Haddock v. Nationwide and Revenue Sharing

An interesting decision was handed down last month in the much watched Haddock v. Nationwide 401(k) fee case. The courts, for the first time, certified a class consisting of all pension benefit plans using a specific provider, in this case Nationwide. Here is the class definition from the ruling made by U.S. District Judge Stefan Underhill:

“All trustees of all employee pension benefit plans covered by ERISA [The Employee Retirement Income Security Act of 1974] which had variable annuity contracts with Nationwide or whose participants had individual variable annuity contracts with Nationwide at any time from January 1, 1996, or the first date Nationwide began receiving payments from mutual funds based on a percentage of the assets invested in the funds by Nationwide, whichever came first, to the date of November 6, 2009.” Haddock v. Nationwide Financial Services Inc., No. 3:01-cv-1552 (SRU) (D. Conn)

Background:

In 2001, the trustees for a handful of 401(k) plans filed suit against Nationwide Financial Services Inc., claiming Nationwide’s contracts with mutual fund companies and retention of revenue sharing was a breach of Nationwide’s fiduciary duty. Central to their claim is the assertion that revenue sharing is a plan asset, which implies that Nationwide’s alleged quid pro quo engagement with mutual fund companies involving revenue sharing violates ERISA’s prohibition of fiduciary “self-dealing”.

Revenue sharing is a practice whereby mutual fund companies pass a portion of their management fees to other “intermediaries.” In the context of a 401(k) plan the mutual fund company passes a portion of the fund expense ratios to other service providers such as the plan’s custodian or recordkeeper. For fuller treatment of plan fees, including revenue sharing, click here.

In 2006 the court denied the defendant’s motion for summary judgment, finding “triable issues of fact” relating the characterization of revenue sharing as a plan asset. In its ruling, the court noted that no explicit definition of plan assets can be found in ERISA and that the regulations and current case law do not provide a definition of plan assets as they relate to revenue sharing. The court called for a “functional approach” to defining plan assets using a two pronged test. According to the ruling plan assets would include benefits received by defendant (1) as a result of its exercise of fiduciary discretion or authority, and (2) at the expense of plan participants or beneficiaries. See Haddock v. Nationwide Fin. Servs., 419 F. Supp. 2d 156 (D. Conn. 2006) for details.

Needless to say this ruling was widely read and discussed within the 401(k) community.

Recent Ruling:

Judge Underhill found that the class of “all trustees of all pension benefit plans…which had contacts with Nationwide” meets the numerosity, commonality, typicality and adequacy requirements for class certification. Judge Underhill also found that the primary purpose of the class would be to obtain injunctive and declaratory relief (i.e. to stop Nationwide from continuing its practices related to “revenue sharing”) and that monetary relief is secondary.

At the heart of this issue is the allegation that Nationwide used it’s collective pool of 401(k) money as leverage to negotiate with mutual fund companies for more revenue sharing in exchange for inclusion of their funds on its 401(k) platform; and that the revenue sharing received was not used to offset a pre-disclosed fee, but rather was additional income for Nationwide. Indeed, the plaintiffs

"allege that the revenue sharing payments were not made in return for any services, arguing that those services were already being paid for by the Plans and participants through the standard fees charged by Nationwide…In other words, Nationwide was already being compensated for those administrative tasks, and, therefore, the revenue sharing payments were pure profit."

Judge Underhill in a prior ruling found “the Trustees have raised a triable issue concerning whether Nationwide in fact performed services in consideration for those payments.”

Because Nationwide was (allegedly) leveraging its collective pool of plan assets for its own benefit, then the trustees of these plans constitute a class that has standing in relation to the fiduciary breach claim.

Conclusion

As a provider we are certainly wary of any developments that would impede our industry’s ability to provide quality and cost-effective services. However, Nationwide is not alone in its treatment of revenue sharing. Many providers either don’t disclose revenue sharing and/or don’t use revenue sharing to offset pre-established fees. We often analogize 401(k) fees to icebergs: you only see the small amount “above the surface.”

I hope this case will call attention to some of these less than transparent practices and will drive more providers to disclose all of their revenue, not just to plan sponsors, but also to plan participants.

The impact of this case will ultimately dependent on whether congress passes real fee disclosure rules for the financial services industry. But that is a discussion for another blog post.