ERISA Alert. Plan Sponsors Impacted by Hidden 401(k) Fee Litigation

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1 ERISA Alert October 2007 ALBANY AMSTERDAM ATLANTA BOCA RATON BOSTON CHICAGO DALLAS DELAWARE DENVER FORT LAUDERDALE HOUSTON LAS VEGAS LOS ANGELES MIAMI NEW JERSEY NEW YORK ORANGE COUNTY ORLANDO PHILADELPHIA PHOENIX SACRAMENTO SILICON VALLEY TALLAHASSEE TAMPA TOKYO TYSONS CORNER WASHINGTON, D.C. WEST PALM BEACH ZURICH Strategic Alliances with Independent Law Firms BRUSSELS LONDON MILAN ROME TOKYO Plan Sponsors Impacted by Hidden 401(k) Fee Litigation Corporate governance events in the financial services industry over the last few years have caused employer plan sponsors to pay more attention to transparency or full disclosure and explanation of fees charged by plan service providers. This is now at the top of the priority list at the U.S. Department of Labor (DOL), as well as a new favorite subject of the plaintiff class action bar who have now brought more than 14 major lawsuits accusing Fortune 100 companies and members of their boards of directors and senior officers of violating the Employee Retirement Income Security Act (ERISA) of 1974, as amended by allowing their employees to be overcharged by their 401(k) plan vendors for investment management and administration services. A review of recent cases in this area is examined below. Deere and Fidelity 1 A Wisconsin federal district court recently dismissed claims that Deere & Co., by allowing its 401(k) plan participants to pay excessive and unreasonable fees, breached its fiduciary duties under ERISA. The court also dismissed claims against Fidelity Trust for breach of fiduciary duty by charging and keeping the allegedly excessive fees and failing to adequately disclose information about the fees and costs to plan participants. Fidelity was the plan s record keeper and provider of most of the investment options within the plan. The court adopted a narrower interpretation of ERISA s fiduciary requirements than is customary in ERISA cases, creating a split of authority among the district courts before whom these excessive fee cases are currently pending (See Bechtel below). The court held that since Deere had complied with all of the statutory reporting and disclosure requirements mandated by ERISA (i.e., requiring plans to provide summary plan descriptions, annual reports, and summary annual reports), it did not breach its duties. The court found no merit in the participants contention that ERISA s fiduciary duty rules impose additional disclosures separate and apart than those described in the statute s minimum reporting and disclosure requirements. In this case, Fidelity Trust was compensated in part for its duties as trustee and record keeper by direct payment from Deere. However, each of the 23 funds for which defendant Fidelity Research was investment advisor charged fund investors an asset-based fee ranging from.07 to 1.01 percent. Although these fees were set forth in each fund prospectus, the fact that Fidelity Research shared some of the fee revenue it received with Fidelity Management, and the amount of this revenue sharing of asset-based revenue, was not known to Deere or disclosed to plan GREENBERG TRAURIG, LLP ATTORNEYS AT LAW

2 participants. 2 However, the court held that [n]othing in the statute or regulation directly requires such a disclosure. According to the court, the disclosure in the reports and prospectuses accurately reflect the expenses actually paid to the fund manager for fund management. To the extent that the charge includes profit, said the court, it is unlikely that the fund sponsor would know or be in a position to control its redistribution among related corporations and there is no evidence of intent in the statute or regulations to reach this type of detail. In this regard, the court emphasized that recent proposals to amend the DOL regulations 3 to require revenue sharing disclosures in the Form 5500 or annual reports make it apparent that present regulations do not require it. These proposals for regulatory change originated in the ERISA Advisory Counsel Report of the Working Group on Plan Fees and Reporting on Form The Report examines the nature of the revenue sharing and its effect on the adequacy of expense disclosure for 401(k) plans as presently required by ERISA regulations and concludes that the fiduciary responsibility provisions of ERISA require that plan sponsors know the amount of fees paid in relationship to the services provided and to understand the revenue sharing arrangements between plan providers. Therefore, the Department of Labor should consider amending the Form 5500 and the accompanying Schedules 5 According to the court, a review of the Report confirms that the revenue sharing issue is a matter of policy concern within the DOL and also unequivocally confirms that present regulations do not require disclosure of the information. Accordingly, the court found that failure to include such information does not violate existing ERISA standards for disclosure 6 (emphasis added). Moreover, the court emphasized that there is no merit to plaintiffs' contention that disclosure not required by the statutory disclosure requirements is separately required by the general ERISA fiduciary obligations. 7 According to the court, disclosure requirements are generally limited to those expressly prescribed by the statutory language of ERISA 8 and that the latitude of courts to develop the meaning of general fiduciary duties is limited as applied to disclosure obligations. 9 COMMENT The court s holding in Deere is of limited value since the DOL has decided to follow the recommendations of the ERISA Advisory Council by revising the Schedule C to the Form 5500 to require full disclosure of expenses on bundled and unbundled investment arrangements and in particular indirect compensation that service providers receive from third or related parties in connection with the provision of plan services. The DOL has also initiated an enforcement investigative project, called the Consultants and Advisors (or CAP) Project, designed to look at a significant number of consultants to ERISA plans and to focus particularly on the consultants undisclosed and indirect compensation. The purpose of the CAP Project is to determine whether these arrangements and sources of compensation were disclosed to plan fiduciaries and other decision makers and, if so, whether the fiduciaries themselves undertook a careful and appropriate analysis of the service provider in relation

3 to those disclosures. The project is primarily focused on investment advisors but invariably will lead to further investigations of individual plans who are clients of those investors. Some of the class action cases against large companies have already raised that point and several others will get to that point in the not so distant future. Finally, the DOL will be amending its regulations relating to provision of services that will impose new legal obligations on the service provider to provide specific types of disclosure to the plan fiduciary and the decision makers. Specifically, the DOL will be proposing an amendment to the current section 408(b)(2) regulations that defines a reasonable arrangement which would have to be satisfied for the statutory exemption for provisions of service to apply. This will include disclosure of significant amounts of information about compensation, particularly indirect sources of compensation the service provider receives, in connection with the plan s activities and with the plan s engagement of service providers. The Deere case also contradicts the DOL s position on the ERISA section 404(c) safe-harbor. The court held that even if the defendants breached their fiduciary duties in selecting the mutual fund options, they are insulated from liability under ERISA section 404(c). The court reasoned that because the plan offered a brokerage window with more than 2,500 mutual funds to choose from, it was impossible that all investment options offered under the plan charged excessive fees. Therefore, the court concluded that even if some of the Deere plan s investment options charged excessive fees, these excessive fees were the result of the participants exercise and control over the investments. According to DOL, the scope of ERISA section 404(c) relief is limited to losses or breaches "which resulted from" the participant's exercise of control. The DOL has long opined that ERISA fiduciaries remain responsible for prudently selecting a plan s menu of investment options, regardless of how participants select among those options. In other words, ERISA section 404(c) plan fiduciaries are still obligated by ERISA's fiduciary responsibility provisions to prudently select the investment options under the plan and to monitor their ongoing performance. 10 Accordingly, it would be the DOL s view that fiduciaries, breaching their duties by having an investment option that charges excessive fees, would not be protected under ERISA section 404(c). Kanawi v. Bechtel 11 A California federal district court denied Bechtel Corp. s motion to dismiss ERISA breach of fiduciary claims against the Bechtel Corporation, the Bechtel Plan Committee and its Vice President of Retirement Plans for failure to disclose unreasonable and excessive fees to plan participants. The court, unlike the holding in Deere, rejected Bechtel s argument that its compliance with the statutory reporting and disclosure requirements mandated by ERISA created a safe harbor from fiduciary liability. The court stated: To hold otherwise would be to hold that any amount of misrepresentation or dishonest dealing on behalf of the Plan, at least with respect to the fees and expenses charged against the Plan, cannot provide the basis for a cause of action so long as such fees and expenses are disclosed in the manner prescribed by ERISA and the [DOL s] regulations. Defendants have provided no authority for such a proposition, and the Court declines to adopt that position here. 12

4 Haddock v. Nationwide Financial Services, Inc. 13 A Connecticut federal district court concluded that payments made under revenue sharing arrangements between mutual funds and administrative service providers can be plan assets, and hence give rise to liability for prohibited transaction and breach of fiduciary duty claims under ERISA. In this case, Pension Plan Administrator persuaded participant-directed 401(k) retirement savings plans to use Nationwide as their investment provider. Nationwide specifically offered a selection of mutual funds to the plans. It retained authority to delete and substitute mutual funds from the list of available investment options approved by the plan sponsors. Nationwide had service contracts with the mutual funds, under which it received payments from mutual funds based on a percentage of assets that plans and participants invested in those funds through Nationwide. The court determined that Nationwide may be a fiduciary to the extent that it exercises authority or control over plan assets by determining and altering which mutual funds are available for plan and participant investments and that Nationwide s receipt of payments from mutual funds in exchange for offering the funds as an investment option resulted from its fiduciary status. The court then used a functional test, broadly interpreting plan assets and embracing Congress remedial purposes in adopting ERISA, to consider whether the payments by mutual funds to Nationwide constituted plan assets. The court held that plan assets include items a defendant holds or receives (1) as a result of its status as a fiduciary or its exercise of fiduciary discretion or authority and, (2) at the expense of participants. 14 Other Complaints Filed Against Financial Institutions Fee class action suits are not limited to 401(k) plans or ERISA. Actions have been brought by 457(b) plan participants under state fiduciary laws against Nationwide Life Insurance Company (in Ohio federal district court) and against ING Life Insurance and Annuity Company (in Connecticut federal district court). Motions to dismiss are pending in these actions. Furthermore, 403(b) plan participants have sued Nationwide Life Insurance Company and Security Benefit Security Group Inc., the issuers of annuities and mutual funds. The complaint alleges that the National Education Association (NEA) accepted payments from Nationwide and Security Benefit in return for giving them exclusive endorsements as 403(b) providers. Plaintiffs further allege these annuities charged grossly excessive fees. The suit alleges that Nationwide and Security Benefit violated their fiduciary duties by benefiting from improper revenue sharing arrangements with the mutual funds they selected for the 403(b) plan. A similar suit has been brought by 403(b) plan participants against ING Life Insurance and Annuity Company, which is a spin-off of Eliot Spitzer s (then New York Attorney General, now governor) investigations against ING and the New York State United Teachers, which settled for $33 million and require ING to provide additional fee disclosures going forward.

5 Conclusion In this litigious and regulatory environment, underscored by increased congressional interest in fees charged to plans, it is clear that plan service providers with complex payment structures, such as revenue sharing arrangements, must be mindful that their acts are causing enormous fiduciary issues and concerns to plan sponsors. What is also clear is that new legislation 15 will require more transparency of the fees charged to plans. In this regard, service providers may want to review their current revenue payment structures and arrangements to be adequately prepared in the event of new legislation, but at a minimum to avoid being a named defendant in one of these costly class action lawsuits. 1 Hecker et al v. Deere & Company, Fidelity Management Trust Company and Fidelity Management and Research Company, 2007 WL (W.D. Wis., 2007). 2 Moreover, the court emphasized that Deere could have negotiated lower fees with Fidelity Research, or could have selected different funds from different providers with lower rates but made no efforts to do so. 3 See 71 Fed. Reg. 41,392, 41,394 (July 21, 2006). 4 See 5 Executive Summary at pp Deere & Co., et. al., 2007 WL , Id. 8 Ames v. American Nat. Can Co., 170 F.3d 751, 759 (7th Cir. 1999). 9 Jordan v. Federal Express Corp., 116 F.3d 1005 (3d Cir. 1997). 10 See Amended Brief of the Secretary of Labor as Amicus Curiae Opposing the Motions to Dismiss in Tittle v. Enron, CV No. H (S.D. Texas 2002), citing to DOL Advisory Opinion No A ("In connection with the publication of the final rule regarding participant directed individual account plans, the Department emphasized that the act of designating investment alternatives in an ERISA section 404(c) plan is a fiduciary function to which the limitation on liability provided by section 404(c) is not applicable."). 11 U.S.D.Ct., ND Calif., 3:06-cv CRB, 05/15/ U.S.D.Ct., ND Calif., 3:06-cv CRB, 05/15/2007, (at p.4) F.Supp. 2d 156 (D. Conn. 2006). 14 The court cited to Acosta v. Pac. Enters., 950 F.2d 611 (9th Cir. 1992) where the Ninth Circuit referred to the need for a more functional approach, and mentioned that in determining whether a particular item constitutes an asset of the plan, it is necessary to determine whether the item in question may be used to the benefit (financial or otherwise) of the fiduciary at the expense of plan participants or beneficiaries. 15 H.R. 3185, 110th Cong., 1st Sess. (2007) which prohibits any plan administrator from entering into a contract for services unless the service provider issues a statement disclosing all the fees participants will pay. Such fees include: sales commissions, estimated trading costs, start-up costs, investment advice and management fees, administration and record keeping fees, legal fees, trustee fees, termination or surrender charges, asset based fees, 12b-1 fees, soft dollars, and other costs that may be specified by the DOL.

6 This GT Alert, previously published in The Journal of Benefits & Compensation, was written by Jeffrey Mamorsky and Jose Jara. Questions regarding this information should be directed to: Jeffrey Mamorsky at Jose Jara at Albany Amsterdam Atlanta Boca Raton Boston Chicago Dallas Delaware Denver Fort Lauderdale Houston Las Vegas Los Angeles Miami New Jersey New York Orange County Orlando Philadelphia Phoenix Sacramento Silicon Valley Tallahassee Tampa Tokyo Tysons Corner Washington, D.C West Palm Beach Zurich This Greenberg Traurig Alert is issued for informational purposes only and is not intended to be construed or used as general legal advice. The hiring of a lawyer is an important decision. Before you decide, ask for written information about the lawyer s legal qualifications and experience. Greenberg Traurig is a trade name of Greenberg Traurig, LLP and Greenberg Traurig, P.A Greenberg Traurig, LLP. All rights reserved.