Decision Against Transamerica Criticizes Fiduciary Warranties (and Pretty Much Everything Else) – UPDATED

A little reported decision out of the Central District of California, Santomenno v. Transamerica Life Ins. Co., No. 12-2782, has the opportunity to cause great heart burn (or worse) to insurance company platforms for retirement plans. A plan participant from two different retirement plans filed a class action lawsuit against Transamerica Life Ins. Co. (“TLIC”) seeking to represent a class of over 15,000 retirement plans serviced by TLIC. A copy of the complaint can be found here.

In a sweeping decision on TLIC’s motion to dismiss, the court found that plaintiffs have plausibly alleged numerous fiduciary violations of ERISA including that TLIC, because of the facts and circumstances alleged, may be a fiduciary with responsibility to monitor its own compensation.

Claims:

The following claims survived TLIC’s motion to dismiss:

  • Fees TLIC charges in excess of the fees charged by an underlying mutual fund are excessive.
  • TLIC’s investment management fees on separate accounts are excessive.
  • TLIC receives “fee income” or “Revenue Sharing Payments” from Plaintiffs’ investments, ranging from 15 to 25 bps.
  • TLIC breached its ERISA fiduciary duties by
    • Failing to invest in the lowest cost share class of the mutual funds underlying separate account investment options, even though TLIC had the leverage to do so.
    • Failing to use its economic leverage to negotiate lower fees for collective trusts and traditional separate accounts.
  • TLIC committed prohibited transactions under ERISA § 406(b), 29 U.S.C. § 1132(a)(3), by paying advisory fees from employees’ accounts to affiliates Transamerica Investment Management, LLC (“TIM”) and Transamerica Asset Management, Inc. (“TAM”) for advising or subadvising certain mutual funds, collective investment trusts, or traditional separate accounts.

The court also criticized the fiduciary warranty included in the plan’s contracts. “Based on the allegations before the court, it appears that the Fiduciary Warranty amounts to insurance provided by TLIC to employers against law suits by employees for breach of fiduciary duty, but this insurance is paid for by the fees assessed on the employees’ assets. The court has found no indication that the employers pay TLIC separately for such insurance. Thus, instead of an insurance company bargaining with a party seeking to obtain the best rate for itself in its insurance purchase, the insurer is bargaining with a party who is not in fact bearing the financial burden of the insurance, though it will reap the benefits. Because the contract does not appear to have been negotiated at arm’s length, TLIC may not shield itself behind the contract from an alleged breach of duty.” Order at 15.

“Plaintiffs may be able to show that TLIC used the promise of the fiduciary warranty to direct employers to select TIM- and TAM-managed accounts,” which the court found could be a prohibited transaction. Order at 26.

Immediate Appeal:

TLIC has filed a 1292(b) motion asking the district court to certify the following question for immediate appeal to the 9th Circuit Court of Appeals. (such appeals are rarely asked for and even more rarely granted):

Whether a service provider is a fiduciary with respect to fees charged to an ERISA plan where the plan’s named fiduciary agreed to the fees before the service provider charged and collected them.

The district court has yet to rule on this motion. We are tracking the case and you will hear about any developments here first.

UPDATE April 25, 2013 6:00pm Central: The district court has denied Defendants’ motion. Barring any other maneuvers, the case will now proceed to the discovery phase.

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Background:

Santomenno v. Transamerica Life Ins. Co., No. 12-2782 (C.D. Cal.), was originally filed in 2011 in the District of New Jersey, but subsequently moved to the Central District of California by Defendants in March of 2012. The plaintiffs are represented by a conglomerate of firms, including Keller Rohrback, LLP. Defendants are represented by O’Melveny & Myers, LLP. This case is different than the traditional excessive fee case in that Plaintiffs are suing the bundled service provider and not the plan sponsor.

TLIC is an insurance company that sells bundled 401(k) plans in the small and mid sized market. Plan sponsors sign an administrative services agreement and a Group Annuity Contract. The investments offered by TLIC are all separate accounts, typically with mutual funds as the underlying investment. The wrapper is alleged to be 75 bps. Thus, for example, an 18 bps Vanguard fund charges 93 bps to participants. However, some of the mutual funds and collective trusts are managed by Transamerica Investment Management, LLC (“TIM”) or Transamerica Asset Management, Inc. (“TAM”), affiliates of TLIC. Plaintiffs have alleged that all or nearly all mutual funds selected for inclusion as a separate account, have a contractual agreement with TLIC to pay it revenue sharing.

Significant Holdings by the Court:

Is TLIC a fiduciary?

“TLIC does not contest that under the GAC it has fiduciary responsibility for the separate accounts. It concedes that it has “limited fiduciary responsibilities” for monitoring the investment performance within its separate account investment products.” (TLIC Mot. at 12.) But TLIC disavows any fiduciary duty with respect to its fees because they were set by contract before TLIC assumed its fiduciary responsibilities as defined in the same contract.” Order at 12.

“The court rejects this formalistic line-drawing. TLIC is negotiating to become a fiduciary and negotiating for the fees that, as a fiduciary, it will assess on the employees’ retirement accounts. The reductio ad absurdum of the principle that a future fiduciary is not responsible for the terms of its own compensation is that the fiduciary could 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 simply because it negotiated this fee by contract. The contract can immunize the future fiduciary TLIC from fiduciary breach no more than it can immunize the employer. To hold otherwise would allow fiduciaries to contract themselves out of their duties, so long as it was done prior to the assumption of those duties. TLIC is entitled to reasonable fees and profits for the services that it provides to the plans, but as a fiduciary TLIC is accountable for the reasonableness of those fees. This conclusion does no damage to the sanctity of contracts; it simply acknowledges that where fiduciary duties are involved, the fiduciary rules apply. Because TLIC is negotiating to assume the high duties of an ERISA fiduciary, it must be accountable to the beneficiaries of the plan for the reasonableness of its compensation.” Order at 13.

Ability to change fee schedule.

TLIC also argued that the ability to change its fee schedule upon advance notice did not provide it “discretion” over its fees because employers could reject any noticed fee changes by terminating their contracts. The court rejected this argument, holding that “whether the employer chooses to terminate the contract or not is immaterial to determining whether TLIC has the discretion to change the fees,” and that “[t]his is all the more true where, as here, there are financial and logistical hurdles to prevent an employer from cancelling a contract.” Order at 16-17.

Ability to add or delete investment options.

“The court finds that TLIC has a fiduciary duty that attaches from its power to add and delete investment options, such that it ‘exercises authority or control over plan assets by determining and altering which mutual funds are available for the Plans’ and the participants’ investment.’ Haddock v. Nationwide Fin. Servs. Inc., 419 F. Supp. 2d 156, 166 (D.Conn. 2006).” Order at 19.

“The facts alleged by Plaintiffs are sufficient to state a claim for TLIC’s fiduciary responsibility on this theory. Unlike in Hecker, where the complaint alleged that the service provider ‘played a role’ in the choice of funds rather than exercising ‘final authority,’ Hecker, 556 F.3d at 584, here there is no indication that an employer has final authority over such changes beyond its ability to terminate the contract. As discussed above, an employer’s ability to terminate a contract if it does not approve of a unilateral decision to substitute or delete options does not somehow transform TLIC’s decision into the employer’s decision.” Order at 19-20.

Plan sponsor’s ability to terminate is not the same as fiduciaries discretion.

The court held that “TLIC conflates its discretion to do an act, i.e., its election to switch to investment options with allegedly excessive fees, with the employer’s possible remedy in terminating the contract. It also appears to assume again that the employer has the right to terminate the contract only because the contract so specified. But the employer may have both the right and the obligation to terminate the contract if employees’ investments were placed in or moved into investment accounts with excessive fees, regardless of the terms of the contract with TLIC.” Order at 20 n.8.

Having OR exercising discretion are both fiduciary functions.

“[T]he court therefore finds that in the ERISA context, having and exercising discretionary authority are so close as to be identical, and that under ERISA, a fiduciary duty attaches not because a party takes a discretionary action but when that party acquires the power to take a discretionary action.” Order at 22.

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If you know of other cases that you would like tracked here, please email Tom at tclark@fraplantools.com.

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