Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans


Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

Ninth Circuit: AT&T’s $20 Recordkeeping Fee Presumed Imprudent in Litigation

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By Daniel Aronowitz

The Ninth Circuit Court of Appeals has ruled in Bugielski v. AT&T Services, Inc. that when AT&T contracted with Fidelity in 2012 and 2014 to add managed account and brokerage link services to its participants, it was a prohibited transaction under ERISA because Fidelity was a “party-in-interest” to the plan.  Never mind that the managed account and brokerage link investment services had nothing to do with the recordkeeping services Fidelity provided to the plan.  Or that these transactions were investment services to plan participants, not the plan itself.

The practical effect of the ruling is that AT&T is guilty of fiduciary imprudence until it can prove itself innocent under the threat of huge liability.  The Third and Seventh Circuits both have ruled that this literal interpretation of ERISA yields “absurd” and “nonsensical” results because it opens up plan fiduciaries to abusive class action litigation.  Is this really what members of Congress like Ted Kennedy, Joe Biden and Strom Thurmond intended in 1974 when they voted for ERISA?  We doubt it.  The complex intricacies of ERISA defy conventional statutory interpretation.

The unfair result in this case is exacerbated by the actual fees that plaintiffs claimed were “excessive.”  AT&T has to defend the prudence of a rock-bottom $20 recordkeeping that was negotiated with the help of a first-class consultant.  Not stopping there, AT&T’s fiduciaries negotiated a most favored customer clause, requiring Fidelity to lower the fee in the event any other Fidelity client received lower fees.  The fees were so low that Fidelity redacted the record in the district court so that no one would find out it offered such a discount to AT&T.

This case screams for legislative or regulatory intervention.  If all changes or additions to essential plan service contracts are prohibited transactions, there has to be a way to prove that the plan fiduciaries met the reasonable contract and reasonable fee exemption in rule 408b2 without having to spend millions of dollars in litigation.  This case is a gift to the plaintiffs’ bar, as they will now argue that the prohibited transaction exemption is an affirmative defense that cannot be decided on a motion to dismiss.  This opens every plan in America to more abusive class action litigation, even when the service provider contracts are necessary and reasonable.  This cannot be what Congress intended under ERISA fiduciary law, nor what even a progressive Department of Labor should sanction.  This decision requiring AT&T to defend its rock-bottom fees in endless litigation continues the trend of distorting ERISA into a litigation and liability trap for plan sponsors.

(1) If necessary service contracts are prohibited transactions, how can a plan sponsor prove that the transaction qualifies for the statutory exemption without the burden of litigation?

If the Ninth Circuit is correct in its interpretation of the rule 406 of ERISA, it is a goofy result:  it means that every transaction with an existing service provider to the plan, even when it is necessary and essential to the operation of the plan (like recordkeeping), is prohibited.  You can then only finalize the transaction if you meet an exemption, but any plaintiff lawyer can challenge your right to the exemption with a class action lawsuit.  Again, you are guilty of fiduciary imprudence until you can prove that the plaintiff lawyers serving as ERISA police are wrong.

The Court said that the Department of Labor’s Employee Benefits Security Administration (EBSA) in its rule 408b2 regulations has confirmed that arms-length transactions for necessary plan recordkeeping services with an unrelated service provider are “generally” prohibited under rule 406(a)(1)(C) of ERISA.  The justification of the categorical bar is that the section 408b2 provides relief in the form of an exemption.  EBSA takes the position that section 406(a)(1)(C) applies to any provider of services to plans.  Section 406(a)(1)(C) “generally prohibits the furnishing of goods, services, or facilities between a plan and a party in interest, unless the exemption in section 408(b)(2) applies.”  In turn, section 408(b)(2) provides relief from the prohibited-transaction bar for service contracts or arrangements between a plan and a party in interest if (1) the contract or arrangement is “reasonable,” (2) services are “necessary” for the establishment or operation of the plan,” and (3) no more than “reasonable compensation is paid” for the services.

The key question is how do plan sponsors prove that they meet the statutory exemption.  When a plan is sued for a prohibited transaction, how do the plan fiduciaries prove that the contract is reasonable, necessary, and that the fees were reasonable?  Plaintiff lawyers challenging the reasonableness of fees will argue that the exemption is an affirmative defense that cannot be adjudicated on a motion to dismiss.  They will also argue that plan sponsors bear the burden of proof to demonstrate the prudence of their fiduciary process.

This is open season on plan sponsors.  It cannot possibly be what Congress intended with the goofy rule that all transactions are prohibited unless you meet an exemption.  There must be a way to prove the exemption without having to defend an imprudence claim in litigation.

This is when DOL needs to step in and provide some way to keep most cases with routine contracts out of litigation.  The only imprudence challenges that should be allowed to proceed is when the contract is objectively unreasonable, or the fees are objectively egregious – not on plaintiff lawyer contrived standards, but on objective standards.  As shown below, surely a plan with $20 per participant rock-bottom recordkeeping fees should not have to defend an objectively reasonable fee in litigation.

(2) The Rock-Bottom Recordkeeping Fees Secured by AT&T Fiduciaries Prove the Prejudice of Allowing Prohibited Transaction Challenges for Essential Plan Service Contracts

You need to read the appellate briefs to understand this case with proper perspective.  The undisputed record shows that AT&T followed a superlative fiduciary process in negotiating with Fidelity:  (1) they continually sought to reduce recordkeeping fees, ultimately securing a $20 fee; (2) the fiduciaries negotiated a most favored customer clause in which Fidelity was required to provide its lowest possible fee; and (3) retained Deloitte as a consultant to validate that the recordkeeping fee was reasonable.  This is textbook fiduciary best practice.

It is important to remember that the original three complaints in the case, which caused AT&T to spend millions to defend, alleged that AT&T had a $61 recordkeeping fee per participant.  This is the classic misrepresentation of large-plan recordkeeping fees that leading plaintiff law firms use to bring excess fee cases.  The fee is calculated from the $5M+ amount disclosed in the recordkeeping fee section of the Form 5500 disclosed by Fidelity.  The $5M fee to Fidelity was correct, but it was not just for recordkeeping.  It included transaction fees that are earned from non-recordkeeping services, like the BrokerageLink and managed account fees.  We raise this pleading history to demonstrate the dubious credibility of this lawsuit.  As shown below, AT&T’s recordkeeping fee was one-third of the amount alleged in three separate complaints.  Plaintiffs threw all types of excess fee claims against the wall in the hope that one of them would stick.

The truth is different than the complaints alleged.  Over the course of the plan’s contractual relationship with Fidelity, AT&T continually negotiated lower flat fees.  In 2011, the recordkeeping fee was $31 per participant.  It was reduced to $29 the following year.  In 2016, the contract came up for renewal.  AT&T retained Deloitte Consulting LLP, an independent consultant, to review the Plan’s recordkeeping fees and compare them to market rates for similarly situated plans with comparable services.  Deloitte reported that recordkeeping fees charged by comparable plans ranged from $38 to $94 per plan participant, with an average of $50.  Deloitte also concluded that “current financial terms in both Fidelity Agreements remain competitive compared to market trends and well aligned to AT&T’s size and complexity.”  In 2017, AT&T renegotiated its terms with Fidelity again, resulting in a significant reduction to $20 per participant.

But AT&T went even further to ensure that it had the lowest possible fees.  At all relevant times, the plan’s agreement with Fidelity contained a “most favored customer” clause.  That provision guaranteed AT&T that the recordkeeping fees Fidelity charged the plan would be equal to or lower than the fees Fidelity charged “any other of its customers of similar demographics, asset configuration and Plan characteristics/complexity as AT&T for the same or similar Services, in similar quantities.”

The recordkeeping fees Fidelity charged to AT&T were so low that Fidelity wanted the lower court record redacted so that no one would learn about deal that AT&T had negotiated.  Pull the district court’s summary judgment opinion, and you will see lots of redactions every time the $20 per participant fee is mentioned.  That tells you everything you need to know as to whether the AT&T fiduciaries allowed “excess” fees in the plan.

AT&T also retained professional help when it decided in 2013 to expand the benefits offered to plan participants to add a managed account.  AT&T procured the services of an investment advisor and conducted a RFP process, ultimately contracting with Financial Engines in 2014 for investment advice and account management services.  Financial Engines originally charged the plan a flat per-participant fee for its services.  In October 2017, AT&T successfully renegotiated with Financial Engines to eliminate the flat fee and charge only a lower asset-based fee.

Plaintiffs had no evidence that Fidelity would have charged a lower recordkeeping fee when adding managed account or brokerage link services.  To this point, plaintiffs introduced no factual evidence that any other fiduciary has used the existence or amount of fees such as those Fidelity received from Financial Engines or though BrokerageLink to decrease recordkeeping fees.  And they had no evidence to suggest that a prudent fiduciary in the position of AT&T – which had already reduced its recordkeeping fees to well below average and had a “most favored customer clause” – would or could obtain further reductions to those fees based on payments from Financial Engines or an equivalent entity.  Plaintiffs had no expert testimony to support their contention that Fidelity would have lowered its fees.  The claim that Fidelity would have reduced its fees even further is pure conjecture and speculation, but it somehow worked.

What else exactly could AT&T fiduciaries have done to ensure lower fees?  The case is being remanded to the district court to decide if AT&T could have lowered its recordkeeping fee even more when it added non-recordkeeping managed account and brokerage link services to its plan.  But it had a most favored customer clause.  Other large plans use Fidelity for recordkeeping and managed account and/or brokerage link services.  With a most favored customer clause, Fidelity has guaranteed that AT&T must receive the lowest possible recordkeeping fee that it offers.  There is no possibility that AT&T paid too much for recordkeeping services.  Nevertheless, it will spend millions of dollars more in defense fees to defend this case.

The Euclid Perspective

AT&T spent approximately five million in fees paid to Fidelity for recordkeeping, managed account and brokerage link services.  With three motions to dismiss, litigation discovery, and an appeal, AT&T has undoubtedly spent well more than five million to defend the prudence of its $20 per participant, most favored customer contract with Fidelity.  Now it will spend millions more in the remanded litigation.  What exactly is the advice to plan sponsors:  that anytime you contract for plan services, you need to budget millions more to defend litigation claiming that your contract is a prohibited transaction and unreasonable?  That the cost of litigation will be higher than the cost of the necessary services to the plan?

The Third and Seventh Circuit’s warned that allowing this type of prohibited transaction interpretation of ERISA will yield absurd and non-sensical results.  The AT&T case proves their point.  It is a textbook example as to how ERISA has been weaponized to allow the plaintiffs’ bar to harass corporate America with meritless class action lawsuits.  Under ERISA in the Ninth Circuit, you are guilty until you prove yourself innocent.  The result of this case may be the literal interpretation of ERISA, but it is an unfair and absurd result.

Disclaimer:  The Fid Guru Blog is intended to provide fiduciary thought leadership and advocacy for the plan sponsor community in areas of complex fiduciary litigation.   The views expressed on The Fid Guru Blog are exclusively those of the author, and all of the content has been created solely in the author’s individual capacity.  It is not affiliated with any other company, and is not intended to represent the views or positions of any policyholder of Encore Fiduciary, or any insurance company to which Encore Fiduciary is affiliated.  Quotations from this site should credit The Fid Guru Blog.  However, this site may not be quoted in any legal brief or any other document to be filed with any Court unless the author has given his written consent in advance.  This blog does not intend to provide legal advice.  You should consult your own attorney in connection with matters affecting your legal interests.

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