RETIREMENT
A CASE STUDY OF A
FIDUCIARY BREAKDOWN
A recent case offers several lessons for Plan Sponsors and Service
Providers. One of the most critical issues in the case was the failure
of the company to follow its own Investment Policy Statement. This
case illustrates the need for plans to create a proper process for
Fiduciary Risk Management - emphasizing the Investment Policy
Statement as the foundation for a prudent process.
Robert Rafter
President,
RJR Consulting
Matt Sommer,
CFP®, CPWA®, AIF®
Director and Senior
Retirement Consultant,
Janus Capital Group
On March 31, 2012, a U.S. District Court judge for the Federal court
in the Western District of Missouri issued its decision in Tussey v.
ABB, Inc., No. 2:06-CV-04305, 2010 U.S. Dist. LEXIS 45240 (W.D.
Mo. Mar. 31, 2012) and ordered ABB Inc., Fidelity Management Trust
Co., and Fidelity Management & Research Co. to pay:
•
A combined $36.9 million in damages for breaching their
fiduciary duty to ABB’s 401(k) retirement savings plan.
•
The bulk of the damages ($35.2 million) were assessed against
the plan sponsor and other plan fiduciaries (ABB).
•
$13.4 million against ABB for failure to monitor
recordkeeping costs and fees
•
$21.8 million against ABB for removing one fund and
replacing it with another without prudent deliberation
•
$1.7 million against Fidelity for lost float income
The Federal Court found
that the plan sponsor and
other plan fiduciaries:
• F
ailed to follow the plan’s Investment
Policy Statement
• F
ailed to monitor recordkeeping costs
paid through revenue sharing and hard
dollars, and to negotiate rebates for
the plans;
• F
ailed to prudently deliberate prior to
removing and replacing investment
options in the 401(k) line-up;
• S
elected more expensive share
classes for the plans’ investments
when less expensive share classes
were available;
• A
llowed revenue sharing from the
401(k) plans to subsidize other
unrelated corporate services.
Update: In November 2012, a
federal court judge has ordered
Fidelity and ABB to pay $13.4M in
attorney fees and costs associated
with this case. Fidelity has stated it
will appeal the decision.
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What the Law Says
Plan sponsors, other fiduciaries and
their Service Providers need to know
and understand the implications of their
responsibilities under the law. Section
404(a)(1) of the Employee Retirement
Income Security Act of 1974 (ERISA)
provides that a fiduciary shall discharge
his/her duties with respect to a plan
solely in the interest of the participants
and beneficiaries. Further it provides that
a fiduciary must use plan assets for the
exclusive purpose of (1) providing benefits
to participants and their beneficiaries, and
(2) defraying the reasonable expenses of
administering the plan.
This provision is commonly referred to as
the “exclusive benefit rule” and it contains
an embedded ERISA duty of loyalty.
Therefore, any form of self-dealing is
clearly a breach of this duty of undivided
loyalty. In addition, plan fiduciaries must
adhere to a prudent expert standard of
care – to act with the care skill prudence
and diligence that a prudent expert
would use under the circumstances.
This exclusive benefit rule can also be
viewed as the foundation for the Labor
Department’s fee disclosure regulations
referred to below. This rule also provides
the framework under which plaintiffs’
attorneys can and do bring successful
excessive-fee class action litigation.
What the Court Said and
What the ABB Case Means
The U.S. District Court Judge found
that classes of investments with higher
expenses were selected for the plan and
that Fidelity was paid for plan services at
rates higher than market rates in order to
subsidize ABB’s other corporate services.
The court found that ABB failed to monitor
recordkeeping costs and negotiate rebates
from Fidelity Management Trust. The court
found that the ABB 401(k) plan fiduciaries
failed to meet the ERISA’s requirements
for investigating and determining
“reasonableness.”
The Court found that revenue sharing is
commonly used in the industry and was not
a fiduciary violation by itself. Nevertheless,
it is clear that if a plan sponsor adopts
revenue sharing as its method of paying for
record keeping and administrative services,
it must also develop a prudent process for
determining why the plan’s revenue sharing
arrangements are reasonable and solely in
interest of the plan participants.
3
Important Lessons for Plan Sponsors, Plan Fiduciaries
and Advisors:
1. Fiduciaries Have an Ongoing Obligation to Monitor Plan Fees
The Federal Court in the ABB case found that fiduciaries prior to entering into the
revenue sharing arrangement with Fidelity
•
did not prudently investigate the market pricing for similar recordkeeping services and
•
did not benchmark the cost of recordkeeping fees.
The court also found that several years later the ABB fiduciaries hired an independent
consultant to analyze and benchmark the cost of recordkeeping.
“Mercer issued a report in November 2005 (“Mercer Report”), which indicated
that based on Mercer’s research, ABB overpaid for Plan recordkeeping services
and that the Plan’s recordkeeping payments via revenue sharing appeared to be
subsidizing services for ABB corporate plans.”
Tussey v. ABB, Inc., No. 2:06-CV-04305, 2010 U.S. Dist. LEXIS 45240
(W.D. Mo. Mar. 31, 2012)
The ABB fiduciaries ignored the consultant’s financial analysis and its conclusion that
Fidelity’s fees were too high even though the consultant’s report showed that the amount
Fidelity was receiving for recordkeeping services through revenue sharing arrangements
was far in excess of a reasonable fee.
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2. Fiduciaries Should Prudently Select
and Remove Investment Options
The court determined that the ABB
fiduciaries violated their duty of
prudence when they failed to follow
their own Investment Policy Statement
requirements for the selection and
removal of an investment fund.
Specifically, they failed to prudently
deliberate when removing and replacing
the Vanguard Wellington mutual fund
with a Fidelity target-date fund.
share classes that provided higher revenue
sharing rather than pay a hard-dollar per
participant monthly fee. The key isn’t that
the cheapest share class must be chosen,
but there must be a justification on services
or other merits to warrant the fees.
“Specifically, the Court finds that after
the Fund was removed from the Plan
fund line-up, ABB selected share
classes with higher expenses than other
available share classes…. ABB did not
select one investment over another
“The Investment Policy Statement (IPS) specifically outlines the Committee’s
process for de-selection of a fund. The process requires an examination of the
fund’s performance over a three to five-year period, determining if there are five
years of under-performance and if so, placement of the fund onto a “watch list.”
Neither the Pension and Thrift Management Group nor the Committee complied
with this process…. Further, 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…. The recommendation
that the Wellington Fund be removed for poor performance was a blatant violation
of the IPS and illustrates a careless, imprudent decision-making process.”
Tussey v. ABB, Inc., No. 2:06-CV-04305, 2010 U.S. Dist. LEXIS 45240
(W.D. Mo. Mar. 31, 2012)
Other fiduciary failures included selecting
and retaining more costly classes of
investments for the Plans when other less
expensive classes of the same investments
were available. For instance, after removing
the a particular fund as an investment
for the Plans, the ABB fiduciaries chose
solely because of a difference in their
merit or value to the participants.”
Tussey v. ABB, Inc., No. 2:06CV-04305, 2010 U.S. Dist.
LEXIS 45240
(W.D. Mo. Mar. 31, 2012)
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3. Fiduciaries Should Adhere to Plan Documents –Particularly the
Investment Policy Statement
The Court also found that the plans’ IPS required that any rebates associated
with plan investments would be used to offset or reduce the cost of providing plan
administrative services. The Court concluded that revenue sharing would have been
considered a “rebate.” Nevertheless, instead of offsetting the cost of administrative recordkeeping services
as provided in the IPS, all revenue sharing was paid to Fidelity. The IPS also required
that when the plan was offered a choice of mutual fund share classes, the class with
the lowest cost of participation should be selected.
“Section 5 of the IPS states: “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.” The Court interprets this to
mean that ABB will choose the share class that has the lowest expense ratio;
i.e., the cost of participating in the specific investment selected, normally
expressed as an expense ratio…. However, the IPS specifically requires
use of a share class that has the least expenses. ABB’s decision to use
classes of shares with greater expense ratios violates the IPS, a governing
Plan document, and therefore violates ERISA’s duty of prudence.”
Tussey v. ABB, Inc., No. 2:06-CV-04305, 2010 U.S. Dist. LEXIS 45240
(W.D. Mo. Mar. 31, 2012)
Once again, the Court found, that the ABB fiduciaries violated the terms of the IPS
and selected the class of shares that provided the highest revenue sharing to Fidelity.
The Court concluded that the ABB fiduciaries failed to follow the investment policy
statement and imprudently chose more expensive funds. The ABB fiduciaries chose
theses share classes to avoid paying per-participant hard-dollar recordkeeping fee.
6
We can see from the Court’s choice of
language the egregious nature of the
ERISA violations with regard to these
decisions by plan fiduciaries.
4. Plan Assets Cannot Be Used To
Subsidize Other Employer Plans subsidizing other plans is a clear
violation of ERISA’s “exclusive
benefit rule”
The Court also found that while
negotiating with Fidelity about
removing a Fidelity fund as a
plan investment option, ABB had
obtained an independent evaluation
of the Fidelity fee structure from an
outside consulting firm as mentioned
above. The report issued by outside
consulting firm had concluded that
ABB was overpaying for recordkeeping
services and the revenue sharing
from the 401(k) plans appeared
to be subsidizing other services
provided to ABB by Fidelity (including
recordkeeping for the company’s
defined benefit plan, its deferred
compensation plan, its health benefits,
and its payroll).
An email from Fidelity to the ABB
employee responsible for negotiating
Fidelity’s contract suggested that
Fidelity was offering services for
ABB’s health and welfare plan at
below market cost and did not charge
administration fees for ABB’s nonqualified plans. These fees were being
“absorbed” by Fidelity.
The Court found once again that
these circumstances led to ongoing
ERISA violations:
“However, once Mr. Scarpa became
aware that the recordkeeping fees
appeared to be subsidizing ABB’s
corporate programs, he had a
fiduciary obligation to investigate
and prevent any future subsidy. He
failed to take any step to do so.
Instead, ABB selected investments
to ensure revenue neutrality for
Fidelity Trust and ABB continued to
pay above market for recordkeeping
fees…Because of Mr. Scarpa’s
inaction and lack of goodfaith, ABB,
Inc., and the Employee Benefits
Committee perpetuated the use of
Plan revenue sharing to subsidize
discounts for ABB corporate
services, which is a non-Plan
purpose, in violation of ERISA’s duty
of loyalty.”
Tussey v. ABB, Inc., No.
2:06-CV-04305, 2010 U.S.
Dist. LEXIS 45240
(W.D. Mo. Mar. 31, 2012)
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Lessons for Plan Sponsors and Service Providers
These ABB fiduciary breaches could have easily been avoided if ABB plan fiduciaries had
followed their own investment policy statement and periodically benchmarked their fees
against the marketplace.
This ABB case, taken together with the new Department of Labor (DOL) Service Provider
to Plan Sponsor Fee Disclosure Rules, clearly indicates that Plan Sponsors should
develop and follow a detailed fiduciary process including additional steps for reviewing
fees and revenue sharing arrangements. Plan Sponsors and other plan fiduciaries should
pressure service providers to provide sufficient information about any revenue sharing
arrangements to allow them to:
•
Consider how the Plan size might be used as leverage in a negotiation for lower fees
•
Benchmark the fees and expense ratios before deciding to pay for recordkeeping
through revenue sharing
•
Regularly “benchmark” the cost of plan services to obtain current independent data
on the going market price for services
•
Determine whether the revenue sharing and other payments provide the service are
reasonable in light of the services provided
•
Ensure that one employer plan is not subsidizing the services provided to another plan,
where bundled providers offer multiple services and receive compensation through
revenue sharing
Fiduciaries should routinely review and revise the investment policy statement (IPS), to
ensure that (1) their fiduciary actions are consistent with the stated policies set forth in
the IPS and (2) the IPS is up to date and reflects both the Plan Sponsors intent and the
new regulatory environment. Plan sponsors and their Advisors should also make sure that
the IPS is not so detailed and restrictive as to cause unintended liability. Plan sponsors
and other fiduciaries should continue to remain vigilant by developing an ongoing process
for determining whether plan fees are reasonable in light of the services provided, and
thoroughly documenting the basis for all investment decisions.
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Plan Sponsors, Advisors and Service
Providers will need to understand the
implications of the ABB case. This case
illustrates the kind of litigation exposure
and risk that fiduciaries face when they
fail to engage in a prudent process.
Plan Sponsors must certainly develop
a much tighter fiduciary monitoring
process for fees and revenue sharing
arrangements. At the same time, Service
Providers can use the ABB case as
an opportunity to enhance their value
proposition by offering plan fee analysis,
benchmarking, and investment advisory
services to Plan Sponsors. Set forth
below is a checklist that experienced
Service Providers might use:
Service Provider’s
Checklist
•
IPS
•
Due Diligence
•
Fund Analysis
•
Benchmarking
•
Fiduciary Training
•
Committee Meetings
•
Documentation
•
Consultant
•
ERISA 3(21) Fiduciary
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Conclusion
This ABB case illustrates the kind of litigation exposure and risk that fiduciaries face when
they fail to engage in a prudent process and fail to follow the plan documents. In addition to
excessive fee class action lawsuits, the Department of Labor has now issued regulations that
require disclosure of compensation and fees paid for specific services, as well as any conflicts
of interest. Ultimately the new DOL fee disclosure rules are all about determining and
documenting the reasonableness of the plan’s fees. The Department of Labor’s revised
Section 408(b)(2) Fee Disclosure Rules for Service providers became effective July 1, 2012.
It is now more important than ever that plan fiduciaries are able to demonstrate that they
have engaged in a prudent process to understand and monitor fees paid to all plan service
providers.
The selection and removal of investment options should always be based on a prudent
decision making process that begins with adhering to a well-crafted investment policy
statement. Selecting investment share classes with higher fees for participants may produce
better revenue sharing to offset the plan’s administrative costs. Nevertheless, share classes
with lower fees may ultimately produce better investment results for plan participants. As we
have seen in the discussion of the ABB case above, Plan Sponsors and other fiduciaries must
act solely in the interests of plan participants when they make these plan decisions.
It is clear that although the ABB Case represents an extreme, it can be very instructive for
both Plan Sponsors and Service Providers. The case presents an excellent opportunity for
both Plan Sponsors and their Service Providers to construct a strategy for building a defensive
plan to help prevent excessive fee litigation and DOL fee audits.
Janus Can Help
Janus has cultivated a deep understanding of the complexities and needs of
the retirement marketplace and 401(k) advisor. Our Retirement Directors,
with an average of 15 years industry experience, have coached and supported
Service Providers regarding the regulatory environment, practice management
and marketing campaigns. If you would like to discuss strategies that may be
appropriate for your practice with our Retirement Directors, please contact
your Janus Director at 1-877-33JANUS (52687).
10
About the Authors
Robert J. Rafter, J.D.
Robert currently serves as President of
RJR Consulting, an independent firm
providing strategic consulting services to
large investment firms. Prior to starting
RJR Consulting, Robert served as Senior
Vice President and Director of Institutional
Corporate Retirement Services for Smith
Barney’s Corporate Client Group. In that
role, he had responsibility for institutional
retirement sales, marketing and broker
training efforts.
Robert has chaired and spoken at
numerous industry conferences on the
corporate retirement plan challenges
faced by both employer sponsors and
financial institutions. He is a Founding
Lecturer atUCLA Anderson School
of Management – The Retirement
Advisor University where he teaches the
Fiduciary Standard of Care course for
the program.
Robert is a lawyer with deep experience
and expertise in fiduciary matters. He
is a frequent author and public speaker
on retirement plans, fiduciary standards,
risk management, investment advice
and related subjects. Robert was a
standing member of the Investment
Company Institute’s Pension Committee.
A graduate of the University of California
at Berkeley and the Fordham University
School of Law, Robert is a member of
the New York and Federal Bar.
Matt Sommer, CFP®, CPWA®, AIF®
Matt Sommer is Vice President and
Director of the Janus Retirement
Strategy Group. In this role, he provides
advice and consultation to Financial
Advisors and Consultants surrounding
some of today’s most complex retirement
issues. His expertise covers a number of
areas including regulatory and legislative
trends, practitioner best practices,
and financial and retirement planning
strategies for high net-worth clients.
Prior to joining Janus, Matt spent 17
years at Morgan Stanley Smith Barney
and its predecessors. Matt held a
number of senior management positions
including Director of Financial Planning
at Citi Global Wealth Management and
Director of Retirement Planning
at Smith Barney. Matt received his
undergraduate degree in Finance
from the University of Rhode Island
and received a Masters of Business
Administration with a specialization in
Finance from the Lubin School of
Business at Pace University.
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The opinions expressed are as of September 2012 and are subject to change at any time due to changes in regulatory, legal, market and/
or economic conditions. The comments should not be construed as a recommendation but as an illustration of broader themes.
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