New Ruling in a Fee Case:  After Trial, Defendants Win Some, Lose Some; DOL Issues Its Long Awaited Fee Disclosure Regulation; Agencies Issue Guidance on PPACA Internal Claims and Appeals and External Review Processes

ERISA Litigation Alert

New Ruling in a Fee Case: After Trial, Defendants Win Some, Lose Some

In one of the first fee cases to go to trial, the district court found that the defendants breached ERISA's prudence standard when they invested in retail share classes of three mutual funds instead of the institutional share classes of those same funds. Institutional share classes are offered to institutional investors, such as 401(k) plans, and often require a minimum investment. They usually also charge lower fees than retail share classes because the amount of assets invested is greater than that which an individual investor can usually make in a retail share class. Retail share classes may also pay higher revenue sharing fees, and, at least with respect to the three funds at issue in the case, that was true. Tibble v. Edison International, CV 07-5359 SVW, July 8, 2010.

Beginning in 2007, plaintiffs' class action law firms began filing lawsuits against some very large companies including Boeing, Bechtel, United Technologies, and Deere, alleging that the defendants breached ERISA's fiduciary standards of prudence and loyalty and engaged in prohibited transactions because they chose investment options for their 401(k) lineup that had higher expense ratios than equally available options with lower expense ratios. In general, these cases are collectively referred to as "fee litigation cases" or "fee cases." In Tibble, plaintiffs made the same basic allegations against Edison International and other 401(k) fiduciaries for selecting six mutual funds with higher expense ratios that paid more revenue sharing than other lower cost options.

In May 2009, both parties in Tibble filed motions for summary judgment. The Tibble court granted partial summary judgment for defendants on the majority of plaintiffs' claims. Siding with the defendants, the court dismissed all allegations that they engaged in prohibited transactions for including mutual funds with higher expense ratios and revenue sharing. See Tibble v. Edison International, 639 F. Supp.2d 1074, 1086--97 (C.D. Cal. 2009). The court reserved for trial plaintiffs' allegations that defendants violated ERISA's prudence and loyalty standards for offering the six funds as part of the 401(k) plan lineup.

No Violation of ERISA's Duty of Loyalty

ERISA requires that a fiduciary "discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries." ERISA Section 404(a)(1)(A). At trial, the court found that the defendants did not violate their duty of loyalty in the process of selecting the fund classes with more revenue sharing fees because the defendants were not "motivated by a desire to capture revenue sharing" in making those selections. The court noted that the company's overall trend between the years 2002 to 2008, reflected a movement toward selecting funds with reduced revenue sharing. The court also found that there was no evidence that the defendants considered revenue sharing when selecting fund choices.

Defendants Violated ERISA's Prudence Standard in the Selection of Three out of the Six Funds at Issue in the Case

The court held that the record was devoid of any "credible reason why the Plan fiduciaries chose the retail share classes of the William Blair, PIMCO and MFS Total Returns funds." In essence, the court concluded that defendants failed to engage in a prudent process in selecting the higher expense ratio retail share class of the three mutual funds. With respect to the remaining three funds -- Janus Small Cap, PIMCO Capital Appreciation, and Franklin Small (-Mid) Cap funds -- all had undergone a name change after 2001. Due to the statute of limitations barring the plaintiffs from seeking remedies for any alleged harm prior to 2001, the plaintiffs alleged the name change triggered new fiduciary obligations requiring that the plan fiduciaries scrutinize these funds at the time of the name change. The court disagreed and held the plan fiduciaries had demonstrated prudent monitoring of each of these three funds and held that the plaintiffs had failed to prove that the plan fiduciaries violated ERISA. The parties have been directed to submit additional briefing to aid the court in its determination of damages.


As of now, the time to file an appeal for either side had not run. The case therefore may not be over. Assuming the trial court's finding of facts is correct, this case once again demonstrates the importance for fiduciaries to document the process by which they make their decisions. It is important to note that the court's decision should not be read to necessarily mean that fiduciaries cannot choose funds with higher expense ratios or that selecting retail versus institutional funds is per se a violation of ERISA. The court simply could not identify a procedure in which the fiduciaries had engaged to decide if the selection had been made prudently. The absence of that process is what caused the court to rule against the fiduciaries.


DOL Issues Its Long Awaited Fee Disclosure Regulation

On July 16, 2010, the United States Department of Labor ("DOL") published its long-awaited regulations on ERISA Section 408(b)(2), the statutory exemption that allows plan service providers to be compensated for their services without engaging in a prohibited transaction. The published regulation is an interim final regulation meaning that although public comments are invited, the regulations are essentially in final form, but may be modified after additional comments are received. The deadline for additional comments is August 30, 2010.

The proposed regulations were first issued in December 2007 and finalized, but not released during the Bush administration. When the Obama administration took power, these regulations were among several still under review at the Office of Management and Budget and were pulled for additional review by the new administration. The regulations were further delayed by pending federal legislation that could have had an impact on the regulations if enacted. Because it appeared that any legislation on the issue was not likely to pass anytime soon, the DOL finally released the interim final regulations. The regulations and attendant prohibited transaction class exemption are effective one year after the date of publication or July 16, 2011.


ERISA Section 406(a) sets forth a series of prohibited transaction between a plan and a party in interest -- persons that have close relationships to a plan, i.e., a fiduciary, service provider, plan sponsor, among many others. ERISA's prohibited transaction provisions are intended to be per se prohibited unless an exemption applies. There are many statutory and administrative exemptions. Without these exemptions, plans would literally be unable to transact any business. ERISA Section 406(a)(1)(C) prohibits the furnishing of goods, services, or facilities between a plan and a party interest. ERISA Section 408(b)(2) allows a 406(a)(1)(C) transaction to move forward if (1) the contract or arrangement between the plan and party in interest is reasonable; (2) the services are necessary for the establishment or operation of a plan, and (3) no more than reasonable compensation is paid for the services. Current regulations only provide that a contract or arrangement is reasonable if the plan is able to terminate the arrangement without penalty on a reasonably short notice. See 29 C.F.R. Section 2550.408b-2(c). The interim final regulations amend paragraph (c) of the existing regulation to add vendor disclosure requirements in order for a contract or arrangement to be deemed "reasonable." 

The Regulations

In general, the interim final regulations require that "covered service providers" make certain fee disclosures in writing to the fiduciaries of a "covered plan" within certain timeframes. The regulations also clarify that, while the disclosures must be made in writing, the agreement or arrangement does not require a formal written contract as was the case under the proposed regulations.

Covered plan: A "covered plan" is a defined contribution or defined benefit plan within the meaning of ERISA that is not exempted from ERISA coverage under ERISA Section 4(b), i.e., church plan. IRAs and SEPs are not covered under the regulations, and most significantly, welfare plans are not covered either. The DOL is planning to address welfare plan fee disclosure issues in separate regulations. Also excluded are vendors providing services for less than $1,000.

Covered service providers: There are three categories of covered service providers.

Category A: Includes three sub-categories:

    1. A fiduciary service provider or registered investment advisor providing services directly to the plan.  
    2. A fiduciary providing services to an investment contract, product, or entity that holds plan assets in which the covered plan has a direct equity investment.  
    3. Investment advice provided directly to the covered plan by a registered investment advisor under either the Investment Advisers Act of 1940 or state law.

Category B: Recordkeepers or brokers providing services to participant directed plans if one or more investment alternative is made available through an arrangement connected to the recordkeeper or broker.

Category C: Services for indirect compensation. This category includes, among others, any number of services such as accounting, appraisal, banking, legal, investment brokerage, or third party administration for which the covered service provider, an affiliate, or subcontractor reasonably expects to receive indirect compensation.

Covered service providers do not include an affiliate or subcontractor of a covered service provider.

Initial Disclosures: Includes details about the services that will be provided, the status of the provider, and compensation.

Services. The covered service provider must provide a description of the fiduciary services that it will provide.

Status. The covered service provider must provide a statement that it is a fiduciary to the plan, or expects to provide services directly to the plan under a contract or arrangement as an investment advisor registered under the 1940 Act or state law.

Compensation. The covered service provider must disclose in writing direct and indirect compensation for the services it is providing.

(1) Direct compensation is defined as compensation received directly from the covered plan, and the covered service provider must provide a written description of all direct compensation either in the aggregate or by service.

(2) Indirect compensation is defined as any compensation received from any source other than the covered plan, the plan sponsor, the covered service provider or its affiliates or subcontractors and includes, among others, any compensation paid under a 12b-1 fee or soft dollar arrangement or commissions, finder's fees, etc.

(3) The covered service provider must disclose the fees that it will pay its affiliates or subcontractors in connection with the services under its arrangement with the plan.

(4) Finally, disclosures must include any compensation for termination of the contract or arrangement.

Manner of Receipt. The regulations require that the disclosure state if the covered plan will be billed for the compensation or if the compensation will be deducted directly from the plan.

Timing of disclosures. In general, the disclosures must be made sufficiently in advance of finalizing the agreement or contract to allow the fiduciary to engage in a prudent decision with respect to the reasonableness of the fees in light of the services provided. In general, changes to the arrangement that cause a change in fees must be disclosed as soon as practicable, but in no event in less than 60 days.

Impact of the non-compliance. If a fiduciary fails to satisfy the new requirements of the 408(b)(2) regulations, the contract or arrangement with the vendor may be deemed a prohibited transaction for which correction will be necessary. A failure to satisfy the requirements will also leave plan fiduciaries more exposed for litigation alleging that the plan expenses are unreasonable and therefore the contract or arrangement prohibited. The regulations however provide two forms of potential relief for the plan fiduciaries: 
  • Disclosure errors made by a covered service provider made in good faith will not automatically convert the arrangement or contract into a prohibited transaction, provided that the covered service provider corrects its omission as soon as practicable after discovering the problem, but in no event later than 60 days.
  • The regulations establish a class exemption for a plan fiduciary that learns about a disclosure failure after entering into a contract or arrangement with the covered service provider.  


Agencies Issue Guidance on PPACA Internal Claims and Appeals and External Review Processes

On July 22, the Departments of the Treasury ("Treasury"), Labor ("DOL") and Health and Human Services ("HHS") jointly published an interim final rule (the "IFR") implementing requirements under the Patient Protection and Affordable Care Act ("PPACA") for group health plans and health insurance issuers to establish processes for internal claims and appeals and for external reviews. The IFR, published in the Federal Register on July 23, implements section 2719 of the Public Health Service Act ("PHSA"), as enacted by PPACA, which requires group health plans and health insurance issuers offering individual and group health insurance coverage to comply with applicable state and/or federal procedures for internal and external appeals. The rules are generally effective the first plan year (policy year for individual health insurance policies) that begins on or after September 23, 2010, i.e., January 1, 2011 for calendar-year plans and policies.

Points of Interest 

  • For internal claims and appeals, plans and insurers must follow the DOL Claims Procedure regulations set forth in 29 C.F.R. 2560.503-1 ("DOL Claims Procedure") but with certain additional requirements as set forth in the IFR. 
  • The IFR's additional requirements for the DOL Claims Procedure include rules that require notification of a benefit determination on an urgent claim be made within 24 hours, impose new conflicts of interest criteria for claims adjudication, and broaden the application of deemed exhaustion (see further discussion below). 
  • While internal appeals are pending, plans and insurers cannot reduce or terminate coverage for an ongoing course of treatment without providing advance notice and the opportunity for review. 
  • Existing state external review processes will be deemed in conformance with the IFR minimum requirements for a transition period -- i.e., for plan years beginning before July 1, 2011. 
  • Self-funded plans (except for church plans and certain governmental plans), as well as issuers in states that do not have existing external review laws, must follow federal external review procedures, which will be established through future guidance. 
  • The federal external review process and acceptable state external review processes will include the consumer protections of the Uniform Health Carrier External Review Model Act issued by the National Association of Insurance Commissioners ("NAIC Uniform Model Act" or "Model Act"). 
  • The rules do not apply to "grandfathered" plans. Please see our previous alert on grandfathered plans.


The IFR applies to a plan's or issuer's internal claims and appeals and external appeals processes maintained pursuant to state or federal law. A number of definitions are set forth for these purposes. The IFR broadens the definition of an adverse benefit determination, beyond the applicable definition in the DOL's current claims procedure regulation, to include rescissions of coverage (as defined in the previously-issued IFR regarding rescissions; see our July 16, 2010 Employee Benefits Alert) and -- for individual policies -- a denial of coverage in an initial eligibility determination.

Under the federal external review process, an adverse benefit determination that is based on a failure to meet eligibility requirements of a group health plan is not subject to review.

The IFR defines an appeal -- or internal appeal -- as the review of an adverse determination by a plan or issuer. An external review, by contrast, is a review of an adverse determination conducted pursuant to a state or federal external review process, as specifically described in the IFR.

Internal Claims and Appeals

Group health plans and health insurance issuers offering group health insurance coverage must comply with all requirements of the DOL Claims Procedures, except to the extent those rules are modified by additional requirements in the IFR. Under the additional requirements, plans must, among other things, issue notifications involving urgent care claims within 24 hours, provide claimants with information related to their claim in sufficient time to allow them to respond before the notice of a final internal adverse benefit determination is due, and include diagnosis, procedure and denial codes and descriptions in adverse benefit determination notices.

Individual health insurance issuers must generally meet the same requirements for internal claims and appeals processes as apply to issuers of group health insurance coverage. One notable exception is that issuers must make final benefit determinations after only one level of internal appeal.

Deemed Exhaustion

A claimant is deemed to have exhausted the internal claims and appeals processes if a plan or issuer fails to strictly adhere to all of the requirements for the internal claims and appeals standards. There is no exception for substantial compliance or de minimis errors. In such case, the claimant may initiate an external review, or pursue available remedies under ERISA section 502(a) or applicable state law on the basis that the plan or issuer failed to provide a reasonable internal claims and appeals process that would yield a decision on the merits of the claim. For ERISA Section 502(a) actions brought under these circumstances, the claim or appeal will be deemed denied on review without the exercise of discretion by an appropriate fiduciary, meaning that courts may refuse to afford deference to the plan or issuer who made the adverse benefit determination.

External Review

Issuers of individual and group health coverage must comply with applicable state external review laws that, at a minimum, include the consumer protections of the Model Act, available at Self-insured group health plans for which application of state external review laws are not preempted by ERISA -- e.g., church plans and nonfederal governmental plans -- must also comply with state external review laws that include, at a minimum, the consumer protections of the Model Act.

For plan years beginning before July 1, 2011, existing state external review processes are deemed to be in compliance with the IFR. This transition period gives states an opportunity to amend their laws to incorporate the Model Act consumer protections. For final adverse benefit determinations issued after the first day of the plan year beginning on or after July 1, 2011, the federal process will apply unless HHS determines that the state law meets the minimum requirements of the IFR. Health insurance issuers, self-funded church plans, and nonfederal governmental group health plans in states that do not have external review laws must follow the federal external review process as of the first plan year beginning on or after September 23, 2010. In addition, the agencies have requested comments -- and will likely issue further guidance -- with respect to the applicability of the transition period to state external review processes that apply to only some, but not all, health insurance markets.

HHS will establish standards for the federal external review process that will be similar to the process in the NAIC Model Act. The federal standards will, among other things, describe how a claimant initiates external reviews, procedures for preliminary reviews to determine if the adverse decision is eligible for external review, minimum qualifications for Independent Review Organizations ("IROs"), a process for approving IROs eligible to conduct external reviews, a process for random assignment of external reviews to IROs, standards for IRO decision-making, and rules for providing notice of a final decision.

Culturally and Linguistically Appropriate Notices

The notices required under the standards for internal claims and appeals must be provided in culturally and linguistically appropriate manner. For plans that cover fewer than 100 participants, if least 25 percent of plan participants are literate only in a non-English language, notices must be provided in that non-English language upon request. In the case of plans that cover 100 or more participants, if at least 500 participants or 10 percent of participants (whichever is lower) are literate only in a non-English language, the plan must provide notice upon request in the non-English language. For individual health insurance coverage, if at least 10 percent of the population in a claimant's county of residence is literate only in a non-English language, an issuer must provide upon request notices in that non-English language.

If the applicable numerical threshold is met, plans or issuers must include in the English versions of all notices a prominently displayed statement in the non-English language offering to provide the notices in the non-English language. For claimants who request non-English language notices, plans or issuers must provide all subsequent notices in the non-English language. To the extent that a plan or issuer maintains a customer assistance process (such as a telephone hotline) that answers questions or provides assistance with filing claims, the plan or issuer must provide such assistance in the non-English language. 

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