District Court Rules in Favor of Fidelity in Revenue Sharing Fee Litigation

Practical Law Legal Update w-024-1349 (Approx. 6 pages)

District Court Rules in Favor of Fidelity in Revenue Sharing Fee Litigation

by Practical Law Employee Benefits & Executive Compensation

Background

The plaintiffs in this case are individual participants in several 401(k) plans offered by their employers. The defendants include, among other parties, several Fidelity businesses (Fidelity). Fidelity provides access to its FundsNetwork, an investment platform that includes thousands of mutual funds and other investment vehicles offered by asset management companies.

The plaintiffs alleged that in January 2017, Fidelity began charging the mutual fund companies that are a part of the FundsNetwork "infrastructure fees" that are:

Calculated based on the assets of the plans invested in the mutual funds.
Negotiated with mutual fund managers.

The plaintiffs also alleged that Fidelity has tripled the amount of the infrastructure fees charged to mutual funds since January 2017 (specifically, they alleged the fees were doubled in January 2018 and increased by 50% in January 2019). According to the plaintiffs, the mutual fund companies have allegedly passed on the additional costs of the infrastructure fees to the plans through higher investment fees. As a result, the plans and their participants have paid more than they agreed to pay in their service agreements and trust agreements (the contracts) with Fidelity because of the mutual funds' higher expense ratios.

The plaintiffs filed a class action lawsuit in the US District Court for the District of Massachusetts, claiming that Fidelity breached its fiduciary duty to the plans by requiring mutual fund managers on the FundsNetwork to pay infrastructure fees. Specifically, those fees constitute prohibited transactions under ERISA (see Practice Note, Prohibited Transactions and Exemptions Under ERISA and the Code). The plaintiffs sought, among other things, to recover the infrastructure fees Fidelity defendants received from the mutual funds.

Fidelity filed a motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).

Outcome

The plaintiffs offered three theories of how Fidelity acted as a fiduciary of the participants' retirement plans and then breached that duty, each of which the court rejected.

The plaintiffs first argued that Fidelity is an ERISA fiduciary to the retirement plans because it exercises discretion in establishing its own compensation by setting the amount of the infrastructure fees. Furthermore, they argued that Fidelity breached its fiduciary duty by unilaterally increasing the amount of its compensation from the plans after entering into the contracts, by increasing its infrastructure fees, which are passed on to the mutual funds, and ultimately, the plans, in the form of higher expense ratios and fees.

The court rejected this argument because:

As the plaintiffs conceded, Fidelity negotiates the payment of infrastructure fees with the mutual funds. Therefore, Fidelity did not unilaterally change its fees.
The plaintiffs did not plausibly allege that the mutual fund managers who pay the infrastructure fees to Fidelity are required to pass on the costs of the fees to the plans or to the plan participants. The mutual fund managers, not Fidelity, decide whether to pass on those costs.

Therefore, the plaintiffs failed plausibly to allege that Fidelity unilaterally controls the terms of the compensation it receives from the Plans.

The plaintiffs also argued that Fidelity is a fiduciary with respect to its use of the omnibus accounts, which Fidelity uses to process all trades and maintain plans' investments in mutual funds. The court rejected this theory because the plaintiffs did not allege that:

As directed trustees of the omnibus accounts, Fidelity fails to follow the instructions it receives from plan sponsors and participants as to which mutual funds are selected for investment, or how the investments should be allocated.
Fidelity improperly redirects the investments of plan participants through the omnibus accounts from mutual funds managed by companies that do not pay infrastructure fees to mutual funds managed by companies that do pay infrastructure fees.

The plaintiffs also argued that Fidelity is a plan fiduciary because it controls the menu of investment options available to the plans. The court rejected this argument, as well, because:

Under the contracts, the plan sponsors (not Fidelity) select which investment options are made available to the plan participants from the FundsNetwork. Fidelity is not a plan fiduciary by virtue of the fact that it selects which mutual funds are available on the FundsNetwork Platform. The court cited Leimkuehler v. Am. United Life Ins. Co. as one of the cases that have held that a platform provider does not become a plan fiduciary by having control over the investment options that plan sponsors may choose from for their plans (713 F.3d 905, 907-08 (7th Cir. 2013)).
Fidelity's discretion to amend the service and trust agreements to comply with changes in the law or to update services and procedures, which it can do only after first providing written notice, does not mean that Fidelity has any discretion to alter the specific investment options available to plans.

The court granted Fidelity's motion to dismiss for failure to state a claim because the plaintiffs' factual allegations do not plausibly allege that Fidelity is a fiduciary to the plans in which the plaintiffs participate.

Practical Implications

Third party service providers to plans should take note of the Massachusetts' district court decision that Fidelity was not a fiduciary because:

Fidelity did not control the terms of the compensation it received and therefore was not a fiduciary for the compensation it received.
The plan sponsors, not Fidelity, select the investment options that are available through the FundsNetwork.

To learn more about:

The law governing the disclosure of investment-related information to participants and beneficiaries in participant-directed defined contribution plans, see Practice Note, Fee and Investment Disclosure Requirements for Participant-Directed Plans.
The requirements of the Department of Labor's (DOL's) final regulations governing the required disclosures of compensation and fees from plan service providers to plan fiduciaries of pension plans (including 401(k) plans), see Practice Note, Service Provider Disclosure Requirements for Pension Plans.

District Court Rules in Favor of Fidelity in Revenue Sharing Fee Litigation | Practical Law