Pension & Benefits News Fidelity avoids liability as fiduciary for imposing revenue sharing fees on funds on investment platform
Wednesday, May 27, 2020

Fidelity avoids liability as fiduciary for imposing revenue sharing fees on funds on investment platform

By Pension and Benefits Editorial Staff

Fidelity’s imposition of “infrastructure fees” on mutual funds included on its investment platform did not constitute control over factors determinative of its compensation from ERISA plans sufficient to create fiduciary status, according to a federal trial court in Massachusetts. The fees were passed on by the mutual funds to plan participants as investment fees. However, Fidelity negotiated the fees with the funds, and not with the plans, and the funds were not required to pass the costs on to the plans or the participants.

Fidelity Investment platform. Fidelity contracts with 401(k) plans to provide an investment platform consisting of thousands of mutual funds and other investment vehicles (FundsNetwork). Plan trustees and participants choose the mutual funds in which their contributions and any matching contributions are invested. However, Fidelity is empowered with complete discretion to substitute, eliminate and add mutual funds offered through its FundsNetwork, without providing notice to the plans or plan participants.

In January 2017, Fidelity began assessing “infrastructure fees” (i.e., revenue sharing) to mutual funds on its FundsNetwork. The fees were negotiated with the mutual fund managers and were based on the assets of the plans invested in the mutual funds. The mutual funds, in turn, passed on the additional costs of the infrastructure fees to the plan through higher investment fees, thereby subjecting the plans and plan participants to greater costs (via higher expense ratios) than they initially agreed to pay in the service contracts with Fidelity. The fees also increased exponentially, tripling during the January 1, 2017—January 1, 2019 period.

Fidelity also maintained “Omnibus Accounts,” which held plan assets and through which Fidelity processed all trades and maintained all investment positions of the plan in their respective mutual funds. Fidelity used the Omnibus Accounts as leverage in negotiating infrastructure fees with mutual fund managers looking to be included on the FundsNetwork.

Participants in several plans in contractual arrangements with Fidelity brought a class action suit, alleging that Fidelity was a fiduciary and breached its duties under ERISA by imposing the infrastructure fees. Fidelity filed a 12(b)(6) motion to dismiss, primarily challenging its alleged status as a fiduciary. The trial court agreed that Fidelity was not acting as a fiduciary and dismissed the case.

Fiduciary power to set own compensation. Initially, the court explained that a service provider that retains discretion to set its own compensation from an ERISA plan can be subject to ERISA liability as a fiduciary. However, service providers are not considered fiduciaries when they are negotiating the terms of their compensation with plans. By contrast, an entity may, after entering into an agreement with a plan, retain sufficient control over factors that determine its compensation to render it a fiduciary with respect to that compensation. Thus, the threshold issue in the case, as framed by the court, was whether the plan participants had plausibly alleged that Fidelity had sufficient control over the factors that determined its compensation from the plans (and not from the funds) to make it a fiduciary.

Did Fidelity control compensation by imposing infrastructure fees? The participants argued that Fidelity was an ERISA fiduciary because it exercised its discretion in negotiating and establishing its own compensation through its setting of the amount and receipt of the “secret” infrastructure fee payments. The participants stressed that the fees were negotiated after Fidelity entered into service contracts with the plans and the unexpected fees were passed on to the plans and plan participants in the form of investment management fees, transaction fees, distribution fees, commissions, sub-transfer agency fees, marketing fees, and 12b-1 fees.

In dismissing the argument, the court stressed that Fidelity negotiated the payment of the infrastructure fees with the mutual funds and not with the plans. In addition, the court noted that the mutual funds were not required by Fidelity to pass on the cost of the fees to the plan or plan participants. Thus, the court concluded, Fidelity did not unilaterally control the terms of the compensation it received from the plans. Absent such control, Fidelity was not a fiduciary with respect to the compensation it received from the plan.

Use of Omnibus Accounts. The participants next argued that Fidelity acted as a fiduciary in its use of the Omnibus Accounts. However, the court noted that the participants did not allege that Fidelity, as a directed trustee, failed to follow instructions from plan sponsors and participants as to the mutual funds selected for investment or the allocation of the investments. Nor did the participants charge that Fidelity improperly redirected the investments of plan participants through the Omnibus Accounts from mutual funds managed by companies that did not pay infrastructure fees to mutual funds managed by companies that did pay the fees. Thus, Fidelity, as a directed trustee, lacked the power to force plans or participants to accept its choices regarding plan management or assets, that would have made it a fiduciary.

Control of investment options on FundsNetwork. Finally, the participants contended that Fidelity was a plan fiduciary because it controlled the menu of investment options available to the plans. The court, however, dismissed the participants’ theory, noting that plan sponsors, and not Fidelity, selected the investment options made available to plan participants from the FundsNetwork. Fidelity functioned solely as a directed trustee, the court stressed, and did not provide investment advice to any parties with respect to the selection of options.

Fidelity did select the funds that were available on the FundsNetwork platform. However, the court, relying on established precedent, explained that control over the broad menu of investment options from which plan sponsors may choose their plan’s investment options does not transform a platform provider into a functional fiduciary.

The court conceded that Fidelity had the discretion to remove or substitute any investment option, after those options had been chosen by the plan sponsors or plan participants, in order to comply with changes in the law or to update services and procedures. However, this authority, which could be exercised only after the provision of prior written notice, did not, the court ruled, constitute discretionary power to alter the specific investment options available to the plan participants.

Source: In re Fidelity ERISA Fee Litigation, (DC Mass).

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