The U.S. Court of Appeals for the Ninth Circuit recently issued a decision (Bugielski v. AT&T Services, Inc.) that could have significant implications for how plan fiduciaries measure provider compensation—especially recordkeepers. And, in so doing, the decision may enable plan fiduciaries to cast more light on how recordkeepers are compensated.
The case involves the AT&T Retirement Savings Plan. The Plan uses Fidelity as the recordkeeper and in 2012 Fidelity added two participant services —self-directed brokerage accounts through Fidelity’s BrokerageLink account platform and optional investment advisory services through Financial Engines. Participants paid additional fees for these services.
Here’s the ERISA wrinkle that makes this case important: Fidelity also received additional compensation as the result of offering these services—receiving revenue sharing payments from the mutual funds offered on BrokerageLink and payment from Financial Engines of a portion of the fee Financial Engines received from participants.
The plaintiffs claimed that the fiduciaries of the AT&T plan did not obtain information about the revenue sharing payments received by Fidelity from the mutual funds on the BrokerageLink platform or the payments from Financial Engines. Without information on this “indirect” compensation paid to Fidelity, the plaintiffs claimed that the AT&T fiduciaries did not fulfill their basic obligations to act prudently and to determine if Fidelity’s compensation for recordkeeping was “reasonable.” Moreover, according to the plaintiffs, if the fiduciaries did not assess the reasonableness of Fidelity’s fees, then the ongoing use of Fidelity was a prohibited transaction under ERISA.
The district court concluded that the compensation received by Fidelity from these outside sources “exists independent of the Plan and stems from an agreement to which the Plan is not a party”. The court dismissed the plaintiffs’ claims, ruling that AT&T had no obligation to consider the indirect compensation received by Fidelity from the BrokerageLink funds or Financial Engines—and so, the contract was reasonable based on Fidelity’s disclosure of its direct compensation.
Based on its review of ERISA and a literal reading of applicable DOL regulations (described below) the Court of Appeals reversed the dismissal of the claims and sent the case back to the District Court. In general terms, the Court of Appeals agreed with the plaintiffs’ assertion that AT&T was obligated to consider this indirect compensation received by Fidelity and that the failure to do so triggered breaches of fiduciary responsibilities.
The Legal Framework.
ERISA specifies that a plan fiduciary may not allow a plan to engage in a “prohibited transaction” and defines prohibited transactions in very broad terms— banning the “furnishing of goods, services, or facilities between the plan and a party in interest.” However, that broad prohibition is tempered by an (almost equally broad) exemption—permitting plans to contract or make “reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.” (emphasis added).
DOL regulations issued in 2012 take these requirements a bit further by specifying that a contract will not be considered a reasonable arrangement unless the service provider discloses all direct and indirect compensation that the provider will receive “in connection with” services provided to the plan. The logic behind the regulations is simple—a plan fiduciary cannot truly know whether the plan is paying “reasonable” fees unless the fiduciary knows the full amount of all remuneration being received by the provider.
Under the regulations “indirect compensation” is ‘‘compensation received from any source other than the covered plan, the plan sponsor, the covered service provider, or an affiliate”. In this case the Fidelity received revenue from mutual funds on BrokerageLink and from Financial Engines—so the Court of Appeals’ conclusion that Fidelity was receiving “indirect compensation” was not really a stretch.
Commentary on Additional Considerations
This case could have significant implications. It is not uncommon for plan fiduciaries to focus on direct fees—and pay little or no attention to indirect compensation—the AT&T plan is not an outlier. Assuming this opinion stands (i.e., it is not appealed to the Supreme Court or is appealed—but upheld) one can expect that the plaintiffs’ bar will be eager to use indirect fees as a basis for a new wave of fiduciary litigation.
Additionally, a focus on indirect compensation should serve to improve the quality of fiduciary decisionmaking; without understanding the full picture of a provider’s revenue sources a fiduciary cannot fully assess the reasonableness of a provider’s direct fees or how well a provider is truly serving the plan. This goes to the basic goal of the DOL regulations interpreted in this case. As noted by the DOL in 2007 (when initially proposing these rules):
However, the complexity of … [the way plan services are provided] has made it more difficult for plan sponsors and fiduciaries to understand what the plan actually pays for the specific services rendered and the extent to which compensation arrangements among service providers present potential conflicts of interest that may affect not only administrative costs, but the quality of services provided. …
Fundamental to a fiduciary’s ability to discharge these [fiduciary] obligations is the availability of information sufficient to enable the fiduciary to make informed decisions about the services, the costs, and the service provider.
The regulations require disclosure of all “indirect compensation” received by covered service providers “in connection with” services to the plan. These terms are vague and providers’ sources of “indirect compensation can be complicated.
It will take time (and perhaps more litigation) before fiduciaries fully comprehend how providers’ many revenue streams affect their plans.