Fidelity at center of new strategy for ERISA breach lawsuits

A recent spate of fiduciary breach lawsuits against Fidelity Investments represents a new strategy by plaintiffs' attorneys to identify alleged ERISA violations affecting defined contribution plans, industry observers say.

The litigation argues that Fidelity violated ERISA through offering competitors' mutual funds to Fidelity clients. The lawsuits by current and former DC plan participants focus on the adequacy of fee disclosure and whether record keepers are considered defined contribution fiduciaries.

Plaintiffs alleged that Fidelity is a fiduciary and is charging "secret" fees; Fidelity responded that it discloses the fees and that it isn't a fiduciary.

Lawsuits filed in February, March and April argued that Fidelity's management of its Fidelity FundsNetwork makes it subject to ERISA rules governing fee transparency and self-dealing. These lawsuits have been consolidated into a single class-action complaint, In Re Fidelity ERISA Fee Litigation. The participants' complaints were filed on behalf of respective DC plans as well as "similarly situated" DC plans. However, the plans are neither plaintiffs nor defendants.

The FundsNetwork is an open architecture investment platform that Fidelity makes available to competing asset managers that provide their products to Fidelity's DC clients. Fidelity charges "infrastructure fees" to some of these providers so it can maintain the FundsNetwork platform, the company wrote in a July 1 response to the lawsuits. The FundsNetwork connects "hundreds of asset management companies offering a total of over 10,000 mutual funds" to Fidelity investors, the company wrote.

Plan participants accused Fidelity of operating a "secret" payment "kickback" scheme by charging and manipulating fees to mutual fund providers.

"Fidelity's receipt of the kickback payments at issue violates ERISA's prohibited transaction and fiduciary duty rules and should not be countenanced," said the consolidated complaint filed May 15 in a U.S. District Court in Boston. The consolidated complaint lists 10 lawyers in six law firms representing current or former participants in 11 defined contribution plans.

"The secret payments do not bear any relationship to the services performed by Fidelity," said the complaint, adding that the infrastructure payments are made "at the expense of the plans and participants." The complaint said fees charged by mutual fund companies to DC plans would be higher due to their paying the infrastructure fees.

Fidelity's July 1 response asked that the lawsuit be dismissed. The infrastructure fees "were heavily negotiated with the fund managers" and the fees were "disclosed to all investors," Fidelity wrote.

If Fidelity were declared a fiduciary, it would have to follow rules requiring it to charge plans no more than the cost of its service and agree to remit excess compensation to plans that Fidelity received from third parties, the company wrote.

"If service providers were deemed fiduciaries to 401(k) plans when negotiating their compensation … there would be no providers left in the business," Fidelity added. "Nothing in ERISA prevents Fidelity from acting in its own interest when negotiating its compensation."

The Fidelity case has attracted the attention of regulators in Massachusetts; Boston is Fidelity's home town. In late February, the Massachusetts Securities Division, a unit of the secretary of the commonwealth's office, sent "preliminary inquiry letters" to Fidelity and "certain funds" in the FundsNetwork program, according to an email from Debra O'Malley, a spokeswoman for William Galvin, the secretary of the commonwealth.

The letters requested the identity of all Massachusetts pension and retirement plans in which Fidelity is a fiduciary or service provider; details of all fees payable by mutual fund firms to Fidelity; a description of the "infrastructure fee;" the names of Fidelity units that receive the fee; and a description of how the fees are disclosed.

The lawsuits also have attracted the attention of ERISA attorneys, who note that participants' lawyers continue to seek new angles for ERISA challenges.

"Over the years, the plaintiffs' bar has become more sophisticated," looking beyond the "old generic claims that sponsors overpaid," said Michael Kreps, a partner at Groom Law Group, whose firm represents sponsors in ERISA cases and isn't involved in the Fidelity litigation.

Regardless of the outcome, Mr. Kreps said sponsors must pay close attention to contract terms with service providers. "Sponsors have the obligation to understand the fees and make sure they talk to service providers about fees and services," he said. "Sponsors need to show they have a prudent process in place to address fees."

A key issue in the Fidelity case is the fee-transparency section of ERISA called Section 408(b)(2). The plaintiffs argued that the infrastructure fees "clearly constitute" indirect compensation, requiring disclosure by Fidelity to clients to meet the ERISA guidelines, according to their complaint. "Fidelity does not disclose the amount of these secret payments."

However, a three-page notice provided by Fidelity to institutional investors said the infrastructure fee is disclosed to new clients and in annual 408(b)(2) notices to existing clients. The notice was issued Feb. 28 following the filing of the first infrastructure fee lawsuit.

"These fees are not in connection with Fidelity's services to the plan and are not considered indirect compensation under 408(b)(2) regulations," the notice said. "The infrastructure fee is not paid by participants, plans record kept by Fidelity or by plan sponsors."

The notice also said sponsors aren't required to disclose the infrastructure fee to participants because this fee "is not charged for Fidelity's services to any plan and is not paid by participants or plans."

Even though sponsors haven't been named as defendants in the Fidelity case, attorneys note that they should pay close attention.

"If plaintiffs are correct, the onus would be on the sponsor to go to the Labor Department to say this isn't adequate disclosure," said Allison Wielobob, general counsel for the American Retirement Association, Arlington, Va.

To any DC sponsor under any circumstance, "we say make sure fees are reasonable and well known," said Ms. Wielobob, whose trade group hasn't commented on the Fidelity case.

"If the responsible plan fiduciary received this disclosure and did not fully understand — or simply did not know what 'infrastructure fees' were, because that is not a term of art — the fiduciary had a responsibility to follow up with Fidelity," Marcia Wagner, founder and managing partner of The Wagner Law Group, Boston, wrote in an email. Her firm isn't involved in the Fidelity case.

"A plan sponsor needs fully to understand what it is paying for," she added. "It may not need to know exactly how the fees are being allocated among the relevant parties, but it needs to understand the overall bottom-line cost of the product."