For providers of financial services to Employee Retirement Income Security Act of 1974 plans, fees are a double-edged sword.
They are an important source of profit, but the more aggressively they are applied, the greater the regulatory and litigation risk they entail.
A recent bulletin from leading ERISA attorney Fred Reish of Drinker Biddle & Reath LLP indicated that the Labor Department is ramping up efforts to detect improper or undisclosed compensation by service providers under the DOL's Consultant/Adviser Project.
Being subject to an investigation is very bad news for the service provider and potentially for its ERISA plan clients, as well. According to the Labor Department's description of CAP, “when ERISA violations are uncovered, [the DOL] will seek corrective action for past violations as well as prospective relief to deter future violations ... [The DOL] also may need to investigate individual plans to address such potential violations as failure to adhere to investment guidelines, and improper selection or monitoring of the consultant or adviser.”
The risks are highest for fiduciaries because they are subject to the “exclusive purpose” rule, which requires ERISA fiduciaries to discharge their duties for the exclusive purpose of providing benefits to the plan participants and beneficiaries, and to incur only reasonable expenses in administering the plan.
Among the first things the Labor Department seeks to establish in conducting a CAP investigation is the fiduciary status of service providers. Even if a service provider doesn't intend to serve in a fiduciary capacity, it may be deemed to be a fiduciary by virtue of its activities.
Mr. Reish noted: “Providers such as broker-dealers who do not acknowledge fiduciary status ... may nonetheless become functional fiduciaries by virtue of providing individualized advice or being able to set their compensation.”
New Labor Department disclosure requirements that go into effect next year will require service providers to delineate their services, costs and compensation, and fiduciary status. These disclosures are likely to make CAP examinations more efficient and, therefore, more numerous.
Although regulatory risk is likely to be the most common concern among service providers and their ERISA plan clients, it isn't necessarily the biggest risk. Litigation and headline risks are featured in the nightmare scenario for providers that aren't sufficiently attentive to their fiduciary obligations.
Consider a lawsuit filed last month, Kruegar v.
Ameriprise Financial Inc. The case involves Ameriprise's own employees' suing the financial services firm for using certain proprietary mutual funds in their plan that the plaintiffs allege are inferior and excessively expensive, compared with alternatives available in the marketplace — and to funds available through other share classes of those used in the plan.
The case is unique in that Ameriprise and its affiliates are involved as both plan sponsor and service providers. The arrangement contains inherent conflicts of interest and elevated risks.
The allegations in the case are sweeping and include breach of fiduciary duty, unjust enrichment, prohibited transactions and failure to monitor.
EXPENSIVE LITIGATION
The direct costs of litigation are sure to be expensive, the potential damages of a finding against Ameriprise could be in the tens of millions, and it is already a public relations disaster.
Looking beyond the serious charges, and litigation and PR costs involved, consider the disruption to the organization. Defendants in the case include, in addition to the company itself, members of the compensation and benefits committee of its board, retirement plan committees and committee members.
If the case is certified for class action, the suit could apply to tens of thousands of employees.
Even if the case is settled in favor of the defendants, there will be no winners. Litigation necessarily distributes damages to all.
Service providers, regardless of whether they believe themselves to be fiduciaries, must be alert to potential consequences of the decisions that they make about the structure, amount and distribution of fees associated with their products and services. A highly recommended awareness-building ex-ercise for service providers is to periodically review their products, services and business practices as they imagine themselves before a regulator, in a court of law or with a reporter, explaining how they serve the best interests of investors.
Blaine F. Aikin is chief executive of Fiduciary360 LLC.
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