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“BReaking BAd:” Anatomy of a Fiduciary Breach | January 2014
By Philip J. Koehler, Esq.

The television series “Breaking Bad,” winner of ten Primetime Emmy Awards, was one of the most gripping crime dramas in recent memory.  It tells the story of the last two years of the life of Walter White.  Walter is a decent, but aloof and overqualified, middle age high school chemistry teacher.  He is living a life of quiet desperation in Albuquerque, New Mexico with his wife and two children when he is diagnosed with Stage III lung cancer.  The cost of his medical treatment forces him to take a part time job at a car wash, leaving his self-esteem in shreds.  During an impromtu ride-along with his brother-in-law, a DEA agent, Walter witnesses a drug bust and has an “epiphany” of sorts when he gets a first hand introduction to the highly profitable methamphetamine trade.   He quickly decides to capitalize on his Ph.D. in chemistry and begins manufacturing and selling the drug with the help of Jesse, a former student and small time drug dealer.  Walter rationalizes this new endeavor as the only way he can secure his family’s financial future before he dies.  But, as he navigates the seamy and violent underworld of Meth trafficking through his alter ego, “Heisenberg,” raking in millions of dollars, Walter’s rationalization morphs into something sinister and disconnected from the genuine interests of his family, corrupting his superior intellect and blinding him to the suffering he inflicts on many people.  He clings to this illusion whenever pangs of conscience arise, but by the time the series draws to a tragic conclusion, Walter’s repeated and feeble insistence that everything he’s done he did “for his family” earns him nothing but bitter contempt.

There appear to be many shades of “Breaking Bad” or what can also be called a “Faustian Bargain.”  In Goethe’s classic story of Faust, Mephistopheles, or Satan in human form, makes a bet with God, that he can lure God’s favorite and most morally correct human being (Faust), away from righteous pursuits.  To do this, Mephistopholes offers Faust a lifetime of whatever he desires, in exchange for which Faust must serve him in Hell when he dies.  For Faust, as for Walter, the basic structure of the deal is accepting an immediate benefit, which on the surface appears to further one’s legitimate aims, but comes with the hidden or delayed cost of inflicting greater harm.  After reading hundreds of fiduciary breach cases, one discovers that this is often at the very core of fiduciaries “Breaking Bad.”

Early last year, in Tussey v. ABB, the District Court for the Western District of Missouri issued an 81-page Trial Order holding the defendant-ABB 401(k) Plan fiduciaries liable for multiple fiduciary breaches and granting the plaintiff- class of plan participants substantial relief, including restitutional damages to the plan of $36.9 million plus attorneys’ fees.  The fiduciaries’ appeal is currently pending before the 8th Circuit Court of Appeals.  While there has been considerable public comment about the soundness of the Trial Order and, if affirmed, what it portends for ERISA fiduciaries going forward, we may be missing the bigger picture, which is the untold human story of how things went so wrong.

Of course, it’s not the purpose of the Court to tell us a convincing and dramatic story.  Rarely are all the details for a compelling storyline entered into the record, or if they are, do the parties consent to their being publically available.  However, in this case, there is an unusual amount of detailed material reported in the Trial Order and the parties’ pleadings filed in the court docket.  There’s nothing that resembles Walter White’s visceral story of “Breaking Bad,” but there’s ample evidence to reconstruct the “Faustian Bargains” that otherwise well-intentioned executives were induced to make.  The Order should be required reading for anyone who is, or seeks to become, an ERISA fiduciary.

The key players in Tussey v. ABB include:

  • Members of ABB’s board of directors who sat on the board’s three-member Pension Review Committee (“PRC”) and three-member Employee Benefits Committee (“EBC”).   (The PRC and the EBC are the named fiduciaries of the ABB’s Union and Non-Union 401(k) Plans (the “Plan”).  The Plan covered more than 17,000 employees and had assets of approximately $1.5 Billion.  The PRC had fiduciary responsibility regarding Plan investments and the EBC had fiduciary responsibility to act as the Plan’s “Administrator.”  The EBC was also responsible for the management of all of ABB’s other employee benefit plans, including ABB’s defined benefit plans, health and welfare plans and a nonqualified deferred compensation plan for a select group of management and highly compensated employees, called the “Restoration Plan.”)
  • The Pension & Thrift Management Group (“PTM”) was a department within ABB.  (The employees working in the PTM served as the PRC’s staff.)
  • John W. Cutler, Jr. (“Cutler”) served as the “Director” of the PTM and was a plan fiduciary.
  • John Sackie (“Sackie”) was Vice President of Human Resources during the relevant time.
  • Fidelity Investments (“Fidelity”), one of the world’s largest money managers, managed at least thirteen mutual fund options available under the Plan.
  • Fidelity Management Trust Company (“Fidelity Trust”), a wholly owned subsidiary of Fidelity, was the Plan’s trustee and record-keeper.

ABB engaged Fidelity Trust in 1995 to provide record-keeping and directed trustee services in exchange for a flat dollar per participant fee (“Plan Services”).  This arrangement changed as the PRC added more and more revenue sharing mutual funds to replace nonrevenue sharing funds or revenue sharing funds that rebated their revenue sharing payments directly to the plan.  Eventually, Fidelity Trust was paid primarily with “revenue sharing” dollars.  Some of these dollars flowed directly from the funds offered under the Plan.   Fidelity credited additional amounts of revenue sharing to Fidelity Trust through an internal allocation within the Fidelity family of companies, aka “internal revenue sharing.”   None of these revenue sharing arrangements were disclosed to participants before the complaint was filed.

Fidelity’s relationship with ABB expanded to include services outside the Plan, or what Fidelity termed a multi-practice engagement.”  ABB engaged Fidelity to provide recordkeeping for several of ABB’s defined benefit plans in 1997, the Restoration Plan and hundreds of ABB’s health and welfare benefit plans in 1999 and 2000; and general payroll for all ABB employees in 2004 (“ABB Corporate Services”).   None of the ABB Fiduciaries calculated the total fees paid to Fidelity Trust or attempted to determine their reasonableness.  Not surprisingly, while Fidelity lost money on the ABB Corporate Services, it made a substantial above-market profit on Plan Services.  Previously, ABB was cautioned by its pension consultant that the Plan was paying excessive fees to Fidelity Trust and this could be construed as subsidizing the cost of Fidelity’s Corporate Services.   ABB took no action in regard to this communication.

Shortly after becoming Director of the PTM in 1999, Cutler convinced the PRC to adopt an Investment Policy Statement (“IPS”).  However, at the same meeting in which the committee approved the IPS, Cutler recommended that it remove the Vanguard Wellington Fund (the only remaining nonrevenue sharing fund) due in part to its alleged “deteriorating performance.”  The Vanguard Wellington Fund was the Plan’s single largest fund (with assets over $120 million) and internal communications showed that Fidelity targeted it for replacement with its revenue sharing Fidelity Freedom Funds.  Contrary to Cutler’s representation, the Vanguard fund performed exceptionally well, beating Morningstar’s 5-year benchmark by over 400 basis points.  When Cutler made his recommendation to the PRC he had no information about the fund’s actual performance and did not, as required by the newly approved IPS, perform any calculations that would have justified placing it on a watch list, let alone removing it from the fund lineup.

That same year Cutler and Sackie met with Fidelity to review, what Sackie described as, the pricing implications of changing the Plan’s fund lineup.  At this time, the Plan paid Fidelity Trust for Plan Services with a combination of revenue sharing plus a $10 per participant fee.  On the other hand, Fidelity had clearly priced its Corporate Services as a loss leader to induce ABB fiduciaries to look the other way on its fees for Plan Services.  For example, Fidelity charged no fees for providing record keeping to the nonqualified Retoration Plan (in which Sackie was a participant).

At that meeting Fidelity pointed out the financial incentives to ABB if more assets in the Plan were moved to Fidelity mutual funds and dangled three options in front of Sackie and Cutler:  (1) it would reduce the per participant fee to zero if the Vanguard fund was mapped over, and defaulted, to the Fidelity Freedom Funds and Fidelity’s index funds were retained,  (2) it would reduce the per participant fee to zero for all non-union employees and from $10 to $8 for all union employees if the Vanguard fund was not mapped over, but Fidelity’s index funds were retained, and (3) if the Vanguard fund was retained and Fidelity’s index funds were not retained, it would reduce the per participant charge for non-union employees to $4, but increase the charge for union employees to $27.  A provision in the Collective Bargaining Agreement between ABB and the Union obligated ABB to pay the spread between union and nonunion employees.  Thus, absent mapping over the Vanguard fund and defaulting it to Fidelity Freedom Funds, while also retaining Fidelity’s index funds in the line up, Fidelity would force ABB to absorb a hard dollar expense.

During the pendency of the PRC’s review of a new fund line up, Fidelity did an end run around ABB and approached all of the proposed non-Fidelity fund managers under consideration to get revenue sharing.  Cutler complained to Fidelity that they were frustrating his objective of getting revenue sharing rebates from these funds.  He told Fidelity that “it is CRITICAL that ABB negotiate these separate from Fidelity.”  Sackie, however, intervened on behalf of Fidelity, telling Cutler that “we have to be careful here [or]…we’ll find ourselves ‘squeezing the balloon’. In other words they will give us the rebates and impose a recordkeeping charge. I’d rather have the discussion with [Fidelity] to see what is the best arrangement.”   In eventually selling Option #1 to the PRC, Cutler backed down, knowing that Sackie had to approve ABB’s payment of hard dollar recordkeeping fees but no approval was necessary if the fees were paid by the clueless participants through revenue sharing.

Perhaps Sackie’s casual reference to “squeezing the balloon” as a metaphor for the cross-subsidization arrangement that benefitted him and ABB made sense from his perspective, since he is not a defendant or a fiduciary.  His sense of the “best arrangement” certainly gave short shrift to the plan participants.  But, as a fiduciary, Cutler faced his moment of truth in that exchange.  He failed miserably to demonstrate a modicum of prudence or loyalty to plan participants, taking the Mephistophelean bait set by Fidelity.

What should Cutler have done?  With over 17,000 participants, a substantial percentage of which were represented by a bargaining unit, and in the context of a plan whose fund line up was constantly shifting, it was inevitable that some number of inquiring minds would make revenue sharing an issue.  At the very least, he should have sought independent legal counsel.  Barring that he should have raised the cross-subsidization issue with the PRC and recommended the dissolution of Fidelity’s “multi-practice engagement.”  That, of course, would have precipitated a “whose ox gets gored” debate inside ABB, which could well have drawn in many other powerful stakeholders and ultimately threatened Cutler’s job.  In such a situation Cutler should have been willing to resign.  If Cutler wasn’t willing to live up to his fiduciary responsibilities, because he feared the threat to his employment, then he should have found a nonfiduciary role to play instead.  The best way to navigate a minefield if you don’t have the stomach for it is….don’t go into the minefield.

So what happens to apparently qualified and generally well-intentioned fiduciaries like Cutler and the members of the PRC?  Unfortunately, the record doesn’t tell us.  But, for anyone whose ever been involved in litigation, it’s obvious no one wants to be sued.  For those with aspirations of climbing the corporate ladder or sitting on a corporate board, it’s hardly a feather in one’s resume.  Even for a fiduciary that prevails, the inconvenience, money, emotional distress, ill will and reputational damage makes it a no-win proposition.  For defendants who are held personally liable, the ramifications to their careers, financial well-being and families can linger for many years.   Whether it is affirmed or not, when the smoke clears from Tussey v. ABB, even assuming that ABB’s corporate indemnification program and fiduciary liability insurance policy sheltered the fiduciaries from substantial out-of-pocket costs, part of the wreckage will include their shattered reputations, if not careers.