In the first federal appellate decision addressing the new breed of ERISA “excess fee” cases, the U.S. Court of Appeals for the Seventh Circuit last week held, in Hecker v. Deere & Co that the Employee Retirement Income Security Act (“ERISA”) does not require an employer that sponsors 401(k) plans for its employees to disclose to plan participants that the plans’ investment advisor shared revenue with the affiliated plan trustee. According to the court, nothing in ERISA prohibits a fiduciary from selecting funds from one management company, or requires a fiduciary to scour the market to find the cheapest funds. The court also held that merely “playing a role” in the selection of funds to be offered in a plan is not enough to transform an entity into a fiduciary.
In Hecker, a class of participants in the Deere 401(k) plans sued Deere, the sponsor of the plans; Fidelity Management Trust Co. (Fidelity Trust), the directed trustee and recordkeeper who performed administrative tasks for the plans and managed two of the investment options; and Fidelity Management & Research Co. (Fidelity Research), the investment advisor for the Fidelity mutual funds offered as investment options under the plans. Deere selected the investment options, 23 of which were managed by Fidelity Research. The remaining investment options included two investment funds managed by Fidelity Trust, a Deere stock fund, and a “BrokerageLink” option giving participants access to 2,500 additional funds managed by companies other than Fidelity. Fidelity Research shared its revenue earned from mutual fund fees with Fidelity Trust, which compensated itself with those fees rather than through a direct charge to Deere. Based on statements in the summary plan descriptions supplements, however, the participants were under the impression that Deere was paying the administrative costs for the plans.
Distressed primarily by the fee levels, the participants brought suit. The participants claimed that Deere breached its fiduciary duties by failing to disclose the revenue sharing arrangement. They further alleged that both Fidelity companies were “functional fiduciaries” of the plan. Finally, they claimed that Deere and the Fidelity companies breached fiduciary duties by selecting funds with excessively high fees. The participants’ claims were dismissed by the trial court for failure to state a claim, and the participants appealed.
Fidelity’s Alleged Status as a Fiduciary.
The Seventh Circuit affirmed the district court’s dismissal. The Court reasoned that merely discussing the offerings with Deere did not cause the Fidelity entities to have sufficient control over the selection of funds as to confer “functional” fiduciary status. The Court characterized Fidelity’s role as that of furnishing professional advice, much like a lawyer or accountant. The Court found that Fidelity merely “played a role” in the process; it did not have the “final authority” over investment fund offerings necessary to establish a fiduciary role.
Claims Against Deere for Failing to Disclose Revenue-Sharing and for Limiting Investment Offerings to Fidelity Funds.
The Court similarly rejected the fiduciary duty claims against Deere. Deere did not breach its fiduciary duty by failing to inform participants that Fidelity Trust received a portion of the fees collected by Fidelity Research. The Court found that ERISA did not require disclosure of revenue sharing. “While Deere may not have been behaving admirably by creating the impression that it was generously subsidizing its employees’ investments by paying something to Fidelity Trust when it was doing no such thing,” there was no allegation of a fraudulent statement of a dollar amount. The Court held that it was sufficient for Deere to disclose the total fees for the funds and direct the participants to the prospectuses for information about fund-level expenses. The Court explained that the participants submitted evidence that Deere believed that Fidelity Trust’s services were free, and the decision may have been different if Deere had intentionally misled its employees.
The Court also quickly dismissed the participants’ other claim —that Deere imprudently agreed to limit the investment options to Fidelity Research funds and therefore offered only investment options with excessive fees. The Court held that Deere provided for a wide range of expense ratios and levels of risk in the investment offerings, and that it was of no consequence that the majority of these investments were Fidelity fund investments. (While there are pros and cons to allowing individual brokerage accounts in a retirement plan, in this case, the existence of those alternatives was helpful to Deere because it allowed participants to choose investments with lower fees.) The Court noted, however, “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund” and that “if particular participants los[e] money or d[o] not earn as much as they would have liked, that disappointing outcome [is] attributable to their individual choices” rather than the actions of the fiduciary.
The Court also assumed, without deciding, that the ERISA Section 404(c) safe harbor applied to the selection of investment options. This safe harbor allows plan fiduciaries who permit participants to direct their own investments to be shielded from fiduciary liability for the decisions of the participants. The Court saw no plausible argument in the complaint that Deere had failed to comply with the requirements of Section 404(c).
What This Decision Means for Employers.
While the decision in Hecker v. Deere & Co favors employers, this case spotlights a hot topic, 401(k) plan fees, that requires ongoing employer attention. Employers need to consider their fiduciary responsibilities with respect to retirement plan investments, and take steps to minimize litigation exposure.
An employer that is allowing participants to direct investments needs to carefully assess the investment options it is providing, and the disclosure of fees and other pertinent information. As discussed in Hecker, in response to complaints regarding fee disclosure, the Department of Labor has proposed extensive fee disclosure regulations. Final regulations were anticipated to be effective January 1, 2009, but are on hold under the new Presidential administration. Employers will need to comply with these new regulations when they are finalized and become effective, and may also be subject to additional legislation that has been proposed. Further, maintaining a program for compliance with the safe harbor provisions of ERISA Section 404(c) will help protect fiduciaries from liability for the participants’ own choices.