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Best practices for plan fiduciaries
next issue no. 9: Fiduciary perspective
The Employee Retirement Income Security Act (ERISA) establishes fiduciary standards of conduct for employers and other persons who sponsor, maintain and administer certain retirement plans (e.g., 401(k) plans). Plan fiduciaries are subject to one of the highest levels of responsibility in law under ERISA.
There has been a recent flood of ERISA lawsuits related to plan fees, appropriateness of plan investments and other fiduciary matters. Since 2020, more than 170 lawsuits challenging retirement plan fees and investments have been filed in federal court with the pace of cases escalating. Settlements have regularly been in the millions of dollars.7
ERISA litigation also has had the knock-on effect of driving insurance rates for fiduciary liability coverage up by 15–20 percent.8
It is important to understand exactly who is an ERISA fiduciary, what their responsibilities are, and what steps can be taken to help protect the plan and fiduciaries when sponsoring, maintaining and administering a retirement plan.
Who is a plan fiduciary?
There are generally two types of plan fiduciaries: (1) named fiduciaries and (2) functional fiduciaries.
Every ERISA retirement plan has to have at least one named fiduciary authority who has control over operation and administration of the plan.9 This designation is regularly done at an entity or position level, rather than the name of the person specifically, which means that the plan documents do not need to be updated whenever a new person takes on that position.
The named fiduciary can be an individual or entity (e.g., the employer), or a group of individuals (e.g., plan committee). The plan can have more than one named fiduciary, but the plan must have at least one named fiduciary.
A functional fiduciary is someone engages in one or more of the following activities:10
- Exercises any discretionary authority or control over management of the plan and/or the plan assets;
- Provides investment advice for a fee or other compensation (direct or indirect) with respect to any assets of a plan, or have any authority or responsibility to do so;
- Has any discretionary authority or responsibility in the administration of the plan.
A person who engages in one of the above activities is a fiduciary for that action only.
A plan fiduciary must act in accordance with the following rules in carrying out their fiduciary duties solely for the interests of plan participants.11
- Exclusive benefit rule – Fiduciaries must carry out their obligations for the exclusive purpose of providing benefits to participants and defraying reasonable expenses of administering the plan.
- Prudent person rule – Fiduciaries must act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. For purposes of this rule, prudence is judged under a test that examines the process used to reach the fiduciary decision, rather than judging on the outcomes of that decision. This underscores the need for documentation and process management to meet fiduciary standards.
- Diversification rule – Fiduciaries must diversify plan investments so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. For purposes of this rule, there must be at least three different investment options so that participants can diversify investments within an investment category and diversify among the investment alternatives offered by the plan.12
- Plan documents rule – Fiduciaries must administer the plan in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with ERISA and the federal tax code. Plan documents include (but are not limited to) the plan document, plan trust agreement, plan policies, investment policy statements, summary plan descriptions, and plan forms. Fiduciaries should read these documents carefully and ensure that decisions taken are consistent with them.
Common fiduciary responsibilities13
Selection and monitoring of plan service providers
Plan sponsors are responsible administrating and record keeping a plan in the sole interest of plan participants. Administering and record keeping a retirement plan requires expertise in a variety of areas. Because plan sponsors are not generally equipped to administer and record keep a plan themselves, they hire plan service providers to help administer and record keep the plan.
Selection and monitoring of the various vendors, consultants, investment managers and other parties to the plan is one of the key responsibilities of a fiduciary. The duty does not end with the selection of investment options or consultants, but specifically includes ongoing monitoring to ensure that the plan service provider remains appropriate for the plan.
ERISA contains provisions that allow plan assets to be used for two purposes: paying benefits and paying reasonable expenses of administering the plan. Excessive fee court cases have been climbing, so this is an area of increased scrutiny for fiduciaries. Proper examination of underlying administrative fees, and documentation of processes to ensure that fees are reasonable are an increasingly important area for fiduciaries to monitor. Again, it is the process and procedure that are important, as higher investment management fees are not necessarily automatically excessive, as long as the process in determining the suitability of the investment options can be justified.
With fiduciary responsibility comes fiduciary liability. Plan fiduciaries who breach their fiduciary responsibilities, obligations, or duties are personally liable to make the plan whole for any losses resulting from the breach. In addition, plan fiduciaries are personally liable for returning any profits made by the fiduciary through use of plan assets to the plan.14
In addition, plan fiduciaries may be jointly liable for the actions of other plan fiduciaries. For example, if a fiduciary knowingly participates in another fiduciary’s breach, conceals that breach or does not act to correct a breach then they are potentially liable.15
There are a number of ways plan fiduciaries can limit their potential liability.
- Documenting plan fiduciary actions and decisions. Documentation and proper process remain one of the most important ways that fiduciaries can protect themselves. Notes of relevant meetings, how decisions were reached, and what information was requested and analyzed in carrying out fiduciary duties should be properly recorded. It is often not the outcome that is examined for prudency, but the decision making process that went into the outcome, and the only way to justify a decision as being prudent is through thorough and complete documentation.
- Fiduciary training. Proper training of fiduciaries should be undertaken to ensure that each fiduciary understands their roles and responsibilities. The U.S. Department of Labor has initiated a national campaign of seminars and webcasts to help fiduciaries understand their role and keep up-to-date on the latest regulations and legal rulings. External consultants and other firms can also be utilized to help with ongoing training of fiduciaries.
- Fiduciary liability insurance. Insurance is an important step in helping to protect fiduciaries, as the process of working with D&O and ERISA insurance brokers can help the plan and fiduciaries identify potential risk areas.
- Hiring professional fiduciaries. Many plan sponsors hire one or more ‘professional fiduciaries’ to be responsible for specific plan fiduciary functions. For example, plan sponsors often hire an investment manager to manage plan investments.16 Some plan sponsors hire a plan administrator who has responsibility for administering the plan.17 Plan sponsors may remain responsible for selection and monitoring of professional fiduciaries, but are not liable for the individual decisions of that professional fiduciary.
- Fiduciary safe harbors. ERISA provides a number fiduciary safe harbor rules for specific fiduciary decisions that deem a fiduciary to have met his or her fiduciary responsibility if the rule is followed. For example, a plan sponsor that adopts a qualified default investment alternative (QDIA) may be relieved of liability for investments made to the QDIA made on behalf of participants who fail to direct the investment of their plan account.18
Not all actions taken by an employer for its retirement plan are fiduciary in nature. Some actions taken by an employer for its retirement plan are non-fiduciary business decisions (“settlor decisions”).
The DOL takes the position that decisions related to establishment, design and termination of plans generally are not fiduciary activities governed by ERISA. For example, in making the decision to create a plan, the business is acting on behalf of the business, not its employees, so these are not fiduciary decisions.
It is important to identify settlor decisions because expenses incurred in connection with the performance of settlor functions may not be paid by the plan as the expenses would be incurred for the benefit of the employer. For example, legal or consulting services in connection with plan formation may not be paid by the plan.19
We believe that by taking proper precautions and having an awareness of fiduciary responsibilities under ERISA plan sponsors and committees can work diligently and productively while maintaining appropriate protections.
In this issue
7 Bloomberg Law. 5 April 2022.
8 401k Specialist. 8 August 2022.
9 29 U.S. Code § 1102
10 29 U.S. Code § 1002(3)(21)
11 29 U.S. Code § 1104(a)
12 26 CFR § 1.401(a)(35)-1
14 29 U.S. Code § 1109
15 29 U.S. Code § 1105
16 29 U.S. Code § 1002(3)(38)
17 29 U.S. Code § 1002(3)(16)
18 29 U.S. Code § 1104(c)(5)
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals
Please note that this information should not replace a client’s consultation with a tax professional regarding their tax situation. Nuveen is not a tax advisor. Clients should consult their professional advisors before making any tax or investment decisions.
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