To Breach a Fiduciary Duty One Must Be a Plan Fiduciary
ERISA imposes fiduciary responsibilities on certain persons who must act solely in the interest of plan participants and beneficiaries and act to “defray[ ] reasonable expenses of administering the plan.” 29 U.S.C. § 1104(a)(1)(A)(ii).
A service provider can become an ERISA fiduciary in one of two ways. First, a person is a fiduciary if the plan identifies them as such. See 29 U.S.C. § 1102(a). Second, ERISA specifies when a person or entity acts as a fiduciary with respect to a plan, including by exercising discretionary authority or discretionary control respecting plan management or disposition of its assets; rendering investment advice for a fee or other compensation; or having discretionary authority or discretionary responsibility in the administration of such plan. See 29 U.S.C. § 1002(21)(A).
“In order to state a claim that a service provider to an ERISA-governed plan breached a fiduciary duty by charging plan participants excessive fees, a plaintiff first must plead facts demonstrating that the provider owed a fiduciary duty to those participants.” McCaffree Financial Corp. v. Principal Life Ins. Co., 811 F.3d 998, 1002 (8th Cir. 2016). Service providers generally are not named fiduciaries in plan documents. Instead, the plan or its participants assert that the complained-of conduct falls within § 1002(21)(A) and the service provider therefore is acting as a “functional fiduciary.”
Initially, it is important to identify the alleged act which constitutes the supposed fiduciary breach. Courts recognize that an ERISA fiduciary duty claim must plead that the defendant was acting as a fiduciary when taking the specific action on which the claim is based. See Pegram v. Herdrich, 530 U.S. 211, 226, 120 S.Ct. 2143 (2000); see also Santomenno ex rel. John Hancock Trust v. John Hancock Life Insurance Company, 768 F.3d 284, 296–297 (3rd Cir. 2014). For example, in ordering dismissal of a breach of fiduciary duty claim against a service provider, the Ninth Circuit noted “the challenged action is the withdrawal of predetermined fees” (deemed not a fiduciary act) and not the “management of the pooled accounts” (likely a fiduciary act), and thus the challenged action did not give rise to fiduciary liability under ERISA. See Santomenno, 883 F.3d 833, 840–41.
Receiving Contractually Agreed Upon Compensation Is Not a Fiduciary Act
Most circuits hold that a service provider’s collection of contractually negotiated compensation, for the services provided to the plan or its participants, is not a fiduciary function, even though the services themselves constitute fiduciary acts. As stated by the Eighth Circuit, “a service provider’s adherence to its agreement with a plan administrator does not implicate any fiduciary duty where the parties negotiated and agreed to the terms of that agreement in an arm’s-length bargaining process.” McCaffree, 811 F.3d 998, 1003. The Second Circuit echoed this sentiment:
When a person who has no relationship to an ERISA plan is negotiating a contract with that plan, he has no authority over or responsibility to the plan and presumably is unable to exercise any control over the trustees’ decision whether or not, and on what terms, to enter into an agreement with him. Such a person is not an ERISA fiduciary with respect to the terms of the agreement for his compensation.
F.H. Krear & Co. v. Nineteen Named Trustees, 810 F.2d 1250, 1259 (2nd Cir. 1987); see also Santomenno, 883 F.3d 833, 837–38. “Insurance companies do not normally exercise discretion over plan management when they negotiate at arm’s length to set rates or collect premiums. That is because these negotiations occur before the agreement is executed, at which point the insurer has no relationship to the plan and thus no discretion over its management.” Depot, Inc. v. Caring for Montanans, Inc., 915 F.3d 643, 654 (9th Cir. 2019). According to the Ninth Circuit, these arm’s length negotiations presumably are governed by the marketplace. See id. at 655.
However, gray areas arise where the contract authorizes particular action by the service provider which ultimately determines its compensation, and this action arguably is subject to discretion. Thus, “after a person has entered into an agreement with an ERISA-covered plan, the agreement may give it such control over factors that determine the actual amount of its compensation that the person thereby becomes an ERISA fiduciary with respect to that compensation.” F.H. Krear at 1259.
The Tenth Circuit has articulated a two-step analysis to determine whether a service provider is a functional fiduciary in such situations:
First, courts decide whether the service provider’s alleged action conformed to a specific term of its contract with the employer plan. By following the terms of an arm’s-length negotiation, the service provider does not act as a fiduciary. Second, if the service provider took unilateral action beyond the specific terms of the contract respecting the management of a plan or its assets, the service provider is a fiduciary unless the plan or perhaps the participants in the plan . . . have the unimpeded ability to reject the service provider’s action or terminate the relationship with the service provider.
Teets v. Great-West Life & Annuity Insurance Company, 921 F.3d 1200, 1212 (10th Cir. 2019) (citations omitted). The second step provides an additional defense and shifts the focus to whether the plan or its participants possessed the ability to reject the allegedly discretionary action.
In Central Valley Ag Cooperative v. Leonard, 986 F.3d 1082, 1084 (8th Cir. 2021), a large Nebraska agricultural cooperative offered its employees the opportunity to participate in a self-funded health care plan. The Co-op subsequently sued various defendants who either marketed or administered those health care plans alleging they breached ERISA fiduciary duties and engaged in prohibited transactions, including arising from the TPA’s receipt of a set compensation based on the review of medical bills submitted to the plan and payment recommendations as to those bills, i.e., 30% of the savings resulting from the review were paid to the TPA.
The Eighth Circuit reiterated, “[a] service provider does not act with the ‘discretion’ required to establish a fiduciary relationship if its actions (1) conform to specific contract terms, or (2) can be freely rejected by the plan sponsor.” Id. at 1087 (emphasis added). In the subject arrangement, the defendants satisfied both prongs of this test: (1) the compensation paid to the TPA was set forth in the contract and (2) the plan “ultimately decided what portion of each medical bill was paid.” Id. Although plaintiff argued the defendants had expanded the number of medical claims subject to review which had the potential to increase their own compensation, the Court noted that plaintiff still had to approve the payment recommendations and decide what portion of each medical bill was paid. The defendants therefore were not plan fiduciaries as to the alleged conduct as a matter of law, and summary judgment was affirmed in their favor.
Another example, which pre-dates Teets, is Insinga v. United of Omaha Life Insurance Company, 2017 WL 6884626 (D. Neb. Oct. 26, 2017), where the subject 401k plan negotiated a contract with United of Omaha to provide investment services for employees. The plan had the option to invest in three different accounts, including a Maturity Account. Under the Maturity Account, the contract allowed United of Omaha, at least once a month, to declare a Guaranteed Interest Rate for any contributions directed to the account and the Guaranteed Interest Rate would be declared before contributions were made. As summarized by the district court, “United guarantees the principal in the Maturity Account as well as the Guaranteed Interest Rate. The difference between the Guaranteed Interest Rate and the return that United actually earns on the funds in the Maturity Account (“spread”) is kept by United as its compensation.” Id. at *2. Insinga, a plan participant, alleged the defendant breached fiduciary duties by setting the Guaranteed Interest Rate for its own benefit, retaining the spread, and charging excessive administrative fees. United of Omaha argued its monthly declaration of the new interest rate was “merely a term of the Contract.”
The Insinga Court agreed with United of Omaha and dismissed this fiduciary duty claim, finding the insurer did not change the contract terms by declaring a new Guaranteed Interest Rate every month and therefore “does not become a fiduciary by declaring the monthly Guaranteed Interest Rate.” 2017 WL 6884626, at *3. Second, the district court found “the connection between the Guaranteed Interest Rate and United’s compensation is too attenuated as to give United discretion over its compensation” and “its compensation is largely controlled by the Plan’s choices and other factors outside United’s control” such that the effect of the Guaranteed Interest Rate on United’s compensation does not make it a fiduciary. Id. at *4. Specifically, “[i]f the Plan determines that the declared interest rate is too low, it has full discretion to invest in a different fund.” 2017 WL 6884626, at *3.
Similarly, the First Circuit recently affirmed the dismissal of fiduciary duty claims against a service provider where fees were allowed by the contract with the plan and numerous intervening and independent decisions by other plan fiduciaries negated the argument the defendant was controlling its own compensation. See In re Fidelity ERISA Fee Litigation, 990 F.3d 50 (1st Cir. 2021).
However, a different result was reached in Rozo v. Principal Life Insurance Company, 949 F.3d 1071 (8th Cir. 2020), where Principal offered a 401(k) plan that gave participants a guaranteed rate of return, i.e., “the Composite Crediting Rate” or CCR. Here, in reversing the lower court’s ruling in Principal’s favor, the Court noted the contract allowed Principal to set the CCR every six months, but the actual rate is not a specific contract term. According to the Rozo Court, Principal
unilaterally calculates this CCR every six months. Before the CCR takes effect—typically a month in advance—Principal notifies plan sponsors, which alert the participants.
If a plan sponsor wants to reject the proposed CCR, it must withdraw its funds, facing two options: (1) pay a surrender charge of 5% or (2) give notice and wait 12 months. If a plan participant wishes to exit, he or she faces an “equity wash.” They can immediately withdraw their funds, but not reinvest in plans like the PFIO for three months.
Id. at 1073.
Under this scenario, the Eighth Circuit ruled Principal was a fiduciary in setting the CCR. Applying the two-part Teets test, the Rozo Court explained:
At Teets step one, Principal’s setting of the CCR does not “conform[ ] to a specific term of its contract with the employer plan.” Every six months, Principal sets the CCR with no specific contract terms controlling the rate. Principal calculates the CCR based on past rates in combination with a new rate that it unilaterally inputs . . .
At Teets step two, the plan sponsors here do not “have the unimpeded ability to reject the service provider’s action or terminate the relationship.” If a plan sponsor wishes to reject the CCR, it must leave the plan, with two options: (1) pay a 5% surrender charge or (2) have its funds remain in the plan for 12 months. Charging a 5% fee on a plan’s assets impedes termination. Likewise, holding a plan’s funds for 12 months after it wishes to exit impedes termination. Principal, therefore, is a fiduciary exercising control and authority over the CCR.
949 F.3d 1071, 1074–75 (citations omitted). This Court held the CCR was a new contract term because plan sponsors did not have an opportunity to agree to the CCR until after it was proposed. The case was remanded for trial on the breach of fiduciary duty claims.
No Party in Interest Status Absent a Prior Relationship
Even where the service provider is not a fiduciary with respect to the subject act (such as the receipt of agreed upon fees), potential liability exists for the alleged participation in a prohibited transaction with a plan fiduciary under 29 U.S.C. § 1106.
Section 1106 restricts transactions between fiduciaries and non-fiduciary third parties, referred to as “parties in interest.” The latter can include service providers. See 29 U.S.C. § 1002(14)(B). The Supreme Court generally described the type of transactions prohibited by § 1106 as follows: “These are commercial bargains that present a special risk of plan underfunding because they are struck with plan insiders, presumably not at arm’s length. What the ‘transactions’ identified in § [1106(a) ] thus have in common is that they generally involve uses of plan assets that are potentially harmful to the plan.” Lockheed Corp. v. Spink, 517 U.S. 882, 893, 116 S.Ct. 1783 (1996) (citation omitted). Violation of § 1106(a) can subject the plan fiduciary or party in interest to liability.
Numerous courts have held the initial contract with the service provider, before the provider has any relationship to the plan, cannot serve as the prohibited transaction under § 1106. This straight-forward principle presents an ideal basis for a motion to dismiss.
In Sellers v. Anthem Life Insurance Company, 316 F.Supp.3d 25, 34–35 (D.D.C. 2018), the court focused on the express language of § 1106(a)(1), as well as the statute’s purpose, to reject the “circular reasoning” that the subject transactions were prohibited because the insurer was a party in interest, and the insurer was a party in interest because it engaged in the prohibited transactions. “Rather, the statute only prohibits such service relationships with persons who are ‘parties in interest’ by virtue of some other relationship - for example, with the employer who sponsors the plan. It does not prohibit a plan from paying an unrelated party, dealt with at arm’s length, for services rendered.” Id. at 35.
As recognized by Sellers, some unpublished district court decisions support a contrary view. However, the weight of authority follows the reasoning in Sellers.
In Chavez v. Plan Benefit Services, Inc., 2018 WL 6220119 (W.D. Tex. Sept. 12, 2018), for example, plan participants sued entities that marketed and administered their retirement, health and welfare benefit plans alleging they charged excessive fees and the plans’ contractual arrangement with the defendants was a prohibited transaction. Plaintiffs did not contend the defendants were plan fiduciaries but only parties in interest to the prohibited transaction. The “first pertinent question” was when the defendants became parties in interest under § 1002(14). The district court answered that defendants “were not parties in interest when they initially contracted to provide services because, at that time they were not yet ‘providing services to the plan’” and the initial contract to provide services to the plan does not qualify as a prohibited transaction. Id. at *3.
The plaintiffs conceded this point but asserted a separate transaction under § 1106(a) occurred each time fees were paid to the defendants under the contracts. The Chavez Court also rejected this argument and, as in Sellers, focused on the statutes themselves to reach the conclusion that “the crux of a transaction under both § 1106 and § 1108 is the act of contracting that establishes the legal rights and obligations between the parties.” Id. Payment of fees in fulfillment of an existing contractual obligation failed to qualify as a separate transaction under the statutes because it was neither “contracting” nor “making reasonable arrangements.” Id. The prohibited transaction claim therefore was dismissed as “a plan fiduciary does not cause a plan to engage in a presumptively prohibited transaction under § 1106(a) when it pays the fees of a party in interest so long as the contractual obligation to pay those fees arose before that party assumed party in interest status.” 2018 WL 6220119, at *4.
Recently, the Tenth Circuit agreed that to hold the initial service agreement constitutes the prohibited transaction “leads to an absurd result: the initial agreement with a service provider would simultaneously transform that provider into a party in interest and make that same transaction prohibited under § 1106.” Ramos, 1 F.4th 769, 787. According to the Tenth Circuit, “some prior relationship must exist between the fiduciary and the service provider to make the provider a party in interest under § 1106.” Id. This view also is supported by the Third Circuit. See Danza v. Fidelity Mgmt. Trust Co., 533 Fed.Appx. 120, 125–26 (3rd. Cir. 2013).
A Plaintiff Must Seek Appropriate Equitable Relief
A prohibited transaction claim against a non-fiduciary third party may seek an injunction or “appropriate equitable relief” under § 1132(a)(3), but not legal remedies such as monetary damages. In contrast, personal liability is imposed upon “[a]ny person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries . . .” 29 U.S.C. § 1109(a). Plaintiffs alleging prohibited transaction claims against service providers primarily desire to recoup the excessive fees collected under the subject contract rather than obtain an injunction, and therefore must allege a viable equitable remedy exists.
As a general rule, equitable remedies are directed against some specific thing and give a right to some particular thing, rather than a right to recover a sum of money generally from the defendant’s assets. See Teets, 921 F.3d 1200, 1224. For example, equitable restitution cannot seek to impose personal liability on the defendant but must seek to restore to the plaintiff particular funds or property in the defendant’s possession. See id. at 1225 and Depot, Inc., 915 F.3d 643, 661. This pleading hurdle can be difficult for plaintiffs to overcome where the allegedly excessive fees paid to a service provider became part of the defendant’s general assets.
The Tenth Circuit has stated that satisfying the appropriate equitable relief prong of § 1132(a)(3) functions as an element of the ERISA claim, and “[i]f a plaintiff cannot demonstrate that equitable relief is available, the suit cannot proceed.” Teets, 921 F.3d 1200, 1223. Courts therefore have dismissed prohibited transaction claims where the complaint failed to identify specific property possessed by the service provider which could be recovered in equity. See Depot, Inc., 915 F.3d 643, 660–66; Sellers, supra, at *42 (holding “Plaintiffs’ own pleadings establish that the funds they seek are not recoverable from Anthem in equity; rather, Plaintiffs seek legal relief from Anthem’s general assets” and the prohibited transaction claim therefore could be resolved by motion to dismiss); and Insigna, supra, at *5.
The Subject Contract May Provide the Winning Defense
At first glance, defending ERISA claims against service providers can appear daunting and for good reason. In Teets, supra, the district court certified a class of 270,000 plan participants before granting summary judgment in defendant’s favor. Luckily, sound legal arguments, well-supported by case law, have proven effective in resolving breach of fiduciary duty and prohibited transaction claims, based on the alleged receipt of excessive compensation, at the pleading stage.
As with most ERISA cases, the contract terms are critical. Where the disputed fees are expressly allowed by contract, and not subject to any discretionary actions by the service provider, the collections of such fees should not equate with a fiduciary act. Instead, the negotiations culminating in such agreements are considered arm’s length transactions governed by competition in the marketplace, and which the named plan fiduciary can freely reject. Even where subsequent discretionary actions by the service provider ultimately affect the amount of its compensation, fiduciary liability may be avoided where a plan fiduciary or participants possess the unimpeded right to limit or reject the discretionary action.
Two potential avenues exist to dispose of a prohibited transaction claim. First, where the subject contract is the initial contract entered between the service provider and plan, courts consistently hold this contract cannot constitute a prohibited transaction. The allegations of the complaint and the date of the contract often provide the necessary facts to support a motion to dismiss on this ground. Second, a defendant should examine whether the plaintiff has adequately alleged an equitable remedy required by § 1132(a)(3).
Given the important purpose served by a service provider’s relationship with a plan, more and more courts are taking a commonsense approach to validating the manner in which a service provider arrives at its fee structure.
David T. McDowell is a founding partner and the current managing partner of McDowell Hetherington LLP, a national litigation firm specializing in, among other things, class action defense of life insurance and financial service entities. David represents life insurers in state and federal trial and appellate courts around the country.
Charan M. Higbee is a senior attorney in McDowell Hetherington LLP’s California office. For more than twenty-five years, Charan has handled insurance matters in state and federal court during every phase of litigation. Charan’s specialty is representing insurers in cases involving life, health and disability policies and group policies subject to ERISA.