Service Provider Managing Stable-Value Fund Was Not a Functional Fiduciary Under ERISA: Tenth Circuit

Practical Law Legal Update w-019-7942 (Approx. 5 pages)

Service Provider Managing Stable-Value Fund Was Not a Functional Fiduciary Under ERISA: Tenth Circuit

by Practical Law Employee Benefits & Executive Compensation

Background

The plaintiff in this case participated in an Internal Revenue Code Section 401(k) plan sponsored by his employer and governed by ERISA. Participants in the plan could choose from 29 investment options selected by the employer, including the stable-value fund giving rise to the parties' dispute. Money invested in the stable-value fund earned interest at a rate set by the service provider on a quarterly basis (the credited interest rate). The service provider kept the margin (the difference between the fund's total yield and the credited interest rate) as revenue. Between 2008 and 2016, the service provider lowered the credited interest rate from 3.55% to 1.10%, but its margin stayed relatively the same. The plan's contract with the service provider prohibited it from concurrently offering alternative low-risk investment products.

Participants could withdraw their principal and accrued interest from the fund without penalty. Additionally, the plan could terminate its contract with the service provider in response to changes to the credited interest rate. If the plan terminated the contract, however, the service provider could impose a 12-month waiting period before returning participant funds to the plan.

The participant sued the service provider under ERISA, alleging the service provider breached its fiduciary duties or, alternatively, was a non-fiduciary party in interest to a prohibited transaction (see Practice Notes, ERISA Fiduciary Duties: Overview, Prohibited Transactions and Exemptions Under ERISA and the Code, and ERISA Litigation: Causes of Action Under ERISA Section 502 and ERISA Litigation Toolkit). He sought declaratory and injunctive relief and "other appropriate relief" including restitution and accounting and disgorgement of profits. After granting class certification, the district court granted summary judgment for the service provider, finding that the service provider:

Was not an ERISA fiduciary.
Was not liable as a non-fiduciary party in interest to a prohibited transaction because there was insufficient evidence that it had actual or constructive knowledge of the circumstances making the transaction prohibited.

Outcome

On appeal, the Tenth Circuit affirmed, concluding that:

The service provider was not a fiduciary.
The participant failed to show that the relief he sought qualified as equitable relief under ERISA.

Service Provider Was Not a Fiduciary Under ERISA

Under ERISA, a party that is not a named fiduciary may become a functional fiduciary for a plan if it exercises control over plan assets (see Practice Note, ERISA Fiduciary Duties: Overview: Functional or Inadvertent Fiduciary). To be held liable, the alleged breach must arise from the functional fiduciary exercising discretionary control over plan assets. Courts consider an employee benefit conract, such as the contract between the service provider and the plan in this case, to be a plan asset.

The participant argued that the service provider was a fiduciary under ERISA because it exercised authority or control over plan assets (the credited interest rate) and, consequently, its compensation. He alleged that the service provider breached its fiduciary duties by:

Setting the credited interest rate for its own benefit.
Setting an artificially low credited interest rate to increase its profits.
Charging excessive fees.
Engaging in a prohibited transaction.

The Tenth Circuit addressed only the threshold question of whether the service provider was an ERISA fiduciary. It explained that to establish a service provider's fiduciary status, an ERISA plaintiff must show that the service provider:

Did not merely follow a specific contractual term set in an arm's length negotiation.
Took a unilateral action regarding plan management or assets without the plan or its participants having an opportunity to reject its decision.

Regarding the first prong, the court agreed that the contract between the plan and the service provider did not set the credited rate or even prescribe a formula for determining the credited rate. Therefore the service provider's status as a functional fiduciary turned on whether the participants could reject a change in the credited rate.

The court agreed with the service provider that participants could reject the credited interest rate by withdrawing their money from the fund. The court also dismissed the participant's argument that the 12-month waiting period and prohibition on the plan offering alternative low-risk investment products impeded participants' ability to leave the fund. According to the court:

The service provider had never exercised its option to impose a waiting period, and the participant failed to show that the possibility of a waiting period had deterred other plans from terminating their contracts with the service provider.
The participant failed to show that the absence of an alternative low-risk investment product deterred participants from leaving the fund.

Given the service provider's lack of discretion or control over the credited interest rate, the court determined that the service provider was not acting as a functional fiduciary under ERISA.

Participant Failed to Show He Sought Equitable Relief Under ERISA

The Tenth Circuit also upheld the district court's decision on the participant's alternative claim that the service provider was a non-fiduciary party in interest that participated in a prohibited transaction. Section 406(a) of ERISA (29 U.S.C. § 1106(a)) prohibits certain transactions between a plan and persons that are parties in interest to the plan, including the transfer to or use by or for the benefit of a party in interest, of any assets of a plan. A plaintiff seeking to recover from a non-fiduciary party in interest must show that "appropriate equitable relief" is available (ERISA § 502(a)(3) (29 U.S.C. § 1132(a)(3)); see Practice Note, ERISA Litigation: Causes of Action Under ERISA Section 502: Claims for Injunctive or Appropriate Equitable Relief). As the Tenth Circuit stated, ERISA Section 502(a)(3) functions as an element of an ERISA claim. If a plaintiff cannot demonstrate that equitable relief is available, a suit against a non-fiduciary cannot proceed.

The Tenth Circuit affirmed the district court but based its decision on the participant's failure to show that the relief he sought was equitable under ERISA Section 502(a)(3). Noting that equitable relief under ERISA requires the plaintiff to show entitlement to a constructive trust on particular property held by the defendant that was used to generate profits (see Practice Note, ERISA Litigation: Causes of Action Under ERISA Section 502: Determining Equitable Relief), the Tenth Circuit held that the participant failed to show that his requests for disgorgement of profits, constructive trust, restitution, and accounting qualified as equitable relief under ERISA because he did not identify the particular property in the service provider's possession that rightfully belonged to him.

Concurrence

One judge wrote a concurring opinion disagreeing with the majority's discussion of the prohibition on the plan offering an alternative low-risk investment product. In the judge's opinion, the participant had no burden to show that the prohibition deterred participants from leaving the fund because the service provider had not moved for summary judgment on that basis. Instead, the concurring judge would have affirmed on the grounds that the plan selected the fund and agreed to its terms.

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