., _ F.3d _, 2013 WL 1591450 (7th Cir. 2013). This opinion is likely to have vast implications for that type of litigation specifically and the scope of fiduciary status generally. In recent years, a number of lawsuits have been brought accusing 401(k) plan service providers of improperly receiving “revenue sharing” payments from the expense ratios of the mutual funds in which the plan’s assets are invested. The Leimkuehler opinion addresses a threshold issue in such cases – whether financial service providers are fiduciaries under ERISA for purposes of negotiating or receiving revenue sharing payments.
Leimkuehler, Inc. is a small company that manufactures prosthetic limbs and sponsors a 401(k) plan for its employees. American United Life (“AUL”) is an insurance company that provided the plan’s investment options through a group variable annuity contract. Plan contributions were first deposited in an AUL separate account (as required for an insurance company receiving retirement assets) and then invested in various mutual funds as directed by the participants. Had the participants invested directly in the mutual funds, the funds would have been required to keep track of each individual participant’s investments. However, AUL aggregated the investments, thus keeping for itself the responsibility of tracking the participants’ individual investments and communicating with participants. Because the mutual funds did not have to undertake this administrative responsibility, they were willing to “share” with AUL a portion of the fees they received as part of the fund’s expense ratio.
AUL created a “menu” of 383 different funds that it presented to Leimkuehler, which then selected the specific funds to be made available for investment through the plan. Leimkuehler retained the right to change its selections. However, AUL also reserved the right to make substitutions or deletions, which it did on two occasions.
Leimkuehler’s lawsuit alleged that AUL had breached fiduciary duties under ERISA by receiving revenue sharing payments from the mutual funds. AUL denied that is was a fiduciary at all, and so a threshold issue was whether AUL fit ERISA’s definition of a fiduciary. Because AUL was not a specifically named fiduciary, it could have fiduciary status only if it qualified as a functional fiduciary. As relevant to this case, ERISA specifies that a person is a fiduciary “to the extent” he exercises any “discretionary” authority of control over plan management “or exercises any authority or control respecting management or disposition of its assets ….” 29 U.S.C. § 1002(21)(A). Plaintiff advanced two arguments that AUL met this test, and the Department of Labor (DOL) advanced a third.
First, Plaintiff argued that AUL exercised authority or control over the management or disposition of the plan’s assets by selecting which mutual fund share classes to include in its investment menu. The court characterized this as a “product design” theory, and found that the argument was foreclosed by its prior decision in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009). In Hecker, the plan had offered a large list of available mutual funds, and the court found that assembling the list of available options was not a fiduciary act. The Leimkuehler court recognized that Hecker was different in that the plan sponsor there had apparently retained the final say over which funds would ultimately be included. However, this difference was not sufficient to truly distinguish Hecker because AUL had never exercised its contractual right to change funds in a way that gave rise to a claim. (One instance was outside the limitations period and the other did not involve revenue sharing.)
Second, Plaintiff argued that AUL exercised authority or control over plan assets by maintaining the separate account, which required tracking individual investments and other administrative tasks. Although maintenance of the separate account was largely ministerial, Plaintiff argued that that no discretion is required under the statute when a person has “any authority or control” over plan assets. The court agreed with this position, and clarified its prior authority, which suggested discretion is always a prerequisite to fiduciary status. However, the court also observed that a person is a fiduciary only “to the extent” it exercises authority or control over plan assets. Because Plaintiff was not alleging any mismanagement of the separate account, AUL’s authority or control over the separate account was not sufficient to render it a fiduciary for purposes of selecting the funds offered to the plan administrator.
Finally, the DOL argued that AUL was a fiduciary because it had authority to delete or substitute funds on the menu. However, the DOL conceded that AUL could be a fiduciary only “to the extent” it exercised that contractual right, and neither of the two occasions on which AUL did exercise that right gave rise to a claim. The DOL argued that AUL exercised its contractual right by not exercising it every time it invested plan assets in a fund that was more expensive than another fund that it could have chosen. The court rejected this “non-exercise” theory of exercise as unworkable and unprecedented. Instead it found that an omission was insufficient to satisfy the requirement that the individual exercise authority or control over plan assets. (It should be noted that once fiduciary status has been established, an omission may be sufficient to establish a breach, but an omission is not sufficient to create fiduciary status in the first instance.)
Leimkuehler is a significant development for this type of litigation, but is unlikely to be the last word. For example, although Leimkuehler was brought by the plan’s trustee, many such cases are brought by participants against the employer, plan administrator and service providers. Thus, the entities who made the final decisions over which investments to include are defendants, and at least some of them are likely to be fiduciaries. Leimkuehler does not address situations in which the defendant is a fiduciary. Moreover, some courts outside the Seventh Circuit have ruled in favor of Plaintiff’s challenging revenue sharing practices. See, e.g., Braden v. Wal-Mart Stores, 588 F.3d 585 (8th Cir. 2009); Tussey v. ABB, Inc., No. 2:06–CV–04305–NKL, 2012 WL 1113291 (W.D. Mo. Mar. 31, 2012). Nevertheless, Leimkuehler is an important new precedent in this area, and its analysis of fiduciary status will be influential in a wide range of situations where financial services providers have some control over plan assets, but are not exercising discretion in negotiating or receiving their fees.