Compliance September 26, 2011

Appellate Court Rejects Another Revenue-Sharing Case

Another plan sponsor has prevailed in a revenue-sharing case – and at the appellate court level. 
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This time the case was Loomis v. Exelon, a case argued before the 7th U.S. Circuit Court of Appeals, which had previously weighed in on the case that appears to be setting the tone in most of these cases, “Hecker v. Deere & Co.”    In Loomis, Exelon employees had argued that the company breached its fiduciary duties to its 401(k) by providing investment options requiring the payment of excessive fees. (see Court Tosses 401(k) Participants’ Request for Investment Losses Relief). 

Here the 7th Circuit noted that “the district court decided that the current suit is a replay of Hecker and dismissed it on the pleadings,” and, despite some discussion of the issues, upheld the lower court’s dismissal – with prejudice – of the case.  Writing for the court, Chief Judge Easterbrook concluded, “Unless Hecker is to be overruled, our plaintiffs cannot prevail” – and was clearly in no mood to overrule its own determination in the Hecker case.

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The Department of Labor had argued in a friend of the court brief that, in dismissing the Exelon employees’ Employee Retirement Income Security Act fiduciary duty claims, the trial court required an “unduly high pleading standard” not contemplated by ERISA. Solis’s also contended the lower court misread the 7th Circuit’s ruling in Hecker.  

Exelon Offerings

In this particular case, the Exelon plan offered 32 funds, 24 of them mutual funds open to the public, with expense ratios ranging from 0.03% to 0.96%.  According to the court, the plaintiff-participants contend that the plan administrators violated their fiduciary duties under ERISA by offering “retail” mutual funds, and in “requiring participants to bear the economic incidence of those expenses themselves, rather than having the Plan cover these costs”.  Here the court noted that “all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition”  Additionally, the 7th Circuit was persuaded that participants had available a “wide range” of options.  The court also restated its holding in Hecker, that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund.” 

Regarding the inclusion of those retail funds on the menu, the court noted that “Both Exelon and the funds distribute literature and hold seminars for the participants, educating them about how the funds differ and how to identify the low expense vehicles. Plaintiffs do not contest the adequacy of the Plan’s and the funds’ disclosures. What plaintiffs contend instead is that, if a pension plan offers only “institutional” vehicles, fees will be lower on average, and that participants tempted by a high-expense fund might save.”   

The 7th Circuit did delve into some new waters regarding the motivations of the plan sponsor in offering those retail funds, but ultimately noted that “…there is no reason to think that Exelon chose these funds to enrich itself at participants’ expense. To the contrary, Exelon had (and has) every reason to use competition in the market for fund management to drive down the expenses charged to participants, because the larger participants’ net gains, the better Exelon’s pension plan is. That enables Exelon to recruit better workers, or reduce wages and pension contributions without making the total package of compensation (wages plus fringe benefits) less attractive.”  The court went on to assert that “competition thus assists both employers and employees, as Hecker observed”, a finding it held in contrast with plaintiffs in an 8th Circuit case involving Wal-Mart employees where it was alleged that that the plan sponsor limited participants’ options to ten funds as a result of kickbacks.  “Nothing of the sort is alleged in this case,” the 7th Circuit justices noted.

The Exelon ruling included a discussion over the relative advantages of retail mutual funds compared with “institutional” offerings that might not be as liquid and/or transparent, noted that the expenses of those retail funds in the Exelon plan were lower than averages provided by the Investment Company Institute (ICI), and also wondered aloud “…why mutual funds would offer lower prices just because participants in this Plan have pension wealth that in the aggregate exceeds $1 billion”.  The court noted that “Exelon can’t commit that sum, or any portion of it, to any one fund without abandoning the arrangement under which the participants themselves choose where their money will be invested”.

Regarding an alternative pricing scenario put forth by plaintiffs, the court cautioned that “A flat-fee structure might be beneficial for participants with the largest balances, but, for younger employees and others with small investment balances, a capitation fee could work out to more, per dollar under management, than a fee between 0.03% and 0.96% of the account balance.” 

As for whether the employer was under some kind of obligation to underwrite the plan fees, the court said “ERISA does not create any fiduciary duty requiring employers to make pension plans more valuable to participants.  When deciding how much to contribute to a plan, employers may act in their own interests.”

 

Ultimately, the 7th Circuit held that “Exelon offered participants a menu that includes high-expense, high-risk, and potentially high-return funds, together with low-expense index funds that track the market, and low-expense, low-risk, modest-return bond funds. It has left choice to the people who have the most interest in the outcome, and it cannot be faulted for doing this.”

The case is online at http://www.ca7.uscourts.gov/tmp/BK1FEU3V.pdf 

 

IMHO September 26, 2011

IMHO: “Better” Business

There was another judicial decision in another revenue-sharing case earlier this month—and another victory for a plan sponsor.

 

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The case was Loomis v. Exelon, a case argued before the 7th U.S. Circuit Court of Appeals (see Appellate Court Rejects Another Revenue-Sharing Case), which had previously weighed in on the case that appears to be setting the tone in most of these cases, “Hecker v. Deere & Co.”  Hecker, as you may recall, involved a situation with a large, multi-billion-dollar plan that offered its participants access to a couple of dozen funds from a single provider alongside a self-directed brokerage window that afforded access to funds beyond that (see Appellate Court Backs Revenue-Sharing Case Dismissal).  The 7th Circuit dismissed that challenge, finding that the competitive forces of the market were sufficient to ensure reasonable fee levels for the specific funds on the menu, and that, if the participants felt otherwise, they could always pursue other options via the brokerage window.

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In Exelon, there was no brokerage window, though there were 32 fund options, mostly (24) mutual funds—mutual funds that were retail-class funds.  Once again, the 7th Circuit noted that “all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition,” and restated its holding in Hecker that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund.”   And then the court launched off into what, IMHO, was an odd juxtaposition of the benefits of those retail funds against “institutional” funds, which it claimed don’t offer the same level of liquidity, transparency, and ability to benchmark against comparable investments.  Really?  Have they never heard of an “I” share1?

I once opined that, based on the Hecker decision, I would advise plan sponsors to give “participants LOTS of fund choices —via a brokerage window if possible—and I would make sure that there were at least some low-cost fund choices available via that window,” and that, among other things, I wouldn’t concern myself “overly much with the fees paid by the plan/participants—so long as those fees were paid via mutual fund expense ratios that are the same as those paid by investors in the retail market” (see IMHO:  “‘Winning’ Ways?”).  It was a tongue-in-cheek remark, of course, but the Hecker decision struck me as heavily – perhaps too heavily – dependent on free-market principles: Participants weren’t forced to put money in the plan, those who chose to do so weren’t forced into any particular option, and the fees associated with those options were, almost by definition, reasonable since they were subject to free and fair market forces. 

That same court was similarly inclined here—and, if you can’t embrace the rationale, one can at least appreciate the consistency.   

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1 in fairness, the Exelon court did acknowledge the existence of instutional class holdings.  It just didn’t accord their advantages/comparability any substance in their analysis.  

More than that, in this case, the 7th Circuit noted that Exelon had no real motivation to put “bad” fund options on the retirement plan menu.  “[T]here is no reason to think that Exelon chose these funds to enrich itself at participants’ expense. To the contrary, Exelon had (and has) every reason to use competition in the market for fund management to drive down the expenses charged to participants, because the larger participants’ net gains, the better Exelon’s pension plan is. That enables Exelon to recruit better workers, or reduce wages and pension contributions without making the total package of compensation (wages plus fringe benefits) less attractive. Competition thus assists both employers and employees, as Hecker observed.”

The question here isn’t whether Exelon, or any employer, reaps personal benefit from the plan, or how it is structured.  Employers do, of course, reap the recruiting/retention benefits of providing a robust and competitive package of benefits, alongside certain tax benefits—though, in my experience, these pale in comparison to the investment of time, money, and effort required.  The decision to offer a plan, like the decision to participate, is voluntary.  Bad law and intrusive regulation can weigh on the former, and poor plan design and lax administration can surely restrain the latter.

ERISA fiduciaries are, however, not merely expected to offer a “competitive” program, nor is it enough to simply steer clear of arrangements that enrich their bottom line at the expense of participants.  Rather, every plan decision is supposed to be not just in the interests, but in the BEST interests, of participants, and from the perspective—or with the assistance—of experts in the field. 

That test may, of course, be satisfied by merely offering access to the same types of investments available to retail investors, but that doesn’t mean we shouldn’t expect—better. 

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