Fidelity Faces a Myriad of Allegations in New ERISA Lawsuit

In addition to self-dealing allegations, the complaint calls out Fidelity for not negotiating revenue sharing refunds for its 401(k) plan participants and not considering stable value options for its plan investment lineup, among other things.

A new lawsuit has been filed against Fidelity Investments and its parent company, FMR, accusing the firm’s 401(k) plan fiduciaries of self-dealing among other things.

Alleging that, “For financial service companies like Fidelity, the potential for imprudent and disloyal conduct is especially high, because the plan’s fiduciaries are in a position to benefit the company through the plan’s investment decisions by, for example, filling the plan with proprietary investment products that an objective and prudent fiduciary would not choose,” the complaint accuses plan fiduciaries of using the plan as an opportunity to promote Fidelity’s mutual fund business at the expense of the plan and participants.

According to the complaint, the defendants loaded the plan exclusively with Fidelity-affiliated investments, without investigating whether plan participants would have been better served by investments managed by unaffiliated companies. It says the plan included almost every non-identical Fidelity mutual fund in its investment lineup (hundreds in total), “many of which were inappropriate offerings due to their poor performance, high fees, lack of diversification, or speculative nature.”

The lawsuit says because the defendants’ failed to manage the plan in accordance with their Employee Retirement Income Security Act (ERISA) fiduciary duties, among the 20 defined contribution plans with more than $5 billion in assets for which necessary data was available, Fidelity’s plan performed the worst (almost three times worse than average), representing more than $100 million per year in losses compared to the average plan.

The lawsuit alleges that the defendants knew their conduct was unlawful because they settled a similar lawsuit four years ago. In that settlement agreement, Fidelity did not admit to any wrongdoing.

In a comment to PLANADVISER, Fidelity says it strongly disputes the allegations in the complaint; it provides an excellent retirement plan to its employees; and it plans to vigorously defend against this lawsuit.

Specific allegations

Saying the Fidelity 401(k) plan is one of the 20 largest private-sector defined contribution plans in the United States, the lawsuit accuses the defendants of failing to appropriately utilize the plan’s bargaining power to lower costs, and as a result, plan participants paid significantly higher fees than participants in similar plans.

The lawsuit claims that as of the end of 2016, the plan had “by far” the highest fees among the approximately 110 defined contribution plans with more than $5 billion in assets. The plan’s fees were 0.58% of assets, more than double the asset-weighted average of 0.24%, and a full 0.10% higher than its closest peer, the complaint says. “Had the plan’s fees simply matched the average for plans with more than $5 billion in assets, total fees would have been $47 million lower in 2016 alone.”

The plaintiffs allege that Fidelity needlessly increased average plan expenses by including every Fidelity fund within every asset class. For example, the complaint says, as of the end of 2015, the plan included six different funds within the Diversified Emerging Markets Morningstar Category, with a broad range of expenses. The plaintiffs say the defendants breached their fiduciary duties by failing to investigate whether the additional costs of each of these duplicative, more expensive options were justified.

The complaint also says the offering of Fidelity sector funds was duplicative and unnecessary, and that some fund were poorly managed by Fidelity. It says none of these sector funds provided any diversification benefit to participants, they were not conducive to participant implementation of a prudent investment strategy, and they were more expensive than diversified alternatives. In addition, the complaint says there were years—or in some cases, decades—of evidence that in certain asset classes, Fidelity’s managers could not generate competitive returns. “Had the fiduciary defendants conducted such an investigation, they would have readily found better-managed options,” the complaint says. “A prudent and loyal fiduciary would have removed funds that exhibited consistent underperformance, saving participants millions of dollars.”

The defendants also failed to investigate the availability of lower-cost marketplace alternatives, according to the complaint. For example, the complaint says, the plan offered all eight of Fidelity’s mutual funds within the High Yield Bond Morningstar Category. These funds ranged in fees from 0.67% to 1.02%. The complaint compares them to marketplace alternatives with fees ranging from 0.13% to 0.49%.

Different investment vehicles and share classes

The lawsuit calls out Fidelity for not adequately investigating non-mutual fund alternatives such as collective trusts and separate accounts, pointing out that the firm offers its institutional clients collective trust and separate account products that are similar or identical to mutual funds in the plan. “Had an adequate investigation occurred, the fiduciary defendants would have switched the plan’s investments to such vehicles in light of the enormous cost savings as well as the lack of benefit from the mutual fund structure,” the complaint says.

The defendants are also accused of failing to adequately investigate the availability of lower-cost share classes of several of the mutual funds in the plan. Specifically, the plaintiffs say the defendants in some cases failed to use lower-cost K shares of the Fidelity-branded funds and failed to use lower-cost Z shares of the Fidelity Advisor-branded funds. For example, the complaint says, the plan used the standard no-load version of the Fidelity Emerging Markets fund, with expenses of 0.96% per year, even though K shares of the Fidelity Emerging Markets fund would have cost participants only 0.81% per year.

Revenue sharing and stable value vs. money market

The defendants are accused of failing to demand revenue sharing rebates from the investment manager that managed all of the plan’s investments (Fidelity) or the affiliated entity that made those payments, Fidelity Investments Institutional Operations Company (FIIOC), even though FIIOC made similar payments to most of its other retirement plan customers. “Had the fiduciary defendants simply negotiated a contract in line with Fidelity’s recordkeeping contracts with other retirement plans, revenue sharing rebates from 2015 and 2016 would have covered Fidelity’s standard recordkeeping charges (which would have been between $1 and $1.5 million per year, given the number of participants), with an excess of approximately $31.5 million per year that could have been refunded to participants,” the complaint says.

The lawsuit also claims that throughout the relevant period, the plan’s capital preservation options have consisted exclusively of Fidelity-affiliated money market accounts that have earned little interest given the structural disadvantages associated with money market funds compared with other capital preservation options. It says Fidelity did not include its stable value fund in the plan, because doing so would constitute a prohibited transaction to which no exemption would apply. However, the plaintiffs say Fidelity should have investigated nonproprietary stable value offerings in the marketplace, which would have revealed the availability of stable value vehicles that earned much better returns than the proprietary money market funds in the plan at comparable or lower levels of risk.

Finally, the complaint points out that for several years prior to 2012, Fidelity made discretionary contributions to participant accounts equal to 10% of participants’ compensation. In 2012, according to the plan’s Form 5500, Fidelity continued to make discretionary contributions equal to 10% of participants’ eligible compensation, but began characterizing a portion of this contribution as a “refund” of investment management fees paid by participants the prior year. However, the lawsuit alleges that in reality, this “refund” was “a poorly-disguised gimmick that provided no benefit to plan participants.”

The complaint says, “Fidelity took money that it was going to contribute anyway and recharacterized a portion of it as a fee ‘refund.’ Thus, for every dollar in investment management fees that Fidelity gave back to plan participants, Fidelity reduced its profit sharing contribution to participants by the same amount.”