Fiduciary Liability: Key Issues to Consider

1
Fiduciary Liability Key Issues to Consider

• John R. Nelson, Esq.
• February 4, 2004
• JRN Benefits
• Santa Barbara, CA
• www.jrnbenefits.com

2
Introduction

• Exponential growth of defined contribution plan
  assets
• As of year-end 2001 -- about 3 trillion in
  assets
• Source EBRI, September 2003
• Some one is responsible for managing these assets
• Who
• What are your responsibilities
• How do you meet these responsibilities

3
Liability for breach of fiduciary duty

• ERISA 409(a) Any person who is a fiduciary
  with respect to a plan who breaches any of the
  responsibilities, obligations, or duties imposed
  upon fiduciaries by this title shall be
  personally liable to make good to such plan any
  losses to the plan resulting from each such
  breach . . .
• Key Points
• Definition of fiduciary Who is a fiduciary?
• What are the fiduciarys responsibilities,
  obligations, or duties?
• Personal liability!
• Officers and directors who have discretionary
  authority or control over plans are fiduciaries.
  Decision makers cant shield themselves form
  personal liability by arguing that their actions
  were undertaken on behalf of the Employer. See
  US DOL Enron Amicus Brief, Aug. 30, 2002

4
Definition of Fiduciary

• ERISA 3(21)(A) A person is a fiduciary with
  respect to a plan to the extent he
• Exercises any discretionary authority or control
  over the management of the plan, or the
  management or disposition of plan assets
• Has any discretionary authority or responsibility
  in the administration of the plan
• Renders investment advice for a fee or other
  compensation, with respect to plan assets
• Key points
• Exercises discretion
• Has discretionary authority
• Investment advice, for a fee

5
Definition of Fiduciary Ministerial
functions

• People who perform purely ministerial functions
  for a plan within a framework of policies,
  interpretations, rules, practices and procedures
  made by others are NOT fiduciaries
• Examples of purely ministerial functions
• Application of rules determining eligibility for
  participation or benefits
• Maintenance of participants employment records
• Preparation of reports required by government
  agencies
• Calculation of benefits
• Orientation of new participants explaining
  rights and options under the plan
• Preparation of participant statements
• Processing claims

6
Definition of Fiduciary

• Q Does a person automatically become a
  fiduciary with respect to a plan by reason of
  holding certain positions in the administration
  of the plan?
• A Yes. Some offices or positions by their very
  nature require persons who hold them to perform
  discretionary functions.
• For example, a Plan Administrator or a Trustee
  must, by the very nature of his position, have
  discretionary authority or responsibility in the
  administration of the plan.
• Key Points
• Plan Administrator
• The person designated as the Administrator in the
  Plan document, or the Employer
• Not the third party administrator (TPA)!
• Trustee

7
Definition of Fiduciary

• Q Are members of the board of directors of the
  Employer fiduciaries with respect to a plan
  maintained by the Employer?
• A Yes, to the extent they have responsibility
  for the functions described in 3(21)(A) of
  ERISA.
• For example, the board of directors may be
  responsible for the selection and retention of
  plan fiduciaries and service providers. In such
  a case, directors exercise discretionary
  authority or control respecting management of
  such plan.
• Duty of surveillance and oversight. Leigh v.
  Engle, 727 F. 2d 113 (7th Cir. 1984)
• Standard of care Corporate officers who appoint
  fiduciaries must ensure that the appointed
  fiduciary clearly understands his obligations,
  that he has at his disposal the appropriate tools
  to perform his duties with integrity and
  competence, and that he is appropriately using
  those tools. Martin v. Harline, 15 EBC 1138,
  1149 (D. Utah 1992)

8
Definition of Fiduciary

• Q Is an officer of the Employer a fiduciary with
  respect to the plan solely by reason holding
  such office?
• A No. Offices and positions must be examined to
  determine whether they involve the performance of
  any of the functions described in 3(21)(A) of
  ERISA.
• For example, a Benefits Supervisor might be
  responsible to calculate the amount of each
  participants benefits in accordance with a
  written formula. The Benefits Supervisor does
  not perform discretionary functions and is not a
  plan fiduciary.

9
Definition of Fiduciary

• Q How many fiduciaries must a plan have?
• A Each plan must have a Plan Administrator. If
  the plans assets are held in trust, the Plan
  must have at least one Trustee
• Otherwise, there is no required number of
  fiduciaries that a plan must have.

10
Definition of Fiduciary

• Trustee
• Plan Administrator
• Plan Committee
• Board of Directors
• Investment Advisor

11
Duties and Responsibilities

• Trustee
• ERISA 403(a) The Trustee(s) shall have
  exclusive authority and discretion to manage and
  control the assets of the Plan
• Three exceptions
• Authority to mange plan assets has been delegated
  to an investment manager
• ERISA 404(c) Plan permits participants to
  choose, from a range of investment alternatives,
  how their individual account will be invested
• Exception for directed (custodial) trustee The
  plan provides that the trustee is subject to the
  direction of a named fiduciary who is not a
  trustee (e.g., the Employer) the named
  fiduciary (e.g., the Employer) is responsible

12
The Trustee

• Trustee Understand the difference under ERISA
  between a discretionary trustee and a directed
  (or custodial) trustee
• A discretionary trustee has authority and
  responsibility to manage plan assets a directed
  trustee merely holds custody of plan assets
• A discretionary trustee assumes responsibility
  and liability to discharge its duties in
  accordance with the fiduciary standards set forth
  under ERISA. A directed trustee assumes no such
  fiduciary responsibility or liability.
• So, whats the point of having a corporate
  trustee?

13
The Trustee

• What is the appropriate standard of conduct for a
  directed trustee?
• Enron litigation
• Northern Trust Clear on its face The
  trustee may rely on direction unless it is clear
  on its face that direction violates ERISA or the
  terms of the plan.
• DOL Knew or should have knew The trustee can
  not follow direction if the trustee knows or
  should have known that the direction violates
  ERISA or the plan terms.
• Duty of inquiry.

14
Standard of Conduct

• Prudent man rule or prudent expert?
• ERISA 404(a)(1) A fiduciary must discharge
  his duties
• With the care, skill, prudence and diligence
  under the circumstances then prevailing that a
  prudent man acting in a like capacity and
  familiar with such matters would use
• Procedural prudence Courts focus on the
  fiduciarys conduct in arriving at an investment
  decision, not its results
• See, e.g., In re Unisys Savings Plan Litigation

15
Self-directed participant accounts

• Typically, self-directed accounts are set up as
  follows A menu of no- or low-load mutual
  funds, andA brokerage option which allows a
  participant to invest in individual securities
• Investments are earmarked to participants
  individual accounts (unit based accounting)
• Daily valuation environment
• Participants can structure their individual
  account portfolio consistent with their risk and
  return investment objectives
• Disadvantage Most participants lack the
  knowledge or time to properly manage their
  investments

16
Self-directed participant accounts

• Compare, the pooled trust fund where plan
  assets are invested as a pool by the trustee or
  investment manager
• Participants have an undivided interest in the
  pool
• Periodically, e.g., quarterly, semi-annually,
  annually, earnings are allocated to participants
  accounts
• Disadvantage
• One size fits all investment portfolio
• Distributions Period of time between valuation
  date and date of distribution, participant's
  account is not credited/charged with plans
  investment return
• Participant does not have access to real time
  information about his or her account

17
Potential Fiduciary Liability

• Plan fiduciaries may be aware of individual
  employees who have selected inappropriate
  investments
• A young employee who is far from retirement age
  has a large account balance invested in the money
  market fund
• An employee close to retirement age has 100
  percent of his account in the plans emerging
  markets fund
• Do you have a duty to warn these employees that
  their selected investments may be poor choices?

18
ERISA Section 404(c)

• If you allow participants to direct the manner in
  which their accounts are invested, then
• You must take advantage of the protection
  afforded by section 404(c) in order to reduce
  your potential fiduciary liability for losses
  incurred by participants as a result of their
  investment decisions

19
Fiduciary Responsibility

• Trustee/Employer
• ERISA 403(a) The Trustee(s) shall have
  exclusive authority and discretion to manage and
  control the assets of the Plan
• Exceptions
• Authority to mange plan assets has been delegated
  to an investment manager
• ERISA 404(c) Plan permits participants to
  choose, from a range of investment alternatives,
  how their individual account will be invested

20
What ERISA Section 404(c) provides

• The Employer No other person who is a fiduciary
  with respect to the plan will not be liable for
  any loss that is the direct and necessary result
  of the participant's exercise of investment
  control
• Exceptions The participant's investment --
• is not in accordance with the plan document
• would jeopardize the plans tax-qualified status
  under the IRC
• could result in a loss which exceeds the
  participant's account balance (e.g., margin
  account)
• results in a prohibited transaction

21
What ERISA Section 404(c) does not provide

• The Employer is responsible for the selection and
  retention of the plans investment options
• See Advisory Opinion No. 98-04(A) The act of
  designating investment alternatives in an ERISA
  section 404(c) plan is a fiduciary function to
  which the limitation on liability provided by
  section 404(c) is not applicable.
• At reasonable intervals, the performance of the
  plans investment options must be reviewed to
  ensure that the performance has been in
  compliance with the terms of the plan and
  statutory standards, and satisfies the needs of
  the plan

22
What ERISA Section 404(c) Does Not Provide

• Who is responsible -- and therefore liable -- for
  asking these and other questions on behalf of
  plan participants
• Is it the Trustee? Yes, unless . . .
• The Trustee is a directed trustee. Then
  Employer, or
• Has authority been delegated to an investment
  manager
• Definition of investment manager
• Is registered as an investment adviser under the
  Investment Advisers Act of 1940 or under relevant
  State law, and
• Has acknowledged in writing that he is a
  fiduciary with respect to the plan
• Where does the buck stop? It stops here!

23
ERISA Section 404(c), requirements

• The participant is provided or has the
  opportunity to obtain sufficient information to
  make informed decisions with regard to investment
  alternatives available under the plan
• Explanation that the plan is intended to
  constitute a 404(c) plan (see the plans
  SPD)Enron The plaintiffs allege that the
  Savings Plan does not qualify as a 404(c) plan
  because the participants were not informed that
  it was intended to be one.
• A description of the investment alternatives
  available under the plan
• With respect to each investment alternative, a
  general description of the investment objectives
  and risk and return characteristics, including
  information relating to the type and
  diversification of assets comprising the
  portfolio of the designated investment
  alternative
• In the case of an investment alternative which is
  subject to the Securities Act of 1933, a copy of
  the investment alternatives most recent
  prospectus

24
ERISA Section 404(c), requirements

• An explanation of any restrictions on transfers
  to or fro a designated investment alternative
• A description of any transaction fees and
  expenses which affect the participant's account
  balance (e.g., commissions, sales loads, deferred
  sales charges)
• A description of the investment alternatives
  annual operating expenses (e.g., investment
  management fees, administrative fees, 12b-1 fees)
  and the aggregated of such expenses expressed as
  a percentage of the investment alternative's
  average net assets
• Past and current investment performance,
  determined net of expenses
• Subsequent to an investment in an investment
  alternative, any materials provided to the plan
  relating to exercise of voting or similar rights
• Note No 404(c) protection for default
  instructions, e.g., If you the participant do
  not give investment instruction, your account
  will be invested in the money market fund.

25
Summary

• Steps you should take today to reduce your or
  your organizations potential liability
• Bring your plan into compliance with ERISA
  404(c).
• Relief from liability for imprudent investment
  decisions by participants and beneficiaries
• Duty to select and monitor the plans menu of
  designated investment alternatives

26
Duty to select and monitor

• Institute a procedure (i.e., a process) for
  selecting and monitoring the Plans investment
  options
• Adopt written guidelines
• Identify responsible parties
• State the Plans purpose and objectives
• Establish minimum investment standards
• Choose investment options on basis of
  compatibility with plan objectives and
  participant demographics
• Create an Investment Policy Statement