The 10th U.S. Circuit Court of Appeals has ruled in an Employee Retirement Income Security Act (ERISA) fiduciary breach lawsuit that alleged various elements of wrongdoing on the part of Great-West Annuity and Life Insurance Company.
The complaint underlying the case suggests Great-West breached the fiduciary duties of loyalty it owed (according to plaintiffs) to customers under ERISA Sections 502(a)(2) and (3)—namely by setting predetermined interest rates artificially low and charging excessive fees in order to increase its own profits from the sale and servicing of certain group annuity contracts. Plaintiffs also allege Great-West engaged in self-dealing transactions prohibited under ERISA Section 406(b), and caused the plaintiff’s retirement plan to engage in prohibited transactions with a party in interest in violation of ERISA Section 406(a).
At question in the case is the Great-West Key Guaranteed Portfolio Fund, as offered to the Farmers’ Rice Cooperative 401(k) Savings Plan. The lead plaintiff in the case is John Teets, a participant in the Rice Cooperative 401(k) plan who elected to invest his plan contributions in the fund. The investment relationship between Great-West and the plan, during the timeframe in question in the suit, was governed by a group annuity contract entered into on March 4, 2008. Among other provisions, the contract provided for a participant’s investment to accrue interest at a rate set prior to each quarter. According to Teets, the interest rate was “determined unilaterally by defendant, without any specified methodology … However, pursuant to the contract, the effective annual interest rate is guaranteed never to be less than 0%.” Money invested in the fund is not kept in a segregated account, but rather is deposited into defendant’s general account.
In short, the appellate court ruling, in response to an appeal from the plaintiffs, takes the side of the defense and determines that Great-West was not a fiduciary in this matter and that the lead plaintiff has not adduced sufficient evidence to impose liability on Great-West as a non-fiduciary party in interest. Technically, the appellate court exercised jurisdiction under 28 U.S.C. § 1291, affirming the lower court ruling.
Not all parties are fiduciaries
The complicated litigation reached the 10th Circuit on appeal from the U.S. District Court for the District of Colorado, which ruled on the case in favor of Great-West back in December of 2017.
Before digging into the substance of the issues raised and settled in the now-affirmed district court ruling, the appellate decision steps through a detailed description of its conception of the various requirements and intentions of ERISA. On the one hand, the court emphasizes that a party not named specifically as a fiduciary in a contract or a retirement plan’s governing documents can nonetheless be a “functional fiduciary” by virtue of the authority the party holds over the plan. At the same time, the text of the decision details the appellate court’s belief that that so-called functional fiduciaries’ obligations are limited in scope, such that “plan management or administration confers fiduciary status only to the extent the party exercises discretionary authority or control.”
Some other important preliminary points raised by the appellate decision are that functional fiduciaries must actually exercise their authority or control over the plan’s assets to create liability, and that any alleged breach of a functional fiduciary’s obligations must arise out of a concrete exercise of that authority or control. Finally, the appellate court emphasizes that, although named fiduciaries and functional fiduciaries obtain fiduciary status in different ways, they are bound by the same restrictions and duties under ERISA.
As detailed by the appellate court, ERISA also restricts transactions between fiduciaries and non-fiduciary third parties, referred to as “parties in interest.” Such parties can and do include retirement plan investment and recordkeeping service providers, per ERISA Section 3(14)(B).
“A fiduciary may not allow a plan to engage in a transaction the fiduciary knows or should know is (1) a sale or exchange, or leasing, of any property between the plan and a party in interest; (2) lending of money or other extension of credit between the plan and a party in interest; (3) furnishing of goods, services, or facilities between the plan and a party in interest; (4) transfer to, use by or for the benefit of, a party in interest, of any assets of the plan; or (5) acquisition, on behalf of the plan, of any employer security or employer real property in violation of [§] 1107(a).”
Important to clarify, as the appellate ruling does, is the fact that, although parties in interest have no fiduciary obligations to a plan or its participants, the Supreme Court has read ERISA Section 502(a)(3) to allow a suit against a party in interest for its participation in a prohibited transaction. This is the framework under which the appellate court reviewed the Great-West lawsuit, and which is used by other higher and lower courts to assess allegations of wrongdoing against non-fiduciary parties.
Strong backing of district court ruling
Before the district court, plaintiffs claimed that Great-West had breached its general duty of loyalty under ERISA Section 404 by setting the credited rate of a certain investment for its own benefit rather than for the plans’ and participants’ benefit; setting the credited rate artificially low and retaining the difference as profit; and charging excessive fees. In addition, the plaintiff argued Great-West, acting in a fiduciary capacity, had engaged in prohibited transactions.
“As a prerequisite to bring both of these claims,” the appellate decision recounts, “the plaintiffs alleged that Great-West is an ERISA [functional] fiduciary because it exercises authority or control over the quarterly credited rate and, by extension, controls its compensation.”
Technically, the district court limited its review of these two fiduciary duty claims by addressing only this prerequisite—that is, whether plaintiffs had sufficiently established Great-West’s fiduciary status. Because the district court found that Great-West was not a fiduciary, it did not address whether Great-West had breached any fiduciary obligations. Great-West’s fiduciary status is thus the focus of the appellate court review of the fiduciary duty claims.
A third claim, raised in the alternative in the district court complaint, was based on Great-West’s having non-fiduciary status. Plaintiffs alleged that Great-West was a non-fiduciary party in interest to a non-exempt prohibited transaction under ERISA Section 406(a) insofar as it had used plan assets for its own benefit. On all three claims, plaintiffs sought declaratory and injunctive relief and “other appropriate equitable relief,” including restitution and an accounting for profits.
After discovery, the parties filed cross-motions for summary judgment. The district court denied the plaintiffs’ motion and granted summary judgment for Great-West. It disposed of the first two claims at the same time, concluding that Great-West was not acting as a fiduciary of the plan or its participants. It held that Great-West’s contractual power to choose the credited rate did not render it a fiduciary under ERISA because participants could “veto” the chosen rate by withdrawing their money from the fund in question. As to Great-West’s ability to set its own compensation, the court held that Great-West did not have control over its compensation and thus was not a fiduciary because the ultimate amount it earned depended on participants’ electing to keep their money in the investment fund each quarter.
The district court also granted summary judgment against plaintiffs’ third claim, concluding that Great-West was not liable as a non-fiduciary party in interest because plaintiffs had failed to establish a genuine dispute as to whether Great-West had “actual or constructive knowledge of the circumstances that rendered the transaction unlawful.”
Following this defeat, the appellate court was asked by plaintiffs to reconsider whether Great-West is a functional fiduciary because it exercises authority or control over plan assets when it sets crediting rates or its compensation; and whether, if Great-West is not a fiduciary, it is liable as a non-fiduciary party in interest for its participation in a transaction prohibited under ERISA.
In short, the appellate court in its de novo review reaches the same conclusions as the district court. Some points of emphasis in the appellate decision include that, by following the terms of an arm’s-length negotiation and the subsequent contract, retirement plan service providers do not as such act as a fiduciary. To establish a service provider’s fiduciary status, an ERISA plaintiff must show the service provider did not merely follow a specific contractual term set in an arm’s-length negotiation, and instead took a unilateral action respecting plan management or assets without the plan or its participants having an opportunity to reject its decision.
“Because Great-West does not have unilateral authority or control over the credited rate, it also lacks such control over its compensation,” the appellate decision states. “We therefore affirm the district court’s summary judgment ruling that Great-West is not a functional fiduciary.”
Also emphasized by the appellate court is how the plaintiff “has not cited any case in which a court has deemed a service provider to be a fiduciary based on participants’ lack of alternative investment options, or on anything other than imposing a penalty or fee for withdrawal.”
“Moreover, the plaintiffs have not cited, and we have not found, a case finding fiduciary status based solely on restrictions on participants’ ability to leave a fund,” the appellate decision says. “Even if the ability of participants to reject service provider actions is relevant to the fiduciary status, plaintiffs failed to provide factual support to counter Great-West’s assertion in district court that participants can freely transfer their money out of the fund.”
Finally turning to the non-fiduciary party in interest claims, the appellate court again sides wholly with the district court’s reasoning, noting that the ERISA Section 406(a)22 prohibition most relevant to this case is the “transfer to, or use by or for the benefit of a party in interest, of any assets of the plan.”
The text of the appellate court decision goes into substantial detail on all these matters, offering a timely refresher on the mechanics of ERISA as perceived by an influential panel of appellate court judges. There is also a short addendum written by one of the judges regarding the majority’s analysis in Part II(A)(3)(a)(ii), offering a different approach to the same conclusions.