Pension & Benefits News Excess revenue sharing fees and retention of underperforming investment options not sufficient to establish fiduciary breach
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Thursday, November 5, 2020

Excess revenue sharing fees and retention of underperforming investment options not sufficient to establish fiduciary breach

By Pension and Benefits Editorial Staff

A plan participant failed to adequately allege that plan fiduciaries breached their duty of prudence by authorizing excessive revenue sharing fees and retaining underperforming and costly investment options, according to a federal trial court in Illinois. Strictly adhering to Seventh Circuit precedent, the court explained that: (1) the fees, absent self-dealing, were reasonable, and (2) the plan offered a wide range of investment options, including high cost retail and lower cost index funds.

Revenue sharing and underperforming investments draw ERISA suit. CareerBuilder maintained a 401(k) plan that, as of 2017, had 2,600 participants and over $180 million in assets. A former employee participating in the plan brought a putative class action suit against plan fiduciaries, challenging the plan’s recordkeeping fees as a violation of the duty of prudence.

Recordkeeping fees were paid as “hard dollar” payments or as revenue sharing payments. Plan fiduciaries, however, were empowered to select funds with higher revenue sharing in order to offset reductions in hard dollar payments. The plan’s average per capita recordkeeping costs ranged from a low of $136.39 in 2016 to a high of 222.43 in 2014. By contrast, the complaint asserted that a reasonable fee would have been $40 per participant.

The participant further charged that the funds imprudently authorized the selection and retention of high cost and underperforming funds. Specifically, the participant alleged that the fiduciaries should have leveraged the plan’s bargaining power to negotiate institutional class funds that were less expensive than the retail funds held by the plan. In addition, the participant noted that, even though less expensive funds were available for 22 of the 23 funds offered by the plan, the fiduciaries retained 40 percent of the funds for 5 years without change. According to the participant, the fiduciaries retained the more expensive actively managed funds, including those that were outperformed by index funds, to ensure that more revenue was shared with the plan’s recordkeepers.

CareerBuilder brought a Rule 12(b)(6) motion to dismiss the participant’s action for failure to state a claim. The trial court, relying heavily on Seventh Circuit precedent, granted the motion, but without prejudice, allowing the participant to file an amended complaint.

Allegations do not allow plausible inference of imprudence. Initially, the trial court noted that the Seventh Circuit, in Divane v. Northwestern University and Hecker v. Deere, has prevented courts from “paternalistically” interfering with a plan’s investment options, as long as plan fiduciaries: (1) do not engage in in self-dealing and, (2) offer a comprehensive menu of investment options. According to the Seventh Circuit, ERISA does not require a fiduciary to scour to the market to find and offer the cheapest possible funds. By extension, the existence of a cheaper fund does not mean that a particular fund is too expensive “in the market generally” or that it is otherwise an imprudent choice.

Moreover, the Seventh Circuit has stressed that, because the prudence standard is process-based, the mere underperformance of a plan’s investment options is not actionable, as long as the plan’s fiduciaries have acted prudently. Accordingly, the Seventh Circuit has rejected ERISA complaints suggesting that high fees and underperforming funds were sufficient to state a claim for fiduciary breach, where the plan offered some cheaper investment alternatives, and the complaint did not allege flawed decision-making or self-dealing.

Applying the governing precedents in the Seventh Circuit, the trial court agreed that the participant had not adequately pleaded a breach of the duty of prudence. Initially, the court noted that the fees at issue were essentially the same as those approved by the Divane court. In addition, the fees were viewed as consistent with prudent portfolio management, especially where the revenue sharing was used to hold down mandatory per capita costs.

Second, the court again relying on Divane, explained that the plan’s failure to invest in institutional funds did not give rise to an inference of a lack of prudence where the plan also offered a mix of investment options, including cheaper alternative funds. A plan, the court stressed is not required to offer only index funds but may also offer more expensive funds as long as the fiduciary’s overall performance is not deficient.

The court further stressed that the fact that some of the funds underperformed their cheaper counterparts did not establish an imprudent process. Nor was the fiduciaries’ failure to offer every index fund “under the sun” imprudent, where the plan offered a mix of investments (with expense ratios within the acceptable range of 0.04% to 1.06%) and there were no other indicia of a flawed process. Citing Divane one more time, the court concluded that it would be beyond its role to “seize ERISA for purpose of guaranteeing individual litigants their own preferred investment options.”

Source: Martin v. CareerBuilder, LLC (DC IL).

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