May 26, 2013

By: Robert J. D’Anniballe, Jr.

Employee Retirement Income Security Act (“ERISA”) fiduciaries and plan sponsors, as defined by 29 U.S.C. § 1002(21)(A), have numerous investment responsibilities – particularly the responsibility to comply with and adhere to plan documents, perform their duties in the sole interest of a plan’s participants for the exclusive purpose of providing benefits to a plan’s participants and beneficiaries and the duty to defray administrative costs for the plan.

On March 31, 2012, the United States District Court for the Western District of Missouri issued an expensive lesson in prudence and diligence in Tussey v. ABB, Inc. (No. 2:06-CV-04305) (W.D. Mo. March 31, 2012), which held 401(k) plan fiduciaries liable for approximately $35 million in damages for plan losses caused by imprudent decision-making and prohibited transactions in violation of ERISA.  In Tussey, ABB, Inc. sponsored two 401(k) plans, one for non-union employees and another for union employees, with assets totaling over $1 billion dollars.  The plan fiduciaries for ABB, Inc.’s pension plans were required to select and monitor the plans’ investment options.  These investment options included mutual funds offered by Fidelity Investments (“Fidelity”), such as the Fidelity Freedom Fund.

Additional Defendants Fidelity Management Trust Company and Fidelity Management & Research Company respectively served as the plans’ investment advisor and record keeper.  The fees for these services were paid mainly through revenue sharing.  The court emphasized that the type of revenue sharing employed in this case is a common industry practice, but found the fiduciaries’ process faulty in this instance because the fiduciaries failed to follow procedures in required plan documents.  These failures could have been avoided simply by complying with the plan documents.

Failure to Calculate and/or Monitor Record-Keeping Costs

In direct contravention of the Investment Policy Statement (“IPS”), and required plan documents, the plan fiduciaries failed to calculate or monitor the dollar amount of record keeping fees paid to Fidelity via the revenue sharing arrangements.  The court found that although ABB, Inc. did monitor its expense ratios charged by the plans’ investment options, and despite evidence that these expense ratios were comparable to those charged in similar plans, the plan fiduciaries failed  to calculate how much Fidelity received in revenue sharing from those options, even after an outside consultant informed them they were overpaying fees for record keeping services and that such revenue sharing appeared to be subsidizing other services that Fidelity provided to ABB, Inc. unrelated to the plans at issue.  The court accepted the report of this outside consultant, as well as the testimony of plaintiff’s expert, as evidence that the ABB fiduciaries paid above-market prices for these services.  The IPS required that revenue sharing be used to offset or reduce the plans’ recordkeeping costs, and that the plan fiduciaries must use the plans’ purchasing power to negotiate reduced costs for such services.

Because revenue sharing in this instance was used to pay for record-keeping services above the market price, the court found that the plan fiduciaries failed to utilize revenue sharing to offset or reduce the plans’ recordkeeping costs or negotiate reduce costs.  The court held that this was a breach of ABB, Inc.’s duty of prudence required by ERISA § 404(a)(1)(D).

Failure to Properly Select and De-Select Investment Options

During the period between May 2000 and February 2001, the plan fiduciaries opted to remove one option, the Vanguard Wellington Fund (hereinafter the “VWF”), and replace it with the Fidelity Freedom Fund.  The court found that the IPS required a “winnowing process” when removing or replacing an option in the plans’ menu of investment options.  This “winnowing process” involves monitoring an investment fund’s performance, analyzing its performance over a certain period of time and removing poor performers from the menu if their performance does not improve.  The fiduciaries elected to replace the VWF with the Fidelity Freedom Fund without conducting such a “winnowing process.”  The head of ABB, Inc.’s Pension Review Committee cited the VWF’s “deteriorating performance” despite conducting scant research.  An analysis of that fund’s performance in the five years prior to de-selection would have revealed a “stellar” performance with the exception of one down year.  Moreover, the fiduciaries only considered three other funds, including the Fidelity Freedom Fund.  By only reviewing three funds, the court concluded that the fiduciaries did not engage in a “winnowing process” as required by the IPS and, therefore, violated their duty of prudence required by ERISA § 404(a)(1)(D).

The IPS further provided that when selecting a mutual fund that offered multiple share classes, the fiduciaries were to select the class with the lowest cost to the participants.  The court found that the fiduciaries here acted imprudently by purchasing Fidelity mutual funds with more expensive share classes, thus providing greater revenue sharing to Fidelity.

The court also concluded that ABB, Inc. selected the Fidelity Freedom Fund to replace the VWF so that it could reduce the fees it would be required to pay the plan for union employees, and this is a prohibited transaction in violation of ERISA § 406(a)(1)(D).

Improper Use of Plan Assets to Subsidize Corporate Services

A plan’s assets are to be used for the sole benefit of the plan’s participants and beneficiaries.  In Tussey, the court found that the fiduciaries were utilizing plan assets to subsidize certain corporate services such as employee payroll services and administering the health and welfare benefit plan.  Using plan assets to benefit a party in interest, like the employer or another plan, is a classic breach of fiduciary duty.  Worse still, this constitutes a prohibited transaction under ERISA and the Internal Revenue Code, meaning it must be “unwound” and subjects the employer to payment of excise tax penalties.

The Appeal

ABB, Inc. has appealed this decision, as well as related decisions awarding attorney’s fees and costs to the plaintiffs, to the United States Court of Appeals for the Eighth Circuit, filing its opening brief on February 26, 2013.  The plaintiffs-appellees have yet to file their responsive brief, having filed for two extensions of time.  Their brief should be filed by May 13, 2013.

Among the issues raised on appeal, ABB, Inc. claims the trial court erred by finding that the IPS is a binding plan document.  Rather, ABB, Inc. contends the IPS is a wholly separate document drafted by the Pension Review Committee as guidance for selecting plan investment options.  According to ABB, Inc. however, the IPS is neither mandated by ERISA nor binding upon the plan fiduciaries.

In finding the IPS to be a binding plan document, the court relied on the Interpretive Bulletin Relating to Written Statements of Investment Policy, Including Proxy Voting Policy or Guidelines, 29 C.F.R. § 2509.94-2 (1994).  According to this bulletin, “Statements of investment policy issued by a named fiduciary authorized to appoint investment managers would be part of the ‘documents and instruments’ governing the plan within the meaning of ERISA § 404(a)(1)(D).”  ABB, Inc. argues that this Interpretive Bulletin discusses investment policy statements under different subject matter.  Moreover, ABB, Inc. claims that the bulletin was not subject to notice-and-comment rulemaking and, therefore, lacks the force of law.

ABB, Inc. further contends that there is no evidence that it breached any fiduciary duty, and that the court wholly disregarded the discretion afforded fiduciaries to make decisions.  For instance, ABB, Inc. states that there is no evidence to support the court’s conclusion that ABB, Inc. elected revenue sharing in lieu of a flat dollar fee to shift recordkeeping fees to – and then to conceal those fees from – plan participants.  ABB, Inc. also argues that mapping the Fidelity Freedom Fund onto the VWF did not violate the IPS and that the court invented the “winnowing process” requirement out of whole cloth.

Also of note regarding the mapping claim, ABB, Inc. argues that the six-year statute of limitations for a claim of an ERISA violation expired prior to the filing of this action on December 29, 2006.  The court held that this claim was timely because the fiduciary activity related to replacing the VWF with the Fidelity Freedom Fund did not conclude until February 2001, within the six-year limitations period.  ABB, Inc. contends that the only fiduciary action was the actual decision to replace the VWF with the Fidelity Freedom Fund, made between May and November of 2000; all other activity related to implementing that decision was administrative and non-fiduciary.  Thus, the fiduciary activity would have occurred prior to December 29, 2000, outside of the limitations period.

Action Items

However the appeal turns out, the Tussey decision is a harsh lesson for ERISA plan fiduciaries.  How did the fiduciaries in Tussey get in trouble?  They completely failed to comply with and adhere to the plan documents and governing procedure regarding the monitoring of fees and investment selection.  To avoid liability in the future, plan fiduciaries are urged to consider the following:

• Follow the Plan Documents – ABB, Inc.’s problems could easily have been avoided by diligently reviewing and complying with the plan documents for both 401(k) plans at issue.  These documents should clearly outline what a plan must do, such as diligently researching investment options and selecting one with the lowest cost, and what it must refrain from doing, such as subsidizing corporate services.  At least one, if not all, fiduciaries should review the plan documents at regular intervals to determine their requirements and whether revisions are necessary to resolve ambiguities or update old policies.

• Monitor Plan Fees – In Tussey, the court found no evidence that the plan fiduciaries took any effort to determine whether the fees associated with the plans were appropriate, despite ABB, Inc.’s contention that it followed common industry standards and practices related to fees and revenue sharing.  Plan fiduciaries must be diligent in ensuring that service providers to a plan do not receive above-market fees for services provided, particularly when those fees are paid via revenue sharing.  It should be noted that in Tussey, the IPS imposed heightened negotiation requirements arguably above and beyond what ERISA requires.  Thus, the full extent of the fiduciary duty to seek or negotiate lower fees in any given situation may vary.  Regardless, plan fiduciaries must make every effort to monitor fees for services to the plan and ensure that they are reasonable and appropriate, particularly in light of any requirements listed in the plan documents.  Resources are available to aid plan fiduciaries in determining whether the fees they are paying are commensurate with the services provided, including the U.S. Department of Labor’s regulations on the disclosure of retirement plan service provider fees and expenses.

• Follow the Governing Procedure – The court hammered ABB, Inc. not because the plans performed poorly, but because the plan fiduciaries failed to follow proper protocols and act prudently.  Proper protocols and prudence include: regularly reviewing, adhering to and updating plan documents; having fiduciaries knowledgeable about plan investments meet regularly to discuss investment options; diligently researching current and potential investment options by reviewing a fund’s prior performance, investment strategy and current managers; and enacting and following a procedure for adopting changes.

• Update Plan Documents – The law of fiduciary duties owed to ERISA plans has undergone dramatic changes in recent years.  And new cases such as Tusseysignificantly impact the nature and substance of fiduciary duties owed to ERISA plans, particularly when dealing with excessive fee issues.  Regular review and update of plan documents to reflect these changes in the law is a must.

Keep in mind, the Tussey decision is not the last word on ERISA fiduciary duties with regard to fees.  The Eighth Circuit may overrule all or part of the decision.  Regardless, the decision remains a lesson in diligently monitoring fees for services provided to a 401(k) plan and ensuring the investment options offered by a plan and the related fees work in the best interest of plan participants.  Notably, the new fee disclosure regulations imposed by ERISA § 408(b)(2) should make it easier for plan fiduciaries to fulfill their duties with regard to fees as described by the Tussey decision.  By following the Tussey decision’s lessons, fiduciaries may avoid costly litigation.