Landmark 401(k) Judgment Puts Plan Sponsors on Notice

May 1st, 2012
by Portico Wealth Advisors

In a recent ruling by the Missouri Federal District Court, ABB, Inc. (manufacturer of energy-harnessing and automotive plant technologies) and the members of its Pension Committee were found joint and severally liable for breach of their fiduciary duty as retirement plan sponsors.  The court opined that the company’s 401k, provided by Fidelity, was largely populated with mutual fund choices that were selected more for the opacity of their fee structure than for the underlying merits of the investments themselves.

In turn the court levied the following judgments in favor of the plan participants:

  • Failure to monitor recordkeeping fees and to negotiate rebates:    $13.4MM
  • Failure to prudently select and retain investment options:             $21.8MM
  • Improper use of “free float” interest on plan assets (Fidelity):        $  1.7MM

In all, the fines represent about 3% of the plan’s roughly $1.4B in assets.

Despite the landmark nature of this case (i.e. a judgment was issued, as compared to the preponderance of cases that end in settlements) plan sponsors in the small- and mid-sized markets, collectively $0-$100MM in plan assets, are likely to view these results as a concern limited to firms in the Fortune 1000.

However, even the sponsor of a $5MM plan should take note, as a proportional judgment against its plan ($150K) would likely be meaningful to that company’s bottom line.

Key findings stemming from the case include:

Failure to monitor recordkeeping and to negotiate rebates

The ABB retirement plan’s menu contained funds that used revenue sharing (a portion of the overall expense ratio of the funds) to pay for recordkeeping and administration of plan.  Although the court explicitly stated that the use of revenue sharing is not a fiduciary breach per se, failing to understand the amount and reasonability of the plan’s revenue sharing component was a deficiency.  Since ABB’s Investment Policy Statement (IPS) stated that revenue sharing was “to be used to offset or reduce the cost of providing administrative services to plan participants,” it stands to reason that ABB would need to know how much recordkeeping for a plan of their size and headcount would cost, independent of any revenue sharing relationships.  The court determined that ABB was negligent in never determining said costs.  Compounding matters, ABB was told by a retirement plan consultant that they were overpaying for services, and opted not to take action.

Implications for Small/Mid-Sized Plans:
  1. Plan sponsors should have an IPS that contains a definitive set of rules regarding the selection, monitoring, and maintenance of their plan’s investments.
  2. The IPS should be reviewed regularly and the processes outlined within it should be followed.
  3. Plan sponsors are responsible for understanding the core set of services required to run their retirement plan, i.e. recordkeeping, administration, investment consultancy, and custody/trusteeship, and the industry-standard costs of each.

Failure to prudently select and retain investment options

ABB leveraged revenue sharing as a means to pay for plan services, in part, because the charges were less transparent.  Plan sponsors often opt to use revenue sharing specifically to avoid any top-line fees being billed to either the company or their participants.  The court found that selecting investments on that basis, as opposed to their underlying merits, was a blatant violation of the plan’s IPS and the company’s fiduciary duty to its participants.  In the case of one particular swap of the Vanguard Wellington Fund for one of Fidelity’s Freedom Funds, the court upheld that none of the stated IPS criteria for investment selection and monitoring, e.g. specific performance metrics, benchmarking, and watch-listing, were used.  In turn, the court was left to conclude that the primary motivation for the swap was the difference in explicit fees to the participants, which is not a reasonable fund selection criterion.  In addition, ABB’s IPS stated that an explicit goal of the plan was to use funds with the least expensive share classes.  Since revenue sharing is an add-on to a fund operating expenses, selecting share classes that engaged in that practice was a de facto violation of the IPS.

Implications for Small/Mid-Sized Plan Sponsors:
  1. Selecting funds because of their ease of administration or revenue sharing amount alone is a fiduciary breach.
  2. Simply having an IPS is not enough.  The company and its fiduciaries must follow the rules outlined within it.

Improper use of “free float” interest on fund assets

This portion of the judgment, levied against Fidelity, related to the use of interest earned on plan assets while temporarily parked in transitional holding accounts.  The court found that the interest earned on those assets are an asset of the plan, and as such, Fidelity’s crediting of that float to the mutual funds as a whole, instead of to the plan directly, was improper.

Implications for Small/Mid-Sized Plan Sponsors:
  1. Sponsors should be aware of the actions of their vendors.
  2. Vendor violations can increase the overall scrutiny of a plan and can ultimately pull a sponsor into litigation.

In summary, ABB, Inc. was found guilty of fiduciary breach in its retirement plan.  The members of its Pension Committee were also found in breach and are joint and severally liable for any shortfall in the company’s ability to satisfy the judgment.

Some of the breaches were the result of acts of commission, while others were more of omission.  In either case, however, several themes were apparent.  First, plan sponsors should have a “deliberative process” when it comes to the implementation and maintenance of their retirement plan and its associated investments.  Secondly, simply having the process, i.e. an Investment Policy Statement, is not enough; that process must also be followed.  Lastly, firms that chose to ignore their responsibilities, the actions of their vendors, and the advice of industry experts run the risk of being found in breach of their fiduciary duty.