A federal judge has found that a provider breached its fiduciary duty of overseeing its own 401(k) by failing to monitor proprietary funds and its recordkeeping expenses—though it was not obligated to consider options other than mutual funds.
The suit was filed in October 2018 by plaintiffs Kevin Moitoso, Tim Lewis, Mary Lee Torline (and now joined by Sheryl Arndt) on behalf of participants in the Fidelity Retirement Savings Plan, which, according to the suit, at the end of 2016, had nearly $15 billion in assets and covered 58,000 participants. The plaintiffs alleged a number of breaches common to the recent wave of proprietary fund/fiduciary breach litigation: that the Fiduciary Defendants “have not managed the Plan with the care, skill, or diligence one would expect of a plan this size,” but rather that they “…used the Plan as an opportunity to promote Fidelity’s mutual fund business at the expense of the Plan and its participants.”
The suit further alleged that the Fidelity defendants “…loaded the Plan exclusively with Fidelity-affiliated investments, without investigating whether Plan participants would have been better served by investments managed by unaffiliated companies.” The suit claimed that, at least compared with 20 other plans with more than $5 billion in assets in a report by Cerulli Associations, these violations added up to “over $100 million per year in losses compared to the average plan.”
‘Both Sides’ Now
“Having heard the arguments of both sides,” Judge William G. Young of the U.S. District Court for the District of Massachusetts, ruled (Moitoso v. FMR LLC, D. Mass., No. 1:18-cv-12122, 3/27/20) that Fidelity:
- Breached its duty of prudence “by failing to monitor its mutual fund investments and by failing to monitor recordkeeping expenses.”
- Did not breach “its duty of prudence by failing to investigate alternatives to those mutual funds because a prudent fiduciary would not be required to conduct those specific investigations.”
- Did not breach its duty of loyalty.
- Has “not engaged in prohibited transactions because its dealings with proprietary products were no less favorable to the Plan as a whole than to other shareholders of Fidelity funds.”
Judge Young also ruled that FMR LLC (parent company)is liable for the breach of its duty to monitor the Plan Fiduciaries with regards to their ongoing handling of the mutual fund investments and recordkeeping expenses,” and that on that count “the Plaintiffs may recover from Fidelity Entities for any profits traceable to the aforementioned breach of the fiduciary duty to monitor.” Indeed, citing the (recently settled) case of Brotherston v. Putnam Investments, LLC, he noted that “at trial, the Plaintiffs will bear the burden of proving the extent of any losses, and Fidelity will bear the burden of proving that any losses to the Plan were not caused by the lack of monitoring.”
Case History
Now the case here has some history—and Judge Young (who has been involved with it) devoted some of the lengthy 67-page decision to recounting what had gone on before. And then he noted that “It is worth remarking that, in this Court’s experience, case stated hearings usually involve but a modicum of fact finding—nothing more than the drawing of reasonable inferences. Here, by converting the summary judgment record to their case stated presentation the parties have provided the Court with a plethora of affidavits characterizing the facts.” He continued by noting that “This Court has independently drawn its own inferences from the stipulated facts.”
Settlement State
He noted that “the current litigation is not the first class action concerning this particular Plan,” citing a 2013 class action that alleged that Fidelity “breached its fiduciary duty of loyalty by offering only Fidelity mutual funds on the Plan, failing to offer cheaper alternatives, and committing prohibited transactions under ERISA,” and then a second suit filed in January 2014 “alleging that Fidelity had violated its fiduciary duties by paying excessive recordkeeping fees.” Now, in October 2014 he explained that Judge Casper approved a settlement agreement between Fidelity and the plaintiffs that required Fidelity to “pay $12,000,000 into a common fund and rewrite the plan document to provide more benefits and protections for Plan members.”
Now, as it turns out, all of the named plaintiffs in the current case were members of that settlement class, and as part of the settlement, the plaintiffs agreed to release the defendants from “any and all claims, debts, demands, rights or causes of action, suits, matters, and issue or liabilities whatsoever … including both known Claims and Unknown Claims” in any way related to the claims at hand in that litigation.
That said, following the settlement, Judge Young explained that Fidelity “to address the issue of excessive recordkeeping costs, the Settlement also required an update to the Plan’s existing revenue credit system to create mandatory revenue-sharing with Plan participants” that either “met or exceeded the management fees and revenue generated by Fidelity pursuant to its role administering the various funds, which includes the cost of recordkeeping, and is paid to the Plan at the end of each year.” However, Judge Young noted that “the Plan’s fiduciaries have said they did not monitor these administrative costs, on the grounds that all administrative expenses paid to Fidelity would be credited back to the Plan through the Revenue Credits.”
Young went on to note that “former employees who had left Fidelity, though still members of the Plan, do not receive any part of the Revenue Credit, unless they were employed for a portion of a Plan year,” that “before the implementation of the Revenue Credit, Fidelity had provided a discretionary profit-sharing contribution to the Plan account of each individual equivalent to 10% of their compensation,” but that after the Revenue Credit’s implementation, “Fidelity adopted a practice of flexing the amount of discretionary profit-sharing based on the amount returned to each account through the Revenue Credit, so the total of the (mandatory) Revenue Credit and (discretionary) profit-sharing remained at 10% of compensation per year.” That in turn led the plaintiffs to call the implementation of the Revenue Credit an “accounting gimmick.”
Current Case
As for the case before him, Judge Young noted that Fidelity “contends that the Plaintiffs are essentially re-litigating the Bilewicz Settlement Agreement, despite the settlement agreement’s (which included these plaintiffs) covenant not to sue. For their part, the plaintiffs point to three places where they allege Fidelity has breached its duties of prudence and loyalty; their duty to monitor funds in the plan, that Fidelity had a duty to investigate alternatives to mutual funds including stable value funds, collective trusts, and separate accounts, and that they had a duty to monitor and control administrative expenses, and that the Revenue Credit system did not eliminate this responsibility.” Moreover, they claim that the Fidelity defendants “inappropriately placed the interests of Fidelity over the interests of Plan participants,” that payment by the Plan to FMR LLC for administrative expenses constitutes a prohibited transaction, and finally that “the Revenue Credit is essentially illusory, so FMR LLC is still receiving net compensation from administrative expenses; and (2) the class members did not receive the Revenue Credits because they are former employees.”
Essentially, the plaintiffs argue that “the settlement and res judicata do not bar their claims because their claims arise from breaches of Fidelity’s continual duty of prudence and loyalty after the signing of the settlement.”
Change in Circumstances
Here, Judge Young notes, “the Plaintiffs argue, and the Court agrees, that the holding from Tibble v. Edison Int’l suggests that there has been a sufficient 'change in circumstances' justifying this new suit, because fiduciaries have a continual duty to monitor investments." Moreover, he noted that “Fidelity’s duty of continual monitoring, combined with its failure to monitor, means that the claims in the case at hand do not arise out of the “same transaction or series of connected transactions.”
A point of some discussion (and disagreement) was the designated investment alternatives (DIA). Judge Young noted that “the Plaintiffs contend that the proprietary funds offered on Fidelity’s platform were not offered through a program ‘similar’ to a brokerage window,” a point with which he concurred. “The manner in which Fidelity offered funds to Plan participants was not ‘similar’ to the manner in which it offered funds through a brokerage window, but instead was far more similar to the manner in which it had offered the funds when they were considered ‘on the Plan’ prior to the Settlement…” There was some discussion in the ruling as to the Labor Department’s stance on the issue, though ultimately the issuance and subsequent withdrawal of guidance in a Field Assistance Bulletin was seen as a decision not to have an opinion. As for this court, Judge Young wrote that “…in the absence of other regulations explicitly imposing such a duty, it is hesitant to state unequivocally that there either is, or is not, a fiduciary responsibility to monitor self-directed brokerage accounts.”
That the BrokerageLink platform “required visiting a separate webpage, creating a separate login, and waiting up to two business days, while participants could automatically access the Fidelity funds,” and that there was ‘no difference’ between how Fidelity funds were offered before and after the Settlement…” Judge Moore noted that after the settlement, “only 1.41% of Plan participants moved to the nonproprietary funds on BrokerageLink," going on to explain that “on the whole, the offering of the proprietary Fidelity funds on NetBenefits appears highly dissimilar to expert-level self-directed brokerage accounts (of the sort offered through BrokerageLink), and highly similar to the type of fund normally offered ‘on a plan.’”
Recordkeeper Reminder
Oh, and if that weren’t enough, Judge Moore cautioned that “…allowing a recordkeeper easily to disclaim fiduciary liability for its proprietary funds contradicts the goals of ERISA,” that while there “…is no law preventing a recordkeeper from offering its own proprietary funds in a brokerage window,” when that recordkeeper “…is also the manager of a retirement plan, however, it is not a disinterested party.”
He went on to state that “this concern occasions significant reason not to give Fidelity the benefit of the doubt, given that its theory would allow it effectively to disclaim all fiduciary liability whatsoever for mutual funds available outside the two DIAs.” In essence, he concluded that “as Fidelity was not offering its funds in the equivalent of a brokerage window, it can face fiduciary liability for its lack of monitoring subsequent to the Settlement.”
Now, Judge Moore left unanswered “the question whether this alleged lack of prudence actually led to any losses,” citing the recent Brotherston case in explaining that on that issue “the defendant bears the burden of proof,” though “the plaintiff still bears the burden of showing the existence and extent of the alleged loss.”
As for arguments that Fidelity breached its fiduciary duties by failing to investigate non-mutual fund investment vehicles, such as collective trusts and separate accounts, and that the firm had a duty to investigate stable value funds as an alternative to its money market accounts. Here Judge Moore was disinclined to “bite,” noting that “Fidelity did not incur liability because it had no inherent duty to investigate these particular types of funds.”
Expense ‘Account’
Regarding the fiduciary duty to monitor recordkeeping expenses, Judge Moore noted that “Fidelity does not dispute that the Plan Fiduciaries declined to monitor recordkeeping expenses but argues that it has not violated its fiduciary duties because all expenses were returned to the Plan through the mandatory Revenue Credit, and thus netted to zero.” In essence, he notes that “…argument rests on the proposition that there is no breach of a duty to be cost-conscious where there are no costs.”
Now, remember this particular rebate structure was a condition in the 2014 settlement. Judge Moore notes that as an example in 2017 Fidelity charged $288 per participant for recordkeeping services, as well as an additional $212 per person for “Additional Value for Fidelity Products” ($500/per participant), and yet the parties here stipulated that if Fidelity were a third party negotiating this fee structure at arms-length, the value of services would range from $14-$21 per person per year—going on to point out that “the recordkeeping services provided by Fidelity to this Plan are not more valuable than those received by other plans of over $1,000,000,000 in assets where Fidelity is the recordkeeper.”
Moore points out that “the main dispute between the parties concerns whether the Revenue Credit system shields Fidelity from fiduciary liability notwithstanding the lack of monitoring, because the Plan itself could not have sustained any losses when all revenue was automatically returned to it.”
Here Moore noted that “Fidelity’s decision to change its yearly discretionary payments based on the amount of mandatory Revenue Credit was a business judgment,” that those discretionary payments were “outside the Plan,” and that while they were “calculated in response to the Plan,” though not dictated by it. “Businesses must be able to make business decisions based on weighing the costs of their fiduciary outflows, simply as a function of balancing their books.”
That said, Moore called out “the apparent belief on the part of the Plan Fiduciaries that the Plan incurred no recordkeeping expenses does not provide a defense, because they failed closely to investigate the available documentation to confirm that this belief was true.” In fact, considering the disparity in the costs reported versus what might have been available to them, “it is fair to say that but for the lack of monitoring on the part of the Plan Fiduciaries, the members of the class action would have paid less in recordkeeping costs.” Moore concluded “the Plan Fiduciaries were negligent in failing to monitor recordkeeping expenses, an important component of the administration of their fiduciary duties,” and one, he wrote, was outlined in Fidelity’s own education materials.
“In conclusion,” Moore wrote, “Fidelity has breached its duty of prudence with regard to its failure to monitor the recordkeeping expenses, and the class members may recover under the equitable doctrine of surcharge,” explaining that, “as with the failure to monitor the proprietary mutual funds, the Plaintiffs at trial will bear the burden of proving the exact extent of loss (an exercise that may or may not be trivial given the parties’ stipulations), while Fidelity will bear the burden of showing this lack of monitoring has not caused this loss.”
“There remains a live issue as to whether Fidelity’s statute of limitations defense is viable,” Moore concluded, noting that “this decision addresses only the question of liability, not causation or loss.”
What This Means
This case was complicated—more so than most because of existence of the prior settlement, and the reality that the named plaintiffs here were also involved in that prior suit.
Regardless, the key element here would seem to be that there is a duty to monitor recordkeeping expenses, even if the net effect of those fees is $0. Zero turns out not to be “free,” though the reality of those expenses might well mitigate damages.
