Revenue Sharing, Soft Fees Questioned in Latest ERISA Suit

A new complaint filed in the U.S. District Court for the Eastern District of Pennsylvania accuses BTG International of breaching the Employee Retirement Income Security Act (ERISA) in the operation of a profit sharing 401(k) plan.

The plaintiff, seeking class-action status on behalf of similarly situated participants in the BTG International Inc. Profit Sharing 40l(k) Plan, alleges company officials allowed the plan’s recordkeeper, John Hancock, to receive excessive and unreasonable compensation through a variety of undisclosed channels. In addition to the BTG company, the complaint directly states its allegations against the plan’s named fiduciaries—three top executives.

The text of the complaint details alleged fiduciary breaches relating to “direct hard dollar fees paid by the plan to John Hancock; indirect soft dollar fees paid to John Hancock by non-John Hancock managed sub-advised accounts added and maintained in the plan to generate fees to John Hancock; fees collected directly by John Hancock from John Hancock-managed sub-advised accounts, added and maintained in the plan to generate fees to John Hancock; and float interest, access to a captive market for 401(k) rollover materials to plan participants, and other forms of indirect compensation.”

“In order to provide for these revenue streams, defendants larded the plan with excessively expensive sub-advised accounts—to the exclusion of superior alternatives—which in turn paid John Hancock out of the excessive fees they collected from plan investments,” the complaint states. “In fact, since the plan is a group annuity 401(k) product, defendants offered only investment options primarily offered by John Hancock to the exclusion of all other options.”

The complaint stipulates that the plaintiff is bringing this action “by and through their undersigned attorneys based upon their personal knowledge and information obtained through counsel’s investigation.” According to the complaint, the plaintiff “anticipates that discovery will uncover further substantial support for the allegations.”

One salient feature of this lawsuit is that the lead plaintiff moved his personal 401(k) fund from the plan in September of 2016. The complaint argues he nevertheless “remains a plan participant under ERISA since he was a participant during the times of the alleged breaches of fiduciary duty; may be eligible to receive benefits though the plan; and maintains a colorable claim for such benefits.” He participated in the plan from May of 2013 until September of 2016, the complaint says.

According to the complaint, during the class period, of the plan’s more than 100 investment options, 53 of them “appear to be managed by John Hancock, with the remainder paying revenue sharing to John Hancock.” The plan’s most recent Form 5500 filing with the U.S. Department of Labor states that at the end of the 2017 plan year the plan had 810 participants with account balances. At all relevant periods, the compliant says, John Hancock served, and continues to serve, as the plan’s recordkeeper.

Here the complaint presents the attorneys’ and plaintiff’s view of the recordkeeping market: “The recordkeeper of a defined contribution plan, like the plan, maintains participant account balances, provides a website and telephone number for plan participants to monitor and control their plan accounts, and provides various other services to the plan. These services are highly commoditized, with little or nothing distinguishing the services provided by one recordkeeper over another.”

The suit continues: “For providing various services, third-party plan administrators, recordkeepers, consultants, investment managers, and other vendors in the 40l(k) industries have developed a variety of pricing and fee structures. At best, these fee structures are complicated and confusing when disclosed to plan participants. At worst, they are excessive, undisclosed, and illegal.”

According to the complaint, BTG and the individual defendants “failed to have a prudent process for evaluating the amount and reasonableness of this compensation. Instead of evaluating the cost of these services in the marketplace, BTG and the individual defendants permitted John Hancock to administer and do the recordkeeping for the plan without meaningful market competition.”

The complaint alleges that defendants did nothing “to limit or curtail John Hancock’s growing compensation, rather, John Hancock was allowed to generate ever higher fees despite costs which were either stable or falling. Failing to do so constituted a breach of the duties of prudence in violation of 29 U.S.C. §1104(a) and cost the plan millions of dollars in excessive fees charged directly by John Hancock or collected by John Hancock from the plan’s investment options through revenue sharing.”

The text of the complaint goes into some detail about the handling of the plan’s Form 5500 annual filings, and how the plan may be tracking revenue sharing payments.

“Defendants negligently prepared and/or intentionally misstated their form 5500s with the Department of Labor each year from 2012 to the present,” the complaint states. “From 2012 through 2016, the plan’s Form 5500 state the John Hancock received no direct or indirect compensation whatsoever for its services. The defendants are obligated as fiduciaries to accurately report this compensation. It wasn’t until 2017 the Plan’s Form 5500 reported that John Hancock received a total of $318 in direct compensation for its services and no indirect compensation whatsoever. Again, it is believed … that this information was not reported accurately. The defendants, as fiduciaries, should have questioned, on behalf of the members of the plan, the amount of compensation John Hancock actually received. Failure to do so is a clear breach of their fiduciary duties. … While the hard dollar fees above appear modest or misstated, it must be the case that the vast majority of John Hancock’s compensation came in the form of revenue sharing. Industry commentators and analysts consider revenue sharing as the ‘big secret of the retirement industry.’”

The lawsuit suggests that, to “severely reduce, or eliminate hard dollar payments altogether, a plan’s fiduciaries and/or a service provider like John Hancock may agree to set a fund’s asset-based fee (its expense ratio) at a level high enough: (A) to cover the Fund’s services and profit; and (B) to provide excess revenue sharing more than sufficient to cover all other plan services and more. This causes a plan’s recordkeeping fees to appear deceptively low in disclosures to plan participants and government regulators.”

From here, the complaint argues plan fiduciaries have limited their selection of funds to only those funds which provide sufficient revenue sharing, thus foregoing superior investment alternatives and selecting or maintaining inferior investment options based upon revenue-sharing relationships.

“These alternatives include different share classes of the identical sub-advised account that charged lower fees because they do not pay revenue sharing, institutional products by the same fund managers which offer materially identical services for even lower cost, or superior alternatives offered by different managers who are unwilling to pay revenue sharing to the plan recordkeeper,” the complaint says.

The full text of the complaint is available here.