Fidelity says it's entitled to alleged 'secret payments' in 401(k) plans

Given the thin margins in the retirement business, firm says it was justified in cutting deals with money managers to boost profits

Jul 9, 2019 @ 2:51 pm

By Greg Iacurci

Fidelity Investments said it is legally entitled to payments it receives in connection with 401(k) investments and that the collection of such fees has become necessary for record keepers given the prevailing economics of the industry.

Fidelity, the largest record keeper of workplace retirement plans, made these claims in a filing asking a federal court to dismiss a lawsuit alleging the fees caused the Boston-based firm to profit at the expense of customers' retirement savings and breached its fiduciary duty.

A participant in T-Mobile USA Inc.'s 401(k) plan, Andre W. Wong, sued Fidelity in February, claiming that mutual funds and other investment products offered through Fidelity's FundsNetwork platform are required by the firm to pay "kickbacks" if revenue-sharing payments made to Fidelity fall below a certain level.

Those payments, Mr. Wong argued, increase investment costs for participants and weren't properly disclosed. Other plan participants have since filed similar class-action lawsuits against Fidelity.

Addressing their consolidated complaints, Fidelity said plaintiffs "try to dress up their claims by repeatedly referencing 'secret payments' or 'secret kickback payments.'"

However, the fee is nothing more than an "arm's length" payment negotiated with certain money managers, and such compensation negotiations don't mean Fidelity is acting as a fiduciary, the firm said. Fidelity negotiated its "infrastructure fees" with asset managers on the FundsNetwork platform in 2017.

In addition to legal reasons, there are "practical" justifications to reject the notion that Fidelity has fiduciary status, the company said, due to squeezed profits among record keepers.

"As is clear from the public record, retirement plan service providers operate at increasingly thin margins, and to continue in business they must negotiate arrangements that allow them some amount of profit," Fidelity said in the filing, made July 1 in the U.S. District Court of the District of Massachusetts.

"If plaintiffs' view of fiduciary status were correct, then service providers like Fidelity could not profit from the services they provide to plans: They could not charge the plans anything more than cost," it added. "If that were the case, there would be no service providers left in business."

More of these sorts of fee arrangements are cropping up between record keepers and asset managers. Empower Retirement, for example, last year launched a platform called Empower Select, requiring mutual-fund providers to pay for fund distribution, which also helps Empower offer the product to small and midsized 401(k) plans at a reduced price point. The platform has some requirements around use of in-house investments, advisers said.

Principal Financial launched a product in May that also requires clients to use some proprietary funds.

Such moves are largely in response to fee compression, advisers said. Median record-keeping fees have fallen by half over the past decade — to $59 per participant in 2017 from $118 in 2006, according to consulting firm NEPC.

Further, plan sponsors and their advisers have shifted away from using record keepers' in-house investments due to fiduciary concerns, depriving the firms of more revenue.

"I think the pendulum has swung so far one way, starting a number of years ago with the move away from proprietary products, I think it's swinging back the other way," said Brady Dall, an adviser at 401(k) Advisors Intermountain.

Fidelity has been targeted in other fee lawsuits in the past. One, for example, alleged the firm took payments from managed account provider Financial Engines. That suit was ultimately dismissed.

The firm also gained attention last year for charging some employers a fee on 401(k) assets held in Vanguard Group investment funds, which some advisers felt was meant to push clients to adopt its own funds more readily.

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