Recently, in a class action lawsuit over 401(k) fees, a federal court ruled that a manufacturing company and individual members of its employee benefits committee breached their ERISA fiduciary duties for failing to evaluate recordkeeping fees, including "revenue-sharing" payments¹  made to an affiliate of the plan's trustee, and use of "float" income²  by the trustee.

Revenue-Sharing  Payments

The company sponsored two 401(k) plans. All investment options offered by the two plans made revenue-sharing payments to an affiliate of the plan's trustee.

The court held that the company and the committee members breached their fiduciary duties by:

• failing to calculate the actual dollar amount of the recordkeeping fees the plan paid  through the revenue-sharing arrangements;
• failing to consider how the plan's size could be used to reduce the recordkeeping costs;
• failing to obtain a benchmark cost analysis of the services prior to choosing revenue sharing; and
• ignoring the advice of  an outside consulting firm who told the company that the recordkeeping fees were too high and they were subsidizing other services provided to the company by the trustee and its affiliates.

For their failure to make any meaningful effort to review the revenue sharing payments, the court found the defendants liable for $13.4 million in losses suffered by the plans.

The court also found the defendants liable for another $21.8 million in losses suffered by the plan after assets had been transferred from an actively balanced mutual fund to the trustee's target-date fund. The court found that the company and the committee members had replaced the actively balanced mutual fund not because of performance concerns, but because the trustee's target-date fund generated more revenue sharing. 

In its ruling, the court acknowledged that ERISA fiduciaries may use revenue-sharing to pay for administrative fees rather than paying with a "hard dollar" per-participant fee.  However, the court said that if a fiduciary uses revenue-sharing to pay administrative fees, the fiduciary must go through a deliberative process to determine whether this is in the best interests of plan.

Float Income

The court also found "improper" use of float income by the trustee. In its ruling, the court emphasized that the trustee had not disclosed to the company or the committee members how float income would be used. In fact, the court found that the trust agreement specified that the trustee would be paid solely through revenue sharing. Therefore, when the trustee used float income for the benefit of investment companies and to pay its own bank expenses, the court concluded that the trustee had breached its fiduciary duty by earning more income than it was entitled to under the trust agreement. For its improper use of float income, the court found the trustee liable for $1.7 million in losses suffered by the plans.

While the court let the company and the committee members off the hook due to an apparent lack of disclosure on the part of the trustee, this appears to be a fairly unusual situation.  In our experience, most financial service agreements specifically provide that service providers are entitled to keep float income attributable to plan assets. Therefore, plan sponsors should carefully review the use of float income the same way they review the use of revenue-sharing and other plan assets to pay administrative expenses.  

Comments

This case highlights the importance of knowing where plan money is coming from and where it is going. Plan administrators and other fiduciaries should:

• Investigate the financial arrangements between investment advisors and investment companies, especially revenue-sharing arrangements.
• Review the actual dollar amount paid via revenue-sharing arrangements to determine if such arrangements are a fair and reasonable way to pay administration expenses, especially with respect to the selection of a qualified default investment alternative (QDIA).
• Consider obtaining an independent third-party benchmark analysis and report choosing revenue sharing as a plan's method of paying for administrative services.
• Review the actual dollar amount involved when service providers retain the right to keep float income attributable to plan assets.

The Department of Labor's fee disclosure regulations, effective July 1, 2012, should assist fiduciaries in reviewing revenue sharing and other compensation arrangements. The final regulations require covered service providers to disclose fees and other compensation and to furnish, upon written request by a plan administrator, all related information that the fiduciaries need in order to evaluate the compensation arrangements, including detailed information regarding a service provider's revenue-sharing arrangements.  Plan administrators now have a powerful tool to demand this detailed disclosure from their service providers, and in light of the above case, have a fiduciary duty to use it.

_{1  Revenue-sharing payments are fees paid by mutual fund companies to brokers and investment advisors for selling the mutal funds to clients.}

_{2 Float, in this situation, is the time delay from when money is deducted from the plan's account until the money is actually sent to the payee's account. Float income is the value of the use of the money in the meantime.}