Court Affirms Arrangement Between Sponsor and Recordkeeper Not a Prohibited Transaction

The 10th U.S. Circuit Court of Appeals was asked to review a lower court’s decision in Ramos v. Banner Health, in which participants in Banner Health’s 401(k) plan alleged plan fiduciaries breached their duties under the Employee Retirement Income Security Act (ERISA) in several ways.

In particular, they accused the fiduciaries of failing to prudently monitor certain plan offerings; retaining certain investment options for too long; using a revenue-sharing model to pay for recordkeeping services, which resulted in the paying of excessive recordkeeping fees and allegedly improper payments; and impermissibly using plan assets to pay certain Banner expenses.

Following an eight-day bench trial, the U.S. District Court for the District of Colorado concluded that Banner’s uncapped, revenue-sharing agreement with its recordkeeper Fidelity did not constitute a prohibited transaction under ERISA. The court did determine, however, that Banner had breached its duty of prudence by failing to monitor its service agreement with Fidelity and that this breach resulted in losses to the plan.

The plaintiffs presented four arguments on appeal, including two regarding the District Court’s estimate of losses and its selection of a rate to calculate prejudgment interest. The appellate court affirmed the lower court’s decisions on these two arguments. The other two arguments on appeal were that the District Court misinterpreted ERISA in concluding the service agreement between Banner and Fidelity was not a prohibited transaction, and the District Court abused its discretion by denying the class injunctive relief. The appellate court affirmed the District Court on these two issues as well.

In its opinion, the 10th Circuit said that, specifically, the plaintiffs appear to be most concerned with the District Court’s decision not to require Banner to hold a request for proposals (RFP) to test the market for recordkeeping and administrative services. The plaintiffs say that because Banner has not meaningfully tested the market for recordkeepers in more than 20 years, the District Court should have required Banner to engage in an RFP process.

The appellate court noted that by the time of the lower court’s judgment, Banner had ended the previous uncapped revenue-sharing arrangement and agreed to a per-participant recordkeeping fee with Fidelity. Since Banner had ended the prior arrangement, the Colorado District Court found “there is simply no evidence from which the court can reasonably conclude that Banner defendants will at some point in time resume a policy or practice of violating their duty of prudence with respect to recordkeeping fees.” With this conclusion, the court denied the plaintiffs’ request for injunctive relief in the form of requiring Banner to engage in an RFP process.

The plaintiffs contend the court abused its discretion in denying relief because Banner’s breach of fiduciary duties is ongoing. They say the issue persists since no market testing occurred before Banner reached the current agreement with Fidelity, which “was proposed by Fidelity, and accepted without apparent negotiation by Banner.” They argue that because Banner has still not performed an RFP or otherwise tested the market, Banner’s breach continues.

The 10th Circuit noted that the lower court did not find a breach simply because Banner had failed to perform a request for proposals but because Banner failed to adequately monitor the uncapped revenue-sharing agreement.

“Once Banner changed to the per-participant recordkeeping fee with Fidelity, the breach the court had identified ended,” the appellate court wrote in its opinion. “Because the underlying fee arrangement that triggered the initial finding of breach changed, we cannot say the court’s decision to deny injunctive relief was arbitrary or manifestly unreasonable.”

Turning to whether the service agreement between Banner and Fidelity was a prohibited transaction, the appellate court noted that ERISA prohibits a plan’s fiduciary from “engaging in a transaction, if he knows or should know that such transaction constitutes a direct or indirect … furnishing of goods, services or facilities between the plan and a party in interest.” A “party in interest” includes “a person providing services to such plan.” However, ERISA provides some exemptions from the prohibited transaction rules, thereby “allowing plans to do business with parties in interest if certain conditions are met.”

As an example of this, while a plan usually cannot transact with a party in interest, fiduciaries are not prohibited from “contracting or making reasonable arrangements with a party in interest for office space or legal, accounting or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor,” the 10th Circuit notes, citing ERISA Section 1108.

The plaintiffs argued that the statute’s language is clear, categorical and broad, saying, “Because Fidelity is a service provider and hence a ‘party in interest,’ its ‘furnishing of’ recordkeeping and administrative services to the plan constituted a prohibited transaction.” They also pointed to Department of Labor (DOL) guidance, “Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure,” which says “A service relationship between a plan and a service provider would constitute a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a ‘party in interest’ to the plan.”

The appellate court said the plaintiffs’ interpretation of this “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 [ERISA Section] 1106.” Instead, the court concluded that some prior relationship must exist between the fiduciary and the service provider to make the provider a party in interest under Section 1106.

“ERISA cannot be used to put an end to run-of-the-mill service agreements, opening plan fiduciaries up to litigation merely because they engaged in an arm’s-length deal with a service provider,” the court said. “Instead, ERISA is meant to prevent fiduciaries from engaging in transactions with parties with whom they have pre-existing relationships, raising concerns of impropriety. Otherwise, a plan participant could force any plan into court for doing nothing more than hiring an outside company to provide recordkeeping and administrative services.”

The 10th Circuit also cited the Supreme Court’s decision in Lockheed Corp. v. Spink. In that decision, the high court said Congress passed Section 1106 “to bar categorically a transaction that [is] likely to injure the pension plan.” It also said that what all prohibited transactions under Section 1106 “have in common is that they generally involve uses of plan assets that are potentially harmful to the plan.”

The 10th Circuit concluded that the plaintiffs provided no evidence to show that Fidelity had some pre-existing relationship with Banner or that the service agreement between Fidelity and Banner was anything less than an arm’s-length deal.