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DOL Smacks 401k Adviser for 12b-1 Fiduciary Breach. Plan Sponsors Next?

March 26
00:36 2013

A little more than seven months ago, the Employee Benefits Security Administration (EBSA), a unit of the U.S. Department of Labor (DOL), issued a press release it had reached a settlement with a Connecticut investment adviser for claims 179395_1431_weak_link_chess_300involved a breach of fiduciary duty. The August 23, 2012 release is entitled “USI Advisors of Glastonbury, Conn., agrees to pay $1.27 million to 13 defined benefit pension plans following US Labor Department investigation.” At the time, except for a few industry rags and a local Connecticut newspaper, very little attention was paid to that EBSA release.

Last week changed all that.

In his personal blog, well-known ERISA attorney Fred Reish reintroduced the story under the title, “Fiduciary Advice and 12b-1 fees.” Reish, a partner in Drinker Biddle, explains the EBSA release asserted two claims (that a fiduciary receiving 12b-1 and “some forms” of revenue sharing fees “is a violation of the prohibited transaction rules in section406(b) of ERISA” and the receipt of undisclosed compensation means the fiduciary “set its own compensation.”

Indeed in the original release, Phyllis C. Borzi, assistant secretary of labor for employee benefits security, said, “If you, as an investment adviser, are a fiduciary under ERISA with respect to plan investments in mutual funds, you cannot use your fiduciary authority to receive an additional fee or to receive compensation from third parties for your own personal account in transactions involving plan assets.” She also expected the ruling will require fiduciaries “to be more transparent about the fees they receive when dealing with their plan clients.”

Recall that the summer of 2012, when this settlement was reached, was also the summer the DOL’s 408(b)(2) Fee Disclosure Rule became effective. To Reish, this is a significant coincidence. He explains in his blog he has reviewed several 408(b)(2) disclosure documents where broker dealers claiming to be fiduciaries also receive revenue sharing. He says such “disclosures raise issues about prohibited transactions.”

A more interesting question, though, going back to the USI settlement, is “Why didn’t the DOL fine the plan sponsors of the 13 defined benefit plans?” After all, they had an ongoing fiduciary duty to conduct due diligence with regard to their service providers. Reish told “I suspect this [the USI investigation] started as a service provider investigation and, in the process, the DOL investigator discovered this issue cutting across several plans. Since the DOL position was likely that it was a prohibited transaction on the face of it, the Department likely pursued the advisor without considering the plan sponsor. But, even if the DOL had considered the plan sponsor/primary fiduciary, it might have been difficult to prove that it should have been aware of the violations. Indirect compensation is difficult to identify….and that, in fact, is the primary basis for the 408(b)(2) regulation. Also, I assume that all of these facts occurred before the effective date of the 408(b)(2) regulation.” Reish is correct on the latter point as the original EBSA states, “The alleged violations in this case occurred between 2004 and 2010,” in other words, well before the effective date of 408(b)(2).

Marcia Wagner, Managing Director of the Wagner Law Group in Boston and an ERISA expert believes the plan sponsors were, in fact, implicated, even though they weren’t specifically cited and fined. “A prohibited transaction implicates fiduciaries who misuse or permit the misuse of plan assets, including, by way of example, by paying fees that are too high. This is what, in essence, most of the Schlicter cases are about.” Wagner presented a paper (“Avoiding Conflicts of Interest As You Grow Your Business,” April 6, 2010) to the ASPPA Benefits Council of New England in which, of the Schlicter cases, she said, “The core allegation is that these defendants breached their fiduciary duties under Section 404(a) of ERISA by causing or allowing plan providers to be paid excessive fees for their services.”

Wagner envisions some future 12b-1 event where the DOL does punish the plan sponsor “as the law evolves and DOL enforcement activities become more and more sophisticated.” On this, Reish agrees, particularly in the aftermath of 408(b)(2) – with one caveat. “In the future,” he says, “plan sponsors will be responsible for reviewing the 408(b)(2) disclosures and identifying any such violations. If they do not, then the plan sponsor fiduciaries could also be liable. But, the plan sponsor is not, for this purpose, required to identify all ‘hidden’ compensation. Instead, plan sponsors must compare the disclosures to the requirements of the regulation and form a ‘reasonable and good faith’ belief that they received complete disclosures.”

So plan sponsors beware. Your next DOL audit may be a lot more than you’ve come to expect.

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s new book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. The book also contains a series of chapters on this subject, including how to create an investment policy statement that defines a set of menu options consistent with the “one portfolio” concept (as well as leaving room for those few remaining do-it-yourselfers).

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Ron Rhoades
    Ron Rhoades March 27, 16:23

    Great article, Chris.

    I would add some comments, which are an excerpt from a blog post I wrote recently about the Tibble v. Edison meeting:

    While other factors (other than fees and costs) are indeed a consideration, I would note that a substantial body of academic research suggests that the level of mutual fund fees and costs is a very substantial and often the best indicator, on average, of the long-term returns of the mutual fund relative to funds with the same investment strategy (i.e., same asset class). I suspect that future cases arising under ERISA, especially after the “Definition of Fiduciary” rule is adopted, will explore this academic research in detail, and then apply it.

    In the interim, there is no question that a fiduciary adviser bears responsibility to ensure that all of the fees and costs borne by the client are substantively fair and reasonable. Each and every fee and cost expended should be for services (or management) which is believed to result in value to the client. Fees that don’t add value to the client are suspect. In this respect, as I opined in an earlier blog post ( that revenue-sharing payments in the nature of 12b-1 fees are highly suspect – and fiduciary advisers (regardless of how registered) would do well to avoid all mutual funds which possess 12b-1 fees. The Tribble court, in dicta, also noted the area of 12b-1 fees as an area for further exploration by the courts, stating:

    “Mutual funds generate this revenue by charging what is known as a Rule 12b-1 fee to all investors participating in the fund. Edison takes the position that because that fee applies to Plan beneficiaries and all other fund investors alike, the allocation of a portion of that total 12b-1 fee to Hewitt is irrelevant. As it put the matter at oral argument: “the mutual fund advisor can do whatever it wants with the fees; sometimes they share costs with service providers who assist them in providing service and sometimes they don’t.” This benign-effect, of course, assumes that the ‘cost’ of revenue sharing is not driving up the fund’s total 12b-1 fee and, in turn, its overall expense ratio. It also assumes that fiduciaries are not being driven to select funds because they offer them the financial benefit of revenue sharing. The former was not explored in this case and the evidence did not bear out the latter, but we do not wish to be understood as ruling out the possibility that liability might—on a different record—attach on either of these bases.”

    So, as you see, even a recent court decision brings into doubt the validity of 12b-1 fees under ERISA, and suggests possible plan sponsor liability on account of such fees being present.

    I repeat my warning – if you are either a registered representative of a broker-dealer firm, or an investment adviser representative of a registered investment adviser firm – be extremely wary of recommending any mutual fund share class that includes 12b-1 fees. This is ESPECIALLY so under ERISA.

  2. Lynne McAuley
    Lynne McAuley March 29, 00:50

    A couple of other points. As a former DOL employee, my guess is that DOL did not want to over-reach before the effective date. It’s pretty much the same as a parent saying to their kids, “if you aren’t in your room by the time I count to 10, you are going to be sorry.” The parents have to count to ten. But after counting to 10, it is all fair game since DOL has been letting everyone know what to expect.

    Imagine if this same situation would occur now. DOL would first pursue the case against the service provider to learn the basic facts. It potentially would get a fair amount of information during that case and open up separate cases on the plan sponsors and come at it that way. That’s what I would do if I were still there.

    Also, what is important is that the prohibited transaction violation was a 406(b) violation instead of a 406(a) violation. The 406 (b) violations involve self-dealing for which there is NO EXEMPTION. So the CSP might comply with 408(b)(2), which gives the CSP a pass re: 406(a)(1)(C). However, potentially, the disclosure could allude to a potential 406(b)(1) violation on the part of the CSP. Suppose the responsible plan fiduciary did the typical due diligence and maybe even read the disclosure. Now suppose the responsible plan fiduciary did not follow-up with any meaningful questions or consider the implications. This could result in a 406(b)(2) violation where the fiduciary did not protect the plan against the adverse interests of another party. How long do you think a provider will be successful under those circumstances?

    Another scenario that makes me pull my hair out is as follows. Okay, suppose the CSP decides to change his or her business practices going forward because from now on, it should be obvious that he/she has been overpaid. Going forward, the plan pays much less. However, the plan is not made whole because the plan has been paying way too much for quite some time. The plan sponsor can not just move on. The responsible plan fiduciary must calculate what has been lost and what group of participants (if not all of them) have been harmed.

    We are in for some interesting times.


  3. Michael McMorris
    Michael McMorris May 15, 09:36

    Dear Mr. Carosa:

    I have been perusing and enjoying your blog posts. Good stuff. But I think an important point was overlooked in the above discussion regarding the USI case. You asked why the DOL didn’t pursue the 13 plan sponsors for prohibited transactions or fiduciary breaches for excessive fees or imprudence. Perhaps they should have fined them because of prohibited transactions. But pursuing them for excessive fees? Don’t forget that these are defined benefit plans. Not DC plans. This is an important distinction because, while a participant’s account balance in a DC plan is net of investment fees, a participant’s benefit in a DB plan is based on a benefit formula and is unaffected by fees (unless the fees are so excessive that they cause the plan to be so underfunded that the benefits cannot be paid, which is highly unlikely). Unlike DC plan sponsors, a DB sponsor bears the investment risk and has a direct financial incentive to make sure the plan is not paying excessive fees because the sponsor is responsible for funding the plan and covering any investment losses/shortfalls. In effect, any imprudence by the sponsor that results in excessive fees or even poor investment results will already penalize the sponsor. So I don’t think that DB plans should be painted with the same broad fiduciary/regulatory brush as DC plans.

    Of course, I am not excusing imprudence. Nor prohibited transactions.

    I’d be interested in your take on the new fiduciary standard as it relates to DB plans versus DC plans. Also, what new considerations are there in terms of trustee-directed DC plans versus participant-directed DC plans? And what about DC plans with participant-directed brokerage accounts instead of a daily val mutual fund platform? Have you opined recently on these topics in light of the latest fiduciary discussion?

    As a side note, do you believe it would serve all plan participants if the DOL focuses more on educating sponsors about their fiduciary obligations than on enforcement? Then would the sponsor be more prudent and not need to pay so much for fiduciary/legal advice? What are your thoughts?

  4. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author May 15, 10:43


    Thanks for the comment. Lots of good points, especially about the practical distinction between DB and DC plans. Also, lots of good questions. Perhaps they’ll make good fodder for future articles. Stay tuned. Much will be said once the DOL and SEC declare their position re: the Fiduciary Rule and the fiduciary standard.

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