On March 31, 2012, the US District Court for the Western District of Missouri decided Tussey v. ABB, Inc.,1 a closely-watched ERISA class action brought by participants of two 401(k) plans challenging the selection of investment options for the plans and the fees paid to the plans’ recordkeeper. In a searing 81-page opinion, the court awarded $35.2 million in damages against ABB and related defendants (“ABB defendants”), and $1.7 million in damages against Fidelity Management Trust Co. and its affiliate, Fidelity Management & Research Co. (“Fidelity defendants”). While there is much to disagree with in the court’s opinion, there are two important lessons that 401(k) plan fiduciaries can learn from it: (1) do not consider the employer sponsor’s financial interests in selecting the plan’s investment options, and (2) be very careful how you write investment policy statements.  

Background

ABB sponsored two 401(k) plans, one for its unionized employees and one for nonunion employees. Fidelity Management Trust Co. served as recordkeeper for both plans. Initially, Fidelity was paid a per-participant, hard-dollar fee for its services, but that changed over time. By April 2001, Fidelity was paid for its services to the non-union plan solely through revenue sharing, and was paid for its services to the union plan through revenue sharing and an $8 per-participant fee.  

Of the total $35.2 million awarded against the ABB defendants, $13.4 million was based on findings that the ABB defendants:

  • breached their duties to act prudently and in accordance with the plan documents by (i) failing to monitor recordkeeping costs under the plans’ revenue sharing arrangement with Fidelity, and (ii) selecting higher fee share classes for six mutual funds when lower fee share classes were available; and
  • breached their duty of loyalty by failing to investigate and discontinue payment of “above market” recordkeeping fees after learning that the above market amount was being used to subsidize other corporate services provided to the plan sponsor by the recordkeeper.  

The remaining $21.8 million was awarded based on findings that the ABB defendants had breached their duties to act prudently, loyally and in accordance with the plan documents and engaged in non-exempt prohibited transactions in deciding to remove a “well performing” balanced fund from the plan’s investment menu and replace it with a series of higher revenue-sharing target date funds affiliated with the plan’s recordkeeper.2 The court rejected plaintiffs’ claim that the ABB defendants acted imprudently by failing to offer more separate account options and commingled funds.  

The court also awarded injunctive relief against the ABB defendants, which required them, among other things, to: (i) conduct a competitive bidding process for a new recordkeeper; (ii) determine the dollar amount of any compensation paid to the recordkeeper and negotiate for rebates if revenue sharing is used to pay for recordkeeping; (iii) disqualify the new recordkeeper from providing any corporate services to the plan sponsor; and (iv) select the share class with the lowest expense ratio in choosing investments.  

Both components of the $35.2 million in damages awarded against the ABB defendants involved evidence of divided loyalties. For the $21.8 million component, there was evidence that ABB was obligated under a collective bargaining agreement to pay the amount by which any hard-dollar fees charged to the union Plan exceeded those charged to the non-union Plan. For the $13.4 million component, there was evidence that revenue sharing from the Plans’ assets was being used to subsidize other corporate services provided to ABB. This aspect of the ABB case underscores a point that we have been making for some time – namely, that the likelihood of a court’s finding liability in a fiduciary breach case increases significantly if the plaintiff can present credible evidence that the fiduciary’s decision making was influenced by divided loyalties. Excessive fee cases typically boil down to a battle of expert testimony on whether the fees paid for plan services are within the range of “reasonableness,” where courts generally are not inclined to “second guess” the fiduciary’s decision. If, however, there is evidence of tainted decision making, judicial scrutiny of the fiduciary’s decision-making process may be heightened, and expert testimony that would otherwise be discounted may be accorded greater weight.  

A more detailed commentary on the court’s opinion is provided below.  

Failure to Monitor Recordkeeping Costs and Discontinue Subsidizing Corporate Services

The court saw nothing improper with revenue sharing itself, describing it as “an acceptable practice in the investment industry.” In this respect, the court’s decision was in accord with the Department of Labor’s teaching on the subject as well as the judicial decisions considering the issue.3 The court concluded, however, that the ABB defendants breached their fiduciary duties by failing to “calculate[ ] the dollar amount of the recordkeeping fees the Plan paid to Fidelity Trust via revenue sharing arrangements” or to “consider how the Plan’s size could be leveraged to reduce recordkeeping costs.” As discussed below, the court seemed particularly troubled by the suggestion that the ABB defendants were overpaying for recordkeeping to subsidize other services that Fidelity provided to ABB.  

The court found that, from 2001 through 2007, the revenue sharing amounts generated by the Plans’ assets “far exceeded the market value for recordkeeping and other administrative services provided by Fidelity Trust.” Crediting the plaintiff expert’s testimony, the court determined that the per-participant amounts paid by the Plan exceeded by two to three fold reasonable per participant fees. The court interpreted Fidelity’s own internal documents as showing that the per participant revenue it earned from the ABB plans was greater than the trend of revenue it earned from other plans.  

Finding that an Investment Policy Statement (“IPS”) adopted by the Plans’ Pension Review Committee in 2000 was a “governing plan document,” the court concluded that the ABB defendants breached their fiduciary duty to act in accordance with the plan documents by “mak[ing] no meaningful effort to monitor the revenue sharing and determine whether it was being used to reduce Plan recordkeeping costs.” The IPS stated that “at all times, [Alliance] rebates will be used to offset or reduce the cost of providing administrative services to plan participants.” Even though the IPS was not incorporated by reference in the plan or trust agreements, the court construed this language to require ABB to “use its ‘purchasing power’ to negotiate for rebates from Fidelity Trust, either in the form of basis points or hard-dollar amounts.”  

Having found that the revenue sharing “far exceeded the market value for recordkeeping and other administrative services,” the court further concluded that the ABB defendants breached their duty of loyalty by failing to investigate and discontinue the use of excessive revenue sharing to subsidize other corporate services that Fidelity provided to ABB. After Fidelity became the Plans’ recordkeeper, it began providing “total benefit outsourcing services” to ABB – taking over “recordkeeping for the … defined benefit plan in 1997; health and welfare plans in 1999 and 2000; and payroll in 2004.” Fidelity made a “substantial profit” on the recordkeeping services it provided to the Plans, but “lost money” on the corporate services it provided to ABB. The court found specifically that excessive revenue sharing generated by the Plans’ assets was subsidizing the cost of these corporate services. Rather than take steps to stop subsidizing corporate expenses, the court found that one of the ABB defendants made the contractual period for the corporate plans the same as for the two 401(k) Plans, thus ensuring that “the contracts for each would be renegotiated at the same time so that Fidelity’s business relationship with ABB and the Plan would be considered together, thereby facilitating continued subsidization of ABB corporate services.”  

Improprieties in Selecting Investment Funds

The court ruled that the ABB defendants breached their fiduciary duties in removing the Vanguard Wellington Fund for “deteriorating performance,” selecting the Fidelity Freedom Funds to replace the Wellington Fund, and mapping participants’ individual account assets from the Wellington Fund to the Freedom Funds. These changes had been finalized in 2001, after the adoption of the IPS, which the court described as “provid[ing] a roadmap for the Committee to follow in selecting, de-selecting, and monitoring investments.” As described by the court, the “de-selection” process in the IPS required “examination of the fund’s performance over a three to five-year period, determining if there are five years of underperformance, and if so, placement of the fund onto a ‘watch list.’” The court described the IPS as requiring a “large winnowing process” for selecting new funds. The IPS further contemplated a “tiered investment strategy,” one tier of which was to be comprised of “several ‘managed allocation’ funds designed to offer the participant a professionally managed, well diversified fund or funds appropriate for the participants’ investment goals.”  

The court held that the ABB defendants acted imprudently and violated the governing plan documents by failing to comply with the “de-selection” process specified in the IPS. The court found that “no calculations were performed regarding the Wellington Fund’s performance in the years preceding its removal, and the fund was not placed on a ‘watch list’ as required by the IPS.” Wholly apart from the IPS, the court stated that the imprudence of the ABB defendants’ decision to remove the Wellington Fund was corroborated by their “lack of research and analysis.” In the court’s view, a “modicum of inquiry” would have revealed that the Wellington Fund was a “consistent, strong-performing fund over its seventy-year existence,” including the five-year period immediately prior to the initial recommendation to remove the Fund for “deteriorating performance.”  

The court further held that the ABB defendants acted imprudently and violated the governing plan documents by failing to employ the “large winnowing process” required by the IPS in selecting the Freedom Funds as the Plans’ “managed allocation” funds. The court found that the ABB defendants “considered only two viable options for a managed allocation fund,” and that they failed to engage in a “deliberative assessment of the merits” in deciding which option to choose. Indeed, the court observed that the only reason offered as to why the ABB defendants preferred the Freedom Funds over other target date funds was the Freedom Funds’ “glide path,” which the court indicated was “not unique to Freedom Funds, but rather is a characteristic embodied by lifestyle funds generally.”

In addition, the court concluded that the ABB defendants breached their duty of loyalty by mapping the Wellington Fund to the Freedom Funds in order to generate more revenue sharing for the Plans’ recordkeeper, thereby keeping fees “opaque” to employees and making it easier for ABB to promote the Plans to current and prospective employees as a valuable benefit provided by the company. The court found also that ABB had a financial incentive to keep the union Plan’s hard-dollar fees low because ABB’s collective bargaining agreement had required ABB to pay any amount by which the hard-dollar fees charged to the union Plan exceeded those charged to the non-union Plan. Mapping to the Freedom Funds resulted in the Plan bearing the full recordkeeping and administrative costs. The court also found that the ABB defendants were influenced by ABB’s “close relationship … with Fidelity, including the use of Fidelity to perform corporate services for ABB.”4

Improprieties in Selecting Share Classes

The court also ruled that the ABB defendants acted imprudently and violated the IPS by selecting higher fee share classes for six mutual funds on the Plans’ investment platform when lower fee share classes were available. The Plans’ Trust Agreement had been amended shortly after the mapping of the Wellington Fund to the Freedom Funds to include a fee change policy that was designed to “minimize future recordkeeping fee negotiations between ABB and Fidelity Trust each time changes were made to the composition of the Plan.” The court described this Trust amendment as a “revenue neutral” policy under which “the agreed upon model for paying Fidelity Trust’s recordkeeping costs would be subject to change should the fund line-up or other Plan characteristics alter the revenue sharing paid to Fidelity.”  

The court found that, after the Fidelity Magellan Fund was removed from the Plans’ investment platform in 2005, the ABB defendants selected share classes for six mutual funds that provided more revenue sharing than other available share classes in order to remain “revenue neutral.” The court concluded that the selection of higher fee share classes violated a section of the IPS, which stated that: “When a selected mutual fund offers ABB a choice of share classes, ABB will select that share class that provides Plan participants with the lowest cost of participation.” In addition, the court concluded that the ABB defendants acted imprudently in deciding to maintain neutral revenue sharing rather than selecting lower fee share classes because the revenue neutral arrangement was not prudently determined to be a reasonable method of compensating the Plans’ recordkeeper and was itself a result of “ABB’s prohibited transaction when it mapped the Wellington Funds to the Freedom Funds.” The court declined to award any additional damages for these breaches, reasoning that any resulting loss was already being compensated by the $13.4 million in damages awarded for excess recordkeeping fees paid to the Plans’ recordkeeper.  

We think it is important to emphasize here what the ABB court did not hold: It did not hold that fiduciaries of participant-directed individual account plans must select the share class or tier level with the lowest expense ratio, even where the plan in question utilizes revenue sharing to compensate its recordkeeper. Rather, the court held that the ABB defendants violated explicit language in the Plans’ IPS, and that it was imprudent for them to attempt to maintain a “revenue neutral” policy where they had “failed to determine the amount of income revenue sharing generated for Fidelity Trust and failed to negotiate for rebates.”  

Concluding Observations

The court’s holding that the IPS was a “governing plan document” is suspect. The Department of Labor interpretive bulletin cited by the court, 29 C.F.R. § 2509.94-2 (1994), indicates that investment managers and trustees must comply with statements of investment policy where their agreement with the plan expressly requires such compliance. The interpretive bulletin does not address a situation where a plan committee adopts a statement of investment policy to guide the committee’s members in the selection of investment options for a participant-directed individual account plan. Regardless of whether this holding is correct, the IPS language upon which the court relied illustrates several points that 401(k) plan fiduciaries should keep in mind when they have such investment policies prepared for their own guidance. Such policies should generally (1) avoid imposing mandates and reciting legal duties; (2) identify potentially relevant facts and circumstances which the plan’s fiduciaries should take into account in making decisions, while giving them appropriate discretion to decide the best course of action after considering those facts and circumstances; and (3) not include provisions that are inconsistent with how the plan is in fact operated. We also think 401(k) plan fiduciaries would be well-advised to review their statements of investment policy and amend them, if necessary, to clarify that they are not to be considered part of the “documents and instruments governing the plan” within the meaning of ERISA § 404(a)(1)(D).  

It is also important to note that ABB’s “mapping” transaction took place before the Department of Labor’s adoption of the QDIA regulation in 2007.5 Plan fiduciaries who comply with that regulation will be relieved from liability for investments made in “qualified default investment alternatives” or “QDIAs” on behalf of participants who fail to direct the investment of assets in their individual accounts. The preamble to the QDIA regulation makes clear that it applies to situations where a plan participant fails to provide an investment direction following the elimination of an investment option.6 Thus, a plan fiduciary who complies with its fiduciary responsibilities in deciding to eliminate an existing investment option will be relieved from liability for investments made in a QDIA on behalf of participants who fail to provide an investment direction after being provided with the required notice. The QDIA regulation requires plan fiduciaries to act prudently in selecting any particular fund over another within a general QDIA category (e.g., target date funds), but also makes clear that plan fiduciaries are not subject to liability in choosing between the general categories of QDIAs (i.e., target date fund, balanced fund, or managed accounts). Thus, for example, a plan fiduciary who otherwise complies with the QDIA regulation is not subject to liability for choosing a target date fund rather than a balanced fund as the plan’s default investment alternative.  

Even if ABB’s “mapping” transaction had been consummated after the QDIA regulation took effect, the Plans’ fiduciaries would have been required to act prudently and loyally in selecting any particular target date fund over another. In addition, the QDIA regulation provides no relief for any liability resulting from a violation of ERISA’s prohibited transaction rules. We think the court was clearly wrong when it suggested that the ABB defendants’ consideration of the Freedom Funds’ “glide path” was irrelevant to a prudent investigation of alternative target date funds. The court did not appear to understand that variations in glide path construction (e.g., starting and ending equity/fixed income allocations, whether the glide path runs “to” or “through” the expected retirement date) can significantly impact performance and are thus an important factor in selecting one target date fund over another. We also find it surprising that the court predicated its finding of disloyalty in part on incidental benefits to ABB as plan sponsor, such as making the Plans look more attractive to current and prospective employees.7 However, since the court also based its finding of disloyalty on the mapping transaction’s effect on ABB’s obligations under its collective bargaining agreement, we think it would be useful for fiduciaries of participant-directed individual account plans that utilize revenue sharing arrangements to review their plan documents and any applicable collective bargaining agreement to make sure that they cannot be interpreted to impose any such obligation on the sponsor.