Fifth Circuit Joins Sister Circuits In Holding that the Collection of a Contractually Predetermined Fixed Fee Does Not Constitute a Fiduciary Act under ERISA

In D.L. Markham DDS, MSD, Inc. 401(K) Plan v. Variable Annuity Life Ins. Co., No. 22-20540, __F.4th__, 2023 WL 8642231 (5th Cir. Dec. 14, 2023), Plaintiffs D.L. Markham DDS, MSD, Inc. (“Markham”) and D.L. Markham DDS, MSD, Inc. 401(k) Plan appealed the district court’s dismissal of their ERISA breach of fiduciary and prohibited transaction claims against Variable Annuity Life Insurance Company (“VALIC”), an insurance corporation that specializes in tax-qualified retirement plans. The Fifth Circuit affirmed the district court’s decision, holding that (1) the collection of a contractually predetermined fixed fee does not constitute a fiduciary act under ERISA; (2) VALIC was not a “party in interest” when it entered into the Plan’s annuity contract; (3) VALIC’s collection of the contract’s surrender fee does not constitute a separate transaction; and (4) the district court did not abuse its discretion in denying Plaintiffs’ request for leave to amend their complaint.

Plaintiffs are a married couple who own Markham, a small dental practice in Auburn, California. They established the D.L. Markham DDS, MSD Inc. 401(k) Plan and Markham is the Plan’s sponsor, administrator, and named fiduciary. Markham hired VALIC to maintain the Plan on VALIC’s retirement platform. Markham chose the Portfolio Director Group Fixed and Variable Deferred Annuity Contract (the “PD Contract”) as the Plan’s annuity contract. VALIC served as the issuer and contract record-keeper of the Plan’s assets, charging various fees for its services. The PD Contract provided for a 5% surrender fee on transfers out of the contract for funds contributed in the previous 60 months. After a few years, Markham notified VALIC that it intended to terminate the PD Contract, and VALIC exercised its discretion under the PD Contract to charge the 5% surrender charge, which amounted to 4.5% of the Plan’s assets, or $20,703.

Markham and the Plan then filed a class action lawsuit against VALIC alleging that VALIC violated ERISA by breaching its fiduciary duties and engaging in a prohibited transaction with a party in interest. The district court granted VALIC’s motion to dismiss, finding that “Plaintiffs’ claim for breach of fiduciary duty failed because VALIC was not a fiduciary; and (2) Plaintiffs’ prohibited-transaction claim failed because VALIC was not a “party in interest” when it entered the PD Contract and the collection of the surrender fee was not a separate transaction.” The district court denied Plaintiff’s request for leave to amend.

On appeal, the Fifth Circuit decided four issues Plaintiffs raised, including “(1) whether VALIC acted as a fiduciary when it collected the surrender fee; (2) whether VALIC was a party in interest when it entered into the PD Contract; (3) whether VALIC’s collection of the surrender fee constitutes a separate transaction; and (4) whether the district court abused its discretion in denying Plaintiffs’ request for leave to amend their complaint.

On the first issue, the Fifth Circuit noted that its sister circuits—the Third and the Ninth Circuits—have considered this issue and have held that accepting predetermined compensation does not constitute a fiduciary act. The court agreed with these holdings, explaining that, “[a]ccepting predetermined compensation that was agreed to by a plan’s named fiduciary does not constitute control over the management of a plan or disposition of the plan’s assets. Here, although VALIC had discretion to waive the fee, the PD Contract set a maximum surrender fee and gave VALIC the right to retain it. Thus, VALIC merely adhered to the PD Contract by collecting the previously bargained-for compensation.” The court held that the collection of a contractually predetermined fixed fee does not constitute a fiduciary act under ERISA.

On the second issue, the court explained that 29 U.S.C. § 1106(a)(1)(C) prohibits fiduciaries from knowingly “engag[ing] in a transaction” for the “furnishing of goods, services, or facilities” with a “party in interest.” ERISA defines “party in interest” as “a person providing services to such plan.” Id. § 1002(14)(B). The court held that VALIC was not a party in interest when it entered the agreement because “a person providing services to such plan” is limited to entities that have already began providing services to the plan at issue. The court rejected Plaintiffs and amicus curiae, the Secretary of Labor’s argument that “a person providing services to such plan” under 29 U.S.C. § 1002(14)(B) includes all service providers, regardless of whether they have begun providing services to the particular plan at issue. The court found that this interpretation contradicts the plain reading of the text: “The word ‘providing,’ used here as a present participle, most commonly describes a person who is currently providing services. Further, the modifying phrase ‘to such plan’ limits the definition to entities providing services to the plan at issue—not service providers in general.” The court held that because VALIC was not yet providing services to the Plan, it was not a “party in interest” under § 1106(a) when it entered the PD Contract.

On the third issue, the court explained 29 U.S.C. § 1106(a)(1)(C) prohibits fiduciaries from causing the plan to engage in a transaction with a party in interest. Plaintiffs argued in the alternative that VALIC’’s subsequent collection of the surrender fee was a prohibited transaction with a “party in interest.” The court agreed that VALIC was likely a “party in interest” when it collected the fee because it had been providing services to Plaintiffs for several years but that the collection of a contractually determined fee is not a “transaction” under § 1106(a). The court held that VALIC’s collection of the surrender fee was not a prohibited transaction.

Lastly, the court held that the district court did not abuse its discretion in denying Plaintiffs leave to amend due to undue delay. Plaintiffs filed their complaint in the Eastern District of California in January 2021 and VALIC filed its initial motion to dismiss in March 2021. The Eastern District transferred the case to the Southern District of Texas a year later and VALIC filed another motion to dismiss with the same arguments. Plaintiffs were aware of the potential deficiencies in their complaint for over a year. The district court found that Plaintiff provided no excuse for their delay. Additionally, the court found that the district court did not abuse its discretion because Plaintiffs’ motion for leave provided insufficient detail of their new allegations.