Fiduciary Liability for Retirement Plan Sponsors: What Employers Should Be Losing Sleep Over
By Christine M. Moehl
SAALFELD GRIGGS
Employers who sponsor retirement plans are considered “fiduciaries” with respect to every employee who participates in their plan. This means, among other things, that the employer faces personal liability for unreasonably poor investment performance. In a bull market, the threat of fiduciary liability is tempered by high investment returns. However, when the market becomes volatile, the prospect of fiduciary liability becomes a more pressing concern, and should be at the forefront of every employer’s mind.
Under the Employee Retirement Income Security Act of 1974 (ERISA), plan fiduciaries must act “with the care, skill, prudence and diligence . . . that a prudent man acting in a like capacity and familiar with such matters would use in [such circumstances].” Note the importance of the italicized phrase, “and familiar with such matters.” In the world of retirement plans, fiduciaries are held to a standard of care much higher than that of a typical business person — they are held to a standard of care imposed on professional investors. In other words, it is not a defense for a fiduciary to say in court that he or she “did the best they could” when picking the plan’s investments. If a professional investor would have known better, then the fiduciary should have known better too.
Does this mean that all employers who sponsor retirement plans should take night classes to become Registered Investment Advisors? Fortunately, no. But employers should be aware of their fiduciary duties and approach them in a careful, deliberate manner. The specific duties that are incumbent upon plan fiduciaries are determined by who directs the investment of the plan assets. Employers have two options when deciding who invests the plan assets. The first option is for the fiduciary to pool the assets and invest them at his or her sole discretion. The second option is to allow the plan participants to direct the investment of their own accounts.
When plan assets are pooled, the fiduciary may rely on the advice of a professional investment advisor. However, perfunctorily following the advice of a third-party does not in itself eliminate — or even substantially reduce — the fiduciary’s exposure to liability. It is important that fiduciaries also establish a written plan investment policy with the help of their investment advisor, and meet with the plan’s advisors on a regular basis to determine if the policy is being followed. At these regular meetings, the fiduciary and the investment advisor should review the plan’s investment returns as compared with their benchmarks, and should modify the plan’s investment mix when necessary. These meetings, documented by formal minutes of the meetings, are the best method for creating a written and defensible history for the plan in the event that a disgruntled participant later makes a legal claim against the fiduciary for poor investment returns.
Many employers believe that empowering the plan participants to invest their own accounts will eliminate all of their fiduciary exposure. In fact, fiduciaries of plans with participant-directed accounts have just as much exposure as fiduciaries of plans with pooled accounts. This is because, in participant-directed plans, the fiduciary must determine not only what funds are offered to the participants on the investment platform, but must also determine what investment fund will serve as the “default” fund for those participants who do not affirmatively elect their own investments. In addition, even when participants invest their own accounts, the fiduciary is not relieved from liability for poor investment results unless the plan complies with ERISA Section 404(c). In order to comply with 404(c), the fiduciary must, among other things, provide the participants with sufficient information regarding the plan’s investment alternatives to enable them to exercise meaningful control over their investments. Most fiduciaries meet this requirement by retaining qualified investment advisors to come into the workplace and meet with the participants on a regular basis.
Another common misconception held by employers who allow their plan participants to direct their own investments is that the more funds offered on the platform, the less exposure they have to fiduciary liability. In fact, the opposite is often true. Although the employer must offer a diversified and appropriate group of investments, offering the participants a bewildering array of investments (e.g., 50 to 100 funds) can negate one of the primary requirements of 404(c), i.e., that the participants be given sufficient information to exercise meaningful control over their accounts.
Regardless of whether the plan assets are pooled or are invested by the participants, the plan fiduciary also must carefully consider the investment fees and expenses. This includes an obligation to determine if the fees and expenses are fair and reasonable under the circumstances. In addition, fiduciaries should confirm that there is adequate disclosure to the participants of the fees and expenses charged, both direct and indirect. Holding regular meetings with the plan’s advisors gives the fiduciary the opportunity to examine all fees and expenses being charged to the plan, and to document that such fees and expenses are reasonable under the circumstances.
If you have questions or concerns regarding fiduciary liability issues, or if you are interested in creating a formal investment committee to serve as the designated fiduciary to your plan, please contact a member of the firm’s Employee Benefits Group.