ERISA Advisory - Update on Cases Challenging Allegedly Excessive Fees Paid By Participant-Directed Individual Account Plans

A spate of ERISA actions have been filed over the past two years challenging service provider and investment fees charged to participant-directed individual account plans.  These cases highlight fee-related issues under ERISA’s fiduciary and prohibited transaction provisions that the Department of Labor has been grappling with for years in advisory opinions and other guidance offered to plan fiduciaries.  The cases generally fall into three categories:  (1) participant claims against sponsors and related plan fiduciaries; (2) participant claims joining plan providers as additional defendants; and (3) plan fiduciary claims against plan providers.

A.                Participant Claims Against Sponsors and Their Related Fiduciaries

In these cases, participants in 401(k) plans sponsored by large employers have brought ERISA fiduciary breach actions against the sponsor and related plan fiduciaries alleging that they caused or allowed the plans to be charged excessive fees for services.  At least thirteen of these cases are now pending in various courts across the country:

• Abbott v. Lockheed Martin Corp., 3:06-cv-00701-MJR-DGW (S.D. Ill.);
• Beesley v. International Paper Co., 3:06-cv-00703-DRH-CJP (S.D. Ill.);
• Boeckman v. A.G. Edwards, Inc., 3:05-cv-00658-GPM-PMF (S.D. Ill.);
• George v. Kraft Foods Global, Inc., 3:06-cv-00798-DRH-PMF (S.D. Ill.);
• Kanawi v. Bechtel Corp., 3:06-cv-05566-CRB (N.D. Cal.);
• Loomis v. Exelon Corp., 1:06-cv-04900 (N.D. Ill.);
• Martin v. Caterpillar, Inc., 1:07-cv-01009-JBM-JAG (C.D. Ill.);
• Nolte v CIGNA Corp., 2:07-cv-02046-HAB-DGB (C.D. Ill.);
• Spano v. Boeing Co., 3:06-cv-00743-DRH-DGW (S.D. Ill.); 
• Taylor v. United Technologies Corp., 3:06-cv-01494-WWE (D. Conn.);
• Tibble v. Edison International, CV07-05359-SVW (C.D. Cal.);
• Waldbuesser v. Northrop Grumman Corp., CV-06-6213-R (C.D. Cal.); and
• Will v. General Dynamics Corp., 3:06-cv-00698-WDS-CJP (S.D. Ill.).

In addition to the plan sponsor, the defendants typically include plan committees, committee members and various company officers, directors and employees who allegedly acted as fiduciaries in administering the plans or making investment-related decisions.  The services for which the plans allegedly were charged excessive fees include recordkeeping, administration, trustee, investment advisory, investment management, brokerage, consulting and other services.  The complaints in these cases do not join the service providers themselves as additional defendants.

The complaints typically include allegations that the defendants failed to investigate or disclose “revenue sharing” payments that plan providers received from third parties.  Another common allegation is that the defendants breached fiduciary duties by “foregoing” or failing to "capture" revenue sharing payments that were never paid to the plan’s service providers.  The theory underlying this claim is that, in determining whether the fees paid for services provided to a plan are reasonable, the plan’s fiduciaries must take into account any amount included in the expense ratio charged by the plan’s investment options that may have been available for revenue sharing purposes but was somehow “left on the table."  A few cases also include allegations that the defendant fiduciaries improperly selected retail classes of mutual fund shares for the plan’s investment platform when they should have selected institutional share classes with lower expense ratios.

In two cases, Boeckman and Nolte, the defendant plan sponsor is a financial institution that provides services and investment products to its own 401(k) plan.  The complaints in these cases allege not only that the defendant financial institution caused or allowed its 401(k) plan to pay excessive fees for services, but also that the arrangements between the financial institution and its in-house plan violate ERISA’s prohibited transaction rules.

Some of the complaints allege that the plan’s employer stock fund charged improper management fees.  According to the complaints in these cases, employer stock funds should not have any management fees at all because there is nothing to manage.  Several complaints include claims that the fiduciaries of unitized employer stock funds have allowed the funds to hold excessive amounts in cash, thereby diluting investor returns. 

The participants in each case typically seek to certify a class of all similarly situated participants in their respective plans.  By way of relief, the participants generally seek to recover not only losses allegedly suffered by the plan through the payment of excessive fees to the plan’s service providers, but also “investment losses” allegedly suffered by the participants’ individual accounts through the payment of excessive expense ratios embedded in the plan’s investment options.  They also seek an accounting of all transactions involving the plans or their assets.  In seeking to recover “investment losses,” the complaints allege that ERISA § 404(c)’s "safe harbor" is unavailable to the plan's fiduciaries because participants were not adequately informed of all of the fees paid directly or indirectly by the plans.

There have been eleven decisions in these cases, nine involving motions to dismiss or strike and two addressing class certification.  In Boeckman v. A.G. Edwards, Inc., 461 F. Supp. 2d 801 (S.D. Ill. 2006), the defendant financial institution moved to dismiss claims alleging that it had violated ERISA’s prohibited transaction rules by charging excessive expense ratios through affiliated mutual funds offered as investment options for its own 401(k) plan.  The court acknowledged that these claims were “weak” in light of ERISA § 3(21)(B), which specifically excludes mutual funds from the statutory definition of a "party in interest."  Nonetheless, the court declined to dismiss the claims at the pleading stage.

In Loomis v. Exelon Corp., 1:06-cv-04900 (N.D. Ill. Feb. 21, 2007), the court dismissed the portion of plaintiffs’ request for relief that sought recovery of “investment losses” incurred by their individual accounts through the payment of allegedly excessive expense ratios.  The court found that the plaintiffs failed to allege a causal connection between the administrative fees charged to the plan and the market-based “investment losses” purportedly suffered by plaintiffs’ individual accounts, as required by ERISA § 409(a).  The court subsequently certified the case as a class action.  Loomis v. Exelon Corp., 2007 U.S. Dist. LEXIS 46893 (N.D. Ill. June 26, 2007). Two days after certifying a class, the court granted the defendants' motion to stay the case pending a ruling by the United States Court of Appeals for the Seventh Circuit on the appeal of Hecker v. Deere & Co., 06-C-719-S, 2007 U.S. Dist. LEXIS 45275 (W.D. Wis. June 20, 2007).  Loomis v. Exelon Corp., 1:06-cv-04900 (N.D. Ill. June 28, 2007).

In George v. Kraft Foods Global, Inc., 06-cv-00798-DRH, 2007 U.S. Dist. LEXIS 18650 (S.D. Ill. Mar. 16, 2007), the court ruled that the complaint’s allegations were sufficient to survive a motion to strike or for a more definite statement under Fed .R. Civ. P. 8.  The court also declined to dismiss the complaint’s allegation that the defendants failed to qualify for the ERISA § 404(c) safe harbor and, accordingly, were liable for plaintiffs’ “investment losses.”  The court construed these allegations as dealing only with the defendants’ ability to maintain a defense under ERISA § 404(c).  It questioned why these allegations were included in the complaint.  But rather than dismiss the allegations, the court indicated that it would simply disregard them.

In Spano v. Boeing Co., 06-cv-743-DRH, 2007 U.S. Dist. LEXIS 28774 (S.D. Ill. Apr. 17, 2007), the court denied the defendants’ motion to dismiss.  Two defendants, the plan sponsor and the Director of Benefits Delivery, argued for dismissal because they were not ERISA fiduciaries, but the court ruled that “at this juncture it is impossible for the Court properly to evaluate whether [these defendants] exercised discretionary control with respect to the Plan such as to make them Plan fiduciaries.”  The court also denied a motion to dismiss a misrepresentation claim that allegedly undermined any ERISA § 404(c) defense that might be interposed by the defendants, reasoning that a complaint is not required to negate an affirmative defense.

In Kanawi v. Bechtel Corp., 3:06-cv-05566-CRB (N.D. Cal. May 15, 2007), the court denied the defendants’ motion to dismiss, holding that plaintiffs’ failure to allege that the defendants breached ERISA’s specific disclosure requirements was not fatal to their claim that defendants breached their fiduciary duties, that the ERISA § 404(c) defense was raised prematurely on a motion to dismiss, and that the court could not decide at that early stage whether the sponsor was a fiduciary.

In Martin v. Caterpillar, Inc., 1:07-cv-01009-JBM-JAG (C.D. Ill., May 15, 2007), the court granted the defendants' motion to dismiss the complaint for including "prolix language" that was "irrelevant to any claim made by the Plaintiffs."  The court indicated that this "unnecessary verbiage" would make it "difficult for Defendants to file an appropriate responsive pleading" as well as "difficult for this Court to conduct orderly litigation."  The court granted the dismissal without prejudice to the plaintiffs' re-filing a complaint that "substantially complies" with the short and plain statement requirement of Fed. R. Civ. P. 8.

In Waldbuesser v. Northrop Grumman Corp., CV-06-6213-R (C.D. Cal. May 23, 2007), the court granted a motion to dismiss the complaint filed by the defendant corporation and members of its board of directors on the ground that the complaint's allegations failed to establish that they had or exercised any fiduciary responsibility with respect to the challenged conduct.  The court subsequently denied the plaintiffs' motion for class certification, stating that "[t]his case does not qualify under Fed. R. Civ. P. 23, as the case is better taken care of by administrative agencies."  Waldbuesser v. Northrop Grumman Corp., CV-06-6213-R (C.D. Cal. August 6, 2007). 

In Taylor v. United Technologies Corp., 3:06cv1494(WWE), 2007 U.S. Dist. LEXIS 57807 (D. Conn. Aug. 9, 2007), the court declined to dismiss claims that the defendants breached fiduciary duties by causing the plan to pay unreasonable fees and expenses and misrepresenting revenue sharing payments, reasoning that the complaint’s allegations were sufficient to survive a motion to dismiss.  The court rejected the defendants’ argument that the plaintiffs defeated their ability to prove the unreasonableness of the fees by pleading that revenue sharing is a ubiquitous industry practice.  The court did, however, dismiss the breach of fiduciary duty claim based on non-disclosure of revenue sharing fees, holding that ERISA does not require such disclosure.

In Abbott v. Lockheed Martin Corp., 06-cv-0701-MJR (S.D. Ill. Aug. 13, 2007), the court ruled that the complaint’s allegations were sufficient to withstand a motion to dismiss for failure to comply with Fed. R. Civ. P. 8(a), which requires that a complaint provide a “short and plain statement of the claim showing that the pleader is entitled to relief.”  The court also denied the defendants’ motion to strike various allegations of the complaint under Fed .R. Civ. P. 12(f). 

B.                Participant Claims Joining Plan Providers as Additional Defendants   

These cases are largely the same as those brought by 401(k) plan participants against sponsors and related plan fiduciaries, except that the participants in these cases have joined the plan’s service providers as defendants.  In the following three cases, Fidelity Management Trust Co. (FMTC) and Fidelity Management & Research Co. (FMRCo) are joined as defendants:

• Hecker v. Deere & Co., 06-C-0719-S (W.D. Wis.);
• Renfro v. Unisys Corp., CV 07-2098 (E.D. Pa.); and 
• Kennedy v. ABB, Inc., 2:06-cv-04305-NKL (W.D. Mo.).

The claims asserted against FMTC and FMRCo are essentially the same in each case.  The complaints allege that FMTC and FMRCo acted as ERISA fiduciaries by agreeing with the plan sponsor that it would limit its selection of investment options to funds offered by FMTC.  They further allege that FMTC and FMRCo breached their fiduciary duties by:  (a) causing or allowing the plans to pay their service providers excessive fees, either directly or indirectly in the form of revenue sharing payments; and (b) “secretly” charging and retaining revenue sharing payments that should have been used to benefit the plans and their participants.  The relief sought against FMTC and FMRCo includes restoration of losses, including "investment losses," an accounting of all transactions involving the assets of the plans, and "equitable restitution."

The claims asserted and the relief sought against the plan sponsors and their related fiduciaries in the cases joining FMTC and FMRCo as defendants are similar to the other thirteen cases brought by 401(k) plan participants.  As in the other thirteen cases, the plan participants in these cases also seek certification of a class of all similarly situated participants in their respective plans.

There has been one decision in these cases at the motion to dismiss stage.  In Hecker v. Deere & Co., 06-C-719-S, 2007 U.S. Dist. LEXIS 45275 (W.D. Wis. June 20, 2007), the court granted the defendants’ motions to dismiss all of the fiduciary breach claims alleged in the complaint.  The court first dismissed the "disclosure-based" fiduciary breach claim against Deere on the ground that ERISA’s fiduciary, reporting and disclosure rules do not require disclosure of revenue sharing payments.  The court then dismissed the claim that Deere breached its fiduciary duties by failing to provide lower fee investment choices on the ground that the complaint on its face established all of the elements of an ERISA § 404(c) defense. Specifically, the court ruled that the Department of Labor regulation implementing § 404(c) did not require disclosure of revenue sharing payments, and that any loss to the participants’ individual accounts resulted from their exercise of control over their accounts because the complaint’s factual allegations revealed that they “could choose to invest in twenty primary mutual funds and more than 2500 others through BrokerageLink.”  The court found it “untenable” that “all of the more than 2500 publicly available investment options had excessive expense ratios.”  The court then held that the claims against FMTC and FMRCo failed for the same reasons as the claims against Deere, and further that these defendants were not the fiduciaries having responsibility over the disclosures and investment selection at issue.  The plaintiffs have since appealed the district court’s ruling to the United States Court of Appeals for the Seventh Circuit.

There is another case in this category involving an IRC § 403(b) annuity plan.  In Montoya v. ING Life Insurance and Annuity Co., 07-CV-2574 (NRB) (S.D.N.Y.), participants of the 403(b) plan brought an ERISA fiduciary breach action against an employee organization that allegedly sponsored and administered the plan, a related trust and trustees that allegedly managed and administered the plan, and the insurance company that allegedly held the plan’s assets and selected its investment options.  The complaint alleges, among other things, that the defendants breached their fiduciary duties under ERISA § 404(a)(1) and engaged in non-exempt prohibited transactions in violation of §§ 406(a)(1)(D), (b)(1) and (b)(3), by charging excessive fees that materially reduced participants’ account balances, by failing to provide complete and accurate information regarding plan fees and expenses, and by participating in "undisclosed revenue sharing schemes with mutual funds, mutual fund advisors and other investment advisors."  The relief sought against the defendants includes recovery of all losses suffered by the plan, disgorgement of profits, imposition of a constructive trust and other equitable relief.  The complaint also seeks certification of a class of all similarly situated participants in the 403(b) plan.

C.                Plan Fiduciary Claims Against Plan Providers

The receipt of revenue sharing payments by service providers who act as plan fiduciaries raises issues under ERISA § 406(b), which prohibits fiduciary self-dealing, conflicts of interest, and kickbacks.  Four ERISA actions brought by 401(k) plan fiduciaries against plan providers allege violations of §§ 406(b)(1) and (b)(3), and a fifth alleges violations of §§ 406(b)(2) and (b)(3):

• Haddock v. Nationwide Financial Services, Inc., 3:01-cv-1552-SRU (D. Conn.);
• Phones Plus, Inc. v. Hartford Financial Services, Inc., 3:06-cv-01835-AVC (D. Conn.);
• Ruppert v. Principal Life Ins. Co., 4:07-cv-00344-JAJ-TJS (S.D. Iowa);
  
• Columbia Air Services, Inc. v. Fidelity Management Trust Co., 1:07-cv-11344-JLT (D. Mass.); and
  
• Zang v. Paychex, Inc., 2:07-cv-13410-JF-VMM (E.D. Mich.).
  

The complaints in these cases allege generally that the plan’s providers breached fiduciary duties and engaged in prohibited transactions by arranging for, receiving and retaining revenue sharing payments from mutual funds.  The complaints seek to certify a nationwide class of similarly situated plans.

In Haddock v. Nationwide Financial Services, Inc., 419 F. Supp. 2d 156 (D. Conn. 2006), the court denied the provider’s motion for summary judgment, holding that the following issues were genuinely disputed:  (1) whether the provider exercised fiduciary control over the selection of the plan’s mutual fund options; (2) whether revenue sharing payments made to the provider were “assets of the plan” under ERISA § 406(b)(1); and (3) whether the provider’s receipt of revenue sharing payments from mutual funds violated § 406(b)(3).  Although it denied summary judgment on the first two issues, the court acknowledged that the provider’s control over mutual fund selection might be limited to deleting or substituting funds from a plan’s approved list and that the assets of mutual funds were not plan assets under ERISA § 401(b)(1).

D.               Implications and Related Developments

Whether these 401(k) plan excessive fee cases will generate “big dollar” recoveries has yet to be seen.  Although the cases are generating a fair amount of discussion in the employee benefit plan community, they are still at the preliminary stages of litigation.  More cases of this type are likely to be filed in the months ahead.  To protect against suits of this nature, 401(k) plan sponsors are likely to demand more extensive and detailed fee disclosures from plan providers going forward.

The Department of Labor currently has several initiatives underway that would address some of the issues raised in the excessive fee cases.  On July 21, 2006, the Department proposed changes to Form 5500 for reporting years beginning January 1, 2008 that would require more extensive reporting of payments made to service providers, including revenue sharing.  The Department is also working on a proposed amendment to Lab. Reg. § 2550.408b-2 that would require a “party in interest” service provider to disclose fee arrangements with third parties in connection with services provided to a plan.  In addition, the Department issued a Request for Information on April 25, 2007, indicating that it is currently considering the extent to which rules should be adopted or modified to ensure that participants and beneficiaries of participant-directed individual account plans have sufficient information about fees and expenses to make informed investment decisions.  

On July 26, 2007, Representative George Miller, Chairman of the House Committee on Education and Labor, introduced H.R. 3185, entitled "401(k) Fair Disclosure for Retirement Security Act of 2007."  The bill would amend ERISA to provide special reporting and disclosure rules for participant-directed individual account plans, add a minimum investment option requirement, establish an Advisory Council on Improving Employer-Employee Practices, and provide for enforcement coordination and review by the Department of Labor.  The bill was referred to the House Committee on Education and Labor.

For more information on ERISA legal issues contact Paul Ondrasik, Melanie Nussdorf and Eric Serron at 202.429.3000.