The words “revenue sharing”—foul language to some 401(k) participant advocates—did not make their way into the Supreme Court’s unanimous ruling in Tibble v. Edison.
But that doesn’t mean the payment schemes arranged between sponsors, investment managers, third-party plan administrators, and record keepers won’t be affected by the decision.
That’s because when the Supreme Court speaks, people listen, especially on rulings affecting the Employee Retirement Income Security Act, says Nancy Ross, an ERISA specialist and partner at Mayer Brown.
She and her Mayer Brown colleague, Brian Netter, said they expect the court’s narrow ruling, which confirmed sponsors’ ongoing duty to monitor investments even after the six-year statute of limitation provided in ERISA, will lead to an increase in litigation.
“We usually see that, whether the Supreme Court rules in favor of plaintiffs, or even when the court rules in a way that limits plaintiffs claims,” said Netter, who clerked for Justice Stephen Breyer before becoming an ERISA specialist in private practice.
In its ruling, the Supreme Court stated the obvious, according to Ross—that the fiduciary duty to prudently monitor investments is ongoing.
But she also warned that duty extends beyond the selection and monitoring of investments. “I expect shortly that this innocuous decision will serve as the backbone for many types of new claims,” said Ross.
Principal among those claims will be how sponsors monitor revenue-sharing agreements with third-party service providers, she said.
While the Supreme Court did not set parameters for what prudent monitoring should look like, some ERISA experts think the court’s finding signaled a tacit rebuke of the use of more expensive retail-class mutual funds, the 12b-1 fees which sponsors have used as part of revenue-sharing agreements to offset the cost of administering some 401(k) plans.
“If you’re a fiduciary to a $1 billion-plus plan, there’s no way you should be offering retail-class shares of mutual funds,” said Jerry Schlichter, lead attorney for the plaintiffs in the Tibble case.
In an interview with BenefitsPro in the immediate wake of the ruling, Schlichter said the High Court’s ruling in Tibble should put all plans and their advisors on notice.
“Many institutional funds have rates for as little as $1 million in investments,” he explained. “Warren Buffet doesn’t pay retail, and neither should participants in a multi-billion dollar plan.”
But 12b-1 fees paid by retail funds, which are typically not offered in the cheaper institutional class shares of mutual funds, are only one of several ways a plan can arrange a revenue-sharing agreement. Neither retail shares nor revenue sharing are illegal under ERISA, reminded Schlichter.
However, “fiduciaries are required to make sure record-keeping costs paid by asset-based revenue sharing are reasonable,” explained Schlichter.
Sponsors face unique liabilities in asset-based revenue-sharing agreements, where service providers are paid a percentage of the value of a plan’s assets, he said, citing the example of a market spike of 25 percent.
“In asset-based revenue-sharing agreements, that could mean the cost of record keeping goes up 25 percent, along with the market, without plan participants getting any additional services. That’s why these arrangements have to be monitored if revenue sharing is going to be used to pay record-keeping costs,” added Schlichter.
Nancy Ross and Brian Netter are in agreement with Schlichter on the duty to monitor revenue sharing agreements. That’s notable, given both the Mayer Brown attorneys have been part of the defense teams in some of the highest-profile claims brought by Schlichter and his firm.
Ross was at one time part of the lead defense team in an excessive-fee claim against Northrop Grumman, which is still being litigated while the Department of Labor conducts its own investigation into the matter.
Netter was a lead attorney in the defense of a claim against Lockheed Martin, which the contractor settled for $62 million this year, said to be the largest 401(k) settlement.
The Tibble decision, which Ross recently said was the result of “clever lawyering” in a seminar exploring the decision’s ramifications, is not the death knell for revenue-sharing agreements, or even for retail-class mutual funds in large plans, she said.
“Revenue sharing is not a four-letter word,” said Ross. “It has gotten a bad rap in light of a number of lawsuits. Done right there is nothing wrong with it, and it can be a real value for participants.”
Netter said there are circumstances in which some arrangements are desirable and others where they are not. He is not of the opinion that all asset-based revenue-sharing agreements are a bad thing.
“If you eliminate all of those arrangements and go to fixed-fee agreements, you may see the cost of record keeping go up for sponsors and participants in some cases. It is certainly possible you could have higher fees without revenue sharing,” said Netter.
Ross and Netter are far less sure than Schlichter that retail shares of mutual funds are headed the way of the dinosaur in large 401(k) plans.
“Retail and institutional funds often have critical differences,” said Netter. “Institutional class funds may have a different liquidity policy, may have withdrawal limitations, or a different investment mix. And sometimes retail shares have more thorough disclosures.”
And those 12b-1 rebates available in retail shares? “It is possible a fiduciary could look at the two different classes and see the retail class is the better option for participants,” said Netter.
Sponsors that were holding out for the Supreme Court to define exactly what prudent monitoring should look like in Tibble had no such luck. In remanding the case, the lower courts might be left to ferret that out.
As for Ross, she’s not expecting courts to deliver bright lines for sponsors to work within.
“I don’t think we are going to get any universal principles of monitoring that will apply to fiduciaries,” said Ross.
And “courts are unlikely to broadly pronounce a retail-share mutual fund is always imprudent,” she added.
So what does the decision in Tibble vs. Edison mean for sponsors in the immediate future when it comes to assessing liability in their revenue sharing agreements?
To Ross and Netter, it all leads back to the necessity of a robust monitoring process.
Two words—thoroughness and vigilance—should be the mantras to a sponsor’s monitoring process, with respect to all plan decisions, including revenue sharing agreements, said Ross.
At the very least, that should mean an annual review of investment selections, and RFPs to service providers at least every three years.
“Difference of opinion is your friend,” she said of fiduciaries and investment committee members.
“Reach a decision and document why you came to a conclusion,” she added.
The spirit of ERISA intended a balance, she thinks, between governing participants’ rights while not discouraging employers from voluntarily offering access to retirement plans.
Courts recognize a need to maintain that balance, and to not dis-incentivize sponsors from providing access to plans, thinks Ross.
“I believe courts will maintain that balance,” said Ross. “If fiduciaries can show they have a methodical procedure, and are keeping up with industry standards to monitor, then at the end of the day that is going to go a long way with courts.”