On February 21, 2019, a participant in T-Mobile’s 401(k) plan sued the parent company of Fidelity Investments in federal District Court, accusing Fidelity of receiving indirect compensation through the use of a “hidden” fee that allegedly incentivizes funds using Fidelity’s platform to conceal the true nature of the fees associated with the funds. The lawsuit further contends that Fidelity was required to disclose the fee to defined contribution plans under the Employee Retirement Income Security Act (ERISA) and that the scheme amounts to a secret kickback in a “pay-to-play scheme.” Within a month, a new lawsuit filed by three separate 401(k) plans serviced by Fidelity claimed many of the same defects as the February lawsuit. Both suits are seeking class status. More are likely to follow.
The genesis of the fee, which Fidelity has been calling an “infrastructure fee,” began in 2016 as a means for Fidelity to ensure that companies selling mutual funds through Fidelity’s FundsNetwork pay a minimum fee of 15 basis points on their respective industrywide assets. Commonly, 15 basis points worth of industrywide asset fees come into Fidelity from the funds participating in Fidelity’s FundsNetwork through sub-transfer agent fees, 12b-1 fees, or other fees. However, now that some hyper-low cost funds have been stripped of these common fees, they no longer hit the 15 basis-point threshold. Failing to hit the 15 basis-point threshold subjects funds on the FundsNetwork to Fidelity’s infrastructure fee, which, according to Fidelity, tops out at five basis points on industrywide assets.
Fidelity notes that these fees help cover the cost of various services, including recordkeeping, trading and settlement, and customer support on the FundsNetwork. Moreover, since the fee is charged by Fidelity to the intermediary selling mutual funds to defined contribution plans (and not directly to the defined contribution plans), the fee is technically not paid by the defined contribution plan’s investors (of course, the cost is most likely passed on to them all the same).
Federal and state regulators (including the U.S. Department of Labor and the Massachusetts Secretary of the Commonwealth) are questioning Fidelity about the infrastructure fee in an effort to determine whether disclosure of the fee should have been made under ERISA.
In response to the lawsuits and probes, Fidelity has asserted that the infrastructure fee has been disclosed to more than 20,000 retirement plan sponsors and is not only paid by retirement plan fund providers but all plans on the FundsNetwork. However, the plaintiffs suing Fidelity allege that Fidelity forced funds subjected to the infrastructure fee from disclosing the fee to investors and that the infrastructure fee bears no relationship to the actual services provided by Fidelity because it is expressed as a percentage of assets and not a flat fee for services. The plaintiffs also assert in court filings that the infrastructure fee generates tens of millions of dollars for Fidelity, if not much more.
As more and more investors turn to lower-cost passive mutual funds, many financial service companies will continue to look to various methods for recouping lost revenue in this industry-wide shift toward lower-cost financial products. The infrastructure fee pioneered by Fidelity was seemingly created for that purpose. However, with all of the untoward attention the fee has created from end consumers and regulators, the overall benefit of the infrastructure fee for Fidelity is in question. As the industry continues to work through the significant disruption of the past few years, all that is certain is that financial management companies will have a herculean task in balancing profitability with fairness and compliance as investors’ preference, sophistication, and knowledge of how fees impact their bottom line rapidly evolve.
