Government Probes Fidelity Over Obscure Mutual-Fund Fees

Boston-based firm characterizes so-called infrastructure fee as solution to ‘broken’ business model

By Gretchen Morgenson

The issue with Fidelity’s infrastructure fee is whether it is adequately disclosed to investors and to plan sponsors overseeing retirement accounts, lawyers say.
The issue with Fidelity’s infrastructure fee is whether it is adequately disclosed to investors and to plan sponsors overseeing retirement accounts, lawyers say. Photo: brian snyder/Reuters

The Labor Department is investigating Fidelity Investments over an obscure and confidential fee it imposes on some mutual funds, according to a person familiar with the inquiry.

The annual charge, which Fidelity calls an infrastructure fee, is aimed at companies selling shares on the asset manager’s fund platform, and was described in a 2017 internal Fidelity document reviewed by The Wall Street Journal. The fee, which appears to have been implemented in 2016, is “designed to ensure that each Fund Firm meets a minimum required payment to Fidelity.” By marking the charge as an infrastructure fee, the fund firms may be able to avoid disclosing it to investors.

Fund companies that decline to pay the amount will “be subject to a very limited relationship” with the company, the document says. Funds can either pay the fee themselves or push the cost onto investors in the mutual fund. This can increase the overall fees of a fund, causing individual investors to pay more and dent returns.

The fee is calculated as 0.15% of a mutual-fund company’s industrywide assets, not just on the dollar amount of assets held by Fidelity customers buying shares on the platform, the document says.

The infrastructure fee appears to be a way for Fidelity to make up for revenue the firm has lost as a result of investors flocking to reduced-cost mutual funds, a situation the firm refers to in the document as “unsustainable economics.” Fidelity also stated in the document that its traditional business model is “broken” and characterized the infrastructure fee as a solution to that problem.

Assets under management are still growing at Fidelity—as of September 2018 they stood at $2.6 trillion—but the company is pressured by investors who prefer low-cost index funds and other passive investment products to Fidelity’s traditional actively managed mutual funds.

Fidelity makes thousands of third-party mutual funds available to its customers, Vincent Loporchio, a Fidelity spokesman, said in a statement. Those customers include holders of 401(k) plans for which the firm acts as record-keeper.

“We receive a fee from some of those mutual-fund companies to compensate us for maintaining the infrastructure that is needed to make those funds available,” Mr. Loporchio said, citing “systems and processes for record-keeping, trading and settlement, making available regulatory and other communications, and providing customer support online and through phone representatives. It is costly to maintain this kind of infrastructure and Fidelity is entitled to be compensated for those costs.”

Fidelity had no comment on the government investigation into the fee.

With $1.5 trillion in third-party mutual-fund assets held by Fidelity customers, the firm’s FundsNetwork is a powerful platform for fund companies seeking to engage with investors.

The infrastructure fee is levied on lower-cost share classes such as those aimed at retirement accounts. The Labor Department has jurisdiction over retirement accounts that are subject to extra protections and disclosures under the Employee Retirement Income Security Act, or Erisa.

A spokesman said the Labor Department can neither confirm nor deny the existence of ongoing or prospective investigations. Enforcing Erisa, the department typically brings civil actions.

The issue with the fee is whether it is adequately disclosed to investors and to plan sponsors overseeing retirement accounts, securities lawyers said. Fidelity’s insistence on confidentiality about the amounts funds pay in infrastructure fees suggests investors who ultimately foot these bills may not be apprised of them.

The document outlining the infrastructure fee, “Fidelity FundsNetwork Business & Services Guide,” is “not to be distributed to the public as sales material in oral or written form,” and “may not be shared with any third party.”

The Fidelity spokesman said the firm “fully complies with all disclosure requirements in connection with the fees that it charges.”

Fund shares offered by Eaton Vance Corp.; Nuveen Investments; Pacific Investment Management Co., or Pimco; and Thrivent Financial for Lutherans are among those available on the Fidelity platform. Asked whether they disclose the company’s infrastructure fees to their clients, spokeswomen for Eaton Vance and Pimco declined to comment.

A Nuveen spokeswoman said the firm provides “extensive detail about all the fees related to the funds we manage.” A spokeswoman for Thrivent said the company doesn’t talk about the fee arrangements it maintains with Fidelity or any other third-party platform.

“Intermediaries and mutual funds are far more candid in their agreements between each other than they are in disclosures to plan sponsors and investors,” said Edward Siedle, a former attorney for the Securities and Exchange Commission who advises pensions on asset-management matters.

The internal Fidelity document was supplied to asset-management companies, the firm said, to help mutual-fund boards evaluate whether fees, including the infrastructure charge, are being used for distribution. That is crucial: When a fund pays a fee that aims to result in the sale of fund shares, either directly or indirectly, securities laws require it to be part of what is known as a 12b-1 plan and to be disclosed to investors. Many lower-cost fund share classes don’t have 12b-1 plans—a reason why they are cheaper.

Funds are also barred from making “payments that are ostensibly made for some other purpose, but which, based on the facts and circumstances, are used in ways that finance distribution,” the SEC said in a guidance update in 2016.

Sponsors of retirement plans must also disclose all payments made related to the plans.

The Fidelity infrastructure fee is also the subject of a lawsuit filed last week in a Massachusetts federal court by a participant in a retirement plan offered by T-Mobile US, Inc. In that suit, the plaintiff contends that the infrastructure charge is prohibited under Erisa and that Fidelity incentivizes mutual funds on its platform to “conceal the true nature of fees associated with these funds.”

The Fidelity spokesman said the company emphatically denies the allegations and intends to defend against them vigorously.

In the internal Fidelity document, the company indicates that it doesn’t consider the infrastructure fee to cover distribution services. Rather, it categorizes the agreement between Fidelity and funds on its platform as “shareholder services”; such fees may not require a 12b-1 plan. A person familiar with the program said each fund must determine what portion of fees paid to Fidelity are for distribution.

The SEC has been examining mutual-fund companies’ payments of fees to financial intermediaries, like Fidelity. In 2015, for example, First Eagle Investment Management agreed to pay nearly $40 million to settle the SEC’s charges that it used $25 million in fund assets to pay for distribution and marketing of fund shares outside of a 12b-1 plan.

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