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CCH® PENSION AND BENEFITS — 03/12/09

Failure to disclose revenue sharing arrangement was not breach of fiduciary duty

An employer sponsor of 401(k) plans did not breach its fiduciary duties by failing to disclose to plan participants a revenue sharing arrangement between the plan’s mutual fund providers, the U.S. Court of Appeals in Chicago (CA-7) has ruled in Hecker v. Deere and Company.

401(k) plan investment options

An employer sponsored and administered 401(k) plans for its employees. As the administrator of the plans, the employer had the final authority to select investment options offered under the plans. However, pursuant to an agreement with a mutual fund provider (Fidelity Trust), which functioned as the directed trustee of two of the plans and advised the employer on investments to be included in the plan, the employer (with the exception of an employer stock fund) limited plan investment options to funds offered by a related entity to the fund provider (Fidelity Research). The plans, however, also offered an investment alternative (i.e., brokerage window) which allowed participants to invest in over 2,500 different publicly available investment funds offered by Fidelity Trust and other mutual fund companies. Plan participants were empowered to direct the investment of their individual account assets. However, participants were restricted to investing in options specified under the plans.

The funds for which Fidelity Trust served as an investment advisor charged investors an asset-based fee. The total fee, expressed as a percentage of the assets invested, was reported in each fund prospectus and itemized between management fees, service fees and other expenses. Fidelity Research also shared a portion of the fee revenue with Fidelity Trust, but this revenue sharing arrangement was not disclosed to participants.

Duty to disclose revenue sharing

ERISA does not explicitly require the disclosure of revenue sharing. However, the participants alleged that the employer breached its general fiduciary duty by not informing participants that Fidelity Trust was receiving money from the fees collected by Fidelity Research. The central issue was whether the employer, having disclosed the total fees imposed by the funds, had an additional fiduciary obligation to reveal how Fidelity Research allocated the monies it collected pursuant to the revenue sharing arrangement.

The trial court found that the information disclosed in the reports and prospectuses that were provided to participants accurately reflected the expenses actually paid to the fund manager for fund management. Focusing exclusively on the fact that the failure to disclose revenue sharing did not violate existing ERISA standards for disclosure, the trial court dismissed as without merit, the suggestion that disclosure is required by ERISA’s general fiduciary standards. Disclosure requirements, the court explained, are generally limited to those “expressly prescribed” by ERISA. ERISA provides detailed disclosure requirements, and it would be “inappropriate,” the court opined, to “ignore and augment them using the general power to define fiduciary obligations.”

The appeals court focused on whether the omission of information about the revenue sharing arrangement was material. Stressing that the total amount of fees, and not the internal post-collection distribution of the fees, was the critical figure in ascertaining the cost and net value of an investment, the court ruled that the omission of the revenue sharing information was not material. As the employer did not deny participants information necessary to prevent them from acting to their detriment, it did not breach its fiduciary duty by failing to disclose the revenue sharing arrangement.

In addition, the appeals court ruled that the failure of the employer to disclose the information did not preclude application of the fiduciary liability defense under ERISA §404(c).

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