Business As Unusual: Fiduciary Do’s and Don’ts

Plan sponsors often gloss over the reality that they are ERISA fiduciaries – or think that if they have hired an advisor, they’ve basically hired a stand-in for that responsibility. But there’s another mistake that even the most well-intentioned make – with remarkable frequency, based on what I hear from advisors.

In the marketplace, it’s normal – even expected – that firms extend more favorable terms and/or discounts to those who do business with them across various offerings. But those “normal” practices can cause you trouble when it comes to doing business with ERISA-governed plans. Here’s how:  

If you make decisions regarding the plan or plan assets, you’re an ERISA fiduciary.

If you have discretion in administering and managing the plan, or if you control the plan’s assets (such as choosing the investment options or choosing the firm that chooses those options), you are a fiduciary to the extent of that discretion or control. Ditto if you are able to hire individuals that control or direct the investment of those assets.

Plan decisions you make as an ERISA fiduciary – including hiring those who provide plan services – must meet certain criteria.

With regard to what a fiduciary must do, the Employee Retirement Income Security Act, or ERISA, sets out a number of requirements for plan fiduciaries in what are generally referred to as the “prudent man” rule, the duty of loyalty and the “exclusive benefit” rule.

Taken in their entirety, this means that plan fiduciaries must carry out their duties as would “a prudent man engaged in a like capacity and familiar with such matters,” to act “solely in the interest” of plan participants and to act for the exclusive purpose of providing retirement benefits to participants. Those duties include the selection and monitoring of providers – and those must be done for the exclusive benefit of participants and beneficiaries. Failing to do so constitutes a breach of your fiduciary duty – and this has been the underlying allegation in just about all of the recent litigation regarding ERISA plans.

There are also certain things you can’t do as an ERISA fiduciary.

Fiduciaries may believe that, in order for a conflict of interest to exist, the fiduciary must somehow act in a manner that is bad for the plan, but ERISA outlines a number of actions that fiduciaries may not take, generally referred to as “prohibited transactions.”
The transactions that constitute an unlawful exchange between a plan and a party in interest, or prohibited transaction, involve the sale, exchange or lease of property; lending of money or other extension of credit; furnishing of goods, services or facilities; or a transfer or use of plan assets. A disqualified person who takes part in a prohibited transaction must correct the transaction and must pay an excise tax based on the amount involved in the transaction.

Note that if a conflict of interest is precluded under ERISA's prohibited transaction rules, the fiduciaries cannot, as a matter of law, allow the plan to become a party to the transaction – even if the action were otherwise reasonable or profitable to the plan. There are exemptions to some of these prohibited transactions, but without that, fiduciaries are absolutely prohibited from entering into a contemplated transaction – even if doing so could otherwise be considered “prudent.”

Businesses make “relationship” deals all the time – ERISA-governed plans can’t.

Remember that as an ERISA fiduciary you have a legal obligation to act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them. 

So, let’s say the local financial institution, currently bidding on the opportunity to manage your plan’s assets, wants to acknowledge the “value of the expanded relationship” by extending a more favorable interest rate, or to expand the firm’s existing line of credit were they to be awarded the plan business.

From a customary “doing business” standpoint, this probably wouldn’t raise any red flags – but then, ERISA isn’t “customary” – and from that standpoint, there are red flags aplenty.

The clear intent of the offer is to reward the decision to award the plan business to the financial institution, or at least to acknowledge that the financial institution is willing to view its business holistically. That said, when it comes to dealing with an ERISA plan, fiduciaries must make those decisions in isolation – solely is the operative word here – and a decision to transfer plan assets in exchange for better banking terms for the company fails that test.

Specifically, it violates 406(b)(1) and (3) because the responsible fiduciary has dealt with the assets of the plan for the benefit of an entity other than the plan participants and beneficiaries. Nor does it matter that as employees of the firm there might be some incidental benefit from the enhanced LOC. Why? Because the decision wasn’t made for the exclusive purpose of providing benefits, nor was it solely in the interest(s) of plan participants and beneficiaries.

What could be worse?

Worse – imagine a situation where the fees or services offered to the plan by the financial institution aren’t the top choice of the plan fiduciaries/committee. Again, in a “customary” business transaction, it’s not unusual to consider the entire relationship, to weigh the breadth of services and costs in totality.

But ERISA isn’t customary – and if better options were readily available, and there is no specific plan benefit justifying the transfer, the plan fiduciaries have run afoul of the duty not only to act prudently, but to do so for the “exclusive purpose” of providing the retirement benefits to plan participants and beneficiaries. And, depending on the nature of the transaction, they may well have run afoul of ERISA’s prohibited transaction restrictions.

Remember that your liability as an ERISA fiduciary is personal.

There are any number of things that can go wrong in running a workplace retirement plan. That’s why it’s important to hire experts – and to keep an eye on them. But don’t forget that ERISA fiduciaries – and your decision as a committee member means that you’re one - can be held personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.

The bottom line: When it comes to dealing with ERISA plans, plan fiduciaries are well-advised to consider if anyone other than the participants benefits as a result of the selection of a service provider or an investment decision. And if so, to tread carefully – very carefully.

- Nevin E. Adams, JD
 
Note: For a more extensive analysis on the subject, I am indebted to the work of Fred Reish who has on this topic, as on many others over the years, provided excellent insights, including this one.

A New ‘Presumption’ of Prudence

Has an index fund become a presumption of prudence?

You may remember that no so very long ago, courts had determined that the holding of employer stock in Employee Stock Ownership Plans (ESOPs) was entitled to a presumption that their fund management was prudent under a “presumption of prudence” standard. That standard was rejected by the U.S. Supreme Court in 2014 in favor of a new one that required plaintiffs to articulate alternatives that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.

Last October a federal appeals court overturned a district court decision regarding an excessive fee suit brought against Putnam Investments by participants in its 401(k) plan regarding the prevalence of proprietary funds in its own plan menu. The district court had ruled that the plaintiffs failed to identify any specific circumstances in which the company and its 401(k) plan put their own interests ahead of the interests of plan participants, and that the plaintiffs also failed to show how Putnam’s allegedly imprudent actions resulted in losses that required redress.

However, upon review the appellate court not only sent the case back for further consideration by the district court, but did so with a new admonition – holding that the burden of proof as to the responsibility for the loss suffered should be on the defendants, rather than the plaintiffs alleging the harm.

In other words, once the plaintiffs established that there was a loss, the defendant has to prove that the loss wasn’t due to a breach of their fiduciary duty. To make matters worse (or at least more confusing), the courts have split on this burden of proof issue. As the Fifth Circuit appellate court acknowledged, the Second, Sixth, Seventh, Ninth, Tenth and Eleventh Circuits have held that the plaintiffs bear the burden of proof, while the Fourth, Fifth, Eighth, and now First Circuits see that as a defendant obligation.

Little wonder that Putnam has petitioned the Supreme Court for a review and resolution of the issue – or that so many entities have weighed in with their support of the plaintiffs in the case (AARP, the AARP Foundation and the National Employment Lawyers Association) and the Putnam fiduciary defendants (the Chamber of Commerce of the United States of America, the American Benefits Council, the Securities Industry and Financial Markets Association and the Investment Company Institute).

In fairness, proving that such losses are a result of a fiduciary breach can be tough – witness the relatively few wins by plaintiffs who have taken that issue all the way to trial (settlement ahead of that seems to be the norm, often just days before). Arguably it could be just as problematic for defendants to refute those claims, even with documentation of a prudent process (the First Circuit ruling speaks to meeting a “burden of showing that the loss most likely would have occurred even if Putnam had been prudent in its selection and monitoring procedures”).

But the most disquieting aspect of the case may lie in the comments by the First Circuit’s Judge William J. Kayatta, Jr. who, dismissing arguments that the shift in burden of proof would undermine plan formation and encourage litigation (“irrespective of the merits”) as crying “wolf,” wrote: “…any fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds.”

Or under that standard, one might well argue, now be forced to defend a decision to do otherwise.

- Nevin E. Adams, JD

Is the Prudent Man Standard Good Enough?

It’s often said that ERISA’s prudent man rule is the highest duty known to law. But is that enough?

Don’t get me wrong – any law that holds human beings to the standards of an expert in any field is a pretty high standard, and one that can be difficult to meet even with the ablest of expert assistance.

I started thinking about this recently when a friend was asking my advice on what he should do regarding the options in his new 401(k) plan. I did what I often do, outlining the pros and cons of various alternatives, helping him to make what I considered to be a well informed – or at least better informed – decision.

I had stepped through all the options and considerations with his plan, a pretty standard combination of automatic enrollment provisions. But then, after asking questions throughout, when I was finished, he didn’t ask what I thought he should do. Instead, he asked what I had done with my own retirement savings.

The process of stepping through my decisions with my friend wasn’t without its limitations. It wasn’t an apples-to-apples comparison, for one thing; my plan didn’t have the same options available to him, nor were our specific financial and familial situations identical.  But it got me to thinking...

Plan fiduciaries have long been reluctant to superimpose their judgments on the participants whose benefit they are charged with overseeing, and with good cause. The financial decisions attendant to participating in a plan (including the decision to participate in the first place) are fraught with the potential for significant disruption, particularly in view of the panoply of personal circumstances that ought to be considered. And while there are doubtless situations in life for which we must do so – the imposition of our best judgments for loved ones not old enough, or no longer able, to do so – most of us have our hands full just keeping up with our own slate of critical determinations.

While we have made significant strides in implementing “automatic” plan designs that help participants get off to a better start than they might have if left to their own devices, it still seems that most fiduciaries gravitate toward the “first, do no harm” standard generally associated with the medical profession’s Hippocratic Oath.

A higher standard might arguably be the so-called “Golden Rule,” which sets as its marker that you do to others how you would like them to do to you. How might that apply to retirement plan designs?

• If you, as a participant, wouldn’t think of setting aside only 3% of pay, even as a starting point, why would you let others do so?
• If you, as a participant, wouldn’t think of contributing to a level that doesn’t give you the full benefit of that company match, why would you let others do so?
• If you, as a participant, would (and do) willingly accelerate your rate of contribution annually, why do you let others pass up that opportunity?
• If you take advantage of a qualified default investment alternative to help ensure that your investments are diversified and rebalanced on an ongoing basis, and particularly if you use that as a default option for new hires, why wouldn’t you do the same for current hires?
• If you think overinvestment in company stock is dangerous, why do you let participants do it?
• If you think participants need help making retirement planning decisions, why don’t you accommodate it?

I realize the answers to some, and perhaps all, of these questions are complicated. “My boss wants us to” is surely the answer in some cases, while “Because I am worried I/we will get sued” comes up frequently. The answer I hear most from plan sponsors is, “I don’t know enough about their individual situations to make the right decision,” though one might also reasonably reply, “Because I’m not required, even as an ERISA fiduciary, to do so.”

But as I said, my conversation about a friend’s new 401(k) got me to thinking about the prudent man standard, and how it’s generally applied to plan design standards.

After all, can it really be in the best interests of plan participants, if it isn’t good enough for you?

- Nevin E. Adams, JD

End Note
The original prudent man rule dates back to the common law, specifically the 1830 Massachusetts case of Harvard College v. Amory. From that case came the notion that trustees were directed “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” In the absence of specific directions in the trust agreement, the trustee was to invest as he would invest his own property, taking into account the needs of beneficiaries, the need to preserve the estate (or corpus of the trust), and the amount and regularity of income.
ERISA’s prudent man rule goes further, requiring that a fiduciary must perform its duties “with the care, skill, prudence and diligence under the circumstances then prevailing, that a prudent man acting in like capacity and familiar with such matters would use…”

Lessened, Learned?

When I’m talking to plan sponsors (and advisers) about the challenges of being an ERISA fiduciary, I’m generally inclined to emphasize the awesome responsibilities that come with the “assignment”: the impact exerted on participant retirement savings; the admonition to ensure that fees paid by, and services rendered to, the plan are reasonable; the implications of the prudent expert rule; and the liability (and personal liability, at that), not only for your own acts, but for the acts of your co-fiduciaries (and hence an urgency around knowing who those co-fiduciaries are). I’m inclined to talk about the limitations of ERISA 404(c) in providing a shield against all that potential liability.

I’ll remind them that the Labor Department considers them responsible for all participant-directed investments outside 404(c)’s provisions, and note how frequently participant directions tend to fall outside those provisions. I’ll tell them how important it is to read the plan document, and to make sure the plan is operated according to its terms. I will remind them that the power to appoint members to the plan committee has been found to extend fiduciary liability to those who do the appointing, and I will, from time to time, remind them that company stock has been called “the most dangerous plan investment,” in no small part because a group of 401(k) participants is a class-action litigant’s dream team.

And then we get a court decision like the 2nd Circuit’s recent holding in Gray v. Citigroup, Inc., and I wonder if I understand ERISA at all.

The Case

Gray is a “stock drop” case (see 2nd “Circuit Affirms Dismissal of Citigroup Stock Drop Charges”), brought on behalf of Citigroup participants whose 401(k) balances were invested in the stock of their employer, stock that dropped precipitously in value in the wake of the 2008 financial crisis, in response to the collapse of the subprime mortgage market. As is common in such cases, the participant-plaintiffs alleged that the stock was retained as a plan investment option after it was no longer prudent to do so, and that those on, and who appointed, the plan investment committee were not only in a position to know that, but to know that well before the stock tumbled in value.

However, the 2nd Circuit noted—and supported—the determination of the lower court that “defendants had no discretion whatsoever to eliminate Citigroup stock as an investment option, and defendants were not acting as fiduciaries to the extent that they maintained Citigroup stock as an investment option.” Moreover, it noted—and supported the District Court’s determination that “even if defendants did have discretion to eliminate Citigroup stock, they were entitled to a presumption that investment in the stock, in accordance with the Plans’ terms, was prudent….”

Now, how is it that the plan’s committee had “no discretion whatsoever” to deal with the company stock investment? Quite simply, because the plan document called for that as an investment option.1 That’s right, apparently the court felt that the plan fiduciaries had no choice in deciding to keep that option in the plan and available because, to put it simply, “the plan document made them do it.”2

Presumption of Prudence

As for the alternative argument, the “presumption of prudence”? Well, it’s come up before in Moench v. Robertson, a 3rd Circuit decision not only cited here, but subsequently adopted by other courts. In Moench, the 3rd Circuit found that a plan sponsor that offered stock as an investment in an Employee Stock Ownership Plan (ESOP) was entitled to a presumption of prudence.3 Moench is an older case (1995), and from a time when suits based on employer stock investments were less prevalent than today.

More recently, such cases have become nearly as routine as a 100-point drop in the Dow, and the judicial system, honoring precedent, and what it has chosen to view as a Congressional endorsement for employer stock investment in these programs, has led a growing number of jurisdictions to summarily (if not peremptorily) dismiss many of these actions. Indeed, when all is said and done, it now seems as though the courts are comfortable imposing a less stringent review of the decision to invest in employer stock than in any other investment on the retirement plan menu.4

Moreover, for those that have, since Enron anyway, worried about the potentially conflicting duties owed by certain committee members to shareholders and plan participants, the 2nd Circuit provided a moment of unexpected “clarity,” resolving with a pen stroke a dilemma that has concerned plan fiduciaries for at least the past decade by declaring, “We also hold that defendants did not have an affirmative duty to disclose to plan participants non-public information regarding the expected performance of Citigroup stock….”

Ironically, it was this very 2nd Circuit that, just a few years ago, called to mind the notion that ERISA’s fiduciary standards of conduct are “the highest known to the law.”

Perhaps they still are, but, IMHO, this decision serves only to lessen that standard.

—Nevin E. Adams, JD

Footnotes:

1 More specifically, the 2nd Circuit noted that “[a] person is only subject to these fiduciary duties ‘to the extent’ that the person, among other things, ‘exercises any discretionary authority or discretionary control respecting management of such plan’ or ‘has any discretionary authority or discretionary responsibility in the administration of such plan.’” And then it went on to decide that the plan fiduciary’s obligation to honor the terms of the plan document effectively displaced that discretionary authority.

2 “When, as here, plan documents define an EIAP as ‘comprised of shares of” employer stock, and authorize the holding of ‘cash and short-term investments’ only to facilitate the ‘orderly purchase’ of more company stock, the fiduciary is given little discretion to alter the composition of investments.”

3 More than a year ago, I noted that “in effect, this ‘presumption of prudence’ seems to have become a magic talisman against which no claim of malfeasance can be successfully alleged, much less established, simply because the courts have discovered (a cynic might say created) a presumption that holding employer stock is appropriate.” (see “IMHO: Prudent Mien?”).

4 One needn’t read between the lines here. In the court’s own words, “We reject plaintiffs’ argument—endorsed by the dissent—that we should analyze the decision to offer the Stock Fund as we would a fiduciary’s decision to offer any other investment option. We agree with the Sixth and Ninth Circuits that were it otherwise, fiduciaries would be equally vulnerable to suit either for not selling if they adhered to the plan’s terms and the company stock decreased in value, or for deviating from the plan by selling if the stock later increased in value.” (In the court’s defense, plan sponsors have, in fact, been sued for selling stock that later increased in value in a couple of rare situations.)

The 2nd Circuit’s decision is available HERE.

You might also find the amicus brief filed by the Department of Labor instructive HERE: