The U.S. District Court for the District of Massachusetts has ruled in favor of Fidelity Investments’ motion to dismiss a consolidated lawsuit alleging it is receiving “secret” or “kickback” payments from mutual fund providers on its FundsNetwork platform.
The ruling comes about eight months after Fidelity filed its dismissal motion, which has successfully argued the firm is entitled to negotiate and collect revenue-sharing fees from mutual fund companies in exchange for access to its “mutual fund supermarket,” as well as for its administrative services. Plaintiffs in the case argued, unsuccessfully, that Fidelity’s ability to influence its own compensation collected via the FundsNetwork platform makes the firm a fiduciary to retirement plans investing in funds via the platform—which in turn would restrict the types of fees it could collect.
Several lawsuits filed against the firm in recent years have claimed revenue-sharing payments tied to the FundsNetwork platform violate the prohibited transaction rules of the Employee Retirement Income Security Act (ERISA), as well as the statute’s fiduciary rules. In its dismissal motion, Fidelity argued that it is entitled to negotiate and collect these fees, and that siding with the plaintiffs in the consolidated lawsuit would be detrimental to retirement savers because of the potential chilling effect on the vibrant mutual fund marketplace.
The dismissal ruling explains that in January 2017, Fidelity began charging mutual funds “infrastructure fees,” which are calculated based on the assets of the plans invested in the mutual funds. Case documents show Fidelity negotiates these fees with mutual fund managers, and that Fidelity has tripled the amount of the infrastructure fees charged to mutual funds since January 1, 2017—first by doubling them effective January 1, 2018, and then increasing them by another 50% effective January 1, 2019.
Plaintiffs in the case argued that mutual fund companies pass on the additional costs of the infrastructure fees to retirement plan clients through their investment fees, with the result that the plans and their participants ultimately pay more (via higher expense ratios) than they agreed to pay in their investment contracts. The Fidelity defendants, on the other hand, argued the case should be dismissed for a failure to state a claim upon which relief can be granted, pursuant to Federal Rule of Civil Procedure 12(b)(6).
In the ruling, the District Court explains that the essence of the plaintiffs’ first theory of liability is that by requiring the payment of infrastructure fees from mutual funds that participate in FundsNetwork after the plans have entered into their contracts with Fidelity defendants, these defendants have unilaterally increased the amount of their compensation from the plans. As such, the plaintiffs contend that Fidelity is a fiduciary under ERISA “by virtue of its discretion and exercise of discretion in negotiating/establishing its own compensation by and through its setting of the amount and receipt of the infrastructure fee payments.”
“Plaintiffs’ first theory fails because they concede that defendants negotiate the payment of infrastructure fees with the mutual funds,” the ruling states. “Plaintiffs’ theory also fails because the complaint does not plausibly allege that the mutual fund managers who pay the infrastructure fees to Fidelity are required to pass on the costs of the fees to the plans or to the participants who invest in their mutual funds. Rather, the decision of whether to pass on those costs is made independently by the mutual fund managers, not by Fidelity. Plaintiffs have therefore failed plausibly to allege that defendants unilaterally control the terms of the compensation they receive from the plans. Without such control, defendants are not fiduciaries with respect to the compensation they receive from the plans.”
The decision notes that the plaintiffs’ second theory (also unsuccessful) is that the defendants are fiduciaries with respect to their use of omnibus accounts through which plan investments are made.
“This theory also fails because plaintiffs do not allege that, as directed trustees of the omnibus accounts, defendants fail to follow the instructions they receive from plan sponsors and participants as to which mutual funds are selected for investment, or how the investments should be allocated,” the ruling states. “Nor do they allege that defendants improperly redirect the investments of plan participants, like plaintiffs, through the omnibus accounts from mutual funds managed by companies that do not pay infrastructure fees to mutual funds managed by companies that do. The court therefore rejects plaintiffs’ second theory of defendants’ fiduciary status.”
The plaintiffs’ third theory is that the Fidelity defendants are plan fiduciaries because they control the menu of investment options available to the plans. This theory also fails, because the relevant contracts make clear that it is the plan sponsors—not the defendants—who select which investment options are made available to the plans’ participants from the FundsNetwork.
“Selecting the funds available on the FundsNetwork Platform does not, without more, transform Fidelity into a fiduciary,” the ruling concludes. “As several other courts have held, having control over the broad menu of investment options from which plan sponsors may choose their plan’s investment options does not transform a platform provider into a functional fiduciary.”
The full text of the dismissal ruling is available here.