This article was originally published in The Advocate.
Fiduciaries are the individuals (and business entities) that are responsible for administering retirement plans, such as the ubiquitous “401(k)” plan. There is a quite a bit of activity in the “ERISA”[i] retirement plan fiduciary world these days. This article will touch on and provide updates regarding those activities. These issues are critical for any business that maintains a retirement plan of some sort, which of course is the vast majority of businesses, large and small. These issues are also critical for the individuals who become fiduciaries in the course of their job performance.
Who Is A Fiduciary?
A fiduciary for ERISA purposes includes anyone who:
- Exercises any discretionary authority or control over to the management of a plan or the disposition of plan assets;[ii]
- Has any discretionary authority or responsibility over the administration of a plan;[iii]
- Is named as a fiduciary in the plan document;[iv] or
- Renders investment advice for a fee or other compensation, directly or indirectly, with respect to any monies or property of a plan, or who has any authority or responsibility in that regard.[v]
As a practical matter, this will may include, among others, a company’s owner(s), President, Chief Executive Officer, Chief Financial Officer, General Counsel, Human Resources Director, Controller, the company itself, and anyone serving on a “plan committee.”
A common misconception is that a plan’s third party administrator (“TPA”) or “recordkeeper” is a plan fiduciary. This is rarely the case. Instead, as stated above, it is the company personnel who are fiduciaries, and it is they who are potentially liable for breaches, whether or not they recognize their status as fiduciaries.
What Are A Fiduciary’s Duties And The Applicable Standards?
Specifically, under ERISA:
- Fiduciaries must discharge their duties solely in the interest of plan participants and beneficiaries for the exclusive purpose of providing benefits to participants (and their beneficiaries), and defraying the reasonable expenses of administering a plan.[vi]
- Fiduciaries must comply with the so-called “prudent expert” rule. This means that they must act with the care, skill, prudence, and diligence under the circumstances that a prudent person “acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims.”[vii] Most fiduciaries will not be able to satisfy this “prudent expert” standard without the advice and involvement of those with the requisite knowledge and experience. Accordingly, the retention of investment, administrative, and legal experts is compelling. It is most often the case that plan fiduciaries are experts in running their businesses, whatever that may be, and not experts in ERISA law.
- Fiduciaries must also act in accordance with the documents and instruments governing a plan.[viii]
- Fiduciaries are charged with diversifying investments so as to minimize the risk of large losses.[ix]
What The Consequences Of A Fiduciary Breach?
Fiduciaries are personally liable for losses to a plan that result from breaches of their fiduciary duties.[x]
There is also the possibility of government imposed monetary sanctions, removal from fiduciary status, criminal sanctions, excise taxes, and attorney fees.[xi] Fiduciaries may also be held personally liable for the breaches of their co-fiduciaries.[xii]
Recent Developments In General
It seems there are more and more potential pitfalls with every day that goes by. The two most high profile and recent fiduciary-related issues are those involving the explosion of civil litigation against fiduciaries primarily focused on paying unreasonable fees, and the recently finalized, but now (sort of) delayed, “fiduciary rule.” There are other issues for awareness that this article will discuss as well.
Excessive Fee Litigation
Class action litigation against plan fiduciaries has increased dramatically in the last year or two. The movement actually began a little over a decade ago. The cases are mostly brought by plaintiff plan participants (that’s right, the company employees and former employees) against defendant plan fiduciaries.
The primary allegations include: (1) the payment of excessive fees by plans for administrative services, (2) the failure to monitor administrative fees (i.e., as plan asset values increase, often so does a “recordkeeper’s” compensation, which may not be proportionately justified), (3) excessive investment related fees (specifically, that less expensive “share classes,” “retail” versus “institutional,” were available for the same investments), (4) investment options were not appropriately monitored and/or changed, (4) unjustified use of proprietary investment funds, and (5) the wrong type of investments were made available (for example, offering of a money market fund instead of a less expensive better performing stable value fund) .
The cases have mostly been brought by a small number of law firms. There have been victories on both sides, with the take home for fiduciaries being that there have been liabilities incurred in the tens of millions of dollars, and it seems the stakes keep getting higher. Many of the recent cases involve “403(b)” plans maintained by universities such as MIT, NYU, Duke, and Yale. The cases are typically brought against very large plans, but smaller plans have been targeted. The focus on small plans could increase because smaller plans could be viewed as lower hanging fruit given that presumably there is less oversight and perhaps the employee fiduciaries spread thinner as they attend to their more regular job duties within a company.
The New Fiduciary Rule
For several years now, there have been regulations in the works aimed at modifying one portion of the “Who Is A Fiduciary” discussion above. Primarily, the changes broaden the definition of those who render investment advice, thus expanding the universe of those who may be considered fiduciaries. Correspondingly, these individuals would then be subject to the fiduciary standards and susceptible to the consequences associated with breaching those standards.
There were several versions of the regulation proposed over the years culminating with the regulation (and associated exemptions via other regulations) being finalized in April 2016. It took several years to finalize the rules primarily due to opposition by the financial services industry. Although, the regulations were finalized in April 2016, they were not set to take effect until later. The intervening change in administration in November 2016 reopened the debate regarding the new rules. Since then, there have been many requests, announcements, and filings by different branches of the federal government. There is also ongoing litigation in several courts brought by trade groups against the U.S. Department of Labor (“DOL”) seeking to eliminate the rules (or portions thereof). In summary, as it now stands, the detailed requirements of the rules are delayed until July 1, 2019. It is difficult to forecast where the rules will land, if anywhere.
Fee Disclosure Regulations and Initiatives
Plan assets are used to pay many fees and expenses; primarily, fees and expenses related to plan administration and plan investments. In recent years, the DOL has placed great emphasis on fee disclosure. The main objective is to educate and inform plan fiduciaries and plan participants about the fees and expenses that are paid by a plan. The following three initiatives fall under this topic of Fee Disclosure Regulations and Initiatives:
- The 404a-5 Regulations
In mid-2012, the “participant level fee disclosure”/“404a-5” regulations became effective. The 404a-5 regulations require plan sponsors (i.e., the companies maintaining retirement plans) to provide annual and quarterly written disclosures to plan participants.[xiii] The 404a-5 disclosures generally require explanations relative to plan administration, expenses, and investments.[xiv] The aim is to assist plan participants in making informed decisions about how they invest their plan accounts.
In order to fulfill their responsibilities, it is important that plan fiduciaries ensure that the regulatory mandated topics are properly covered in the written disclosures, and that those written disclosures are timely distributed to participants by permissible means. In general, the disclosure must be delivered by First Class U.S. Mail or in accordance with DOL guidance regarding electronic deliveries. Delivering required communications to plan participants electronically is not as simple as posting to a website or shooting out emails. There are specified rules that must be followed.[xv]
The 404a-5 regulations are only applicable to plans that allow participants to direct their own investments (which includes the vast majority of your common 401(k) and/or “profit sharing” plan).[xvi]
Most plan sponsors have developed these disclosures in a manner that is legally compliant (usually, with some necessary tweaks). However, the delivery methods are often concerning, as the industry pushes clients to send emails or post the information on a website, while the DOL is yet to embrace the idea of making it that simple. There are permissible electronic delivery methods, but there are certain conditions that must be fulfilled; it seems those conditions are often overlooked. The result is that the disclosures were arguably never made. This creates risk that could lead to litigation.
- The 408(b)(2) Regulations
Also in mid-2012, the “service provider fee disclosure”/“408(b)(2)” regulations became effective. The 408(b)(2) regulations require certain plan service providers to a plan to furnish specified written disclosures and explanations to plan fiduciaries.[xvii]
The 408(b)(2) disclosures must generally explain the services that providers furnish to a plan and the compensation they receive from all sources relative to those services.[xviii] This might seem odd; however, the arrangements entered into by fiduciaries and those entities and persons providing services to a plan are often very complicated and are not understood by the fiduciaries, thus prompting the need for these regulations.
Plan fiduciaries are charged with analyzing and understanding the 408(b)(2) disclosures and explanations so they may determine that the arrangement is reasonable. Failure to do so will constitute a fiduciary breach (and also give rise to a “prohibited transaction”).
The types of service providers that must make 408(b)(2) disclosures are generally investment providers, recordkeepers, consultants, and third party administrators. The service providers are required to advise of all sources of compensation, directly from the plan or indirectly from others.[xix] Indirect compensation is common, and is perhaps the crux of these regulations because the relationships and amounts at issue are often not apparent.
Many service providers have not provided understandable fee disclosures (and/or, in some cases, not at the appropriate time). The disclosures are sometimes often provided to fiduciaries with a comment to the effect that the disclosures must be provided, but really need not be reviewed. To the contrary, the purpose of the disclosures is to allow plan fiduciaries to assess the arrangements and determine their reasonableness.
Notably, DOL has been requesting the 408(b)(2) disclosures during audits and investigations. Accordingly, fiduciaries should maintain copies of the disclosures with the plan records, and should be ready to assert that they have reviewed and understand the disclosures that they have received from their service providers.
- Schedule C of Form 5500
Most ERISA-covered plans are required to complete and file an IRS form every year known as the Form 5500. It is basically a tax return for a benefit plan. The filing is reviewed by the IRS and the DOL.
Schedule C of Form 5500 seeks information about fees paid by plans. Caution should be exercised in completing Schedule C (and the other portions of Form 5500). Often, employers are under the mistaken impression that it is their service providers attesting to the accuracy of this information, when in fact it is the plan sponsor who signs the Form 5500 under penalty of perjury and submits it to the government. Consequently, it is critical that this information be reviewed and understood by plan fiduciaries prior to signature and filing.
Late Deposit of Employee Contributions
The late deposit of employee contributions to a plan continues to be a hot button issue for the DOL, and a major headache for plan sponsors and fiduciaries.
DOL regulations require that employee contributions; for example, 401(k) contributions, be deposited with a plan as soon as reasonably practicable following the applicable pay date.[xx] The standard and the timeframe will vary from employer to employer depending on their established processes and abilities. In most cases, this means within few business days of the actual pay date. Often, the standard will be established based on how fast an employer demonstrates it is able to make such deposits in the past. For example, if over a two year period, most of the payroll periods reflect a deposit in two business days, arguably, that is the standard that will apply to that employer.
The issue of late deposits has been pet project of the DOL for some time now. It is typically an issue of focus in every investigation conducted. Additionally, there is a question on Form 5500 that asks whether contributions were not timely transmitted during the applicable year. When an employer answers that question with a “yes,” there is a very good chance of follow up by the DOL. Last year, several plan sponsors that answered “yes” to that question received letters from DOL inviting them to participate in a correction program known as the “Voluntary Fiduciary Correction Program,” the implication being that failure to participant in the program could lead to a broader investigation
The correction of late deposits does not itself usually involve high dollars; however, carrying out the correction is sometimes logistically burdensome. The correction also requires preparing and filing Form 5330 and paying an excise tax. As such, it is important to understand the rule and avoid violations in the first place, so that the issue may be avoided (or minimized). It is equally important to identify violations and take appropriate corrective action sooner rather than later because correcting discrete instances of late deposits will involve much less work than correcting several years of late deposits.
Protection Through Fiduciary Process
A major discussion point in the retirement plan fiduciary world involves the creation of and engagement in a fiduciary process. Such processes are aimed at avoiding or mitigating the potential dangers and consequences discussed above. There is increased focus in this area given the foregoing, and as a result, is itself a hot topic.
A fiduciary process involves setting up a paradigm whereby fiduciaries are specifically identified, the fiduciaries are informed of and recognize their roles, and conduct themselves pursuant to an established process. The process involves documenting deliberation, decisions, and other actions taken by plan fiduciaries. The goal being to protect fiduciaries from liabilities. The idea is to create somewhat of a roadmap to assist fiduciaries in fulfilling their duties and documenting such. A typical process might include:
- Regular meetings (with written minutes and certain other protocols).
- Review of plan expenses.
- Review of plan investments.
- Review (and compliance with) an investment policy statement (“IPS”).
- Review of plan service providers’ services.
- Documentation of the foregoing, as well as other activities such as timely distribution of summary plan descriptions, 404a-5 disclosures, and other ERISA-required notices.
- Documenting deliberations and decisions relative to plan design (or other changes).
A process might involve having a written “charter” or “bylaws” that identify who the fiduciaries are, their duties, and how they will fulfil their duties. If there are any writings that are intended to guide the fiduciary process such as a charter or an IPS, it is critical that the terms of those documents are understood and followed, otherwise, it would most likely be better if these documents, which are not legally required, did not exist.
Miscellaneous Issues For Awareness
The number of issues impacting fiduciary activities are too many to cover in a single article. In additional to the foregoing issues, some other issues of importance and/or recent focus are:
- Cyber security risks to plans.
- Modifications to the disability claim procedure regulations.
- Appropriate use of default investment funds and/or target date funds.
- Nonstandard investments under plans.
- The use of “brokerage windows” offered as an investment alternative to participants.
- Increased concern relative to annual audits of plan financials conducted for many plans by independent auditors (not to be confused with government audits).
- The use of “ERISA budget accounts” to pay plan expenses.
Plan fiduciaries are subject to very high standards, and a host of complicated laws and regulations. It is important that fiduciaries recognize those responsibilities and risks to ensure legal compliance, avoid participant lawsuits, and avoid undesired governmental scrutiny of plan matters.
John C. Hughes is Of Counsel at Hawley Troxell Ennis & Hawley LLP in Boise, Idaho. His practice is focused in the area of ERISA/employee benefits. He primarily counsels and assists employers with compliance issues relative to all types of benefit plans. John is a Past President of the Boise Chapter of the Western Pension & Benefits Council. He was the Coeditor-In-Chief of the 401(k) Advisor, a nationally circulated monthly newsletter on issues relating to 401(k) plans, from 2012 through 2017.
[i] Employee Retirement Income Security Act of 1974, as amended.
[ii] ERISA Section 3(21).
[iv] ERISA Section 405(c)(1)(B).
[v][v] ERISA Section 3(21).
[vi] ERISA Section 404(a)(1)(A).
[vii] ERISA Section 404(a)(1)(B) (emphasis added).
[viii] ERISA Section 404(a)(1)(D).
[ix][ix] ERISA Section 404(a)(1)(C).
[x] ERISA Section 409(a).
[xi] See generally, ERISA Sections 501 and 502.
[xii] ERISA Section 405(a).
[xiii] 29 CFR § 2550.404a-5(b)(1).
[xiv] 29 CFR § 2550.404a-5(c) and (d).
[xv] See, e.g., DOL Technical Release 2011-03R.
[xvi] 29 CFR § 2550.404a-5(b)(2).
[xvii] 29 CFR § 2550.408b-2(c).
[xx] See 29 CFR § 2510.102(a)(1). There is a seven day “safe harbor” rule for plans with less than 100 participants.