Compliance March 20, 2019

Another Undisclosed Fee Lawsuit Filed Against Fidelity

According to the recent complaint, Fidelity has breached its fiduciary duties to retirement plans by charging mutual fund and other investment companies a substantial fee as a condition for their investment vehicles being offered on Fidelity’s fund platform.

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Participants in several retirement plans served by Fidelity Investments have filed a lawsuit challenging what it claims are undisclosed payments received by Fidelity through its “Funds Network.”

This is the second such lawsuit filed against Fidelity this year. In a statement to PLANADVISER about the new lawsuit, Fidelity said, “Fidelity emphatically denies the allegations in this complaint and intends to defend against this lawsuit vigorously. Fidelity fully complies with all disclosure requirements in connection with the fees that it charges and any assertion to the contrary is not only misleading, but simply false. Fidelity has an outstanding platform that provides significant benefit to our customers, including an extensive offering of funds with no transaction fees, the ability to consolidate investments in one place, and industry-leading tools to help find the right funds. We are committed to remaining an open architecture platform that provides access to thousands of funds to all of our customers, but such a broad offering requires substantial infrastructure. For example, Fidelity must support systems and processes needed for recordkeeping, trading and settlement, make available regulatory and other communications, and provide customer support online and through phone representatives. It is costly to maintain this kind of infrastructure, and Fidelity requires the fund firms on our platform to compensate us for those costs. For a small number of those companies, this includes an infrastructure fee that is charged to the fund firms.  The fee is not charged to the plan sponsor or plan participants.”

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According to the recent complaint, brought on behalf of similarly situation Fidelity retirement plan customers, since at least 2016, Fidelity has breached its fiduciary duties to the plans by charging mutual fund and other investment companies a substantial fee as a condition for their investment vehicles being offered on Fidelity’s fund platform. The lawsuit alleges that “Although Fidelity refers to this arrangement as an ‘infrastructure’ fee, it is in fact an illegal and undisclosed pay-to-play fee that Fidelity extracts from investment companies that wish to ensure their products are marketed and sold through Fidelity.” The plaintiffs say the fee drives up expense ratios borne by 401(k) plan participants, causing these participants to pay more in fees and receive lower returns on their investments.

The complaint cites a Wall Street Journal report that said Fidelity instructed participating mutual funds not to disclose the fee to any third party, including plan sponsors, plan beneficiaries and the public. The Journal further reported that, based on internal Fidelity documents, the fee represents “0.15% of a mutual-fund company’s industry-wide assets.” According to the plaintiffs, that the fee is calculated by reference to industry-wide assets, rather than assets held only through Fidelity, confirms that the fee bears no meaningful relationship to any “infrastructure” maintenance by Fidelity and constitutes excessive compensation.

According to the complaint, Fidelity has significant leverage to coerce payments from mutual fund complexes interested in offering their funds through Fidelity. The firm also offers its own mutual funds, and the fee enables it to offset losses it has sustained from investors flocking to lower-cost index funds.

The plaintiffs point out that the Department of Labor (DOL) and the Massachusetts Securities Division have each opened investigations into Fidelity’s imposition of the fee.

The lawsuit alleges that Fidelity’s assessment of the fee constitutes self-dealing that violates Fidelity’s fiduciary duties and the Employee Retirement Income Security Act’s (ERISA)’s prohibited transaction rule. Additionally, the fee constitutes indirect compensation to Fidelity that must be disclosed to the plans under ERISA, which mandates written disclosure of any such compensation that Fidelity “reasonably expects to receive” in connection with its services. “Despite its fiduciary and disclosure obligations, Fidelity continues to charge the fee and keeps the amount of the fee payments confidential,” the complaint says.

The plaintiffs seek to enforce the Fidelity defendants’ liability to return all plan losses arising from each breach of fiduciary duty and to restore to the plans all profits gained through the use of the plans’ assets. They also seek to enjoin Fidelity’s imposition of the undisclosed fee.
Data & Research March 20, 2019

2018 Largest Asset Allocation De-Risking Year for DB Plans Since 2011

Actions taken by defined benefit (DB) plan sponsors helped them reduce Pension Benefit Guaranty Corporation (PBGC) premiums, according to a J.P. Morgan analysis.

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Entering Q3 2018, corporate pension plans had broken through post-crisis highs and were on course to notch a second year of strong funded status gains, notes J.P. Morgan’s “Corporate Pension Peer Analysis 2018,” written by Michael Buchenholz, head of U.S. Pension Strategy, Institutional Strategy and Analytics.

But because average funded status declined an estimated 7.2% in Q4 2018, J.P. Morgan’s analysis of the largest 100 corporate defined benefit (DB) plans by assets found only a 1.5% improvement to an 87.2% funded status on average for the year.

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Returns for almost every public market asset class fell in 2018, with the exception of extended credit exposures. Agency mortgages/collateralized mortgage obligations (CMOs), commercial mortgage loans (CMLs), bank loans and other securitized assets had small positive returns. “These asset classes are increasingly being utilized as hedge portfolio diversifiers and did their job in 2018,” says Buchenholz.

Generally, the only plan sponsors with positive total returns for the year were those whose fiscal year ended prior to the Q4 market rout. The peer set’s average calendar year return, -3.9%, was the worst performance since a flat 2015 and, before that, the 2008 financial crisis.

De-risking activities

Preceding Q4, rising rates, accelerated contributions, improved funded status and concerns about equity market valuations led to the largest asset allocation de-risking year since 2011. Buchenholz notes that while the pension industry has been steadily increasing fixed income duration every year since at least 2010, data from regulatory filings show that 2018 brought a large shift in actual fixed income allocation. More than 20 of the top 100 plans moved 10% or more of assets into fixed income over the year. J.P. Morgan expects this de-risking trend to continue along with constructing more diversified hedge portfolios and shifting more assets into low-equity-beta alternatives like infrastructure equity.

This shift in fixed income allocation corresponded with lowered return assumptions. The average expected return assumption for plans with 70% or more in fixed income assets was 5.70%.

Buchenholz cites LIMRA research that shows the pace of pension risk transfers continued unabated. One of the major drivers of pension risk transfer activity over the last several years has been the accelerating costs of Pension Benefit Guaranty Corporation (PBGC) premiums. Buchenholz points out that DB plan sponsors have attempted to reduce these outlays by improving funded status, reducing head count, off-loading small balance participants to minimize the variable rate cap, and other “actuarial engineering” transactions, such as the reverse spinoff, which was rebuffed by the PBGC. PBGC data suggests that despite the continued march higher in premium levels, plan sponsors have been successful: The average premium paid as a percentage of assets declined two years in a row, to 16bps for the top 100 plans, and closer to 20bps for all pension plans.

Other topics explored in the review are pension contributions versus other uses of cash and the impact of changes to pension accounting and reporting rules.

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