Fiduciary Practice Reviews Can Pay Off

A recent $140 million fiduciary breach settlement involving Nationwide Financial should be a call to action for retirement specialist advisers, says David Witz of Fiduciary Risk Assessment LLC.

After 13 years and a number of court opinions, all granting relief in the plaintiffs’ favor, Nationwide presented a motion in December 2014 to settle a major lawsuit over its revenue-sharing practices.

According to Witz, the settlement is nearly 10 times greater than some other recent high-profile settlements. The lawsuit was initially filed against Nationwide in 2001 over “undisclosed revenue-sharing payments” collected from nonproprietary mutual funds offered to clients on its defined contribution (DC) plan platform. The suit, Haddock v. Nationwide, claimed that Nationwide violated the Employee Retirement Income Security Act (ERISA) when it kept payments from these funds.

Nationwide is the third-largest writer of 401(k) contracts in the nation, the company says in its press releases. In all, five ERISA plan trustees challenged Nationwide as part of the suit.

Witz says some compliance professionals have interpreted the case to be a blow to the legitimacy of revenue-sharing agreements, but he sees it somewhat differently.

“You can argue until you’re blue in the face that revenue sharing is wrong, but I don’t know how productive that’s going to be, because it’s an established practice and it’s been going on for so long,” Witz says. “The practical application of this is that revenue sharing is being used, and it’s being done by a lot of people, so I don’t expect it to stop any time soon.”

Some feel the case and subsequent settlement is more about collecting revenue that was not fully disclosed, and whether or not Nationwide had a fiduciary obligation to disclose it because it had a significant amount of discretion over how plan participants’ dollars were invested.

For their part, the lead plaintiffs in the action claimed that the refunds of management fees that Nationwide received from nonproprietary mutual funds—i.e., revenue-sharing payments—were plan assets that should have been returned to the plans. Furthermore, they alleged that, in not revealing these “kickbacks,” Nationwide misrepresented the level of fees it was receiving.

Court documents show Nationwide offered the plans various investment options, including insurance products, such as variable annuities. The variable annuity contracts allowed the plans and plan participants to invest in a variety of mutual funds selected by Nationwide.

Even with this level of discretion over plan investments, Nationwide argued it was not subject to ERISA’s prohibited transaction rules because it was not a named fiduciary to the plans and because the revenue-sharing payments were not plan assets. In 2006, the U.S. District Court for the District of Connecticut determined Nationwide Financial Services Inc. and Nationwide Life Insurance Co. were in fact functional plan fiduciaries under ERISA, and the trustees therefore deserved a chance to present further evidence against the Nationwide companies.

The court said, “A rational fact-finder … could find that Nationwide’s ability to select, remove and replace the mutual funds available for the Plans’ investment constituted discretionary authority or discretionary control respecting disposition of plan assets, and thus that Nationwide is an ERISA fiduciary.” The court also said, “The Trustees have also raised triable issues concerning whether the challenged payments constitute plan assets under a functional approach and whether, even if the revenue-sharing payments do not constitute plan assets, Nationwide’s service contracts constitute prohibited transactions.”

In settling the matter before a full trial, Nationwide committed to a number of significant changes to its business practices that will result in different investment options and enhanced disclosures for the plans and for future purchasers of Nationwide’s annuity contracts and trust platform products.

Witz says the settlement includes a number of action items that can be used to create a blueprint to mitigate litigation risk for any retirement plan, whether it is funded with a group annuity contract or a trust.

“To date, this is the largest settlement ever in an ERISA fiduciary breach case involving the receipt of revenue sharing by a service provider,” he tells PLANADVISER. “If you are an adviser who sells and services retirement plans, you need to review and consider adopting some of the same action items.”

Overall, Witz says the Nationwide settlement shows the importance of having well-documented processes and procedures in place that “may add to an adviser’s labor burden, but will result in mitigated litigation risk.” Witz’s first recommendation is for advisers to start presenting all products offered by a single covered service provider (CSP) that a prospect or client qualifies to purchase, rather than selecting a limited product pool to present.

"Typically, multiple products are tied directly to different pricing scenarios that should be communicated to the responsible plan fiduciary, in order to allow them to make truly an informed decision about how participant dollars will be invested,” Witz notes. “Once a purchase happens, any changes that affect pricing after the buying decision is made should also be formally reviewed within 60 days.”

Witz feels any clients using legacy products that have been replaced with more efficient and cost-effective contemporary solutions “should be informed of the likely opportunity of adopting a better solution.”

Next, in cases where the CSP offers the same investment option in multiple share classes, advisers must present their recommended menu with each share class, “or at least the book-ends to demonstrate each pricing scenario or range,” Witz says. “This also includes identifying which investment options are proprietary, non-proprietary, and sub-advised, and identifying the cost impact by using one type of fund over another.”

In the wake of the Nationwide settlement, it’s also becoming increasingly clear that service providers must disclose both the gross and net operating expense ratio broken down by fund, Witz says, as well as any 12(b)(1) or other indirect fees taken from participant balances or investment returns. In addition, CSPs must disclose the amount as a percent and dollar amount, who can receive it, and who pays it, Witz says.

Witz also suggests advisers should provide clients with an estimate of the revenue sharing expected for each fund at the beginning of the plan year and a final tally of the revenue sharing paid for each fund at the end of the year—to show the amount of revenue sharing is being closely tracked. It will also be helpful to hold discussions with clients about where revenue sharing payments come from, and where they are going. Advisers may take the complexity of revenue sharing arrangements for granted—but retirement plan sponsors often have less investing experience.

“The amount of revenue sharing paid should be compared to other platforms to confirm that the amounts received are competitive,” he notes, adding that the entire process should be carefully documented.

“Document the file for any investment option additions, removals, or substitutions added during the course of the contract year by the plan sponsor and the effect that will have on overall cost,” Witz continues. “Documentation must include affirmative consent to the investment change by the plan’s trustees or the investment manager.”