In recent years, a number of lawsuits have been brought accusing 401(k) plan service providers of improperly receiving "revenue sharing" payments from the expense ratios of the mutual funds in which the plan's assets are inveswted. The Leimkuehler v. Am. United Life Ins. Co. opinion from the U.S. Court of Appeals for the 7th Circuit addresses a threshold issue in such cases - whether financial service providers are fiduciaries under ERISA for purposes of negotiating or receiving revenue sharing payments.
Leimkuehler, Inc. is a small company that manufactures prosthetic limbs and sponsors a 401(k) plan for its employees. American United Life is an insurance company that provided the plan's investment options through a group variable annuity contract. Plan contributions were first deposited in an AUL separate account (as required for an insurance company receiving retirement assets) and then invested in various mutual funds as directed by the participants.
Had the participants invested directly in the mutual funds, the funds would have been required to keep track of each individual participant's investments. However, AUL aggregated the investments, thus keeping for itself the responsibility of tracking the participants' individual investments and communicating with participants. Because the mutual funds did not have to undertake this administrative responsibility, they were willing to "share" with AUL a portion of the fees they received as part of the fund's expense ratio.
AUL created a "menu" of 383 different funds that it presented to Leimkuehler, which then selected the specific funds to be made available for investment through the plan. Leimkuehler retained the right to change its selections. However, AUL also reserved the right to make substitutions or deletions, which it did on two occasions.
Leimkuehler's lawsuit alleged that AUL breached fiduciary duties under ERISA by receiving revenue sharing payments from the mutual funds. AUL denied that it was a fiduciary at all, and so the threshold issue was whether AUL fit ERISA's definition of a fiduciary. Because AUL was not a specifically named fiduciary, it could have fiduciary status only if it qualified as a functional fiduciary.
ERISA specifies that a person is a fiduciary "to the extent" he exercises any "discretionary" authority or control over plan management "or exercises any authority or control respecting management or disposition of its assets." The plaintiff advanced two arguments that AUL met this test, and the Department of Labor advanced a third.
First, the plaintiff argued that AUL exercised authority or control over the management or disposition of the plan's assets by selecting which mutual fund share classes to include in its investment menu. The court characterized this as a "product design" theory and found that the argument was foreclosed by its 2009 decision in Hecker v. Deere & Co. In Hecker, the plan had offered a large list of available mutual funds, and the court found that assembling the list of available options was not a fiduciary act.
The Leimkuehler court recognized that Hecker was different in that the plan sponsor there had apparently retained the final say over which funds would ultimately be included. However, this difference was not sufficient to truly distinguish Hecker because AUL had never exercised its contractual right to change funds in a way that gave rise to a claim.
Second, the plaintiff argued that AUL exercised authority or control over plan assets by maintaining the separate account, which required tracking individual investments and other administrative tasks. Although maintenance of the separate account was largely ministerial, the plaintiff argued that that no discretion is required under the statute when a person has "any authority or control" over plan assets. The court agreed with this position and clarified its prior authority, which suggested discretion is always a prerequisite to fiduciary status.
However, the court also observed that a person is a fiduciary only "to the extent" it exercises authority or control over plan assets. Because the plaintiff was not alleging any mismanagement of the separate account, AUL's authority or control over the separate account was not sufficient to render it a fiduciary for purposes of selecting the funds offered to the plan administrator.
Finally, the DOL argued that AUL was a fiduciary because it had authority to delete or substitute funds on the menu. However, the DOL conceded that AUL could be a fiduciary only "to the extent" it exercised that contractual right, and neither of the two occasions on which AUL did exercise that right gave rise to a claim.
The DOL argued that AUL exercised its contractual right by not exercising it every time it invested plan assets in a fund that was more expensive than another fund that it could have chosen. The court rejected this "nonexercise" theory of exercise as unworkable and unprecedented. Instead it found that an omission was insufficient to satisfy the requirement that the individual exercise authority or control over plan assets.
Leimkuehler is a significant development for this type of litigation, but is unlikely to be the last word. Although Leimkuehler was brought by the plan's trustee, many such cases are brought by participants against the employer, plan administrator and service providers. Thus, the entities who made the final decisions over which investments to include are defendants, and at least some of them are likely to be fiduciaries. Nevertheless, Leimkuehler is an important new precedent in this area, and its analysis of fiduciary status will be influential in a wide range of situations where financial services providers have some control over plan assets, but are not exercising discretion in negotiating or receiving their fees.
Patrick DiCarlo specializes in employee benefit law at Alston & Bird. He can be reached at firstname.lastname@example.org.
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