In a three-page opinion and order, the Court of Appeals for the 7th Circuit has denied the plaintiffs’ petition for rehearing in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), which affirmed dismissal of a suit alleging breach of fiduciary duty in failing to properly monitor, negotiate and disclose investment fees in 401(k) plan investment options. The decision has far-reaching implications for “stock drop” and other ERISA fiduciary litigation over 401(k) plans.
The case deals with the extent to which fiduciaries have a duty to disclose details of defined contribution plan investment fees and to negotiate lower fees on behalf of plan participants.
In its original decision, the Court of Appeals affirmed dismissal of plaintiffs’ complaint for failure to state a claim on the grounds that plaintiffs had not adequately alleged a breach of fiduciary duty merely by alleging that the employer accepted “retail” fees from its 401(k) plan provider and did not negotiate presumptively lower “wholesale” fees for its participants. The Court of Appeals in Hecker found that the complaint failed to state a claim for breach of fiduciary duty under ERISA, because plan documents indicated that participants had the power to select among 25 investment options as well as a “brokerage window” that permitted participants to choose other investment options, along with information about fees associated with each option. The Court of Appeals also applied an important defense – ERISA §404(c) – in a much broader manner than the U.S. Department of Labor considered appropriate.
Plaintiffs’ petition for rehearing was supported by amicus curiae briefs filed by the Secretary of Labor, the AARP, and a group of law professors. In response to arguments raised by the Department of Labor in its amicus brief, the Court of Appeals wrote an “addition” to its original opinion. The “addition” responds to the Department of Labor’s arguments that the original Hecker decision failed to give adequate deference to the Secretary’s interpretation of ERISA §404(c) and improperly insulates a 401(k) plan fiduciary from liability for imprudent investment option selections so long as the fiduciary offers participants a very large number of investment options.
The plaintiffs were participants in Deere’s 401(k) retirement savings plans. Fidelity Trust acted as trustee for the plans, while Fidelity Research provided investment advice to Fidelity Trust. The plans were participant-directed investment plans offering plan participants 25 Fidelity-sponsored choices and access to 2,500 other investment vehicles through a brokerage window. Fidelity Trust managed two of these investment options and also acted as record keeper for the two Deere plans.
Each fund under the plan charged participants a fee, typically expressed as a percentage of the contributed assets. These fees varied widely among investment choices – as high as 1% and as low as 0.07%. Fidelity Research shared a portion of these fees with Fidelity Trust, which then used the revenue to pay itself for serving as trustee of the plans. Deere disclosed the total fee amounts to the participants, but did not inform participants that the fees were being split between Fidelity Research and Fidelity Trust.
ERISA Fiduciary Obligations
ERISA provides that “the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan.” Fiduciaries must also discharge their duties “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”
Claims Against Deere
Duty to Disclose Fee-Sharing Arrangement
Plaintiffs alleged that Deere violated fiduciary duties by failing to disclose that the fees were shared between Fidelity Research and Fidelity Trust. The plaintiffs claimed that the fees were used to manage the funds and also to administer the plans. The Court held that Deere properly disclosed the total fee amounts associated with the plan’s investment options. The Court stated in its original opinion that “[t]he total fee, not the internal, post-collection distribution of the fee, is the critical figure for someone interested in the cost of including certain investment in her portfolio. . . .” Accordingly, the Court found no fiduciary obligation to disclose the distribution of fee revenue.
The Court also considered whether Deere defrauded the 401(k) plan participants by suggesting that it was “generously subsidizing its employees’ investments by paying something to Fidelity Trust when it was doing no such thing.” The Court conceded that while Deere may not have behaved “admirably,” its conduct did not violate any ERISA fiduciary duties because it was under no duty to disclose what happened to the fees after they were collected.
Duty to Prudently Select Investment Options
The Court likewise dispensed with the plaintiffs’ claim that Deere chose investment options with unreasonably high fees. It held that “the undisputed facts leave no room for doubt that the Deere Plans offered a sufficient mix of investments for their participants.” The plaintiffs could choose from more than 2,500 available investment options, some of which had fees as low as 0.07%. While the Court acknowledged that other companies might have offered funds with lower fees, it found that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems).”
In its June 24, 2009 Order and Opinion denying the plaintiffs’ petition for rehearing, the Court expanded on the latter point, noting that “Plaintiffs never alleged that any of the 26 investment alternatives that Deere made available to its 401(k) participants was unsound or reckless, nor did they attack the Brokerage Link on this theory.” Moreover, the Court noted, “the complaint is silent about the services that Deere participants received from the company-sponsored plans.”
The Court of Appeals further re-emphasized in its June 24, 2009 Opinion that plaintiffs had failed to meet their burden of pleading facts in their complaint as required by the Supreme Court’s decisions in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009).
404(c) Safe Harbor Defense
The Court’s June 24, 2009 Opinion also reaffirmed its earlier decision that Deere had satisfied the “safe harbor” defense for fiduciary action under ERISA section 404(c) in participant directed 401(k) plans. The safe harbor defense protects fiduciaries from liability for investment decisions if plan participants exercise control over the investment of assets in their plan accounts.
The Court’s original opinion held that the plaintiffs “chose to anticipate the [404(c)] defense in their Complaint explicitly and thus put it in play” for purposes of the motion to dismiss. The Court found that the safe harbor defense protected the defendants in this case, adding that if “particular participants lost money or did not earn as much as they would have liked, that disappointing outcome was attributable to their individual choices.”
In its June 24, 2009 Opinion, the Court of Appeals rejected the Secretary of Labor’s argument that the Court failed to give deference to DOL regulations implementing ERISA 404(c). The Court reasoned that it had carefully reviewed the language of 29 C.F.R. §2550.404c-1, including the footnote in the preamble to the then current regulation, and did not agree with the Secretary’s argument that the footnote was entitled to full deference under Chevron USA Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 (1984).
Claims Against Fidelity Trust and Fidelity Research
The Department of Labor supported the Court of Appeals’ original holding that Fidelity Trust and Fidelity Research were not “functional fiduciaries” with respect to disclosing fees. The Court ruled that “‘playing a role’ or furnishing professional advice is not enough to transform a company into a fiduciary.” The Court found that while Deere may have discussed the investment options with Fidelity Trust, nothing in the complaint suggested that Fidelity Trust wielded control over Deere’s selection of the investment options for the plans.
Similarly, the Court rejected the plaintiffs’ claims that Fidelity Research acted as a “functional fiduciary.” The plaintiffs argued that Fidelity Research controlled disposition of the plans’ assets because it administered the fee-sharing arrangement between itself and Fidelity Trust. The Court rejected this argument, stating that once the fees were collected from the participants, they ceased to be assets of the participants’ plans. Therefore, Fidelity Research did not control the disposition of plan assets and could not be a fiduciary on that ground.
What Impact Will Hecker Have on Future Fiduciary Litigation?
The Court of Appeals’ June 24 “addition” to its controversial decision may be enough to dissuade plaintiffs’ from seeking Supreme Court review of the Court of Appeals’ decision. As it stands now, Hecker imposes important pleading requirements on plaintiffs alleging breach of fiduciary duty under ERISA. Plaintiffs will have to allege much more particularized facts – especially in the 7th Circuit – when they challenge a fiduciary act as being imprudent.
It should also be noted that the Hecker litigation was one of several class action “plan fee” cases brought by a plaintiffs’ asbestos law firm against large employer 401(k) plans. Those cases used boilerplate allegations and few specific facts to challenge the fees of the plans’ investment alternatives. Time will tell whether Hecker is limited to this boiler-plate complaint, or whether it has a broader application to future ERISA fiduciary litigation.