On February 12, 2009, in a highly anticipated decision, the U.S. Court of Appeals for the Seventh Circuit issued its decision affirming the district court’s dismissal of all claims in Hecker v. Deere & Company. The ruling is the first significant appellate decision concerning the ERISA excessive fees litigation that has recently plagued large companies. The Seventh Circuit’s decision in Hecker rejects several recently popular plaintiffs’ ERISA theories regarding improper “revenue sharing” and “excessive fees.”
In a very clear and practical opinion, the Seventh Circuit reached a number of important conclusions:
- Under the law as it existed in 2006 (before the U.S. Department of Labor issued new proposed revenue sharing disclosure rules), plan fiduciaries had no duty to disclose to participants “revenue sharing” between plan service providers.
- There is no breach of fiduciary duty by the plan fiduciaries for selecting investment options with “excessive” fees where the plan offers a sufficient mix of investments options with a range of fees.
- Nothing in ERISA prohibits a fiduciary from selecting funds all from one management company.
- The district court properly found that plaintiffs’ claims were barred by the “safe-harbor” defense of ERISA § 404(c) where the facts about the plan demonstrated the applicability of the defense.
Beginning around September 2006, the St. Louis plaintiffs’ class action law firm of Schlicter, Bogard & Denton LLP filed class action lawsuits targeting a number of large corporations and their ERISA plans. This sparked a new wave of ERISA “excessive fees” litigation. The allegations in these cases are usually that the fiduciaries running the plans failed to properly protect against excessive fees paid by plans and their participants for mutual funds or other investments and also failed to properly disclose revenue sharing between service providers.
Plaintiff Dennis Hecker and other named plaintiffs filed one of these cases against Deere & Company, Fidelity Management Trust Co., and Fidelity Management and Research Co. Deere engaged Fidelity Trust to serve as trustee of two 401(k)-type ERISA plans it offered to employees. Fidelity Trust advised Deere on what investments to include in the plans, but Deere made the final determination. Each plan offered a generous choice of investment options, including 23 different Fidelity mutual funds, two investment funds managed by Fidelity Trust, a fund devoted to Deere’s stock and a “BrokerageLink” account managed by Fidelity, which gave participants access to some 2,500 additional mutual funds managed by different companies. Each plan participant decided for himself or herself where to put 401(k) dollars; the only limitation was that the investment vehicle had to be one offered by the plans. Fidelity Research advised the Fidelity mutual funds offered by the plans. Plaintiffs alleged that Fidelity Research shared revenue that it earned from the mutual fund fees with Fidelity Trust, and Fidelity Trust in turn compensated itself through those shared fees, rather than through a direct charge to Deere for its services as trustee.
Plaintiffs claimed that Deere violated its fiduciary duty under ERISA by providing investment options that required the payment of excessive fees and costs and by failing to adequately disclose the fee structure to plan participants, including revenue sharing. Plaintiffs also alleged that Fidelity Trust and Fidelity Research were “functional fiduciaries” and liable for the same fiduciary breaches as Deere. The operative allegation against the defendants was as follows: “… the fees and expenses paid by the Plans, and thus borne by Plan participants, were and are unreasonable and excessive; not incurred solely for the benefit of the Plans and the Plans’ participants; and undisclosed to participants.” The district court granted defendants’ motion to dismiss the case at the pleading stage.
Seventh Circuit’s Opinion
Dismissal of the Fidelity Defendants
In affirming the district court’s dismissal, the Seventh Circuit first addressed plaintiffs’ argument that Fidelity Trust and Fidelity Research were “functional” or “de facto” fiduciaries. The issued turned on whether the Fidelity entities exercised discretionary authority or control over the management of the plans, the disposition of the plans’ assets or the administration of the plans. The Seventh Circuit rejected plaintiffs’ claim that Fidelity Trust exercised the necessary discretion by “limiting Deere’s selection of funds” to those managed by Fidelity Research. The Seventh Circuit noted that the Trust Agreement gave Deere, not any of the Fidelity entities, the final say on which investment options will be included. The fact that Deere may have discussed the decision or negotiated about it with Fidelity Trust does not mean any of the Fidelity entities had the discretion to select the funds in the plans.
The Seventh Circuit noted that there is a material difference between someone who exercised “final authority” over the choice of funds versus a person who simply “played a role” in the process. Because the Fidelity entities did not have final authority to choose the funds, they were not fiduciaries for purposes of selecting investments. The Seventh Circuit also rejected plaintiffs’ argument that the Fidelity entities exercised discretion over “plan assets” by determining how much revenue Fidelity Research would share with Fidelity Trust. Contrary to plaintiffs’ theory, once fees were collected from mutual fund assets and transferred to one of the Fidelity entities, they became Fidelity’s assets—not assets of the plan.
Dismissal of Revenue Sharing Claim Against Deere
The Seventh Circuit next turned to the claims against Deere, which were distilled into two: Deere breached its fiduciary duty by not informing participants of the revenue sharing between the Fidelity entities, and Deere imprudently agreed to limit the investment options to Fidelity Research funds and therefore offered investment options with excessively high fees.
As the Seventh Circuit pointed out, “critical to plaintiffs’ case is the proposition that Deere and Fidelity had a duty to disclose the revenue sharing arrangement.” The Seventh Circuit held that there was no such requirement under ERISA at the time of the alleged events (although it noted the new proposed rules issued by the Department of Labor requiring disclosure of certain revenue sharing). Participants were told about the total fees imposed by the various mutual funds, and participants were free to direct their dollars to lower-cost funds if that was what they wished to do. How Fidelity Research decided to allocate the monies it collected (a total about which the participants were fully informed) was not something that ERISA required at the time to be disclosed. The “total fee, not the internal, post-collection distribution of the fee, is the critical figure for someone interested in the cost of a certain investment…” In short, plaintiffs’ revenue sharing disclosure allegations failed to state a claim against the plan sponsor.
Dismissal of Excessive Fees Claim and Limited Funds Claim
With regard to the allegations that Deere violated its fiduciary duties by selecting investment options with excessive fees, the Seventh Circuit found it easy to affirm the dismissal. The Deere plans offered a sufficient mix of investments for the participants, with a wide range of expense ratios, ranging from .07 percent to just over 1 percent. “Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition.” 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). Nor did Deere act improperly to limit the investment options to Fidelity mutual funds. No statute or regulation prohibits a fiduciary from selecting funds from one management company—many prudent investors limit themselves to funds offered by one company and diversify within available investment options.
Importantly, the Seventh Circuit noted that this allegation bordered on a “plan design” question that may not implicate fiduciary duties. This part of the opinion suggests another line of defense against similar claims.
Applicability of ERISA Section 404(c) Defense
As an alternative ground for dismissal of the claims, the Seventh Circuit agreed that ERISA Section 404(c) operated as a safe harbor precluding plaintiffs’ claims. This part of the ruling rests heavily on the contents of the Deere plans.
In their complaint, plaintiffs identified specific reasons why they contended Section 404(c) did not apply, including that defendants had failed to provide participants with all material information with which to make decisions because they failed to disclose revenue sharing and that the alleged selection of mutual funds with excessive fees was not the type of conduct falling within the protection of the safe harbor.
As to plaintiffs’ first argument, the Seventh Circuit noted that it had already concluded that revenue sharing arrangements are not material as a matter of law and did not have to be disclosed. As to the second issue on fund selection, the Seventh Circuit concluded that it need not reach that issue (but actually said a lot). Even if Section 404(c) does not always shield a fiduciary from an imprudent selection of funds, it does protect a fiduciary that satisfies the criteria of Section 404(c) and includes a sufficient range of options so that participants have control over the risk of loss. In this case, the plans offered an overwhelming range of options with a wide range of fees. Thus, as a matter of law, any allegations that these options did not provide participants with a reasonable opportunity to meet the goals of the Section 404(c) regulations (see 29 C.F.R. § 2550.404c-1) or control the risk of loss is “implausible.” “Given the numerous investment options, varied in type and fee,” none of the defendants can be held responsible for those investment choices made by the participants.
Impact on Other Excessive Fee Cases
More than a dozen cases against large corporations with virtually identical allegations will be affected by the Deere decision. In some instances, those cases were placed on hold pending the resolution of Deere. This decision is especially important because the Seventh Circuit provides a clear answer rejecting many of the general allegations and theories advanced in the other excessive fees cases. At its core, Deere expressly rejects the alleged need to disclose revenue sharing, finding it not material to participants nor required under then existing law, and provides a complete defense to a claim of “excessive” investment fees where the plan offers a wide range of investments with a wide range of fees in line with those subject to market competition. Although not binding outside the Seventh Circuit (Wisconsin, Illinois and Indiana), this opinion will be highly persuasive in other jurisdictions.