Fiduciary obligations with respect to a brokerage window

In this article we review two recent cases that considered claims by participants in 401(k) participant-directed investment plans that plan fiduciaries failed to prudently monitor investments in what fiduciaries claimed were brokerage windows or “similar plan arrangements.”

We note that in one of these cases – Moitoso v. FMR – the plaintiffs won, at least on the issue of the existence of a fiduciary liability with respect to a proprietary mutual fund window. And some of the court’s language in Moitoso will raise issues for some sponsors. In this regard, however, we want to emphasize at the top that while there is a considerable lack of clarity on this issue, most still believe that a true brokerage window does not present this sort of litigation risk.

We begin our discussion with a brief summary of what we do know and what we don’t know about the legal status of brokerage windows and similar plan arrangements.

Here’s what we do know 

Certain DOL participant disclosure rules, e.g., disclosure with respect to specific fund fees, revenue sharing, and comparative fee chart, apply only to designated investment alternatives (DIAs). For this purpose (at least), DIAs do not include “’brokerage windows,’ ‘self-directed brokerage accounts,’ or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan.” 

Generally, with respect to brokerage windows, the plan administrator must provide (1) a description of the brokerage window, (2) an explanation of any fees and expenses charged on an individual basis with respect to the window, and (3) the dollar amount of (quarterly) fees and expenses actually charged against the individual’s account with respect to the window.

Here’s what we don’t know

Is there a fiduciary prudence obligation with respect to funds/investments in a window? While most do not believe that plan fiduciaries have any obligation to monitor-for-prudence the funds offered in “brokerage windows,” “self-directed brokerage accounts,” or similar plan arrangements, at least some courts are prepared to entertain the idea that they do have such a duty.

What is a “brokerage window?” It is not entirely clear what sorts of arrangements qualify as “’brokerage windows,’ ‘self-directed brokerage accounts,’ or similar plan arrangements.” Specifically, it is not clear whether a “mutual fund window” offering, e.g., 300-400 funds would qualify, whether there is a specific number of funds or types of funds that must be offered, or whether “brokerage” (presumably, the ability to buy publicly traded stocks) must be offered.

If there were a fiduciary prudence obligation and it were breached, how does the plaintiff prove loss? It is not clear how damages (and the related issue of “loss causation”) might be determined where an ERISA prudence lawsuit is allowed with respect to a window arrangement.

In what follows, we consider each of these questions in the context of two recent cases – Moitoso v. FMR and Ramos v. Banner Health – that involve “window” options that present these issues.

Background

Moitoso v. FMR: Moitoso is a class action by a group of former Fidelity employees and participants in Fidelity’s 401(k) plan. The case is complicated in a number of respects, but we will focus only on issues related to investments available to plan participants through Fidelity’s NetBenefits platform, which was limited to proprietary Fidelity funds. 

The plan’s investment menu offered: (1) two options that were formally designated as “designated investment alternatives” (DIAs), Fidelity Freedom Funds (a target benefit option) and the Portfolio Advisory Service at Work (PAS-W) (which we assume was a managed account option); (2) Fidelity mutual funds available through the NetBenefits platform; and (3) non-Fidelity mutual funds available through Fidelity’s BrokerageLink platform. Plan fiduciaries did not “monitor for prudence” funds offered in either the NetBenefits or BrokerageLink platform because the plan provided that fiduciaries would only monitor the plan’s DIAs.

Plaintiffs claimed that plan fiduciaries had a duty to monitor the funds in the NetBenefits platform and that by failing do so they breached their duty of prudence under ERISA.

Ramos v. Banner Health: Ramos is a class action by current and former Banner employees and participants in the Banner 401(k) plan. Again, there are a number of issues in the case, but we will focus only on issues related to investments available to participant through the plan’s “Mutual Fund Window,” consisting of 300-400 mutual funds.

The Mutual Fund Window was part of the plan in 2009 (the beginning of the class period) through August 2014. In 2012, Fidelity’s BrokerageLink platform was also added to the plan.

Plaintiffs, among other things, sued plan fiduciaries for failing to monitor the funds offered in the Mutual Fund Window.

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Now let’s turn to how the Moitoso and Banner courts addressed the issues we identified at the top.

Is there a fiduciary prudence obligation with respect to funds/investments in a window?

The preamble to DOL’s 1992 404(c) regulations states that “the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function.” Many have interpreted this statement as (by negative implication) limiting the scope of ERISA’s fiduciary obligation in a 404(c) plan – that is, if there is no “act of limiting or designating investment options” (e.g., as in a window) there is no fiduciary obligation.

Advocates of this approach cite the 2010 amendment to the 404(c) regulations, which state that 404(c) relief “does not serve to relieve a fiduciary from its duty to prudently select and monitor any service provider or designated investment alternative offered under the plan.” Again, by negative implication, indicating that there is not a fiduciary duty to prudently select and monitor non-DIAs.

They also point to the exclusion in related 2010 404(a) participant disclosure regulations that exclude brokerage windows from the definition of DIA. (We note that this issue is further confused by the fact that “designated investment alternative” is defined differently under the 404(a) and 404(c) regulations.)

This approach has not, however, remained unchallenged. In Moitoso, plaintiffs argued that plan fiduciaries _did_have an obligation to monitor the prudence of all plan investment options, including those available through a brokerage window. Considering this issue, the court found “Some courts have extended the duty to monitor to funds available through brokerage windows while others have not, though this Court has not found a judicial opinion actually analyzing the issue.”

The Moitoso court found that “Regulators [i.e., DOL] have declined to weigh in on this question” but that “other communications indicate that it [i.e., DOL] may not consider such a duty [to monitor for prudence] to exist.” The court went on to say that “in the absence of other regulations explicitly imposing such a duty, it is hesitant to state unequivocally that there either is, or is not, a fiduciary responsibility to monitor self-directed brokerage accounts.” And concluded that it did not need to decide this issue because – in its view – the particular arrangement at issue, a platform/window offering only proprietary funds, was not a brokerage window or “similar plan arrangement.”

The Banner court, on the other hand, dismissed this issue – the duty to monitor funds in a brokerage window – with an aside, stating: “Banner Defendants did not monitor investments available in BrokerageLink [Fidelity’s brokerage window product], nor were they required to do so.” (Emphasis added.)

All of which raises the next question.

What is a “brokerage window?”

Both Moitoso and Banner present this question. In Moitoso, the plan offered, in effect, two separate “window” platforms: “Fidelity funds were available on NetBenefits, the online platform previously used by Fidelity, while participants could access the non-Fidelity funds by creating an account on the separate, self-directed BrokerageLink platform.” 

Plaintiffs in their complaint had challenged plan fiduciaries’ failure to monitor the prudence of the proprietary funds available in the NetBenefits platform. Fidelity argued that it had no such duty because (alternatively) (1) NetBenefits was a brokerage window and therefore the funds in it were not subject to an ERISA duty-to-monitor-for-prudence, and (2) even if it were not a brokerage window, as explicitly stated in the plan the NetBenefits platform was not a designated investment alternative.

Citing cases involving plans of financial services companies in which plaintiffs targeted proprietary funds (although not necessarily offered through a brokerage window), and the potential for abuse in these circumstances, the court found that the NetBenefits (proprietary) platform “was not ‘similar’ to a self-directed brokerage window.” 

In reaching this conclusion, the court cited (among other things) the fact that BrokerageLink (which the court assumed was a “brokerage window”) allowed investors to “access a larger investment universe” and “that was not what was happening with Fidelity’s proprietary funds offered [via NetBenefits] on the Plan.” That the Fidelity proprietary funds on the NetBenefits platform had previously been available as DIAs. And that Fidelity treated BrokeragLink in a different way – with separate enrollment, separate webpage, and separate login.

The court did not take up the question of whether the NetBenefits platform, or the funds offered on it, were DIAs, or what might be the consequence of their possible non-DIA status.

We would observe, on this issue, that it may be argued that the Moitoso court’s conclusions are limited to windows that involve proprietary funds. 

In Banner, the plan offered a “Mutual Fund Window” of 300-400 different investment options. As the court noted, plaintiffs and defendants disagreed about whether “the funds offered through the Mutual Fund Window were designated investment alternatives under ERISA, and whether ‘high level’ monitoring [plan fiduciaries “did not monitor, did not intend to monitor, and did not perceive any obligation to monitor each of the funds available in the Mutual Fund Window”] was sufficient to satisfy the RPAC’s [the plan’s investment committee] fiduciary duties of prudence and loyalty.” The court, however, found that it was not required to decide this issue because the plaintiffs had “failed to demonstrate that any such breach [of the duty to monitor] caused economic losses to Plan Participants.”

Which brings us to our third issue: proving damages and “loss causation.”

If there were a fiduciary prudence obligation and it were breached, how do you prove loss?

Some courts see this as a problematic issue. Participants who invest through a brokerage (or mutual fund) window are making an affirmative decision to do so. They are provided robust disclosure (under both ERISA and SEC rules) about the consequences and risks with respect to these investments. They are in many respects indistinguishable from an ordinary investor.

Moreover, in measuring “loss,” what is the alternative against which the participant’s actual window investments should be measured? The Banner court rejected plaintiffs’ proposal that the performance of a plaintiffs’ window investments should be compared to the performance of the plan’s default target date fund. In doing so, it observed (1) that “a knowledgeable fiduciary” might have “simply chosen to monitor the individual funds in the Mutual Fund Window” rather than move assets to the TDF, (2) that specific Mutual Fund Window investments might have better fit a specific participant’s risk profile/preferences, and (3) that not all funds in the Mutual Fund Window were inappropriate investment options.

Moreover, in Banner plaintiffs’ expert presented a somewhat chaotic loss analysis:

Dr. Buetow [plaintiffs’ expert] also corrected his expert report multiple times to correct serious errors in his damage calculations for the Mutual Fund Window. … His first report calculated damages to be $150 million. However, he had to correct this report due to an associate—since terminated—calculating quarterly returns by dividing annual returns by three rather than four. … Dr. Buetow’s corrected report estimated $140 million in damages. … He subsequently issued another corrected report, which claimed $204 million in damages. … Finally, Dr. Buetow issued another corrected report, after he realized that the quarterly returns for 2009 were not uniform, but rather significantly impacted due to large inflows in certain months earlier in the year. … Dr. Buetow adjusted the inflows, made “other corrections,” and issued another corrected report, this time estimating $23 million in damages.

As noted, on these bases, the court found that plaintiffs had not proved “loss causation.”

The Moitoso court deferred consideration of this issue. Noting that “In their complaint, the Plaintiffs put forward numerous theories regarding how Fidelity’s lack of monitoring could have caused losses to the plan,” it stated that, per the parties’ request, consideration of “whether any loss has occurred and, if so, whether the lack of monitoring caused it” was “premature.”

We note that the issue of loss and “loss causation” was (in a somewhat different context) a central element in the Brotherston v. Putnam litigation.

What about ERISA section 404(c)?

Our focus in this article has been on the courts’ treatment of window arrangements, but ERISA section 404(c) provides that, where the plan “permits a participant … to exercise control over the assets in his account, if a participant or beneficiary exercises control over the assets in his account (as determined under regulations of the Secretary) … no person who is otherwise a fiduciary shall be liable under this part for any loss, or by reason of any breach, which results from such participant’s … exercise of control.”

Under applicable DOL regulations, to use 404(c) the plan must provide participants a “broad range of investment alternatives.” Those regulations also provide that (as noted above), ERISA section 404(c) “does not serve to relieve a fiduciary from its duty to prudently select and monitor any service provider or designated investment alternative offered under the plan.” And (also as noted above) in this regard the 404(c) regulations use a different definition on “designated investment alternative” from the one (quoted above) under the disclosure rules. The 404(c) regulations define DIA as “a specific investment identified by a plan fiduciary as an available investment alternative under the plan.”

In the case of a brokerage window, or a mutual fund window, or any “broad range of investment alternatives” that is not a DIA, why isn’t the question simply whether the participant exercised control? This issue has not been vigorously presented by a fiduciary defendant – at least since the initial Seventh Circuit decision in Hecker v. Deere. It may, however, still be raised in current litigation in connection with the question of “loss causation.” 

We note that this argument – that fiduciaries are relieved of liability not because a particular fund was in a brokerage window but because the participant exercised control as contemplated by ERISA section 404(c) – re-frames the analysis. With the critical question now being whether the targeted fund was a DIA.

Takeaways for sponsors

Keeping it brief:

There is a lack of clarity with respect to a number of issues presented by fiduciary claims with respect to window platforms.

There appears to be a higher level of risk with respect to windows that involve proprietary funds or that make available only a limited number of mutual funds.

Lawsuits on this issue with respect to true brokerage windows still seem unlikely – we note that neither the Moitoso nor the Banner plaintiffs challenged fiduciary management of Fidelity’s BrokerageLink.

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We will continue to follow this issue.