The U.S. Court of Appeals for the Third Circuit recently issued an important decision in one of the many cases alleging that financial services companies breached fiduciary duties under the Employee Retirement Income Security Act by charging allegedly excessive fees.
This type of litigation has grown more prevalent in recent years. However, most appellate courts, including now the Third Circuit, have found these claims unmeritorious.
In Santomenno v. John Hancock Life Insurance Company, the plaintiffs argued that, as a service provider to their 401(k) plan, John Hancock had fiduciary status and that John Hancock breached its fiduciary duties by charging excessive fees. John Hancock offered a group annuity contract, which allowed participants to select investment options from a menu of options, as is common in 401(k) plans. John Hancock selected a big menu of mutual funds, including many of its own funds. However, the plan sponsor was responsible for selecting from the big menu and small menu of funds that would actually be available to the participants.
In connection with this service, John Hancock also offered a Fiduciary Standards Warranty, pursuant to which it promised that if the sponsor selected at least 19 John Hancock funds, then it warranted that the investment options the plan fiduciary selected to offer participant would satisfy ERISAs prudence requirements. John Hancock also periodically monitored the funds on the big menu, make replacements as appropriate and provide evaluations to plan trustees. It also pooled plan assets prior to executing individual participant elections.
The plaintiffs argued that these functions made John Hancock a fiduciary, and thus they should be permitted to move forward with their allegations that the fees John Hancock charged were excessive. The United States District Court for the District of New Jersey dismissed the complaint on the grounds that it did not sufficiently allege that John Hancock was an ERISA fiduciary with respect to any misconduct alleged in the complaint. The Department of Labor submitted an amicus brief in support of plaintiffs position.
The Court of Appeals began its analysis by noting that the threshold question was not whether John Hancock was a fiduciary at all, but rather whether it was acting as a fiduciary (that is, performing a fiduciary function) when taking the action subject to complaint. The plaintiffs specific theories were that the fees were excessive because they were duplicative, and some fees purportedly for other service providers were really revenue for John Hancock. The Third Circuit focused on whether John Hancock was a fiduciary for either of these allegations.
The Third Circuit found that a service provider owes no fiduciary duty to a plan with respect to the terms of its service agreement if the plan trustee exercised final authority in deciding whether to accept or reject those terms. The court also rejected the argument that John Hancock had fiduciary discretion to set its own compensation by including its own funds in the big menu because the plan trustees still exercised final authority over what funds would be included on the small menu. Nor was the court persuaded by the argument that monitoring the funds on the big menu was a fiduciary function related to the plaintiffs fee claims because, again, the trustees retained ultimate authority for selecting funds to be included in the small menu. With respect to the argument that John Hancock could change the fees it charged through its own funds, the court found this contention insufficient to confer fiduciary status on John Hancock because it was not sufficiently related to the plaintiffs actual fee claims and it could change fees only after notice to the trustees, who could terminate the contract without penalty.
Next, the plaintiffs argued that the charging of excessive fees was related to John Hancocks alleged provision of investment advice for a fee. However, the court noted that the DOL regulation defining investment advice for purposes of ERISA required an agreement that the advice provided would serve as a primary basis for the plans investment decisions. According to the court, the plaintiffs allegations were insufficient to satisfy this standard as the agreement expressly disclaimed fiduciary status. The plaintiffs also argued that the regulation was no longer valid because the DOL had proposed a less restrictive replacement. However, the DOL did not join in this argument, and the court found the regulation was valid until actually replaced.
The Santomenno decision is quite significant because it demonstrates the application of limited fiduciary capacity in the context of service provider fee structures. Of course, the opinion does not immunize service providers from fee claims if there is a sufficient nexus between the fee allegations and the scope of the service providers fiduciary duties. However, to state a successful claim, plaintiffs will likely need to show that the service provider had fiduciary control over the amount of its own fees. The opinion also does not address the potential liability of employers who sponsor retirement plans and allegedly authorize the payment of excessive fees from plan assets. However, with Santomenno, the Third Circuit joins the Seventh Circuit in creating a high bar for claims that service providers have fiduciary liability under ERISA as a result of the fees they charge.
Patrick DiCarlo is counsel at Alston & Bird, where he assists ERISA plan sponsors and fiduciaries on regulatory compliance issues, and litigating disputes.
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