Fidelity Latest Financial Firm to Face Fiduciary Challenge

The nation’s largest recordkeeper has been sued by participants in the firm’s own 401(k) for falling short of its fiduciary obligations regarding plan investments – though it’s not the first such suit against the firm.

Plaintiffs Kevin Moitoso, Tim Lewis, and Mary Lee Torline filed suit (Moitoso v. FMR LLC, D. Mass., No. 1:18-cv-12122, complaint filed 10/10/18) 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 allege 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 alleges that they “…loaded the Plan exclusively with Fidelity-affiliated investments, without investigating whether Plan participants would have been better served by investments managed by unaffiliated companies.”

Moreover, and “perhaps worse.” according to the plaintiffs, “the Fiduciary Defendants have included almost every non-identical Fidelity mutual fund in the Plan’s investment lineup (hundreds in total), many of which were inappropriate offerings due to their poor performance, high fees, lack of diversification, or speculative nature” – which, they claim, at least compared with 20 other plans with more than $5 billion in assets in a report by Cerulli Associations, added up to “over $100 million per year in losses compared to the average plan.” Those losses are, according to the plaintiffs, attributable to “excessive fees, reckless inclusion of speculative investments as designated investment alternatives, the failure to investigate nonproprietary options, and the failure to monitor the proprietary options that were included in the Plan’s investment menu to ensure they were serving the goals of the Plan’s participants.”

Fee ‘Charges’

As for those fees, the suit alleges that the Fidelity plan’s fees were 0.58% of assets, “more than double the asset-weighted average of 0.24%, and a full 0.10% higher than its closest peer” – and that had the plan’s fees “…simply matched the average for plans with more than $5 billion in assets, total fees would have been $47 million lower in 2016 alone.” The suit also takes the Fidelity plan fiduciaries to task for not offering collective investment trusts (CITs), for failing to “utilize the cheapest available share class of certain proprietary funds in the plan,” and for not securing the “available revenue sharing rebates from the plan’s investments.” Regarding the latter, the suit claims that “revenue sharing rebates from 2015 and 2016 would have covered Fidelity’s standard recordkeeping charges (which would have been between $1 and $1.5 million per year, given the number of participants), with an excess of approximately $31.5 million per year that could have been refunded to participants.”

While this range of allegations is not unique in cases of this sort, the plaintiffs here characterize the situation as “particularly inexcusable” for the nation’s largest retirement plan recordkeeper in that they “have all the data and resident expertise to build a plan in their participants’ best interests,” and yet – according to the suit – “made no effort to do so.” Moreover, they claim that the defendants here “know their conduct is illegal, having quickly settled a similar lawsuit less than four years ago for an eight-figure sum.”

‘Self’ Directions

The plaintiffs note that plan offers only Fidelity mutual funds as designated investment alternatives, and that in fact the plan’s designated investment alternatives “include almost every non-identical Fidelity mutual fund in existence that is eligible for inclusion in a defined contribution plan,” such that by 2016 the plan offered “234 proprietary funds and zero nonproprietary funds.” And then – apparently attempting to head off a likely point of defense – argued that while the plan offered a self-directed brokerage option (which has, at least in some excessive fee cases, been sufficient to blunt proprietary-only menus), here the plaintiffs argued are not only “administratively difficult to set up and logistically challenging to manage, and as a result are used by 2% or less of participants on average,” but that “participants investing through SDBAs are often subject to additional account fees, transaction fees, and higher investment expenses” and “…often invest in imprudent investments,” since those accounts don’t typically benefit from a fiduciary’s selection of the menu, and that as a result of those factors “performance is generally lower with self-directed accounts compared to managed portfolios.”

The plaintiffs also take issue with the inclusion of 39 sector funds in the plan – which they note are all such offerings that Fidelity offers. They claim that “these sector funds took on substantial uncompensated risk that a prudent fiduciary would have found imprudent,” that the options not only didn’t provide any diversification benefit, but rather that they “constituted speculative bets on particular industries that were not conducive to participant implementation of a prudent investment strategy” – and that, beyond that, they were more expensive options (the suit says the weighted average cost of the Plan’s sector funds was 25% higher than the weighted average cost of the rest of the funds in the Plan). “A prudent fiduciary would not have heaped every single Fidelity sector fund into the Plan given those funds’ high fees and lack of diversification.”

Money ‘Makings’

Not that it was all about the options offered – here the plaintiffs took issue with the lack of a stable value option in the plan, that while “Fidelity offers a stable value fund in the marketplace known as the Managed Income Portfolio,” they had not included this option in the plan, because – they allege “…doing so would constitute a prohibited transaction to which no exemption would apply.” Instead, the plaintiffs allege, “the Plan’s capital preservation options have consisted exclusively of Fidelity-affiliated money market accounts that have earned little interest given the structural disadvantages associated with money market funds compared with other capital preservation options.”

The plaintiffs also claim that Fidelity “…took money that it was going to contribute anyway and recharacterized a portion of it as a fee “refund.” Thus, “for every dollar in investment management fees that Fidelity gave back to Plan participants, Fidelity reduced its profit sharing contribution to participants by the same amount” – arguing that the 10% discretionary profit sharing contribution was “…not a gift, but instead an important part of the compensation package adopted by Fidelity to attract new talent and to retain its existing employees.” Moreover, they claim that “Fidelity created this “fee refund” artifice in an attempt to obscure its fiduciary misconduct.”

Ultimately, the plaintiffs’ arguments boil down to:

  • The “complete absence of nonproprietary investment options in the Plan gives rise to an inference that the Fiduciary Defendants failed to investigate whether nonproprietary designated investment alternatives were available that would have better met the needs of Plan participants due to lower fees and/or superior investment management services.”
  • The “decision to offer almost every Fidelity mutual fund in existence as a designated investment alternative demonstrates that the Fiduciary Defendants put Fidelity’s interests ahead of participants.”
  • The “conduct in managing the Plan’s designated investment alternatives furthered Fidelity’s corporate interests in a number of ways…”, including the addition of fee revenue (“approximately $83 million in 2016 alone”), avoiding “antagonizing Fidelity’s fund managers, some of whom would otherwise have had their funds excluded from the Plan,” not to mention avoiding the “perception of endorsing investment products managed by other firms.”

The plaintiffs do put forth a unique argument in this case – that the Plan’s “exclusive use of proprietary funds ensured that Fidelity’s employees – many of whom are employed to sell others on the benefits of owning Fidelity funds – would themselves own Fidelity funds, thereby building loyalty, product knowledge, and a built-in sales pitch touting the employees’ personal investment in the pitched products.”

The suit claims that the fiduciary failures here have been “devastating” for participants in the plan. They claim that “among the 20 defined contribution plans with over $5 billion in assets for which necessary data was available, Fidelity’s plan performed the worst (almost three times worse than average), representing over $100 million per year in losses compared to the average plan.”

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