April 2012

In Tussey vs. ABB. Inc. (Case No. 2:06-CV-04305-NKL, March 31, 2012),  a United States District Court for the District of Western Missouri decided an important case regarding common fees and revenue sharing within 401(k) plans.  The case imposed extensive liability on the plan sponsor, resulting in $36.9 million of damages, plus Plaintiff’s attorneys’ fees.

The first trial result to factually address these issues is Tibble vs. Edison International, which is now on appeal at the Ninth Circuit (Case No. 10-56415).  In the Tibble case, the trial court concluded that plan fiduciaries breached their duties by offering only retail share classes as investment options.  The Ninth Circuit appeal is garnering industry and government amicus briefs, but is not yet obtaining the attention it deserves with plan sponsors.

In the Tussey case, the trial court summarized the plan sponsor’s liability as follows:

“In 2001 and thereafter (during the relevant statute of limitations period), ABB never calculated the dollar amount of the recordkeeping fees the Plan paid to Fidelity Trust via revenue sharing arrangements, nor did it consider how the Plan’s size could be leveraged to reduce recordkeeping costs. In fact, it did not obtain a benchmark cost of Fidelity’s services prior to choosing revenue sharing as the Plan’s method for compensating Fidelity Trust. … The Court also finds that the Plans overpaid for the recordkeeping services provided by Fidelity Trust. In 2001 and after, the revenue sharing generated for Fidelity by the Plan’s assets far exceeded the market value for recordkeeping and other administrative services provided by Fidelity Trust…. The Court finds that the Plan overpaid for Fidelity Trust’s recordkeeping and administrative services as a result of the use of revenue sharing without any rebates to the Plan.”

The practice of revenue sharing was central to the entire case.  The Court understood that revenue sharing is quite common in 401(k) plans.  It described the practice of revenue sharing as follows:

“Revenue sharing is not an expense explicitly reported in an investment’s prospectus, nor was it disclosed as such to Plan participants. However, each investment on the Plan platform had an expense ratio and that expense ratio is listed in an investment’s prospectus. The expense ratio affects the net asset value (“NAV”) of the investment. The NAV is the “price” of one share of an investment option. Because an investment’s expenses are paid from the assets of the investment, it is the investors who pay for the investment’s expenses. As revenue sharing is one such expense, the investors pay for revenue sharing. In this manner, PRISM Plan (401(k)) participants pay the revenue sharing costs associated with each investment option on the Plan’s platform in which they have invested if that investment shares revenue with Fidelity Trust.

In the investment industry, revenue sharing arrangements with recordkeepers are common.”

While the court took efforts to state that it was not concluding that revenue sharing was per se a fiduciary duty violation, it is clear that a direct explicit “hard dollar” charge to participant accounts would have been more transparent, and would have been perceived better by the Court.  Of course, most plan sponsors purposefully avoid such explicit charges to 401(k) participants’ accounts, preferring instead to perpetuate the myth that such plans are “free”.

The fact that “everyone else is doing it” was not convincing to this Court.  In the Court’s words:

“While ABB’s choice to use revenue sharing to pay for record keeping expenses is not uncommon among plan sponsors, ABB failed to assess the prudence of its choice … It is true that revenue sharing is commonly used in the industry to pay for recordkeeping fees. In addition, a common method for determining the reasonableness of those fees is to examine the expense ratios of various investments. While both of these statements may be true as to what is commonly used in the industry, the Court finds that such inquiries are not sufficient… ABB may not choose revenue sharing as an appropriate method for compensating the Plan’s recordkeeper simply because many others in the industry use that method of compensation. Rather, ABB may deliberately choose revenue sharing as its method of recordkeeping if it will offset or reduce the cost of providing administrative services as compared to other methods of compensation, such as hard-dollar, per-participant fees.”

For larger companies, it is not uncommon to have multiple employee benefit plans that use the same service provider(s).  In ABB’s case, Fidelity also provides services to other ABB plans at lower than market rates.  This allowed the 401(k) plans to subsidize the other plans through revenue sharing, thus saving ABB what would otherwise be the stand-alone cost of administering the other plans.  The Court described this as follows:

“The Court specifically finds that Mr. Scarpa

[an ABB employee] failed to make a good faith effort to prevent the subsidization of administration costs of ABB corporate services due to the revenue sharing generated by PRISM Plan assets. He consistently communicated with Ms. Morlan throughout the negotiations, yet raised no concern directly with her or any other Fidelity Trust representative. His failure to contact anyone at Fidelity Trust is indicative of the purposeful blind eye he turned to the subsidization of ABB corporate services with PRISM funds so that ABB, Inc., could continue to receive discounted services for itself. … Given the disturbing implications of cross subsidization, any prudent, loyal fiduciary, in Mr. Scarpa’s position, would take immediate action to investigate. …

Indeed, Mr. Scarpa, during the same period, negotiated with Fidelity to make the contractual period for the [other] corporate plans the same as for the PRISM [the 401(k)] Plan. This ensured 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. The Court specifically finds that thereafter Mr. Scarpa’s decisions and actions when negotiating a recordkeeping fee on behalf of the Plan were motivated by the discounts ABB, Inc., received for its corporate services, instead of solely in the Plan’s interest.”

The Court also found ABB liable for investment losses associated with the replacement of a lower-cost investment with a higher-cost Fidelity alternative.  This was the wrongdoing that generated the largest damages.   The wrongful conduct ran right to the heart of a plan sponsor’s selection of higher-priced funds, which in turn allowed the entire revenue sharing process to begin:

“The Court finds that Plaintiffs have established a prima facie case of loss to the Plans due to ABB’s fiduciary breaches associated with the selection of more costly classes of investments that had higher expenses when other share classes were available that had lower expense ratios. The evidence shows that participants who invested in the class of share chosen by ABB would have received a greater return on their investment had they purchased the class of shares with lower expense ratios. The Court also finds that ABB has not met its burden to show that the loss established by Plaintiffs was not caused by its deliberate decision to include more expensive share classes on the Plan’s investment platform to perpetuate “revenue neutral” revenue sharing.

…The Court finds that Plaintiffs suffered loss due to the excess paid by participants due to higher expense ratios. But for the higher expense ratios, participants who purchased these six funds would have retained more assets in a given fund, which would then have been compounded by annual market returns for that fund.”

It is clear that the service providers (in this case, Fidelity), clearly have a conflict of interest in any recommendations that they provide.  Nevertheless, on all counts, the various Fidelity companies were not held responsible for any wrongdoing.  A plan sponsor should get no comfort that they are dealing with the market-leading provider of 401(k) services in terms of risk sharing.  The following quote discusses revenue sharing in particular, but similar conclusions were reached on ABB’s other breaches of fiduciary duty:

“Fidelity is not liable for ABB’s fiduciary breaches described here.  Fidelity did not affect nor was it aware of the decision-making process employed by ABB when choosing to compensate Fidelity Trust through revenue sharing. … Fidelity Trust did not act in a fiduciary capacity during such renegotiations.”

Following ERISA § 413, 29 U.S.C. § 1113, the Court applied a six-year statute of limitation from the “date of the last action which constituted a part of the breach or violation.”  This lengthy damage period will consistently make these cases large.

Around two and a half years ago, we reported on a settlement involving fiduciary duties.  At that time, there were multiple defendant-favorable cases.  Most notable of these is Hecker vs. Deere, which we discussed in the article just referenced.   Consequently, most defendants have not been offering large amounts in settlement.  The current ABB case will certainly encourage other class action plaintiff firms to accept and more aggressively prosecute these cases, particularly since the ABB fact pattern is not unusual.

Fulcrum Inquiry performs financial investigations, and damages analysis for litigation.