Fidelity Breached Fiduciary Laws for Hundreds of Millions of Dollars

“Fidelity literally has lined its pockets with at least hundreds of millions of dollars in secret payments by and through self-dealing, other prohibited transactions and breaches of its fiduciary duties...”

Excerpt from Case# 1:19-cv-10654, in U.S. District Court for the District of Massachusetts

When corporations are faced with unfavorable industry developments or conditions, they typically have one of three options: innovate, adapt, or fold.

Rarely would respectable, law-abiding corporations seek the route of illicit activity, concealing illegal means within operational processes, obfuscating ill-gotten gains through terminological diversion.

After all, this is what criminal organizations do when disguised as “legitimate business.”

Not only do illicit organizations rent-seek by monopolizing local territories, markets, or means of exchange, but they do so coercively, iron-handedly, often with a threat to remain silent.

We assume that such actions are the domain of disreputable organizations whose self-serving actions are conducted at the expense of the general public in violation of the laws of governing them.

But if that were true, then how do we account for Fidelity Investments’ contested activities and mode of conduct surrounding its FundsNetwork platform, as detailed in Case 1:19-cv-10654?

How Fidelity’s Coercive Kickbacks Skim Off Managed Funds and Investor Accounts

On the surface, Fidelity’s FundsNetwork appears as a promising technological solution with great value to the world of financial investments. It is a platform that allows investors to access hundreds of mutual funds outside of Fidelity, benefitting not only the investing public but also the mutual funds and advisers participating in the network.

As with any financial service, customers are subject to expense ratio fees that, by law, must be disclosed to clients. Likewise, partner mutual funds and advisers must pay various fees to Fidelity in order to participate in this platform service.

The key term here is “disclosure,” and this is where Fidelity’s alleged violation begins.

According to the lawsuit, plaintiff Jason Bailis of the Publicis Benefits Connection 401(k) Retirement Savings Plan, claims that Fidelity required its various FundsNetworks participants to make “secret payments,” similar to a “pay-to-play” scenario.

So, what’s wrong with Fidelity charging its outside participants for access to its platform? Wouldn’t this be viewed simply as the cost of doing business?

It would be if Fidelity had been willing to disclose the details of the fees, and if they hadn’t prohibited the participating funds from disclosing the fees to its customers.

The confidential payments were under the guise of “infrastructure” fees, which in essence are relationship-level fees. By imposing this expense on its partner funds, Fidelity prohibited the transaction and fiduciary rules set forth by the  Employee Retirement Income Security Act.

In short, the infrastructure fees are “kickbacks” designed to cover any decrease in 12b-1 revenue generated from administration fees, service fees, transaction fees, and various other fees typically charged to the customer.

Mutual funds that fail to kick back this extraneous payment may no longer be granted inclusion into the FundNetworks program.

As the suit claims:

“Fidelity makes it clear to mutual funds that, if they refuse to make the secret payments, they will be restricted in their relationship with Fidelity and Fidelity, inter alia, will not permit a mutual fund to add new funds to the FundsNetwork, will eliminate its existing mutual funds from the FundsNetwork through a hold and redeem approach, will impose additional fees on Fidelity’s clients that invest in the mutual funds, and will eliminate opportunities for these mutual funds to grow their business through Fidelity’s FundsNetwork and by providing access to the Plans.”

Although Fidelity describes the platform as an “open architecture,” they retained the right to control and change the menu of available mutual funds offered by its FundsNetwork.

The main ethical issue with these secret payments is that they tend to increase the mutual funds’ costs which, in the end, are directly deducted from their customers’ funds.

And since Fidelity hides the existence of the kickbacks, in breach of fiduciary duty, the participating mutual funds are prohibited from disclosing the fees to clients as part of their expense ratio.

So, essentially, Fidelity is lining their pockets by charging extraneous fees, the nature of which they refuse to disclose, and the majority of which they skim from non-Fidelity customer funds.

When Competition Gets Tough, the Tough Sometimes Cheat Competition

Why exactly is Fidelity charging these fees that, as noted in the suit, “bear absolutely no relationship to the cost or value of any such services”? It’s in response to the growing trend of investors shifting toward passive mutual funds.

In addition to this trend, the rise in popularity of ETF investments has also caused massive outflows from the mutual fund industry; after all, why pay a fund manager to monitor a product that is by nature “passive”?

Naturally, a decline in managed fund investment leads to a decline in revenue-sharing payments. The market environment has become unfavorable to that particular segment of the financial industry.

In short, Fidelity and their mutual fund clients are being “punished” by the forces of the market. In response, Fidelity has decided to dole out its own punishment toward its mutual fund partners and the customers they serve.

Hundreds of Millions in Kickbacks Per Year

The lawsuit claims that Fidelity is making at least tens of millions of dollars per year in kickbacks. But the likely figure is in the hundreds of millions of dollars per annum.

Let’s step back for a moment and take this in.

So if you are one of those investors who own mutual funds managed by a company participating in FundsNetwork, you may be paying extra fees that “bear...no relationship to the cost or value” of the services you receive.

Fidelity may be tapping into your funds, and the funds of thousands of other mutual fund investors, simply because they cannot compete with the growing trend against managed fund investment.

As an investor who may be a likely target for this cheat, why not resist it all the way? If you want to invest in the broader market, why not just purchase a broad index ETF or a sector ETF?

In other words, why make your money vulnerable to a system designed to illicitly take advantage of it?

Perhaps keeping a portion of your funds outside of the greater financial system might serve you well. And this could easily be achieved by allocating a portion of your funds to privately-stored physical gold and silver.

If a safe haven were truly “sound,” and many are not, then it would be resistant to the manipulations and machinations of those who legally and illegally game the system.

And if even the most reputable financial institutions, like Fidelity Investments, are ethically and morally fallible, then what are we to think about the smaller institutions competing with the larger ones for your money?