Leimkuehler v. Am. United Life Ins. Co.

• Decision Date: 27 June 2013
• Docket Number: 12–1213,Nos. 12–1081,12–2536.,s. 12–1081
• Citation: 713 F.3d 905
• Parties: Robert LEIMKUEHLER, as trustee of and on behalf of the Leimkuehler, Inc. Profit Sharing Plan, and on behalf of all others similarly situated, Plaintiff–Appellant/Cross–Appellee, v. AMERICAN UNITED LIFE INSURANCE CO., Defendant–Appellee/Cross–Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

713 F.3d 905

Robert LEIMKUEHLER, as trustee of and on behalf of the Leimkuehler, Inc. Profit Sharing Plan, and on behalf of all others similarly situated, Plaintiff–Appellant/Cross–Appellee,

v.AMERICAN UNITED LIFE INSURANCE CO., Defendant–Appellee/Cross–Appellant.

Nos. 12–1081, 12–1213, 12–2536.

United States Court of Appeals,Seventh Circuit.

Argued Nov. 28, 2012.

Decided April 16, 2013.

Rehearing and Rehearing En Banc Denied June 27, 2013.^*

Klint Bruno, Attorney, Korein Tillery, Chicago, IL, Kathleen A. DeLaney, Attorney, DeLaney & DeLaney, Indianapolis, IN, Robert L. King, St. Louis, MO, Eric Hyman Zagrans (argued), Attorney Zagrans Law Firm, LLC, Cleveland, OH, for Plaintiff–Appellant/Cross–Appellee.

Joel S. Feldman, Attorney, Eric S. Mattson (argued), Attorney, Bart Andrew Karwath, Attorney, Barnes & Thornburg, LLP, Indianapolis, IN, for Defendant–Appellee/Cross–Appellant.

M. Patricia Smith, Solicitor of Labor, Timothy D. Hauser, Associate Solicitor, Plan Benefits Security, Nathaniel I. Spiller, Counsel for Appellate and Special Litigation, and Stephen A. Silverman, Trial Attorney, U.S. Department of Labor, Washington, DC, Amicus Curiae.

Before KANNE, WOOD, and SYKES, Circuit Judges.

WOOD, Circuit Judge.

This case presents a challenge to the practice known in the 401(k) services industry as “revenue sharing”—an arrangement allowing mutual funds to share a portion of the fees that they collect from investors with entities that provide services to the mutual funds, the investors, or both. Although the practice has been commonplace for years, until quite recently it was opaque to both individual investors and many 401(k) plan sponsors. As the existence and extent of revenue sharing has become more widely known, some have expressed concern that the practice unduly benefits mutual funds and 401(k) service providers to the detriment of plan participants. This concern has fueled a number of lawsuits alleging that the practice violates the Employee Retirement Income Security Act of 1974 (ERISA). This is one such suit.

The district court awarded summary judgment to the American United Life Insurance Company (AUL), which is an Indiana-based insurance company that offers investment, record-keeping, and other administrative services to 401(k) plans. The court ruled that AUL was not a fiduciary of the Leimkuehler, Inc. Profit Sharing Plan (the Plan) with respect to AUL's revenue-sharing practices. The Plan and Robert Leimkuehler, its Trustee, have appealed. Although very little about the mutual fund industry or the management of 401(k) plans can plausibly be described as transparent, we agree with the district court that AUL is not acting as a fiduciary for purposes of 29 U.S.C. § 1002(21)(A) when it makes decisions about, or engages in, revenue sharing. We find it unnecessary to express any view on the question whether revenue sharing yields net benefits to individual 401(k) investors, and we thus affirm the district court.

I

Leimkuehler, Inc., a small company that manufactures prosthetic limbs and braces, operates a 401(k) plan for its employees. (So-called 401(k) plans are, more formally, private, employer-based defined-contribution retirement plans that meet the requirements of Internal Revenue Code Section 401(k). 26 U.S.C. § 401(k). We commented on the importance to millions of people of this type of retirement plan in Spano v. The Boeing Co., 633 F.3d 574, 576 (7th Cir.2011).) Robert Leimkuehler, president of Leimkuehler, Inc., and Trustee of the Plan, brought this suit against AUL, which has provided services to the Plan since 2000.

One of the services AUL provides to the Plan is the use of a group variable annuity contract, which enables individual Plan participants to invest their 401(k) contributions “in” mutual funds. We use quotation marks because, as the contract is structured, no Plan participant invests in a mutual fund directly. Rather, participants' contributions are deposited into a “separate account”—distinct because state insurance law and ERISA require AUL to keep retirement contributions separate from other assets—that AUL owns and controls. AUL uses the funds in the separate account to invest in whatever mutual funds the Plan participants have selected; it credits the proceeds of these investments back to the participants. Because the performance of the separate account mirrors that of the mutual funds, investing in the separate account is the equivalent from the perspective of a Plan participant of investing in the funds directly.

While the separate account means little to a Plan participant, it makes quite a difference to the mutual fund companies. If every individual participant in the Plan were to invest directly in the mutual funds that AUL services, the funds would have to keep track of and service thousands of individual accounts, many of which would contain little money. By pooling individual contributions into the separate account, AUL radically simplifies matters for the participating funds. From the funds' perspective,AUL is a single investor. The use of the separate account thus substantially reduces the mutual funds' administrative, marketing, and service costs.

These costs do not, however, disappear altogether. Instead, AUL must perform many of the services that the mutual funds would otherwise handle themselves. Among other things, AUL keeps track of individual accounts, takes responsibility for calculating the daily value of assets in the separate account, distributes information to the Plan sponsor and participants, and provides a customer-service hotline.

In principle, AUL could cover the costs of providing these services in one of two ways. One way would be to bill the Plan sponsor or Plan participants directly. The other way would be to engage in a practice known as “revenue sharing,” whereby the mutual fund companies pay a portion of the fees they charge investors—fees that are referred to as a fund's “expense ratio” and that are expressed as a percentage of a fund's assets—to AUL. Because a portion of a mutual fund's expense ratio is typically intended to cover the costs of providing the participant-level services that the mutual fund would be furnishing if it were not for AUL, the mutual funds are willing to pay some of these fees to AUL as compensation for AUL's provision of these services.

One additional complication plays an important role in our case. Within a single mutual fund, there are often several different expense-ratio/revenue-sharing levels available, because most mutual funds offer multiple “share classes” to investors. Although each share class within a given fund is invested in an identical portfolio of securities, the classes have differing price structures. The share classes typically made available to 401(k) investors vary primarily (and possibly exclusively) in terms of expense ratio and revenue sharing (if any).

As a general matter, expense ratios and revenue-sharing payments move in tandem: the higher a given share class's expense ratio, the more the fund pays AUL in revenue sharing. It is also generally the case that the more AUL receives in revenue sharing, the less it charges plan sponsors or participants directly for its services. AUL employees stated in deposition testimony (and Leimkuehler does not contest) that AUL offers a range of 401(k) investment products, some of which offer mutual funds with relatively high expense ratios and relatively low billed fees, and others with relatively low expense ratios and relatively high billed fees.

None of this is meant to suggest that there is necessarily a one-to-one correspondence between the cost to AUL of providing participant-level services and the amount that AUL receives in revenue-sharing payments. AUL may be making a profit, perhaps even a sizeable profit, from revenue sharing (just as it may be making a profit when it bills a plan directly for its services). The foregoing discussion simply places AUL's revenue sharing in context. (We note as well that to the extent Leimkuehler's concerns about revenue sharing arise from AUL's historical failure to disclose its revenue-sharing practices, that issue has been addressed recently. The Department of Labor (DOL) promulgated a final rule, effective July 1, 2012, that requires entities like AUL to disclose their revenue-sharing arrangements. 29 C.F.R. § 2550.408b–2 (2012).)

AUL's contract with the Leimkuehler Plan did not enable Plan participants to invest in all of the roughly 7,500 mutual funds currently available on the market. Instead, Plan participants had a significantly narrower range of investment options for their 401(k) contributions. The winnowing of investment options occurred in two stages. At stage one, AUL selected a “menu” of mutual funds and presented this menu to Leimkuehler, in his capacity as Plan Trustee. As of 2010, this investment menu contained 383 funds. For each fund on the menu, AUL also selected a particular share class, and thus a particular expense ratio and level of revenue sharing. As counsel for Leimkuehler conceded at oral argument, share classes were selected at the time AUL developed the menu; they did not change thereafter. Although AUL did not disclose to Leimkuehler or to Plan participants which share class was associated with each fund on the menu, all parties agree that AUL did disclose each fund's expense ratio. Leimkuehler therefore knew how much each mutual fund cost, though he did not know how those costs were allocated between the fund companies and AUL.

At stage two, Leimkuehler selected from the menu the specific funds that he wished to make available to Plan participants. Plan participants could then direct their contributions to one or more of the investment options that Leimkuehler had selected. Under the contract, Leimkuehler retained the right to change his selections, and he in fact did make changes to the mix of available funds at least twice between 2000 and 2010. AUL also...