Alert February 17, 2009

U.S. Court of Appeals for the Seventh Circuit Affirms Dismissal of 401(k) Excessive Fee Litigation

The United States Court of Appeals for the Seventh Circuit (the “Seventh Circuit” or the “Court”) affirmed dismissal of a purported class action lawsuit that asserted ERISA breach of fiduciary duty claims on behalf of participants in the 401(k) plans offered by their employer (the “plan sponsor”).  One of more than two dozen lawsuits that have been filed across the country challenging 401(k) plan fees, this was the first participant-filed suit decided when the United States District Court for the Western District of Wisconsin dismissed the complaint in June 2007.  The complaint, filed in December 2006, asserted claims against the plan sponsor and two of the plans’ service providers, the plans’ trustee/recordkeeper and its investment adviser affiliate, which managed the mutual funds offered in the plans.  Plaintiffs challenged as excessive the fees charged by the mutual funds offered in the plans, and in particular alleged a lack of disclosure regarding a revenue sharing arrangement under which the investment adviser shared a portion of the fees it received for managing the mutual funds offered in the plans with its affiliate, the trustee/recordkeeper.

In its February 12, 2009 decision, the Seventh Circuit agreed with the lower court that neither of the service provider defendants possessed relevant fiduciary authority such that it could be liable under ERISA for any alleged failure to disclose or imprudent choice of investment options.  Specifically, the Court rejected plaintiffs’ assertion that each of the service provider defendants was a fiduciary of the plans because it played a role in the selection of investment options even though the plan sponsor retained the “final say” as to which investment options would be included in the plans.  The Seventh Circuit also rejected the allegation that revenue sharing payments made by the investment adviser to the affiliated trustee/recordkeeper gave rise to fiduciary status, holding that fees collected from mutual fund assets and transferred to an affiliate were not plan assets subject to ERISA. 

The Seventh Circuit also affirmed dismissal of the case against the plan sponsor, finding that it had breached no fiduciary duty based on the alleged failure to disclose revenue sharing between service providers, and that it had not acted imprudently in selecting funds for the plans.  With respect to the challenged revenue sharing practices, the Court held that such practices violate no statute or regulation, and that plan participants were told about the funds’ total fees – the “critical figure” for determining plan expenses.  (Recent Department of Labor regulatory initiatives are aimed at providing greater transparency of service provider compensation, including revenue sharing practices, to plan sponsors and participants.  These initiatives, which include enhanced Form 5500, Schedule C reporting requirements and a proposed regulation under Section 408(b)(2) of ERISA relating to service provider fee disclosures, were discussed in the January 1, 2008 and July 29, 2008 Alerts.  The new administration is reviewing the pending regulations.)  Moreover, the Seventh Circuit held that to the extent that participants wanted detailed information on fund-level expenses, plan materials directed them to the funds’ public filings, which provided that information.  With respect to the sponsor’s selection of investment options for the plans, the Seventh Circuit rejected the plaintiffs’ assertion that the sponsor acted imprudently in limiting its selection to the funds of one mutual fund complex, finding “no room for doubt” that the plans offered “a sufficient mix of investments,” and that in any event ERISA does not require “any particular mix of investment vehicles.”  The Seventh Circuit also rejected plaintiffs’ claim that the funds in the plans charged excessively high fees, noting that mutual fund fees are set in a competitive market and that the plans offered funds with a wide range of fees.  In rejecting plaintiffs’ claims as to both the array of available options and the fees charged, the Court relied heavily on the fact that the plans’ brokerage window option gave participants access to 2,500 additional funds that offered a wide range of fees.

Finally, the Seventh Circuit held that even if it had underestimated the fiduciary duties that ERISA imposes on the plan sponsor, the statute’s safe harbor provision provides an affirmative defense to a claim for breach where certain conditions are met and plan participants exercised independent control over the assets in their plan accounts.  Addressing the plaintiffs’ contention that the district court had improperly considered this affirmative defense in dismissing the complaint, the Court found that the plaintiffs had anticipated the safe harbor defense in their complaint with extensive discussion as to whether the safe harbor’s conditions were met, and as a consequence, the affirmative defense was “in play” and could properly form the basis for a dismissal.  Finding no plausible allegation that the plans did not comply with the safe harbor provisions, the Seventh Circuit held that, particularly in light of the extensive options available to participants through the plans’ brokerage window, any loss to participants “was attributable to their individual choice.”  Accordingly, the sponsor could avail itself of the safe harbor, providing an additional ground for dismissal.  Hecker v. Deere & Co., Nos. 07-3605 & 08-1224 (7th Cir. Feb. 12, 2009).