7th Circuit Provides “Deere” Guidance on 401(k) Investment Fees
Robert Litvin, Esq. on 04/08/2009
In the recent Hecker v. Deere&Co. decision, the 7th Circuit provided some significant guidance regarding the extent of the fiduciary responsibility retained by employers and other fiduciaries when investment control in 401(k) and other defined contribution (DC) plans is passed through to plan participants. In particular, the Court rejected the notion that in the context of describing 401(k) investment fund fees, a fiduciary must disclose revenue sharing agreements in connection with those fees. It also rejected the allegation that the plan fiduciaries selected mutual fund options with excessive fees where over 2,500 mutual funds available to the general public were made available to plan participants. The Court also provided some interesting comments on the scope of ERISA’s “safe harbor” defense for participant-directed investments.
Background
It is no secret that over the past 35 years, since the enactment of the Employee Retirement Income Security Act (“ERISA”), there has been a significant shift by employers toward the use of defined contribution (DC) plans, especially 401(k) plans, and away from the use of traditional defined benefit pension (DB) plans. One of the most significant consequences of such a shift is that employees’ retirement benefits are more directly impacted by their accounts’ investment performance than is the case with DB plans, as each employee’s DC plan retirement benefit is largely a function of the investment performance of his or her individual DC plan account – a point not lost among the millions of Americans who had the courage to open their most recent 401(k) statements. With the increasing utilization of DC plans as the primary source of retirement benefits, especially those with participant-directed investments, more and more focus is being placed on the fiduciary responsibilities of employers and their service providers in connection with offering these types of retirement plans.
ERISA has very broad fiduciary responsibility rules that are imposed upon those who, among others, exercise discretionary authority or discretionary control respecting management of a plan or management or disposition of its assets. Fiduciary responsibility under ERISA carries with it, among other things, the duties of loyalty and prudence, the latter of which is often categorized as the “prudent expert” standard.
ERISA Section 404(c) generally shields employers and other fiduciaries from the consequences of poor investment decisions made by a plan participant, assuming the plan properly enables the participant to “exercise control” over the assets in his or her account. Section 404(c) is misunderstood by many to be a complete shield from fiduciary liability if investment decisions are passed through to plan participants. With a participant-directed DC plan, employers and other fiduciaries generally retain fiduciary responsibility in selecting, monitoring, retaining and replacing the various investment funds offered through the plan.
Hecker v. Deere
Hecker v. Deere can be categorized as one of the many recent “excessive fee” cases brought against employers and their outside vendors who tend to bundle 401(k) recordkeeping and investment advisory services to employers. The plans at issue were two similar participant-directed 401(k) plans (together referred to as the “Deere 401(k) Plan”) for which Fidelity Management Trust Company (“Fidelity Trust”) was an advisor to the employer for purposes of selecting the investment funds available through the plans. Fidelity Trust was also the trustee and recordkeeper for the Deere 401(k) Plan. The Deere 401(k) Plan included as investment options 23 Fidelity mutual funds, two investment funds managed by Fidelity Trust, and a brokerage window operated by Fidelity that provided participants with access to over 2,500 mutual funds managed by various investment firms.
Fidelity Not a Fiduciary
Plaintiffs’ complaint alleged that the employer and Fidelity Trust breached their fiduciary obligations by selecting for the Deere 401(k) Plan investment options that carried unreasonably high fees. Fidelity Trust argued that it was not a fiduciary of the Deere 401(k) Plan, as it did not exercise any authority or control over the plan or its assets. Fidelity Trust pointed out that it only advised the employer as to what investment options to offer under the plan-and that the actual decisions in this regard resided solely with the employer. The Court agreed with Fidelity Trust that, without exercising actual control over the selection of funds, and only “playing a role” in the process of choosing funds, it was not a fiduciary. The complaint also alleged that Fidelity Research, the investment advisor for the various mutual funds offered through the Deere 401(k) Plan, shared the investment fees it received (as a result of participants’ investments in these funds) with Fidelity Trust, thereby causing it to gain “fiduciary” status through its exercise of control over such “plan assets.” The Court disagreed, indicating that since the fees were collected from the mutual fund’s underlying assets, pursuant to ERISA Section 401(b)(1) the funds paid to Fidelity Trust should not be considered plan assets. In the absence of any discretion or control over “plan assets,” neither Fidelity Trust nor Fidelity Research could be fiduciaries as a result of the revenue sharing that took place.
Deere Not Liable as a Fiduciary
The Plaintiffs further alleged that the employer breached its fiduciary obligations in the following two ways:
· The employer failed to inform the Deere 401(k) Plan participants of the revenue sharing agreement between Fidelity Research and Fidelity Trust;
· The employer imprudently limited available investment options under the Deere 401(k) Plan to Fidelity Research funds-which carried excessive fees.
With regard to the first allegation, the Court concluded that because the total fund fees were adequately disclosed (through the fund prospectuses to which participants were directed via the plan’s summary plan description), the employer met its fiduciary obligation with respect to the disclosure of investment fund fees. The Court explained that “[t]he later distribution of the fees by Fidelity Research is not information the participants needed to know to keep from acting to their detriment. This information is not material, and its omission is not a breach of Deere’s fiduciary responsibility.”
With regard to the allegation of excessive fees, the Court again found the employer not liable because the Deere 401(k) Plan offered a sufficient mix of investments for the participants. With 2,500 investment funds available to participants with a wide range of expense ratios, and all of which were offered on the same terms to investors in the general public, the Court recognized that the expense ratios were “set against the backdrop of market competition.” The Court then confirmed that “[n]othing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund.”
ERISA 404(c) Safe Harbor
Finally, the 7th Circuit addressed the issue of the scope of the protection provided by ERISA Section 404(c) assuming all of the requirements (such as the obligation to provide a broad range of investment alternatives and to provide sufficient information to participants about the funds to enable them to make informed investment decisions) thereof are met. The Court declined the opportunity to directly rule as to whether a fiduciary’s actual selection of investment options is protected by the ERISA Section 404(c) safe harbor. It did say, however, that even if ERISA Section 404(c) does not always shield a fiduciary from an imprudent selection of funds under every circumstance that can be imagined, it does protect a fiduciary that satisfies the requirements of ERISA Section 404(c) and includes a sufficient range of investment options to enable participants to have control over their risk of loss. The Court went on to say that given the 2,500 fund offerings made available through the brokerage window, it would be “implausible” to think that these options did not meet the ERISA Section 404(c) “broad range of investment alternatives” standard contained in the ERISA Section 404(c) regulations.
It remains to be seen how employers, their advisors and other courts will interpret the extent to which the 7th Circuit’s apparent endorsement of a plan’s providing access to over 2,500 mutual funds, and otherwise complying with ERISA Section 404(c), serves as a shield against any breach of fiduciary duty claims relating to the fiduciary’s selection and retention of investment fund options.
Conclusion
While the Hecker v. Deere case may provide some comfort, particularly within the 7th Circuit, to the many employers and their outside recordkeepers that offer similar participant-directed 401(k) arrangements, plan fiduciaries should exercise caution before relying upon Hecker v. Deere beyond its specific (and important) holdings regarding revenue sharing and excessive fees. Given the abundance of these arrangements in the marketplace and the large number of disgruntled plan participants who have seen their retirement savings severely depleted, other federal courts, and perhaps the Supreme Court, may take the opportunity to weigh in on the extent of fiduciary liability protection provided by ERISA Section 404(c) with regard to plans that provide access to hundreds or thousands of mutual fund investment alternatives.
Add Comment