Congress: The DOL’s “Conflict of Interest” Rule is Good for American Business

Summary. 

• American corporations, large and small, including business owners, would receive substantial protection from potential liability, as a result of the DOL's proposed Conflicts of Interest Rule. 

• Rather than being hung "out to dry" by their "retirement plan consultants" who largely escape liability for recommendations made to plan sponsors, corporations would be able to hold retirement plan consultants accountable for their recommendations.

• Several recent cases illustrate that American business often suffers, while Wall Street firms and insurance companies escape liability.

• The DOL's rule to remove conflicts of interest, when providing advice to business owners on establishing and maintaining retirement plans, provides important protection for American business. American business, including the U.S. Chamber of Commerce, should support the interests of plan sponsors by supporting the DOL's Conflict of Interest rule.

Introduction.

Congress primarily intended ERISA to be a consumer protection bill. Frank Cummings, ERISA: The Reasonable Expec-tation Bill, 65 Tax Notes 880, 881 (1994). Congress desired employees to have "enhanced protection for their benefits." Metro Life Ins. Co. v. Glenn, 554 U.S. 105, 114, 128 S. Ct. 2343, 171 L. Ed. 2d 299 (2008) (citing Varity Corp. v. Howe, 516 U.S. 489, 497, 116 S. Ct. 1065, 134 L. Ed. 2d 130 (1996)).

To accomplish these goals Congress makes an ERISA fiduciary liable for failing to comply with the strict trust standards codified by ERISA. However, due to a regulation adopted by the U.S. Department of Labor shortly after the enactment of ERISA, and before the beginning of 401(k) plans, many of the insurance companies and broker-dealer firms who currently provide advice to companies (employers, or plan sponsors) escape liability for their recommendations, as they are not found to be “fiduciaries” under the overly permissive language of the 1975 regulation, as interpreted by the courts.

Disputes over defined contribution plan fees and expenses are a common form of recent litigation and raise both duty of disclosure and duty of prudence issues. Fiduciaries have an obligation to administer plan duties with reasonable fees and must attempt to defray unnecessary fees as a part of their prudence obligation. The essence of fee litigation cases is that "the [plan] fiduciaries had an obligation to avoid higher than necessary fees in the mutual fund options offered in a plan menu, and failed to do so." See Stephen D. Rosenberg, Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees After Tibble v. Edison International, J. Pension Benefits, Spring 2011, at 12, 13.

Higher fees and costs associated with investment products result, on average, and pervasively, lower returns for investors in those products. It's that simple. And the academic evidence on this is clear. (For a review of recent academic research on this issue, see my comment letter to the DOL, July 2015.)

In excessive fee litigation, employers are often “on the hook” for claims arising for breach of fiduciary obligations, such as choosing mutual funds and other investment options that possess excessive fees. Yet, the insurance companies and broker-dealer firms, even when they provide “fiduciary warranties” to the employers, largely escape liability in such instances. In essence, employers (plan sponsors) are held liable for following the advice provided to them by insurance companies and broker-dealer firms, yet these firms are not held accountable for such advice. Employers suffer the consequences for the advice provided to them by insurance companies and broker-dealer firms, while these insurance and brokerage firms are “off the hook” through their use of clever disclaimers and other techniques in which they ensure that the courts will not find them to act as "fiduciaries."

To correct this unfair treatment, in which plan participants are harmed, employers (plan sponsors) are often liable, but the real experts (financial services firms) escape liability, the U.S. Department of Labor has proposed to greatly expand the definition of “fiduciary” with its new “Conflict of Interest” proposed regulation. However, Wall Street and the insurance companies are currently spending tens (if not hundreds) of millions of dollars to attempt to stop the U.S. Department of Labor’s proposal to revise its outdated rules. In essence, these financial services firms do not want to be held to account for the advice they provide.

Instead, Wall Street and the insurance companies now propose a new “best interests” standard that, upon closer examination, imposes no new significant duties upon them. While casual disclosure of conflicts of interest (such as “our interests may not be the same as yours”) might be required under this new “best interests” standard, the amount and quality of the disclosures are highly suspect. Even if the disclosures were of sufficient detail, disclosures pose significant problems in their application and effectiveness. While requiring increased disclosures may be a politically expedient solution, they do not provide significant protections for either U.S. business owners nor participants in employer-provided defined contribution plans, such as 401(k) plans.

This memorandum discusses three recent cases in which financial services companies have escaped liability for their advice to plan sponsors. As a result of these and many other cases, the U.S. Department of Labor’s “Conflict of Interest” rule is sorely needed. Otherwise, employers will continue to be misled by many financial services firms into reliance upon their recommendations, and will incur liability, even as those insurance companies and broker-dealer firms usually escape liability for the advice they have provided.

Santomenno v. John Hancock, 768 F.3d 284; 2014 U.S. App. LEXIS 18437; 58 Employee Benefits Cas. (BNA) 2845 (September 26, 2014).

This recent case illustrates how investment providers, such as insurance companies and broker-dealers, who provide advice on investment options to plan sponsors and plan trustees, can escape fiduciary status under current the DOL regulation by inserting provisions in contracts in which they disclaim fiduciary status. Despite the insurance company’s “Fiduciary Standards Warranty” in which the insurance company “warrants and covenants that the investment options” the employer/plan sponsor offers to employees “[w]ill satisfy the prudence requirement of … ERISA,” the courts continue to refuse to hold the insurance companies and broker-dealer firms to account for such representations.

J&H Berge, Inc. (“Berge”), the employer and “plan sponsor” of a 401(k) plan, entered into a group annuity contract with John Hancock under which John Hancock, assembled for the 401(k) a variety of investment options. From these investment options, the trustees of the 401(k) plan chose which investment options to offer to plan participants. The plan participants (employees) could then select from the more limited menu of options where to invest their funds.

As part of its agreement with the Plans, John Hancock offered a product feature called the Fiduciary Standards Warranty ("FSW"). Plan trustees received this feature if they selected for their Small Menus at least nineteen funds offered by John Hancock, rather than independent funds. Under the FSW, John Hancock "warrants and covenants that the investment options Plan fiduciaries select to offer to Plan participants: Will satisfy the prudence requirement of . . . ERISA." However, In the FSW, John Hancock stated that it was "not a fiduciary," and that the FSW "does not guarantee that any particular Investment option is suited to the needs of any individual plan participant and, thus, does not cover any claims by any Individual participant based on the needs of, or suitability for, such participant."

When the plan participants (employees) sued John Hancock alleging that John Hancock rendered investment advice to the plans for a fee, and that it charged excessive fees by selecting its own funds and funds of other companies that had high fees, John Hancock’s moved to dismiss the complaint on the basis that it was not a fiduciary under ERISA, and hence owed no duties of care, loyalty and utmost good faith to the plan participants (employees).

ERISA provides that a person is a fiduciary to a plan if the plan identifies them as such. See 29 U.S.C. ß 1102(a). It also provides that:

[A] person is a fiduciary with respect to a plan to the extent

(i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,

(ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or

(iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 1105(c)(1)(B) of this title.

29 U.S.C. ß 1002(21)(A).

On appeal from the trial court’s grant of John Hancock’s Motion to Dismiss, the appellate court held that John Hancock’s fund selections – including funds with high expense ratios – were mere "product design" features do not give rise to a fiduciary duty, in and of themselves. Additionally, the appellate court, while acknowledging that the U.S. Department of Labor (DOL) had re-proposed a new definition of “fiduciary,” held that the current DOL regulation remained binding. Under the existing regulation, adopted in 1975 and even before 401(k) plans came into existence, a five-factor test exists for determining whether an entity has rendered "investment advice" for purposes of ERISA fiduciary status. An entity is an investment advice fiduciary if it: [1] [R]ender[ed] advice to the plan as to the value of securities or other property, or makes recommendation as to the advisability of investing in, purchasing, or selling securities or other property . . . [2] on a regular basis . . . [3] pursuant to a mutual agreement, arrangement or understanding, written or otherwise, between such person and the plan or a fiduciary with respect to the plan, [4] that such services will serve as a primary basis for investment decisions with respect to plan assets, and [5] that such person will render individualized investment advice to the plan based on the particular needs of the plan. 29 C.F.R. ò 2510.3-21(c)(1). "All five factors are necessary to support a finding of fiduciary status." Thomas, Head & Griesen Emps. Trust v. Buster, 24 F.3d 1114, 1117 (9th Cir. 1994).

While noting the arguments of the employees that the existing DOL regulation “engrafts additional requirements for establishing fiduciary status under 29 U.S.C. ß 1002(21)(A)(ii) that narrow the plain language of this subsection,” the appellate court held that John Hancock was not an investment adviser to the plan, as any advice rendered as to the selection of mutual funds was not “pursuant to a mutual agreement, arrangement or understanding.” Because John Hancock expressly disclaimed taking on any fiduciary relationship, there was no “mutual assent” by John Hancock.

ERISA precludes fiduciaries from contracting away their responsibilities. See 29 U.S.C. ß 1110(a) ("[A]ny provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.") But the appellate court that this provision of ERISA did not prevent John Hancock from disclaiming, in the contract, the existence of fiduciary status.

McCaffree Financial Corp. v. Principal Life Ins. Company, 65 F. Supp. 3d 653; 2014 U.S. Dist. LEXIS 172626; 59 Employee Benefits Cas. (BNA) 2233 (December 10, 2014).

This recent court decision illustrates how employers acting as plan sponsors, who are fiduciaries under ERISA, cannot hold to account many of the insurance companies and broker-dealer firms. Despite the fact that employers are lured into such reliance by representations that the insurance companies and broker-dealer firms “undertake a rigorous due diligence process” in selecting investments and that the investment options offered are “designed to be appropriate for” 401(k) plans, these providers of investment advice continue to escape liability for their recommendations.

McCaffree Financial Corp. (McCaffree) sponsored a 401(k) plan for its employees. McCaffree entered into a group annuity contract with Principal Life Insurance Company (“Principal”) under which Principal offered investment options for the participants of the 401(k) plan and provided other services for the plan. The life insurance company offered a number of “separate accounts” – against which are charged “management fees” and “operating expenses.” For participants in McCaffree’s 401(k) plan, Principal selected and offered 29 separate account options. Each of these separate accounts corresponds with a Principal mutual fund that was otherwise available to retail and institutional investors. For the for the separate accounts fees were layered on top of the fees charged by the Principal mutual funds in which the separate accounts exclusively invest, thereby enabling Principal to reap substantial fees on top of the fees charged by its own mutual funds.

In particular, the Separate Investment Account Rider which formed part of the group annuity contract disclosed that each separate account could be subject to a Management Fee of up to 3% plus another fee on the underlying mutual fund. And Rider disclosed that, on top of the other two fees, each separate account is assessed an Operating Expense charge "which must be paid in order to operate a Separate Account."

Principal’s website stated in part: “The Principal understands the fiduciary responsibilities plan sponsors face in developing and monitoring an investment lineup appropriate to help meet the diverse needs of retirement plan participants. We undertake a rigorous due diligence process as a direct response to this challenge, resulting in a key differentiator -- our Sub-Advised Investment Options.”

Principal also stated in its materials that its Sub-Advised Investment Options are "designed to be appropriate for retirement savings under employer-sponsored plans" and that it has "fiduciary oversight and the ability to oversee the investment manager selection and ongoing monitoring process."

McCaffree filed a class action lawsuit against Principal, alleging that Principal violated ERISA by charging grossly excessive investment management and other fees to the participants in the McCaffree 401(k) plan and to participants in other defined-contribution retirement plans subject to ERISA. McCaffree contended that this conduct violated ERISA's duties of loyalty and prudence and involves self-dealing transactions prohibited by ERISA. In response, Principal contended that “a service provider neither acts as a fiduciary nor breaches any duty when it charges fees that are approved by a plan fiduciary--here, [McCaffree].”

The trial court rejected McCaffree’s arguments that Principal was a fiduciary under ERISA, even though Principal selected the separate accounts that will be available to plan participants. The trial court held that there was no nexus between the selection of the accounts and/or the ability to change the investment options and the excessive fees. Even though the selection of the accounts affected the fees charged to plan participants. The trial court also held that Principal was not a fiduciary as an “investment advisor” under ERISA, for if excessive fees were charged they bore no relation to the investment advice provided.

Tussey vs. ABB, Inc., Case No. 2:06-CV-04305-NKL, United States District Court for the Western District Of Missouri, Central Division, 2012 U.S. Dist. LEXIS 45240; 52 Employee Benefits Cas. (BNA) 2826 (March 31, 2012)

This case illustrates that, even when a financial services provider provides investment recommendations that result in greater income to it, and even when the new investments underperform the replaced investments, the financial services provider can still be “off the hook” – as it is not a fiduciary with respect to the investment decisions undertaken.

This case is relatively famous as a result of a later appellate decision, in which the U.S. Eighth Circuit Court of Appeals addressed the intersection between “float” income and plan assets and held that Fidelity did not breach any fiduciary duties by retaining float income. Additionally, the Eighth Circuit upheld a $13.4 million judgment against ABB (the employer), holding that “ABB used revenue sharing to benefit ABB and Fidelity at the Plan’s expense.”

Subsequently, in July 2015, the trial court, in spite of concluding that ABB was acting in breach of ERISA’s self-dealing prohibitions, held that the employees “failed to satisfy their burden of proof on the issue of damages” with respect to the choice of investments claim. This is despite the trial court’s conclusion that, “as a result of the mapping of the assets of the Wellington Fund into the [Fidelity] Freedom Funds, the [401(k) plan] sustained a loss because the Wellington Fund consistently outperformed the Freedom Funds after the mapping occurred until the six year statute of limitation ran.”

But, prior to the appellate case and the subsequent trial court proceedings, arguments in the original court case were made as to whether Fidelity was liable in connection with the investment advice it provided to ABB (and to ABB’s Pension Review Committee).

ABB, Inc. (“ABB”) offered a 401(k) plan to its employees. The Pension Review Committee of ABB was the named fiduciary of the Plan and is responsible for selecting and monitoring the Plan's investment options. The Plan included mutual funds offered by Fidelity Investments. A Fidelity Investments affiliated company, Fidelity Research, served as the investment adviser to the Fidelity mutual funds which were offered by the 401(k) Plan and invested the balances of bank accounts, which held plan contributions in overnight securities. Another affiliated company, Fidelity Trust, served as the record keeper for the 401(k) plan and, as such, provided educational information, bookkeeping, and other services to the plan participants.

In 2000, Fidelity proposed a substantial reduction in its recordkeeping fees if the assets in the Wellington Fund were mapped, or transferred to Fidelity’s Freedom Funds. At the time, the Wellington Fund, an actively managed balanced mutual fund invested in both stocks and bonds, had a 70-year track record and an annual performance exceeding Morningstar’s benchmark by 4 percent, according to the ruling. In 2000, Fidelity’s three Freedom Funds had been in existence for less than five years. Fees for the Wellington fund were lower than fees for the Freedom Funds, and the Wellington Fund contributed less in revenue sharing fees to Fidelity than the Freedom Funds.

The Amended Complaint noted that the 401(k) plan included approximately sixteen (16) retail mutual funds as investment options in 2005 as well as ABB stock and five (5) custom blended funds charging above average fees. The Amended Complaint also noted that In the financial and investments industry, a large institutional investor with billions of dollars, like the 401(k) plan, routinely can obtain lower prices for investment management and other services than can a retail investor with only thousands, or even a few million, dollars. Yet, the plan participants alleged that the plan sponsor and Fidelity subjected the plan participants “to the high costs of retail/publicly-traded mutual funds and failing to provide investment options with significantly lower costs.”

Fidelity Trust was paid two different ways for its services. Originally, Fidelity Trust was selected by a competitive bid process and was paid a per-participant, hard-dollar fee. But, over time, Fidelity Trust was primarily paid with "revenue sharing." The revenue sharing came from some of the investment companies whose products were selected by ABB to be on the 401(k) platform. Those investment companies gave Fidelity Trust a certain percentage of the income they received from PRISM participants who selected their company's investment option. Fidelity Trust also derived revenue sharing from an internal allocation within the interrelated Fidelity companies. For example, Fidelity's Magellan Fund, was one of the mutual funds placed on the 401(k) platform by ABB. When plan participants invested in Magellan, a set number of basis points (i.e., a percentage) was transferred internally from Fidelity Research, which managed the Magellan Fund, to Fidelity Trust; this was been described by Fidelity and others as internal revenue sharing.

When revenue sharing was used to pay Fidelity Trust, its fee grew as the assets of the Plan that provided revenue sharing grew, even if Fidelity Trust provided no additional services to the Plan. The trial court found that the 401(k) plan overpaid for the recordkeeping services provided by Fidelity Trust, as the revenue sharing generated for Fidelity by the funds in the 401(k) plan assets far exceeded the market value for recordkeeping and other administrative services provided by Fidelity Trust.

In essence, Fidelity (collectively, as to all of its affiliates) was the record keeper of the 401(k) plan and had its investment products in the ABB 401(k) plan. According to the plantiff’s legal counsel, Fidelity was very intimately involved with the plan sponsor, ABB, in making recommendations about investment options. In fact, Fidelity told ABB that any changes had to be “revenue neutral” to Fidelity, even though changes were subsequently made that resulted in greater compensation to Fidelity.

The plan participants alleged that Fidelity Trust and Fidelity Management breached their fiduciary duties to the plan participants by providing investment options whose fees and expenses are excessive and not properly disclosed. The trial court’s order in connection with a Motion to Dismiss noted that “the weighted average expense ratio was high compared to peer plans.”

The plan participants also alleged that Fidelity Trust “plays a central role in the selection of the investment options the Plan makes available to participants,” because Fidelity Trust “does the first-cut screening of investment options, and has veto authority over the inclusion of investment options available in the Plan ” (Am. Compl. ¶¶ 15 -16); (Doc. 110, 4). “The Trust Agreement provides that ABB’s Pension Review Committee may select “only (i) securities issued by the investment companies advised by Fidelity Management & Research Co. . . , (ii) securities issued by the investment companies not advised by Fidelity Management & Research Company” as long as Fidelity Trust approves those elections.” (Fidelity Brief Ex. 1-A, Trust Agreement Between Asea Brown Boveri Inc. and Fidelity Management Trust Company).
However, when sued, Fidelity stated that they were not responsible for any decisions of the company because they (Fidelity) were not a fiduciary. And, after trial and appeal, Fidelity was let off the hook – again.

In Conclusion.

The Committee on Investment of Employee Benefit Assets (CIEBA) has, as its members, the chief investment officers of more than 100 of the Fortune 500 companies who individually manage and administer ERISA-governed corporate retirement  plan assets. In its July 21, 2015 comment letter to the U.S. Department of Labor regarding the DOL's proposed "Conflict of Interest" rule, CIEBA stated: "CIEBA believes that participants deserve thorough, prudent, and unbiased advice from all providers involved in the management of [401(k) plan] assets ... the average 401(k) participant needs safeguards from conflicted advice. Anyone advising participants about their 401(k) assets should be held to the same fiduciary standards as plan sponsors."

I agree. Any firm providing recommendations about which investments to include, or not include, in a 401(k) plans line-up is providing advice. Firms should not escape liability for their recommendations by hiding behind the "suitability doctrine" - which is an inappropriate abrogation of the standard of care to which nearly all other service providers are held.

Since the DOL's regulations were enacted in 1975, defined contribution plans (including 401(k) plans) have arisen and now dominate the retirement plan space. Yet, the regulations failed to keep pace. The result was, over time, the use of these out-dated regulations by insurance companies and broker-dealer firms to escape liability for their investment advice, in most instances.

Employers - American businesses - desire to offer retirement plans for their employees. Not being experts in the complex field of investments, they are often duped by "fiduciary warranties" and "due diligence" recommendations made by insurance companies and broker-dealer firms. Yet, when the s**t hits the fan, only the plan sponsor (employer) is held liable in most instances, and the insurance companies and broker-dealer firms - upon whom they were encouraged to rely - are left off the hook. This is gravely unjust and an inherently unfair result.

It is time to protect American business from these misdeeds. The DOL's proposed Conflict of Interest should be permitted to move forward, toward its final adoption.

Congress, especially the Republicans who have long been advocates for American business interests, should wake up and recognize the substantial harm resulting to both plan sponsors (American corporations) and to retirement plan participants (employees) by the numerous conflicts of interest currently present in much of the financial services industry.


Congress should permit the DOL to proceed with its rules, which will minimize those conflicts of interest. In so doing, American business will be encouraged to offer retirement plans for employees, and American business can hold all providers of investment advice to plan sponsors to account for their recommendations. It is just to do so. It is fair to do so.