By Pension and Benefits Editorial Staff
A plan fiduciary that was compensated for recordkeeping services from the assets of a plan maintained by its parent corporation could not shield itself from liability by claiming the fees as reasonable compensation, according to the U.S. Court of Appeals in San Francisco (CA-9). The reasonable compensation exemption does not apply to prohibited self-dealing. In addition, the fiduciary could not reduce a damages assessment by additional offsets that were based on unreliable and insufficient evidence.
Self-dealing by plan recordkeeper. City National Corporation (CNC) maintained a 401(k)-employee profit-sharing plan for which it served as the plan’s sponsor, administrator, and fiduciary. City National Bank (CNB), a subsidiary of CNC, provided recordkeeping services and also functioned as a plan trustee and fiduciary.
CNB was compensated for its recordkeeping services through an automated revenue sharing arrangement that allowed it to share in a portion of the mutual fund fees charged to the plans. During the period 2006-2011, CNB served as the recordkeeper for the CNC plan and 200 other ERISA plans. However, CNB did not maintain a system for tracking the time its employees specifically spend serving the CNC plan. As a consequence of the automated payment process and lack of contemporaneous records, CNB lacked proof of the expenses it actually incurred in serving the CNC plan between 2006-2011.
In April 2015, the DOL fielded a complaint, alleging that CNB engaged in prohibited self-dealing under ERISA Sec. 406(b) when it set and approved its own recordkeeping fees and regularly accepted those fees as compensation for its services. After the complaint was filed, a financial expert retained by CNC provided a report (Imburgia Report), indicating that CNB’s compensation never exceeded the direct expenses it incurred in servicing the plan. However, the report relied on estimates of the direct expenses incurred by CNB for a given year for all 200 of the plans it serviced and did not provide specific information regarding the expenses actually incurred in servicing the CNC plan.
A federal trial court issued summary judgment for the DOL as to liability. Following an independent accounting of the CNC plan’s revenue, the court also granted the DOL’s motion for summary judgment on damages. Specifically, the trial court awarded $7,367,382 in damages, based on a gross amount of $8,185,596, minus certain unopposed offsets (e.g., prospectus delivery fees and costs of plan audits for plan years 2006-2010) and previously rebated mutual fund revenue compensated between November 2008 and December 2011. In assessing damages, the trial court disregarded additional offsets sought by CNC for certain expenses (e.g., compensation and third-party administration costs) that CNC could not prove it actually incurred during the relevant time period.
Reasonable compensation not a defense to self-dealing. On appeal, CNC and CNB (collectively “City National) did not contest that it engaged in self-dealing by setting and approving the payment of its own recordkeeping fees from plan assets. However, the fiduciary claimed that its conduct was exempt under ERISA Sec. 408(c)(2) as reasonable compensation for recordkeeping services.
The appeals court rejected City National’s argument, noting that binding precedent in the Ninth Circuit has established that the reasonable compensation exemption does not apply to prohibited self-dealing under ERISA Sec. 406(b) (Barbuzza v. Cal. Ass’n of Prof. Firefighters, CA-9 (2015), 799 F. 3d 1257; Patelco Credit Union v. Sahni (CA-9 (2001), 262 F. 3d 897). Moreover, the court explained, the controlling holdings were not limited to circumstances where the fiduciary received kickbacks and transfers of plan assets to a personal account or otherwise received compensation from illegitimate sources. A plan may pay a fiduciary reasonable compensation for services rendered, but the fiduciary, the court stressed may not engage in self-dealing by paying itself from plan funds.
Additional offsets based on unreliable evidence. City National further contended that the additional offsets (e.g., estimates of employee compensation and third-party administrative expenses) established that the plan never suffered a loss because CNB never received more compensation than was necessary for performing the recordkeeping services. However, the appeals court agreed with the trial court that the additional offsets were based on unreliable and insufficient evidence that did not indicated that the expenses were actually incurred.
A breaching fiduciary, the court further advised, is entitled to offsets only if it can establish that the offsets are for expenses benefitting the plan. However, the court determined that the Imburgia Report was not sufficient evidence of City National’s expenses because it was based on after-the-fact estimates of the allocation of employee compensation across all plans serviced by CNB. As there were no contemporaneous time records or other records reliably documenting the amount of time employees spent serving the plan, the figures in the report were only rough estimates and did not satisfy City National’s burden of proof.
In addition, the appeals court concluded that the trial court properly excluded consideration of certain rebates purportedly paid by City National to the plan, certain third-party administrative expenses, and revenue derived from City National’s own proprietary mutual funds. The offsets, the court reasoned, were either not supported by evidence indicating the expenses were actually incurred (e.g., trust account statements, matching rebates to specific accounts, receipts and account statements documenting custodial fees paid to third-party administrators, or invoices justifying printing and mailing costs), or were incurred outside of the relevant time period.
SOURCE: Acosta v. City National Corp. (CA-9).
Interested in submitting an article?
Submit your information to us today!Learn More