District Court Relies on Fee Disclosure Regulation to Dismiss Complaint


In what appears to be the first class action addressing the Department of Labor’s (“DOL’s”) 2012 408(b)(2) disclosure regulations, the U.S. District Court for the Southern District of New York dismissed a case brought against Morgan Stanley for its revenue sharing arrangement with a platform provider, in Skin Pathology Associates, Inc. v. Morgan Stanley & Co., Inc. and ING Life Insurance and Annuity Co., No. 13-cv-3299-AT (S.D.N.Y. Feb. 24, 2014).


A company that sponsored a 401(k) plan sued the broker (“Broker”) and the platform provider (“Provider”) that the plaintiff selected.  The plaintiff alleged that the Broker maintained a list of Alliance Partners, including some that paid compensation to the Broker based on the amount of plan assets record kept by the Alliance Partner through plans that were identified by the Broker.  The plaintiff alleged that the Broker performed no additional services for the payments it received from the Provider, who was one of the Broker’s Alliance Partners that paid it such compensation.

The plaintiff sued on behalf of itself and all other plan fiduciaries and participants who used the Broker and one of its Alliance Partners that paid the Broker with respect to plan assets invested through the Alliance Partner.  The plaintiff alleged that the Broker was a party in interest, as that term is defined in ERISA § 3(14).  The plaintiff did not allege that the Broker was a fiduciary.  But it nonetheless argued that the Broker could be liable for committing a prohibited transaction under ERISA § 406(a)(1)(C) by receiving compensation that was more than reasonable.  (The complaint contained additional counts against the Provider for breach of fiduciary duty, but those counts were voluntarily dismissed.)

District Court Decision

In addressing the prohibited transaction claim, the court first “suggest[ed] that ERISA § 406(a) was not designed to prohibit” the type of arrangement between the Broker and the Provider at issue, particularly given that other provisions of ERISA’s prohibited transaction rules specifically addressed payments from third parties, whereas ERISA § 406(a) did not.  Nonetheless, because the court believed that a transaction could be prohibited under ERISA § 406(a)(1)(C) even absent the use of plan assets, it found that it was “stuck between a rock and a hard place.”

The court found itself on “firmer ground,” however, when it analyzed the exemption contained in ERISA § 408(b)(2) for “making reasonable arrangements with a party in interest for . . . services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.”  The court held that the prohibited transaction claim could not be sustained if the exemption was met.  It relied on the provisions of the DOL’s Section 408(b)(2) fee disclosure regulation that requires covered service providers to disclose compensation paid among related parties.  Under those regulations, the court held, “[f]ee sharing arrangements . . . do not in-and-of themselves create a violation, but their non-disclosure does.”  Given that the complaint contained no allegation of non-disclosure, the court held that the exemption for reasonable compensation was satisfied, and it accordingly dismissed the case against the Broker.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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