Lessons Learned from Litigation (#4)—The ABB Case

This is the eleventh in a series of articles about Best Practices for Plan Sponsors. To be clear, “best practices” are not the same as legal requirements. Instead, they are about better ways to manage retirement plans. In many cases, though, “best practices” also are good risk management tools because they should exceed legal standards, address areas of concern, or anticipate future developments as retirement plans and expectations evolve.

Plan sponsors should be aware of the latest trends in fiduciary litigation to help manage the risk of being sued and, if sued, the risk of being liable. In my past three plan sponsor posts, Best Practices for Plan Sponsors #8, #9, and #10, I discussed the lessons learned from the conditions in the settlement agreements for the Anthem, Vanderbilt and BB&T cases. This article—about the ABB settlement agreement—is another example of the importance of using appropriate share classes and the  monitoring of compensation of service providers . . . and more.

ABB settled the case for $55 million, a tidy sum. The plaintiffs’ attorneys—the Schlichter law firm–received over $18 million of that amount or about a third of the settlement amount. But, as with the other settlements in this series—and as is typical of the recent settlements with the Schlichter firm, there were non-monetary conditions in the agreement. Those conditions are the “lessons” for plan fiduciaries, (e.g., the plan committee members).

Before discussing those conditions, though, I should point out that this is from a settlement agreement. It’s not a court decision. So the conditions aren’t necessarily what the law requires. And the settlement isn’t an admission of wrongdoing. It’s the resolution of a long-running case.

The first condition is that the fiduciaries must: “use a competitive bidding process, including a request for proposal, to select a new recordkeeper.”

Comment:  This condition should not come as a surprise. It is the plaintiffs’ attorneys way of “forcing” the plan fiduciaries to get new (and possibly) lower cost recordkeeping services. The legal basis is that fiduciaries can only use plan assets to pay reasonable expenses or, in the words of ERISA section 404(a)(1)(A)(ii) “defraying reasonable expenses of administering the plan.”  However, ERISA does not require, or even mention, the use of RFPs (Requests for Proposals). Instead, fiduciaries are required to engage in a prudent process to determine whether the cost of services is reasonable relative to the value received. That necessarily involves market data about services and costs. One way to obtain that data is through an RFP process. Another is through benchmarking data. The law is agnostic as to the source. It only cares that the data have integrity. And, fiduciaries must monitor recordkeeping costs and services at reasonable intervals. While the timing of “reasonable intervals” can vary with the circumstances, it is efficient to perform that process on a scheduled basis, e.g., every year or two. The key is that the fiduciary examination reflects the current circumstances, e.g., changes in market pricing, the size of the plan as it grows, the number of covered participants.

The second condition is that “ABB must monitor the Plans’ recordkeeping costs in accordance with the duties of prudence, loyalty and in accord with Plan documents.”

Comment:  The need to monitor is obvious. Circumstances change and, as a result, pricing changes. A prudent process is one that considers the information that a person who is knowledgeable about recordkeeping services and costs would want. That means that market data needs to be obtained and evaluated by the committee members. But the duty of loyalty is less obvious. In my experience, many committee members don’t realize that their duty of loyalty is directly to the participants. In other words, their loyalty—when wearing their fiduciary hats—is not to the employer or even to the plan. It is to the participants. As explained in section 404(a)(1) of ERISA, “ . . . a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries . . .”. It is a paternalistic or maternalistic rule. The duty of loyalty requires that the committee members put the interests of the participants ahead of their own.

The third condition is:  “If revenue sharing is used to pay for recordkeeping, ABB shall determine the dollar amount the Plans are compensating the recordkeeper, and will leverage the Plans’ size to negotiate for rebates.”

Comment: “Revenue sharing” is a generic term for amounts paid to recordkeepers by third parties (usually the plan’s investments, but also other service providers). Unfortunately, while it may be disclosed, it is not always transparent. The Department of Labor (DOL) refers to it as “indirect compensation”. Regardless of the nomenclature, it is money and it is paid to the recordkeeper. For legal purposes, it is considered to be part of the recordkeeper’s compensation and must be calculated and considered when evaluating the reasonableness of the compensation of the recordkeeper. However, in my experience, some committees don’t regularly consider those payments . . . which is what was alleged in this case.

With regard to the requirement to “negotiate for rebates”, I believe that the parties mean that the amount of revenue sharing and the amounts directly paid to the recordkeeper must be combined and compared to the fair and reasonable compensation of a recordkeeper for a plan of that size and those characteristics. Then, if the total compensation was more than a reasonable amount, the fiduciaries must require that the recordkeeper restore the excess amount to the plan. That could be done, for example, by allocating it to participants’ accounts or by placing it into an expense recapture account to be used for the benefit of the plan.

The fourth condition is that:  “So long as ABB serves as a fiduciary to the Plans, ABB shall not use the Plans’ recordkeeper to provide any corporate services to ABB.”

Comment: The facts of this case—at least on this issue, as alleged in the complaint, were unusual. The complaint alleged that the recordkeeper made so much money from the plans, and therefore from the participants, that the recordkeeper was able to provide other services to the corporation at a discounted price. As you might imagine, the spin on that is that the participants were, in effect, paying for corporate services…not a pretty picture. As a result, the settlement agreement included a prohibition on the corporation using the recordkeeper for any services (other than recordkeeping the plans). The moral of the story is that, if corporations are going to use their plan recordkeepers for corporate services (e.g., payroll services or administration of deferred compensation plans), they should closely scrutinize the pricing of those services to make sure that the costs are not subsidized by the 401(k) or 403(b) participants. The best defense, though, is evidence that the pricing of the plan’s recordkeeping services has been continuously monitored and, as a result, is at or below market. If there isn’t any “fat” in the compensation of the recordkeeper (taking into account direct and indirect compensation), it’s hard to assert that the plan is paying for corporate expenses.

The fifth condition is that:  “For investments on the Plans’ investment platform, ABB shall choose the share class of the investments that has the lowest expense ratio.”

Comment: This is a recurring condition in the settlement agreements discussed in this series of articles. Simply stated, it is that, if a plan can afford a less expensive share class of a mutual fund, it is a waste of the participants’ money to use the more expensive share class. Viewed in that limited way, the argument makes sense. But, of course, it is more complicated than that. For example, in some cases, it may be less expensive to use a higher cost share class and restore the resulting revenue sharing to the accounts of the participants who invest in that mutual fund (which produces a lower “net cost” for those participants). However, fiduciaries should keep in mind that, in at least some cases, the plaintiffs’ attorneys are now arguing that, where a similar collective investment trust is available with the same investment manager, the collective trust, which is even less expensive, should be used. For good risk management, the lesson is that committees, and their advisers, need to look at the range of available options, both qualitatively and quantitatively.

Concluding Thoughts

As with the other settlements in this series of articles, the “lessons learned” are the fiduciaries need to understand the plan costs—for recordkeepers and investments. The fiduciaries, typically committee members, need to know the direct and indirect compensation paid or credited to the recordkeepers and to regularly evaluate the reasonableness of the compensation, using industry data. The competitive marketplace decides what is reasonable. Similarly, the costs of the investments also need to scrutinized, not to make sure that they are cheap, but to ensure that they are reasonable based on what’s available to a plan of that size. While mutual funds are the dominant form of investments in participant-directed plans, the plaintiffs’ attorneys are beginning to take the position that plan fiduciaries need to look at alternatives, if similar quality can be obtained for a lower cost. That would include, for example, collective trusts and separately managed accounts. Advisers play a crucial role in educating plan committees on costs and investments options.