[authors, Eleanor Banister, Atlanta, +1 404 572 4930, ebanister@kslaw.com and James P. Cowles*, Atlanta, +1 404 572 3455, jcowles@kslaw.com.]

On March 31, 2012, a federal district court in Missouri delivered to a large manufacturer and institutional fiduciary an expensive lesson in ERISA’s fiduciary obligations in Tussey v. ABB, Inc.  The plaintiffs are current and former employees of ABB, Inc. (“ABB”), a manufacturer of power and automatic equipment.  The defendants are ABB, Inc., two committees responsible for administering ABB’s 401(k) plans, Fidelity Management Trust Company and Fidelity Management & Research Company and John W. Cutler, Jr. (the Director of the ABB group that served as the staff to the plan investment committee). 

The case is a lesson in what can happen when plan fiduciaries fall asleep at the switch. 

Brief Background 

ABB, Inc. sponsors two 401(k) plans, one for collectively bargained employees and one for non-collectively bargained employees.  The Pension Review Committee is the named fiduciary of the plans and is responsible for selecting and monitoring the investment options.  The Employee Benefits Committee of ABB, Inc. is the named plan administrator.  The Pension and Thrift Management Group of ABB, Inc., which Mr. Cutler directed, acts as the staff of the Pension Review Committee. 

Fidelity began recordkeeping for the plans in 1995.  Initially, Fidelity’s recordkeeping fees were based on a per participant fee charged to the plan and deducted from participant accounts.  By 2001, Fidelity was primarily compensated for its services through revenue sharing. 

Lesson 1 -- Fiduciaries must Monitor Plan Recordkeeping Fees.

The court found that the ABB fiduciaries never calculated the amount of the recordkeeping fees paid to Fidelity Management Trust Company (“Fidelity”) via the revenue sharing arrangements it had with ABB plan investments. 

The court also found that the ABB fiduciaries did not investigate the market price for similar recordkeeping services and did not benchmark the cost of recordkeeping fees prior to entering into the revenue sharing arrangement with Fidelity.  Some years later, the ABB fiduciaries did benchmark the cost of recordkeeping, but they ignored their own consultant’s conclusion that Fidelity’s fees were too high.  In fact, the court found that the amount Fidelity was receiving for recordkeeping services through revenue sharing arrangements was far in excess of a reasonable recordkeeping fee, in some years by as much as 100%.

The ABB defendants argued that they monitored fees by monitoring the expense ratios of the investments offered in the 401(k) plans.  The court pointed out that the expense ratios do not show how much revenue is flowing from the investment company to the recordkeeper or what the competitive market is for recordkeeping fees. 

The ABB defendants also argued that revenue sharing permitted participants with larger account balances to pay a proportionately larger share of the recordkeeping fee, a progressivity model for compensating recordkeepers.  However, the court found that the ABB defendants did not engage in any process for evaluating whether the revenue sharing model actually resulted in progressivity and the ABB defendants provided no evidence that progressivity is in the best interests of plan participants.

The ABB defendants also argued that revenue sharing reasonably permitted risk sharing between Fidelity and ABB, Inc. because when the assets of the plans declined, Fidelity shares the loss in revenue sharing, whereas when the assets of the plans increase, revenue sharing increases for Fidelity.  According to the court, the problem with this argument is that Fidelity requested additional fees be paid when revenue sharing declined, but the ABB defendants did not request refunds from Fidelity when revenue sharing increased.

The court concluded that the ABB fiduciaries were not concerned about the cost of recordkeeping unless it increased ABB’s out of pocket expenses or caused the plans to be less attractive to its employees by deducting recordkeeping fees from each participant account.  The court observed that revenue sharing enabled ABB to hide the true cost of recordkeeping from plan participants. 

Lesson 2 -- Follow Plan Documents.

The plans’ investment policy statement required that any rebates associated with plan investments would be used to offset or reduce the cost of providing plan administrative services.  Revenue sharing would have been a “rebate”, but in this case, rather than offset the cost of administrative services, such as recordkeeping, all revenue sharing was paid to Fidelity. 

The investment policy statement also incorporated a direction that when a selected mutual fund offered a choice of share classes, the class with the lowest cost of participation should be selected.  However, the court found that when the ABB fiduciaries selected the class of shares available in the plans, they chose share classes that provided more revenue sharing to Fidelity.  The court found that the ABB fiduciaries failed to follow the investment policy statement and imprudently chose more expensive funds in order to prevent the imposition of a per-participant hard-dollar recordkeeping fee. 

The investment policy also incorporated a very specific process for removing an investment fund, which involved examining a three to five-year period of investment return and determining if there are five years of underperformance, and if so, place the fund onto a “watch list,” and then removing the fund within six months if the investment return does not improve. 

The court found that the Pension Review Committee, which was responsible for selecting plan investments, failed to follow its own procedures in replacing a non-Fidelity fund Fidelity funds that paid Fidelity more revenue sharing.  Instead, the Pension Review Committee acted on the recommendation of Mr. Cutler, the Director of Pension & Thrift Management Group, and performed only scant research on the fund being removed.

Lesson 3 -- Don’t Allow One Plan to Subsidize the Cost of Another Plan

During the course of negotiations with Fidelity in conjunction with removing a Fidelity fund as a plan investment option, ABB obtained an evaluation of Fidelity fees from Mercer, an outside consulting firm.  The report issued by Mercer concluded that ABB was overpaying for recordkeeping services and that the revenue sharing from the 401(k) plans appeared to be subsidizing other services provided to ABB by Fidelity.  Additionally, an email from Fidelity to an ABB employee responsible for negotiating Fidelity’s contract suggested that Fidelity offered services for ABB's health and welfare plan at below market cost and did not charge administration fees for ABB's non-qualified plans, but rather, Fidelity “absorbed” those fees. 

The court held that the ABB employee who received the email failed to make a good faith effort to investigate and prevent the revenue sharing from the 401(k) plans from subsidizing other plans.  Once the ABB employee became aware that the recordkeeping fees appeared to be subsidizing ABB's other plans, he had a fiduciary obligation to investigate and prevent any future subsidy.  Instead, the court found that the ABB employee failed to take any steps to do so and ABB continued to select investments to ensure revenue neutrality for Fidelity and to pay above market for recordkeeping fees.

Lesson 4 -- Float Income Belongs to the Plans

The court also found that the Fidelity defendants breached their fiduciary duties to the plans by failing to allocate the interest earned when contributions and disbursements are held temporarily in overnight accounts (the “float income”) exclusively for the benefit of the plans.

According to the court, Fidelity distributed the float income attributable to the 401(k) plans to investment options not the plans.  It is not clear from the opinion whether the investment options that received the float were investment options held by the plans.  According to the court, since float income constitutes Plan assets, distributing these assets to the investment options rather than the plans was a breach of ERISA’s fiduciary responsibilities.  The court also found that the Fidelity defendants used some of the float to pay expenses of Fidelity that should have been borne by Fidelity, not the plans.

Conclusion

The court found that all of the ABB defendants breached their fiduciary duties by (1) failing to monitor plan recordkeeping costs, (2) failing to negotiate rebates from Fidelity , (3) selecting higher cost classes of investment options when lower cost options were available, and (4) imprudently substituting certain Fidelity investment options for existing plan investment options.  The court found ABB and the Employee Benefits Committee breached their fiduciary duty when they  allowed the 401(k) plans to subsidize the expenses of other ABB plans, including health and welfare plans and nonqualified plans.  The court also found that the Fidelity defendants breached their fiduciary duties when they failed to allocate the income received from overnight investment of plan funds exclusively for the benefit of the ABB, Inc. 401(k) plans. 

The court found the defendants liable for a variety of ERISA fiduciary violations resulting in damages of nearly $40 million.  The damages in this case were significant, but could have been worse.  The plaintiffs argued that the court should adopt a “global damages theory,” which would measure the damages to the 401(k) plans by the investment return on the ABB Inc. defined benefit plan over the period during which the fiduciary breaches occurred.  However, the court rejected the plaintiffs’ global investment theory of damages and instead based damages on the particular amount of the loss resulting from each particular breach.

Action Items

The conduct that resulted in the fiduciary breaches described above was easily preventable by greater diligence on the part of the ABB fiduciaries, both in following their own plan documents and in observing the marketplace.  While the facts of this case may be extreme, it should serve as a wake-up call to all plan fiduciaries.  For example,

• Plan fiduciaries should regularly “benchmark” the cost of plan services to obtain objective evidence of the market price for those services;

• Where vendors provide multiple services to an employer and receive compensation through revenue sharing, plan fiduciaries should ensure that one plan is not subsidizing the services provided to another plan or the employer; and

• Plan fiduciaries should periodically review plan documents, particularly investment policy statements, to be sure that (1) fiduciary actions are consistent with the stated policies and (2) to be sure the documents are up to date and reflect the responsible fiduciary’s intent.

Unfortunately, ERISA does not prescribe any specific time period for conducting benchmarking studies or reviews of plan documents.  The appropriate period will depend on your particular facts and the nature of the services under consideration.  King & Spalding will be glad to help you asses your particular situation or answer any questions you may have about this article.

*Non-lawyer Employee Benefits Consultant