WHATEVER YOU DO, DON'T FALL ASLEEP

By Eric Paley and Stacy Lawkowski, Nixon Peabody LLP

No one is quite sure how it got its nickname, but Missouri lived up to its reputation as the Show-Me State recently when a federal District Court there showed everyone how to bring a successful lawsuit against ERISA plan fiduciaries.

$36.9 million. That's the amount of damages awarded to the victors in Tussey v. ABB, Inc.,

which means, under a standard retainer agreement, their lawyers will walk away with a cool $12.3 million before expenses. And that doesn't even include whatever amount the court ultimately grants in attorneys' fees (though such costs are typically credited against the overall take).

Failure to monitor recordkeeping costs. Failure to negotiate rebates from revenue sharing fees. Selection of overly expensive share classes. Imprudent removal of one fund in exchange for another. Payment of excessive amounts for recordkeeping services to subsidize unrelated corporate services. "Those poor saps at ABB," you're saying to yourself. "They must have really stepped over the line."

Well, no, not really. Sure, as we all know, hindsight is 20/20, and the defendants here certainly did a few things that will make you scratch your head in puzzlement. But mostly, what the good folks of ABB did was administer their retirement plan not unlike many other companies and organizations - including yours - and that, dear reader, is what makes the court's ruling particularly frightening.

Unfazed, you remark, "I'm not overly concerned. After all, federal district courts are trial courts, so their holdings aren't generally viewed as precedent-setting." While that's true, the decision here provides a road map that any plaintiffs' attorney in any state can now follow to chase down putative defendants. In fact, a decision like this could provide just the right amount of leverage to exact settlements from companies and organizations all too willing to pay some amount of hush money to avoid the unpredictable costs and other hazards of litigation.

That slurping sound you hear? It's the plaintiffs' bar licking its lips. Let's roll the highlight reel:

Failure to Monitor Recordkeeping Costs

The Court found that ABB breached its fiduciary duty to its two 401(k) plans because it failed to monitor recordkeeping costs, resulting in overpayments. For the period in question, recordkeeper Fidelity Trust was largely compensated for its services through revenue sharing from the companies selected to be on the plans' investment platform, a permissible and very common practice. However, ABB never calculated the dollar amount of those fees, nor did it consider how the plans' size - over $1 billion - could be leveraged to reduce recordkeeping costs.

In fact, it never obtained a benchmark as to what Fidelity should be paid for its efforts. Outside consultants told ABB that it was paying too much and even remarked that the plans might be subsidizing certain corporate services provided to ABB by Fidelity. But ABB more or less ignored those plaints, even after Fidelity, itself, suggested that it viewed its delivery of corporate services and plan-related services to be interconnected.

So what was ABB doing all this time? Well, it monitored the reasonableness of the expense ratios of the investments chosen for the plans' investment platform, even though that metric doesn't show how much revenue flows to the recordkeeper, doesn't show the competitive market for recordkeeping fees for comparable funds, and fails to account for the size of the retirement plan or the competitive advantage that an investment company enjoys when it is chosen to be on a plan's investment menu. Otherwise, the court found that the ABB fiduciaries simply weren't concerned about the cost of recordkeeping unless it increased the company's expenses or caused the plans to be less attractive to its employees due to the assessment of hard-dollar, per participant fees. Said the court, "The latter was a concern to ABB corporate because the Plans were used by ABB to attract and maintain high quality employees, so it was to ABB's benefit that opaque revenue sharing be used rather than hard dollar fees which were clearly visible to the participants."

In light of the foregoing, no one should be surprised at the court's finding that the plans overpaid for recordkeeping services. Specifically, it determined that the revenue sharing generated by the plan "far exceeded the market value for recordkeeping and other administrative services provided by Fidelity Trust."

Failure to Comply With Investment Policy Statement

Next, the court found that ABB failed to comply with its investment policy statement "because it made no meaningful effort to monitor the revenue sharing and determine whether it was being used to reduce Plan recordkeeping costs. Yes, the plans' Pension Review Committee, a named fiduciary, had indeed adopted an investment policy statement which set out the guidelines concerning "investment management decisions such as selecting, deselecting, and monitoring investment offerings in the Plan[s]." The type of banal stuff one would expect to see in an IPS.

But what got the court all hot and bothered was a statement that, at all times, "rebates will be used to offset or reduce the cost of providing administrative services to plan participants." ABB, as we've already learned, didn't do this, and since the IPS is a governing plan document within the meaning of ERISA, the company's failure to follow it constituted a breach of its duty of prudence.

Revenue Sharing Is Not Per Se Imprudent

Notably, the court did not find that revenue sharing is per se an imprudent method for compensating a plan's recordkeeper. However, it stated that if a plan sponsor selects revenue sharing as a method to pay for recordkeeping services, not only must it "comply with its governing plan documents, it must also have gone through a deliberative process for determining why such a choice is in the plan and participant's best interest." That process involves more than just reviewing expense ratios and is a unique exercise for each plan. The court found that ABB acted imprudently because it failed to undertake such a process. Its stated reason for selecting revenue sharing – progressivity – found no support in the evidence presented to the court; in failing to determine how much revenue sharing its plan funds actually generated for Fidelity, ABB wasn't in a position to analyze how revenue sharing would benefit the plan nor could it negotiate revenue sharing with Fidelity "by leveraging the [Plans'] size to offset or reduce recordkeeping costs."

Selection and De-Selection of Investment Options

The court found that ABB violated its ERISA duty of prudence when it removed the Vanguard Wellington Fund from the plan and replaced it with the Fidelity Freedom Funds. In particular, ABB's Pension and Thrift Management Group acted imprudently when it failed to follow the IPS and considered only two viable options for a managed allocation fund and when it failed to engage in a deliberative assessment of the merits when determining which investment option to select.

The IPS contained a detailed procedure for removing an investment option. It required ABB to examine a fund over a three- to five-year period; determine if there was a five-year period of underperformance; if so, place the fund on a watch list; and then remove the fund within six months if it did not recover. In de-selecting the Vanguard Wellington Fund, ABB virtually ignored this process. Instead, it acted upon the sole recommendation of the director of the Pension and Thrift Management Group member. Additionally, "the lack of research and analysis supporting the decision to remove the [Wellington] Fund corroborates the imprudence", as minimal research would have disclosed that the fund performed solidly over its 70-year existence, including the five-year period preceding the recommendation for removal.

The court also found that the director of the Pension and Thrift Management Group, as a plan trustee, violated his ERISA duty of loyalty and committed a prohibited transaction when he recommended that monies in the Wellington Fund be mapped to the Freedom Funds: "The Wellington Fund was removed and mapped to the Freedom Funds so that ABB, Inc. could reduce its out-of-pocket costs for recordkeeping fees, and at the same time influence employee retention and recruitment, by offering a low cost or "free' retirement plan. [The director] was also influenced by the close relationship ABB had with Fidelity, including the use of Fidelity to perform corporate services for ABB."

Selection of Investment Classes with Higher Expenses

The court found that the defendants breached their fiduciary duties under ERISA in deciding to keep more costly classes of investments on the plans' investment platform when less expensive classes of those same investments were available. In particular, when selecting replacement funds for the plan platform, ABB chose investments because of their effect on ABB's method of compensating Fidelity and a desire to maintain a revenue neutral arrangement with the recordkeeper, not because of a difference in the investments' merit or value to the participants. Compounding the problem was a provision of the IPS that stated, "When a selected mutual fund offers ABB a choice of share classes, ABB will select that share class that provides Plan participants with the lowest cost of participation." ABB's failure to follow this express directive of the IPS, as a governing plan document, was deemed imprudent. Moreover, ABB never prudently determined that revenue neutrality was a reasonable method to compensate Fidelity.

Subsidizing ABB Corporate Administrative Services with Excess Revenue Sharing

The court found that one of the defendants violated ERISA's duty of loyalty when he became aware that the plan recordkeeping fees appeared to be subsidizing unrelated ABB corporate programs (i.e., recordkeeping for the defined benefit plan, non-qualified deferred compensation plan, health benefits, and payroll) but failed to investigate and prevent any future subsidy. At a minimum, he should have calculated how much revenue was generated by the plan investments to determine the amount of such a subsidy. Instead, as a result of the defendant's inaction, ABB chose investments to ensure revenue neutrality with Fidelity and continued to pay recordkeeping fees in excess of market rate, while Fidelity lost money on the unrelated corporate services and made profits on the retirement plan business.

Float

ABB wasn't the only party to take a beating in this action. Fidelity got a wrist-slap of its own. Specifically, the court found that Fidelity breached its ERISA fiduciary duty of loyalty to the plans when it retained float to offset its own costs and distributed the balance to individual investment options. (Float income consists of interest earned when plan assets remain in various bank accounts overnight.) Characterizing float as a plan asset, the court stated that it must be returned to individuals who were participants or beneficiaries of the ABB plan.

Takeaways

There's a lot that can be gleaned from a careful reading of the court's decision, so we commend it to you. Here are just a few takeaways:

• The importance of good plan governance can never be overstated. Contemporaneous detailed minutes of fiduciary meetings may well be the best evidence available should a lawsuit ever be brought. Ensure that investment policy statements and committee charters are followed to the letter and don't contain unnecessary or gratuitous language. If necessary, err on the side of more general provisions than highly specific ones to provide room for more discretion to be exercised.
• Be ever mindful of your fiduciary responsibilities under ERISA. You should view each and every action you undertake through that prism, and when in doubt, do what's best for plan participants and beneficiaries.
• If you don't already benchmark recordkeeping fees, you need to start. Determine how much your plan currently pays, both in hard dollars and by revenue sharing, and compare that amount to what similarly-sized plans in the market pay. To that end, you may well want or need to engage a consultant to assist you. Consider how your plan's size can be used to reduce recordkeeping fees. Going forward, take deliberate care to monitor the revenue sharing in your plan and how it impacts the recordkeeping fees. Where excess exists, seek the establishment of an ERISA budget account to offset plan administrative expenses. Finally, review and, as necessary, revise your investment policy statement to ensure you comply with any recordkeeping fee obligations.
• Speaking of your investment policy statement, be sure that you are following its terms when selecting and deselecting funds. Opt for general language over specific language, and be wary of investment options, the revenue sharing for which may separately benefit the plan sponsor. Any analysis involving potential conflicts of interest should be undertaken seriously and cautiously. When choosing between different share classes, make sure you document your reasoning.
• An inherent conflict exists in receiving corporate services from a plan recordkeeper. You can mitigate that conflict to a great extent by evaluating how much revenue is being generated from your plan's investments and determining the market rate for the corporate services. Based on that information, determine whether your plan is paying a fair price for recordkeeping, and not subsidizing the corporate services.
• Review your service agreements to determine how float is being used. When negotiating recordkeeping agreements, consider requesting that float be returned to participants and beneficiaries and not used to offset internal fees or be allocated to non-plan investor.

Whatever you do, don't fall asleep.

(JTC Update 7/12/15:  On remand from the Eighth Circuit, the District Court still finds fiduciary breach, but then finds that plaintiffs failed to prove damages. )