A recent Ninth Circuit decision highlights the obligation of plan fiduciaries (including the employer and its investment committee) to assure that they understand and evaluate all compensation that a plan’s service providers receive from the plan to assure it is reasonable and disclosed to participants. In Bugielski v. AT&T Servs., Inc., 76 F.4th 894 (9th Cir. 2023), the Ninth Circuit reversed the lower court’s decision granting summary judgment to AT&T and remanded for further review of allegations that AT&T breached its fiduciary duty of prudence and engaged in a prohibited transaction by signing a service agreement which allowed Fidelity, the plan recordkeeper, to receive additional compensation from other service providers. The related entities included Financial Engine Advisors, LLC (which provided investment advisory services to plan participants) and Brokerage Link (Fidelity’s brokerage account platform). The addition of Financial Engine and Brokerage Link allegedly resulted in millions of dollars of revenue sharing fees being paid to Fidelity from participants who invested in mutual funds, over and above the flat per participant fee charged by Fidelity to the plan for recordkeeping services.
The plaintiff participants alleged that AT&T violated ERISA by failing to investigate all the compensation Fidelity received through the separate arrangements Fidelity had with the other plan service providers. The Ninth Circuit determined that amendment to the services agreement adding these additional options for plan participants constituted a prohibited transaction under ERISA 406(a)(1)(C). The Court noted that ERISA 406 has a “broad scope” that creates a “broad per se prohibition of transactions ERISA implicitly defines as not arms-length.” Such a transaction also required fee disclosure under ERISA 408(b)(2), which AT&T did not provide to plan participants. Finally, the arrangements also may have breached AT&T’s fiduciary duty of prudence.
The Ninth Circuit remanded to the district court to determine whether the requirements for an exemption from the prohibited transaction rule under 408(b)(2) applied. Service contracts or other arrangements may be exempt from the ERISA 406 prohibited transaction bar if (1) the contract or arrangement is reasonable; (2) the services are necessary for the establishment or operation of the plan; and (3) no more than reasonable compensation is paid for the services. AT&T argued that reasonableness only applied to the compensation Fidelity received directly from the plan and participants, and not to the indirect fees paid to Fidelity from other service providers. The Ninth Circuit, citing EBSA’s explanation for its amendment to the 408(b)(2) implementing regulations, disagreed and held that reasonableness includes an evaluation of both direct and indirect compensation.
Employers and plan fiduciaries should carefully review (and negotiate) Administrative Service Agreements (ASA) with its plan service providers, and employers need to assure that they understand all sources of fees and compensation (direct and indirect) paid to the plan service providers. It is not unusual for service providers to be paid a flat fee from the plan, and also to disclose in the ASA that they are paid additional compensation from other sources which may include revenue sharing, wrap charges, commissions, referral fees, and other “hidden fees” or “indirect fees”. Although some service providers remit such additional compensation to the plan or offset such additional compensation from the fees charged to participants, others (as in the AT&T case) do not. Despite the “disclosure” in the ASA, many employers fail to understand that service providers may be receiving additional indirect revenue. Other providers may not even disclose such indirect fees unless a specific inquiry is made, despite the duty under ERISA for vendors to disclose all fees. An employer’s failure to understand all fees (direct and indirect) received by a service provider in connection with the services provided to the plan could be a breach of the duty of prudence under ERISA 404, as well as a prohibited transaction. Expenses, such as management and administrative fees charged to the plan, can significantly reduce the value of a participant’s account.
NELGPC attorneys regularly assist plan sponsors in the negotiation of Administrative Service Agreements, and in assessing the reasonableness of fees in relation to the services provided by the vendor. Payment of “hidden” and “indirect” fees is a source of potential liability for plan sponsors – and investment committee members – who may be trying to do a good thing for plan participants, as in the AT&T Case, but violate the very high standard of prudence under ERISA. As the Court in AT&T stated, “ERISA is an enormously complex and detailed statute.”
If you need assistance reviewing or negotiating ERISA provider Fee and Administrative Service Agreements, or have concerns about other ERISA compliance obligations or correction matters, contact a member of the Najjar Employment Law Group, P.C.