The Department of Labor and plaintiffs class action lawyers have been urging the courts to find that 401(k) vendors are fiduciaries when they design investment platforms or have contract provisions permitting them to adjust their fees. This is an important issue in pursuing vendors for “excessive” fees, because under U.S. pension law, fiduciaries may not engage in self-dealing or use discretion to increase their fees. Fiduciaries may also be personally liable for losses resulting from fiduciary breaches.
While there have been some contrary decisions (see, e.g., Mass Mutual Crosses the Line), many courts have been reluctant to extend fiduciary responsibilities and remedies to vendors who simply market plans and recordkeeping services. After a loss at the Seventh Circuit Court of Appeals in Leimkuehler v. American United Life Insurance Company, advocates of fiduciary status suffered another major setback when the Court of Appeals for the Third Circuit recently found in Santomenno v. John Hancock that John Hancock was not a fiduciary under its plan arrangements.
The Hancock Arrangement
Plaintiffs had alleged that John Hancock was a functional fiduciary because it controlled the platform of investments, and the share classes in which plans could invest, and also had the ability to alter the fees it charged for its services. The Santomenno court determined that Hancock’s activities in determining the menu amounted to “product design” and that no connection had been shown between any claimed fiduciary status and excessive fees. In adopting what might be called the “free market” theory of 401(k) plans, the court also said that:
- John Hancock was not an investment adviser when it determined the platform or whether to replace funds in the platform or provided reports to trustees.
- John Hancock did not exercise discretion or control over plan assets when it determined its platform or pooled funds prior to investment allocation. It was up to the plan fiduciaries to select their “small” investment menu from the funds on the platform.
- John Hancock did not exercise discretion and control over plan administration.
- John Hancock did not owe a fiduciary duty to plans in determining the terms of its service agreement “because the plan trustee exercised final authority in deciding whether to accept or reject those terms.”
The “free market” theory espoused by this court and in Leimkuehler will make it much harder to pursue claims against 401(k) vendors. The Third Circuit emphasized that Hancock couldn’t veto menu changes made by the plans, and that plan fiduciaries were free to include non-Hancock funds or to change providers, as there was no termination fee. The result of applying this free market theory is that the responsibility to make sure that plan agreements and fees are reasonable and appropriate lies squarely on the shoulders of plan fiduciaries.
Did the Court Get It Right?
A positive aspect of this decision is that it is important that there be bright lines to warn those who deal with employee benefit plans in advance of their assumption of fiduciary responsibilities under ERISA. If we accept that plan fiduciaries have the negotiating leverage described in the Santomenno opinion, this may well be a correct interpretation of ERISA. Both parties had documents stating that Hancock did not intend to be a fiduciary when acting under these agreements, and ERISA appears to require a greater degree of control or discretion than Hancock had here in order for fiduciary status to attach. While the documents can never be dispositive, service providers should not be ambushed with responsibilities that were not reasonably foreseeable, and this decision avoids doing that.
What About the Little Guy?
However, this decision also does little to help fiduciaries of smaller plans who do not – in the “real world” – have much leverage to negotiate lower fees or different service terms. The reality is that particularly in this small plan market, we find that these documents may be sent by vendors without any indication that the terms are not “take it or leave it”. Small plan fiduciaries may not even realize that the terms are negotiable. Even if they do, as small fish in a big pond, they are much less likely to prevail than fiduciaries of larger plans if they try to get changes made or to find another vendor who will agree to different provisions. While this decision might help small plan fiduciaries if vendors want to demonstrate that their provisions are really negotiable, it may also identify an area where some plans need special protections.
Best Practices in the Free Market
While it is still possible that we will get different decisions by other appellate courts, developing law seems to indicate that typical vendors are not fiduciaries. If the courts are not likely to impose fiduciary responsibilities on vendors, the bottom line for plan fiduciaries is clear: try to negotiate reasonable plan arrangements with expert help if you need it, benchmark your fees and do RFPs if necessary to get the best available deal. Don’t expect the courts to take you off the hook by blaming the vendor if you agree to excessive fees.