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Tussey v ABB Inc.: A Lesson in Fiduciary Duty

Authors, Eleanor Banister, Atlanta, +1 404 572 4930, ebanister@kslaw.com and James P. Cowles*, Atlanta, +1 404 572 3455, jcowles@kslaw.com.

On March 31, 2012, a federal district court in Missouri delivered to a large manufacturer and institutional fiduciary an expensive lesson in ERISA’s fiduciary obligations in Tussey v. ABB, Inc.  The plaintiffs are current and former employees of ABB, Inc.(“ABB”), a manufacturer of power and automatic equipment.  The defendants are ABB, Inc., two committees responsible for administering ABB’s 401(k) plans, Fidelity Management Trust Company and Fidelity Management & Research Company and John W. Cutler, Jr. (the Director of the ABB group that served as the staff to the plan investment committee). 

The case is a lesson in what can happen when plan fiduciaries fall asleep at the switch. 

Brief Background 

ABB, Inc. sponsors two 401(k) plans, one for collectively bargained employees and one for non-collectively bargained employees.  The Pension Review Committee is the named fiduciary of the plans and is responsible for selecting and monitoring the investment options.  The Employee Benefits Committee of ABB, Inc. is the named plan administrator.  The Pension and Thrift Management Group of ABB, Inc., which Mr. Cutler directed, acts as the staff of the Pension Review Committee. 

Fidelity began recordkeeping for the plans in 1995.  Initially, Fidelity’s recordkeeping fees were based on a per participant fee charged to the plan and deducted from participant accounts.  By 2001, Fidelity was primarily compensated for its services through revenue sharing. 

Lesson 1 -- Fiduciaries must Monitor Plan Recordkeeping Fees.

The court found that the ABB fiduciaries never calculated the amount of the recordkeeping fees paid to Fidelity Management Trust Company (“Fidelity”) via the revenue sharing arrangements it had with ABB plan investments. 

The court also found that the ABB fiduciaries did not investigate the market price for similar recordkeeping services and did not benchmark the cost of recordkeeping fees prior to entering into the revenue sharing arrangement with Fidelity.  Some years later, the ABB fiduciaries did benchmark the cost of recordkeeping, but they ignored their own consultant’s conclusion that Fidelity’s fees were too high.  In fact, the court found that the amount Fidelity was receiving for recordkeeping services through revenue sharing arrangements was far in excess of a reasonable recordkeeping fee, in some years by as much as 100%.

The ABB defendants argued that they monitored fees by monitoring the expense ratios of the investments offered in the 401(k) plans.  The court pointed out that the expense ratios do not show how much revenue is flowing from the investment company to the recordkeeper or what the competitive market is for recordkeeping fees. 

The ABB defendants also argued that revenue sharing permitted participants with larger account balances to pay a proportionately larger share of the recordkeeping fee, a progressivity model for compensating recordkeepers.  However, the court found that the ABB defendants did not engage in any process for evaluating whether the revenue sharing model actually resulted in progressivity and the ABB defendants provided no evidence that progressivity is in the best interests of plan participants.

The ABB defendants also argued that revenue sharing reasonably permitted risk sharing between Fidelity and ABB, Inc. because when the assets of the plans declined, Fidelity shares the loss in revenue sharing, whereas when the assets of the plans increase, revenue sharing increases for Fidelity.  According to the court, the problem with this argument is that Fidelity requested additional fees be paid when revenue sharing declined, but the ABB defendants did not request refunds from Fidelity when revenue sharing increased.

The court concluded that the ABB fiduciaries were not concerned about the cost of recordkeeping unless it increased ABB’s out of pocket expenses or caused the plans to be less attractive to its employees by deducting recordkeeping fees from each participant account.  The court observed that revenue sharing enabled ABB to hide the true cost of recordkeeping from plan participants. 

Lesson 2 -- Follow Plan Documents.

The plans’ investment policy statement required that any rebates associated with plan investments would be used to offset or reduce the cost of providing plan administrative services.  Revenue sharing would have been a “rebate”, but in this case, rather than offset the cost of administrative services, such as recordkeeping, all revenue sharing was paid to Fidelity. 

The investment policy statement also incorporated a direction that when a selected mutual fund offered a choice of share classes, the class with the lowest cost of participation should be selected.  However, the court found that when the ABB fiduciaries selected the class of shares available in the plans, they chose share classes that provided more revenue sharing to Fidelity.  The court found that the ABB fiduciaries failed to follow the investment policy statement and imprudently chose more expensive funds in order to prevent the imposition of a per-participant hard-dollar recordkeeping fee. 

The investment policy also incorporated a very specific process for removing an investment fund, which involved examining a three to five-year period of investment return and determining if there are five years of underperformance, and if so, place the fund onto a “watch list,” and then removing the fund within six months if the investment return does not improve. 

The court found that the Pension Review Committee, which was responsible for selecting plan investments, failed to follow its own procedures in replacing a non-Fidelity fund Fidelity funds that paid Fidelity more revenue sharing.  Instead, the Pension Review Committee acted on the recommendation of Mr. Cutler, the Director of Pension & Thrift Management Group, and performed only scant research on the fund being removed.

Lesson 3 -- Don’t Allow One Plan to Subsidize the Cost of Another Plan

During the course of negotiations with Fidelity in conjunction with removing a Fidelity fund as a plan investment option, ABB obtained an evaluation of Fidelity fees from Mercer, an outside consulting firm.  The report issued by Mercer concluded that ABB was overpaying for recordkeeping services and that the revenue sharing from the 401(k) plans appeared to be subsidizing other services provided to ABB by Fidelity.  Additionally, an email from Fidelity to an ABB employee responsible for negotiating Fidelity’s contract suggested that Fidelity offered services for ABB's health and welfare plan at below market cost and did not charge administration fees for ABB's non-qualified plans, but rather, Fidelity “absorbed” those fees. 

The court held that the ABB employee who received the email failed to make a good faith effort to investigate and prevent the revenue sharing from the 401(k) plans from subsidizing other plans.  Once the ABB employee became aware that the recordkeeping fees appeared to be subsidizing ABB's other plans, he had a fiduciary obligation to investigate and prevent any future subsidy.  Instead, the court found that the ABB employee failed to take any steps to do so and ABB continued to select investments to ensure revenue neutrality for Fidelity and to pay above market for recordkeeping fees.

Lesson 4 -- Float Income Belongs to the Plans

The court also found that the Fidelity defendants breached their fiduciary duties to the plans by failing to allocate the interest earned when contributions and disbursements are held temporarily in overnight accounts (the “float income”) exclusively for the benefit of the plans.

According to the court, Fidelity distributed the float income attributable to the 401(k) plans to investment options not the plans.  It is not clear from the opinion whether the investment options that received the float were investment options held by the plans.  According to the court, since float income constitutes Plan assets, distributing these assets to the investment options rather than the plans was a breach of ERISA’s fiduciary responsibilities.  The court also found that the Fidelity defendants used some of the float to pay expenses of Fidelity that should have been borne by Fidelity, not the plans.

Conclusion

The court found that all of the ABB defendants breached their fiduciary duties by (1) failing to monitor plan recordkeeping costs, (2) failing to negotiate rebates from Fidelity , (3) selecting higher cost classes of investment options when lower cost options were available, and (4) imprudently substituting certain Fidelity investment options for existing plan investment options.  The court found ABB and the Employee Benefits Committee breached their fiduciary duty when they  allowed the 401(k) plans to subsidize the expenses of other ABB plans, including health and welfare plans and nonqualified plans.  The court also found that the Fidelity defendants breached their fiduciary duties when they failed to allocate the income received from overnight investment of plan funds exclusively for the benefit of the ABB, Inc. 401(k) plans. 

The court found the defendants liable for a variety of ERISA fiduciary violations resulting in damages of nearly $40 million.  The damages in this case were significant, but could have been worse.  The plaintiffs argued that the court should adopt a “global damages theory,” which would measure the damages to the 401(k) plans by the investment return on the ABB Inc. defined benefit plan over the period during which the fiduciary breaches occurred.  However, the court rejected the plaintiffs’ global investment theory of damages and instead based damages on the particular amount of the loss resulting from each particular breach.

Action Items

The conduct that resulted in the fiduciary breaches described above was easily preventable by greater diligence on the part of the ABB fiduciaries, both in following their own plan documents and in observing the marketplace.  While the facts of this case may be extreme, it should serve as a wake-up call to all plan fiduciaries.  For example,

• Plan fiduciaries should regularly “benchmark” the cost of plan services to obtain objective evidence of the market price for those services;

• Where vendors provide multiple services to an employer and receive compensation through revenue sharing, plan fiduciaries should ensure that one plan is not subsidizing the services provided to another plan or the employer; and

• Plan fiduciaries should periodically review plan documents, particularly investment policy statements, to be sure that (1) fiduciary actions are consistent with the stated policies and (2) to be sure the documents are up to date and reflect the responsible fiduciary’s intent.

Unfortunately, ERISA does not prescribe any specific time period for conducting benchmarking studies or reviews of plan documents.  The appropriate period will depend on your particular facts and the nature of the services under consideration.  King & Spalding will be glad to help you asses your particular situation or answer any questions you may have about this article.

*Non-lawyer Employee Benefits Consultant

Who’s the Beneficiary?  The Courts Provide A Roadmap For Plan Administrators

Author, Donna Edwards, Atlanta, +1 212 572 2701, dedwards@kslaw.com.

In 2009, the US Supreme Court provided a roadmap for plan administrators to follow when determining the proper beneficiary under an ERISA-covered employee benefit plan.  The Court, in Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, et al 1, held  that the administrator of an ERISA-covered employee benefit plan need only look to the governing plan documents to determine the proper plan beneficiary (the “plan documents rule”).

In the Kennedy case, William Kennedy, a participant in DuPont’s tax-qualified retirement plan, designated his wife, Liv, as his primary beneficiary on the plan’s prescribed beneficiary designation form.  The couple later divorced, and Liv gave up under the divorce decree (which did not qualify as a “qualified domestic relations order” (“QDRO”)) any right related to William’s plan benefits.  However, although the plan permitted a beneficiary to submit a “qualified disclaimer” (as described under Internal Revenue Code Section 2518) of plan benefits, Liv did not submit such a disclaimer waiving her plan benefits, and William did not change his beneficiary designation under the plan.  When William died in 2001, both Liv’s and William’s estate claimed his plan benefit.  The plan administrator decided that Liv was the proper beneficiary and paid William’s plan benefit to her.  The estate sued the plan administrator and DuPont. 

The Supreme Court found in favor of Liv, holding that the plan administrator and DuPont were correct in looking only to the governing plan documents, and not the divorce decree, to determine the proper plan beneficiary.  The Court explained that requiring the plan administrator to look only to the plan documents would provide the greatest degree of certainty for both plan administrators and participants and would prevent plan administrators from having to evaluate waivers and other extrinsic evidence to determine the proper beneficiary.

Open Issues  

An issue left open by the Supreme Court in the Kennedy case was the effect of a beneficiary’s waiver of plan benefits made in a manner consistent with plan documents.  We suspect such a waiver, if permitted by and made in accordance with plan documents, should be treated as part of the plan documents and thus given effect. 

In addition, the Court in the Kennedy case stated that its holding did not address a situation in which the plan does not provide an opportunity for a beneficiary to disclaim his or her plan benefit. 

However, the recent case of Boyd v. Metropolitan Life Insurance Co. 2 presented the 4th Circuit Court of Appeals with the opportunity to consider just such a case.  In the Boyd case, a participant in an ERISA-covered life insurance plan, Emma, designated her husband, Robert, as her plan beneficiary in accordance with the plan’s terms.  In the event a participant failed to designate a beneficiary, the plan provided that benfits would be distributed to the participant’s estate.  The plan did not specify any procedure for beneficiaries to follow to waive their benefits. 

Emma and Robert later separated and entered into a separation agreement in which Robert waived any claim to Emma’s life insurance benefits.  Although the plan allowed participants to change their beneficiary at any time by sending a written request to the plan administrator, Emma failed to take this step.  Upon Emma’s death, the plan administrator distributed the life insurance benefits to Robert.  Emma’s estate sued, claiming eligibility to the benefits on the theory that Robert relinquished his rights to the benefits.   

The 4th Circuit held in the Boyd case that the plan documents rule does not hinge on whether a plan provides for a formal waiver procedure, and that the plan administrator properly paid the plan benefits to Robert in accordance with Emma’s beneficiary designation on file with the plan.  The Court noted that Robert did not wish, in fact, to refuse his benefits.

The Court also explained that an ERISA plan beneficiary always has the option to refuse benefits at the moment of distribution.  Thus, the only way a plan really could provide no means for a beneficiary to renounce an interest in benefits would be if the plan somehow prevented the beneficiary from refusing to take the benefit. 3

Finally, the Supreme Court in the Kennedy case noted that the estate contended that requiring a plan administrator to distribute benefits in conformity with plan documents will allow a beneficiary who murders a participant to obtain benefits under the terms of the plan.  However, the Court stated that the “slayer” case was not before it, and thus the Court did not address it.             

Insights

We see a couple of insights for plan administrators from the Kennedy and Boyd cases.  First, plan administrators should look only to plan documents, including any QDROs, waivers or disclaimers permitted by and made in accordance with the plan documents, in determining the beneficiary of a participant’s plan benefit.  Although a third party may have an appealing argument that he or she, as opposed to the participant’s properly designated beneficiary or alternate payee, should receive the plan benefit, the plan administrator’s fiduciary obligation is to follow the plan documents, and the Kennedy case shows that the plan administrator should not consider evidence extrinsic to those plan documents.

In addition, plan administrators should establish clear plan provisions and procedures for beneficiary designations and effectively communicate those provisions and procedures to plan participants, including the effect (if any) of a divorce on beneficiary designations.  Plan administrators should also encourage participants to carefully consider beneficiary designations and to revise them as needed.

King & Spalding would be happy to assist you with any questions you have about properly determining beneficiaries under your ERISA plans. 

Upcoming Filing and Notice Deadlines for Qualified Retirement and Health and Welfare Plans

The table below sets forth key filing and notice deadlines common to calendar year retirement and health and welfare plans through July. Please note that the deadlines will be different if your plan year is not the calendar year. For a look at the key filing and notice deadlines for the entire year, please see the March edition of the K&S Compensation and Benefits Insights.

* * Retirement Plans means all employee pension benefit plans as defined in ERISA §3(2).

The contents of this newsletter and any attachments are not intended to be and should not be relied upon as legal advice. If you are not currently on our Employee Benefits & Executive Compensation Practice mailing list under your own name, and you would like to join to receive our monthly Compensation & Benefits Insights publication and to receive notices of future programs and occasional commentaries on new legal developments in the industry, you can make that request by submitting your full contact information to CBI@kslaw.com.

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