Santomenno v. Transamerica: imprudent provider fees are a sponsor responsibility

On February 23, 2018, the Ninth Circuit Court of Appeals found for defendant plan provider in Santomenno v. Transamerica, finding that Transamerica as plan administrator was not a fiduciary with respect to the negotiation or collection of its own fees. In reaching this decision, the Ninth Circuit stated explicitly that the reasonableness and prudence of plan fees are an issue for plan fiduciaries, not service providers.

In this article we briefly review the court’s decision.

Background

Plaintiffs represent a class of participants in plans for which Transamerica provided recordkeeping and administrative services. Under the arrangement with Transamerica (which included a Transamerica Group Annuity Contract (“GAC”)), plan sponsors created a plan fund menu by selecting funds from a list of investment options. As described by the court, that list “includes several [funds] advised and managed by [Transamerica and its affiliates].” And the Transamerica list of options “did not always offer the lowest-priced share class.”

Plan investments were generally structured as pooled separate accounts (one for each underlying investment option). Transamerica’s compensation was (under the GAC) a fixed percentage of assets in each separate account. In addition, Transamerica received (revenue sharing) fees from managers of funds in the plans’ fund menus. All of these fee arrangements were fully disclosed to plan fiduciaries.

Plaintiffs’ claims

Plaintiffs claimed that Transamerica and its affiliates were fiduciaries and, as such, violated ERISA by:

Charging fees on the separate accounts in addition to those charged by the managers of the underlying investments.

Charging an “Investment Management Charge” on the separate accounts.

Receiving revenue sharing payments from managers of the underlying investments.

Failing to invest in the lowest priced share class of the mutual funds in the separate accounts.

“[N]egotiating the traditional lower fees that are associated with these investment options [separate accounts] but retaining them rather than passing the savings along to Plaintiffs.”

Motion to dismiss

Transamerica moved to dismiss, asserting that it did not violate ERISA because it was “not a fiduciary with respect to the terms of its own compensation.” Following three other circuit courts that had considered “virtually identical claims to those raised here,” the Ninth Circuit agreed with Transamerica.

“Pre-administration” claims

With respect to allegations that related to the period prior to Transamerica becoming administrator – the fee negotiation stage – the court found:

Under two of the prongs of the functional fiduciary definition “[o]nly discretionary acts of plan . . . management trigger fiduciary duties.” … A service provider is plainly not involved in plan management when negotiating its prospective fees or compiling a list of proposed investment options. Rather, at that stage [quoting the Third Circuit in a related case] “discretionary control over plan management lies . . . with the trustee, who decides whether to agree to the service provider’s terms.”

To connect the dots here: if the provider’s fees are unreasonable, approval of them is an ERISA fiduciary breach by plan fiduciaries, not by the provider. The Ninth Circuit makes this point in unmistakable language:

The district court believed that failing to assign a fiduciary duty to a service provider during negotiations with employers would allow the provider to “negotiate for a fee of 99% of each separate account and still be considered to be fulfilling its fiduciary duty of managing the separate account.” But [again quoting the Third Circuit] “any plan sponsor who agreed to a 99% fee arrangement would itself be liable for breaching its fiduciary duty.”

Post-negotiation claims

The court then considered plaintiffs’ claims that Transamerica, after it commenced its duties as a plan administrator, engaged in prohibited self-dealing by: “(1) receiving revenue sharing payments from investment managers; and (2) withdrawing its fees from the separate accounts.”

The court “easily dismissed” the revenue sharing claim with a holding that Transamerica “is not a fiduciary with respect to the revenue sharing payments, because they were fully disclosed before the provider agreements were signed and do not come from plan assets.”

With respect to the claim that it would be a prohibited transaction for a fiduciary to withdraw fees from plan funds, the court held:

[W]hen a service provider’s definitively calculable and nondiscretionary compensation is clearly set forth in a contract with the fiduciary-employer, collection of fees out of plan funds in strict adherence to that contractual term is not a breach of the provider’s fiduciary duty.

Emphasizing the narrowness of this holding, the court explained that “If plaintiffs had alleged that [Transamerica] withdrew more than it was entitled to, or if [its] fee were based on self-reported hours worked, or even if [it] withdrawals involved expenses, this might well be a different case.”

Significance for sponsors

We’ve (briefly) reviewed this case – which involves litigation against a provider – because it makes clear that, with respect to most claims based on the imprudence of provider fees, the target under ERISA will be the sponsor and sponsor fiduciaries, not the provider.

We will continue to follow this issue.