Fidelity Faces Second Lawsuit Over Undisclosed Payment Scheme

Participants in several retirement plans served by Fidelity Investments have filed a lawsuit challenging what it claims are undisclosed payments received by Fidelity through its “Funds Network.”

This is the second such lawsuit filed against Fidelity this year. In a statement to PLANSPONSOR about the new lawsuit, Fidelity said, “Fidelity emphatically denies the allegations in this complaint and intends to defend against this lawsuit vigorously. Fidelity fully complies with all disclosure requirements in connection with the fees that it charges and any assertion to the contrary is not only misleading, but simply false. Fidelity has an outstanding platform that provides significant benefit to our customers, including an extensive offering of funds with no transaction fees, the ability to consolidate investments in one place, and industry-leading tools to help find the right funds. We are committed to remaining an open architecture platform that provides access to thousands of funds to all of our customers, but such a broad offering requires substantial infrastructure. For example, Fidelity must support systems and processes needed for recordkeeping, trading and settlement, make available regulatory and other communications, and provide customer support online and through phone representatives. It is costly to maintain this kind of infrastructure, and Fidelity requires the fund firms on our platform to compensate us for those costs. For a small number of those companies, this includes an infrastructure fee that is charged to the fund firms.  The fee is not charged to the plan sponsor or plan participants.”

According to the recent complaint, brought on behalf of similarly situation Fidelity retirement plan customers, since at least 2016, Fidelity has breached its fiduciary duties to the plans by charging mutual fund and other investment companies a substantial fee as a condition for their investment vehicles being offered on Fidelity’s fund platform. The lawsuit alleges that “Although Fidelity refers to this arrangement as an ‘infrastructure’ fee, it is in fact an illegal and undisclosed pay-to-play fee that Fidelity extracts from investment companies that wish to ensure their products are marketed and sold through Fidelity.” The plaintiffs say the fee drives up expense ratios borne by 401(k) plan participants, causing these participants to pay more in fees and receive lower returns on their investments.

The complaint cites a Wall Street Journal report that said Fidelity instructed participating mutual funds not to disclose the fee to any third party, including plan sponsors, plan beneficiaries and the public. The Journal further reported that, based on internal Fidelity documents, the fee represents “0.15% of a mutual-fund company’s industry-wide assets.” According to the plaintiffs, that the fee is calculated by reference to industry-wide assets, rather than assets held only through Fidelity, confirms that the fee bears no meaningful relationship to any “infrastructure” maintenance by Fidelity and constitutes excessive compensation.

According to the complaint, Fidelity has significant leverage to coerce payments from mutual fund complexes interested in offering their funds through Fidelity. The firm also offers its own mutual funds, and the fee enables it to offset losses it has sustained from investors flocking to lower-cost index funds.

The plaintiffs point out that the Department of Labor (DOL) and the Massachusetts Securities Division have each opened investigations into Fidelity’s imposition of the fee.

The lawsuit alleges that Fidelity’s assessment of the fee constitutes self-dealing that violates Fidelity’s fiduciary duties and the Employee Retirement Income Security Act’s (ERISA)’s prohibited transaction rule. Additionally, the fee constitutes indirect compensation to Fidelity that must be disclosed to the plans under ERISA, which mandates written disclosure of any such compensation that Fidelity “reasonably expects to receive” in connection with its services. “Despite its fiduciary and disclosure obligations, Fidelity continues to charge the fee and keeps the amount of the fee payments confidential,” the complaint says.

The plaintiffs seek to enforce the Fidelity defendants’ liability to return all plan losses arising from each breach of fiduciary duty and to restore to the plans all profits gained through the use of the plans’ assets. They also seek to enjoin Fidelity’s imposition of the undisclosed fee.