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AN OUNCE OF INTERNAL CONTROLS IS WORTH A POUND OF LITIGATION
IN RESOLVING EXCESSIVE FEES FIDUCIARY BREACH CLAIMS

June 2014
By:  Philip J. Koehler, Esq.

In 2007 George Bush was midway through his second term and Barak Obama was the junior Senator from Illinois.  The housing bubble was beginning to burst, but the magnitude of the threat to the U.S. banking system had not yet come to light.  Barry Bonds hit his 756th home run amidst a controversy about his alleged steroid use and Steve Jobs unveiled Apple’s new iPhone.  In July of that year, a group of employees of ABB, Inc., who were among the 17,000 participants in the company’s 401(k) plan, filed a Complaint with the Federal District Court for the Western Division of Missouri alleging that ABB, the individual plan fiduciaries, Fidelity Investments, manager of various mutual funds offered in the plan’s fund line-up, and Fidelity Management Trust Company, the plan’s recordkeeper, (collectively, “Fidelity”) breached their fiduciary duties by permitting the plan to pay Fidelity $37 million in excessive recordkeeping fees.

Most of those stories are so dated that they don’t even qualify as old news, except the ongoing saga of Tussey v. ABB.  If Tussey were a mini-series on HBO or Netflix, it would be starting season eight and no doubt destined to overtake Mad Men as the longest running.  The parties in Tussey have left in their wake a lengthy case docket.  The major milestones to date are as follows:

  • After a four-week trial in 2011, followed by a delay of over a year, the District Court issued its 81-page Trial Order in March 2012 in favor of plaintiffs holding that ABB, the individual fiduciaries and Fidelity breached their fiduciary duties and imposing damages of about $37 million; (For a discussion of the factual findings in the District Court’s Trial Order see the January 2014 edition of the Independent Plan Administrator.)
  • In April 2012 ABB and Fidelity separately appealed the Trial Order to the 8th Circuit Court of Appeals;
  • In March 2014, a three-judge panel of the 8th Circuit issued its opinion (1) affirming in part (as to the Trial Order’s holding that the fiduciaries had breached their fiduciary duty in permitting the plan to pay excessive fees to the extent of about $14 million), (2) vacating in part (as to the Trial Order’s analysis of Fidelity’s use of “float” on trust assets) and discharging Fidelity from liability entirely and (3) reversing in part (as to the Trial Order’s analysis of the remaining fiduciary breach claims regarding excessive fees for $23 million) and remanding those issues to the District Court for further consideration under a heightened abuse-of-discretion standard of review;
  • In April 2014, plaintiffs and ABB fiduciaries filed separate petitions with the 8th Circuit asking for a rehearing by all active judges on the Court; and
  • In May 2014 the 8th Circuit denied both parties’ petitions for a rehearing without comment.

Seven years on, the conventional wisdom is that both parties have plenty of fight left and will each petition the U.S. Supreme Court for certiorari.   If the Supreme Court grants cert. on any of the issues, the parties are essentially back to square one in that regard.   Of course, the Supreme Court grants cert. in a very small percentage of cases and its appetite for ERISA cases may be waning at the moment.   If the Supreme Court denies cert., it will have the effect of leaving the decision by the three-judge panel of the 8th Circuit undisturbed, which would mean the panel’s holdings that:  (1) Fidelity is not liable for its handling of float on trust assets and (2) the ABB fiduciaries breached their fiduciary duty by causing the plan to pay approximately $14 million in excessive recordkeeping fees are final.  The District Court would still have to reconsider the additional claim for $23 million in excessive fees that the panel remanded.  Of course, regardless of how the District Court comes out, a new Trial Order is likely to be appealed to the 8th Circuit, and, in turn, its opinion subjected to requests for an en banc rehearing and eventually petitions for certiorari yet again.  Ten years seems a conservative guess of how long it will ultimately take to resolve all the issues.

The irony here is that ABB established the 401(k) plan as a major component of an HR strategy to incentify and retain rank-and-file employees by enhancing their retirement income security.  The company has demonstrated its commitment to that strategy by encouraging employees to contribute on their own behalf and by making substantial and recurring employer contributions to the plan.  Yet, ABB management seems blind to the damage it is doing by closing ranks with the principal wrongdoer, Fidelity, and continuing to rack up enormous legal fees and other litigation costs to oppose, delay and frustrate the participants efforts to be made whole after both the District Court and the Eight Circuit determined the employees’ claims were meritorious (at least up to $14 million) and Fidelity has successfully walked away.  ABB’s litigation strategy clearly undermines the goals of the 401(k) plan.  By refusing to settle the case, ABB drags out the negative impacts on employee morale and relations with the union employees’ bargaining unit, including chilling the interest of the non-highly compensated employees to participate.   From a shareholder’s perspective, ABB’s management would be hard pressed to explain the value proposition of fighting this fight against its own employees.

ABB reported gross revenue in 2013 of $42 Billion.  The $37 million in restitution requested by the employees is less than one-tenth of one percent of that number.   ABB could settle this case now by offering to pay restitution to the plan without admitting liability in exchange for the employees’ agreement to drop the law suit.  It might do this simply because it’s the right thing to do.  As a practical matter, at least, it would “stop the bleeding.”  If ABB was so inclined, it might offset this expense by reducing its future discretionary contributions to the plan.   If it still wants to seek a litigation solution, it should consider a cross complaint against Fidelity seeking contribution or simply a separate lawsuit brought by the plan fiduciaries on a breach of contract claim.

If a vendor overcharges the plan for its services, the issue of whether or not the fiduciaries are responsible is of secondary importance.  The plan sponsor’s initial response, after verifying the extent of the excessive fees, should be to make the participants whole.   ERISA limits damages in a fiduciary breach lawsuit to a restitutional remedy, which means there is no larger liability (e.g. consequential or punitive damages) to which the plan sponsor is exposed.  Making the participants whole moots the participants’ legal claims.  On the other hand, rejecting the employees’ claims with a “see you in court” response, starts the clock running on the hard dollar costs of the attorneys’ fees and expenses as well as the soft dollar costs in the form of the harm done to employee relations and the goals of the plan itself.  Except where the allegations are demonstrably false, this is a no-win scenario.

What can plan sponsors generally learn from ABB’s predicament?  The District Court’s factual findings laid out in its Trial Order make it clear that ABB had very poor internal controls for financial reporting or risk management regarding the governance of the plan.  Long before the employees cast their allegations of excessive fees as legal issues, they were unresolved managerial issues percolating in the domain of the plan fiduciaries.  Had ABB applied the type of rigorous system of internal controls and procedures over financial reporting and enterprise risk management to the 401(k) plan that it applies to the corporation itself, Fidelity could not have succeeded in embedding its system of hidden fees by pandering to a small group of inside fiduciaries operating without appropriate oversight.

Almost all plan sponsors cover their officers and directors under a corporate indemnification policy that includes indemnification for personal liabilities they incur in performing services as a plan fiduciary.  Consequently, the risk of indemnified fiduciary losses sustained by the plan is a direct exposure of the company’s assets and, therefore, an appropriate target for ABB’s corporate level internal controls for financial reporting and risk management.  Even if the Company maintains fiduciary liability insurance coverage on these individuals, there is still a risk that the coverage is inadequate or that the insurance company will deny coverage, leaving the corporation more or less the indemnitor of last resort.

As mandated by the Sarbanes-Oxley Act of 2002 (“SOX”), the U.S. Securities and Exchange Commission (“SEC”) issued final rules that require all reporting companies to include in their quarterly and annual filings, a report that discusses the effectiveness of the company’s internal control for financial reporting, and a certification that the policies and procedures in place to implement those controls, among other things, effectively:

“Provide reasonable assurance regarding prevention or timely detection of unauthorized, use or disposition of the [company’s] assets that could have a material effect on financial statements.”

ABB is a huge multi-line business operation.  Attached to the company’s 2013 annual report filed with the SEC, are “certifications” mandated by the Securities Exchange Act, as amended by SOX, for all public, and some large private, corporations (“SOX Certifications”).   These include certifications by the CEO and other certifying officers that they have:

“a.      Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company…is made known to us by others within [the Company]….;

 b.      Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures….”

and disclosed to the Company’s auditors and the audit committee of the board of directors:

“a.      All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and

 b.      Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.”

Given the financial risk that indemnified fiduciary losses pose to the corporate treasury, the plan sponsor’s failure to extend the corporation’s internal controls for financial reporting to the level of the plan’s fiduciary governance could jeopardize the accuracy of these SEC mandated certifications.

Secondarily, the language of these certifications can serve as a template that would significantly enhance a plan’s fiduciary Best Practices.   Modified to relate specifically to the management of the plan, attested to by the Named Fiduciary and backed up by the fiduciary’s access to the plan sponsor’s in house legal, risk management, internal audit, expense control and compliance resources, comparably rigorous internal controls would create a formidable barrier to excessive fees and other potential sources of liability arising from the risk of indemnified fiduciaries’ failing to meet ERISA’s standards of fiduciary responsibility.

What should ABB have done when the employees’ demand letter first reached the attention of the company’s General Counsel?  First, ABB should have requested counsel for the employees to delay filing the complaint pending an investigation by ABB’s internal audit staff, with the staff report distributed to the board’s audit committee, CEO and others, besides the fiduciaries. To the extent that the internal audit staff found that the allegations have substance, ABB should have taken a settlement posture and negotiated restitution of the provable excessive fees, while taking appropriate action against Fidelity, including replacing it as the plan’s recordkeeper and consideration of a potential fiduciary lawsuit.  The plan’s Named Fiduciary should have exercised its oversight responsibility by investigating the responsible fiduciaries to determine if they had developed improper relationships with Fidelity (or other vendors), directing them to take other remedial steps, and, potentially, reassigning their duties or simply replacing them.

Yogi Berra once profoundly said:  “You’ve got to be very careful if you don’t know where you’re going, because you might not get there.”  A plan without a system of internal controls is effectively flying blind regarding its and the plan sponsor’s exposure to the risk of loss caused by fiduciary incompetence or malfeasance.  Voluntarily adopting a rigorous system of internal controls, patterned after the SEC-mandated system for reporting companies, or as more fully described by the COSO (The Committee of Sponsoring Organizations of the Treadway Commission) frameworks for internal controls and enterprise risk management, will deter misconduct by indemnified inside fiduciaries by making it more difficult for vendors to unduly influence them.  More importantly it will immunize the plan from the sort of sales pitches still used by companies like Fidelity designed to proliferate the sources of hidden fees.