A federal appellate court has ruled that Fidelity’s FundsNetwork supermarket is… a supermarket, and again rejected claims that Fidelity’s relationship with those fund companies made it a fiduciary.
The Gist
Ultimately, while the appellate court acknowledged that Fidelity does have some fiduciary duties vis-à-vis the plans and their participants, it pointed out that “Fidelity’s actions in a fiduciary capacity are not the subject of plaintiffs’ complaint,” specifically that “Fidelity's fiduciary responsibilities as a directed trustee are distinct from and do not extend to Fidelity's charging of an infrastructure fee.”
The Suit
This is the suit, brought as a class action by Andre W. Wong, a participant in the T-Mobile USA, Inc. 401(k) Retirement Savings Plan and Trust, on behalf of that plan, “and all other similarly situated plans” claims that beginning in or about 2017, Fidelity began requiring various mutual funds, affiliates of mutual funds, mutual fund advisors, sub-advisors, investment funds, including collective trusts, and other investment advisors, instruments or vehicles that are offered to the plans through Fidelity’s FundsNetwork to make what the suit calls “secret payments to Fidelity for its own benefit in the guise of ‘infrastructure’ payments or so-called relationship-level fees” in violation of ERISA’s prohibited transaction rules.
The plaintiffs failed to persuade Judge Leo T. Sorokin of the U.S. District Court for the District of Massachusetts of their case almost exactly a year ago. And didn’t fare any better on its appeal of that decision with the U.S. Court of Appeals for the First Circuit.
The Appeal
In a decision written by Judge William J. Kayatta Jr. (joined in the decision by Judge David J. Barron and Judge William E. Smith, sitting by designation from the U.S. District Court for the District of Rhode Island), the ruling (In re Fidelity ERISA Fee Litig., 1st Cir., No. 20-1286, 3/5/21) noted that since 1989, Fidelity has maintained what it calls a “supermarket” named the FundsNetwork. “Rather than offering groceries, the FundsNetwork stocks thousands of opportunities to invest in mutual funds established by third parties other than Fidelity.” He also noted that Fidelity also charges some of the mutual fund managers a so-called “infrastructure fee” for the privilege of being listed as an investment opportunity in the FundsNetwork, and that—in online notices “…Fidelity describes these fees to its plan customers and their participants as "supermarket fees (paid by the fund company to Fidelity).”
“The pivotal question here,” he commented, “is whether the Complaint’s allegations regarding this arrangement plausibly paint Fidelity as a fiduciary for the plans (or their participants) with respect to the collection of infrastructure fees from some of the fund managers whose funds appear in Fidelity’s FundsNetwork.”
Fiduciary Focus
After a brief discussion about the roles, criteria and implications of being an ERISA fiduciary, the court turned to two arguments made by plaintiffs that Fidelity was a fiduciary to the plan(s) with regard to its fee arrangements with the fund companies listed on its FundsNetwork. The first—basically an attempt to connect the dots between contractual arrangements with the plan and Fidelity and the (separate) agreements with Fidelity and the listed fund companies—was quickly dismissed, as it had been by the district court.
As for their second argument, the plaintiffs had argued that in exercising discretionary control over its Infrastructure fees to the listed mutual funds, it “effectively increased the amount of compensation it received from the plans, and thereby should be deemed to be a fiduciary with respect to the collection of such fees.” The court noted that the fees in question were paid by the mutual funds, not the plans, and while the plaintiffs countered that the burden of any fee paid by a mutual fund to Fidelity is passed through to the plan participants in the form of increased fees charged by the mutual funds to participants who chose those funds, the court noted that the “plaintiffs offer no example of any such pass-through by any mutual fund.”
Shelf Space
That said the court assumed for purposes of considering the motion to dismiss that that argument was true, but quickly noted that “this theory for labeling the infrastructure fee a payment by the plans stumbles initially because Fidelity provides consideration in return for the payment of the fee by the funds—access to the FundsNetwork. In this respect, Fidelity is like a supermarket that charges a vendor a fee in return for favorable shelf space,” and that “no one would deem that fee to be compensation from the supermarket's customers.”
The court noted that this theory also overlooked “…the numerous intervening and independent decisions inherent in the so-called pass-through to which they point.” It was that series of independent decisions that the court said “…precludes us from agreeing with plaintiffs that the infrastructure fees are compensation paid to Fidelity by the plans,” specifically that Fidelity had to negotiate the fee with the fund manager, who remains free to agree or not. “The fund manager— not Fidelity—then decides whether or not to try to increase its fees charged to investors—and such fees must be disclosed,” the wrote.
“Even then,” the court noted that “the fund would only be listed by Fidelity as an available option on the FundsNetwork. It would remain for the plan’s fiduciary investment advisors to decide whether to make the fund available to that plan's participants.” And even then, the court noted, “it would ultimately be up to the participants to decide whether to invest in the fund. Only then would the theoretical pass-through of infrastructure fees posited by the plaintiffs occur.”
And even then, the court noted, “Fidelity and the fund would still have to agree on the fee, the fund would still have to decide to raise its investment fees, and the plan would still have to decide to continue offering the fund on its Small Menu.” The court concludes: “Plaintiffs point to no case treating such a series of independent decisions as the equivalent of Fidelity controlling its compensation from plans. One could just as easily say that by charging infrastructure fees to funds, Fidelity lowers the costs it incurs as a service provider, and thus can agree to charge plans less; indeed, it likely would charge less unless it has market power. All in all, we see nothing here that calls for treating Fidelity's charging of fees to some funds as an exercise of authority or control over any plan assets, management, or administration.”
Network Nexus?
As for an argument that Fidelity was acting as a fiduciary in determining the funds on that network, the court noted that, “Two circuits have rejected this argument as applied to comparable ‘product design’ decisions.” Beyond that, the court turned again to the level(s) of independent decision-making at play here: “The plans and their investment advisors decide which investment opportunities are made available to their participants. In making these decisions, they have a variety of vendors from whom they might obtain access to investment opportunities, either directly or indirectly. Fidelity is just one of those options. Should a plan choose Fidelity, it then chooses which funds to select from Fidelity’s Big Menu of offerings, which include Fidelity and non-Fidelity funds. With knowledge of their participants’ investment goals, the plan and its investment advisors assemble the Small Menu from which the participants pick. Nothing in this arrangement suggests that Fidelity must automatically be treated as if it were also a fiduciary advising which options to select.”
ERISA does not treat as a fiduciary one who offers without advice numerous investment options from which an investment advisor might select investments. To rule otherwise would be to deprive plan fiduciaries of the benefit of having vendors who need not themselves bear the expense of duplicating the investment advisor's fiduciary role.
Citing several cases, and noting that “case law almost directly on point flatly rejects plaintiffs’ notion that Fidelity acts as a fiduciary in selecting funds for its FundsNetwork,” he continued that ”while the Complaint alleges repeatedly that Fidelity controls which funds are made available to the Plans, there is no claim that Fidelity has control over which funds a plan selects for the menu available to the plan’s participants… The T-Mobile Contracts make clear that ‘Fidelity shall have no responsibility for the selection of Permissible Investments for the Plan’ and that ‘[a]ll Plan assets must be invested in the Permissible Investments selected by the Employer…’
“…the Complaint contains no allegation that Fidelity's decision to stop offering a fund in its FundsNetwork removes that fund from those already selected by a plan for its Small Menu.” And no wonder, the court wrote—“as noted already, the T-Mobile Contracts preclude Fidelity from having any ‘responsibility for the selection of Permissible Investments for the Plan.’ And, adding belt to suspenders, if a plan or its investment advisors become dissatisfied with Fidelity's Big Menu offerings, they could opt to shop elsewhere.”
On a final point, Judge Kayatta stated that the plaintiffs’ final fiduciary status argument “trains on the fact that Fidelity can successfully impose infrastructure fees only because it has in its hands lots of plan assets to be invested.” “But,” he cautioned, “Fidelity is able to charge funds a fee because it has lots of customers, not because it controls those customers or their assets in any meaningful manner. The fund simply gets on the store’s shelves, and the participant has the final say on whether the fund also gets in the grocery cart.”
Ultimately, while the court acknowledged that Fidelity does have some fiduciary duties vis-à-vis the plans and their participants, it pointed out that “Fidelity’s actions in a fiduciary capacity are not the subject of plaintiffs’ complaint,” specifically that “Fidelity’s fiduciary responsibilities as a directed trustee are distinct from and do not extend to Fidelity's charging of an infrastructure fee..”
What This Means
The court here—as had the district court before it—found that having influence over the construction of a fund platform chosen by a plan sponsor/fiduciary, from which funds on that platform are selected by a plan sponsor/fiduciary, and ultimately chosen (or not) by plan participants—didn’t render the platform owner to be a fiduciary to the plan(s) that voluntarily decided not only to participate in that platform, but how.
The direct implications of this ruling may be limited for plan fiduciaries or advisors—but it should serve as a reminder that fiduciary status is a function of the ability to control plan assets. Choosing a platform may well reach that level, but building that choice is another matter altogether.
