The landscape surrounding retirement plans maintained by institutions of higher education has been changing in recent years, although certain critical responsibilities that are imposed on plan sponsors have been in place since the 1974 enactment of the Employee Retirement Income Security Act (“ERISA”). In a 2015 report compiled by Transamerica Retirement Solutions it was clear that colleges and universities have moved away from the traditional construct of maintaining just a 403(b) tax-deferred annuity plan, and have gravitated towards the maintenance of 401(k) plans in addition to, or in lieu of, the traditional 403(b) plan. While some 403(b) plans could be structured with minimal employer involvement to avoid the plans being subject to ERISA, many of those plans, as well as all 401(k) plans, are subject to the requirements set forth in ERISA. The purpose of this article is to provide readers with an introduction to the statutory framework governing investment-related issues in 403(b) and 401(k) plans, and the identification of certain best practices to minimize fiduciary exposure. Volumes can be written on this subject, but hopefully this will cause readers to become sensitized to the types of issues that should be addressed by all plan sponsors.
ERISA has a wide range of requirements applicable to employee benefit plans, regardless of whether the plans provide retirement benefits or welfare benefits such as health, dental, vision or disability benefits. The requirements that are the focus of this article are contained in Title I of ERISA and are regulated and enforced by the United States Department of Labor (the “DOL”). While not the focus of this article, it is worth noting that ERISA also contains other Titles that amended the Internal Revenue Code concerning the tax treatment of certain employee benefits as well as provisions applicable to traditional defined benefit pension plans and to union multiemployer plans. These additional requirements are regulated and enforced by the Internal Revenue Service and the Pension Benefit Guaranty Corporation.
The principal building blocks of the requirements set forth in Title I of ERISA are the concepts of a “fiduciary” and of a “party in interest.” ERISA imposes strict duties that fiduciaries have in regard to benefit plans and also identifies a broad range of prohibited behaviors between plans and parties in interest. While ERISA contains provisions dealing with fiduciary responsibilities, reporting and disclosure, structural and trust requirements and enforcement provisions, the fiduciary requirements pertaining to plan investments are the subject of much litigation and deserve to be a focal point for plan sponsors wishing to avoid costly litigation and potential large liabilities.
Under ERISA a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. It is clear that ERISA casts a wide net when it identifies who is a plan fiduciary.
ERISA requires that a plan fiduciary discharge his or her duties solely in the interest of plan participants and beneficiaries. A fiduciary must act with the care, skill, prudence and diligence, under the circumstances, that a prudent man acting in like capacity and familiar with such matters would use in the conduct of an enterprise of like character and like aims. A fiduciary must act for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying the reasonable expenses of the plan. A fiduciary must act to diversify the investments of the plan to minimize the risk of large losses and in accordance with plan documents and instruments to the extent those documents and instruments are consistent with the requirements of ERISA.
With that fundamental statutory framework in mind, it is easy to see how many aspects of the administration of a plan by its fiduciaries can be subject to intense scrutiny both by governmental agencies and by plan participants and beneficiaries who allege that the behavior of plan fiduciaries resulted in losses or low investment returns, or the payment by plan participants of excessive fees and expenses. Unfortunately, in recent years there has been an onslaught of legal action against plan sponsors and fiduciaries, in many cases seeking substantial damages for alleged breaches of a wide array of fiduciary responsibilities. As much as I hate to acknowledge this, there is no shortage of people in my profession who make a living out of aggressively advertising legal services to retirement plan participants in an effort to inundate plan sponsors with requests for information on behalf of their “clients” from which they can begin to piece together a claim and expand their client base into a representative class of plan participants and beneficiaries. Just this week a large client sent me a copy of a letter received by one of its employees from and out-of-state law firm. In the letter, the attorney stated that he found the employee’s resume on a popular website and noted that the employee was employed by my client. He stated that their firm “is currently investigating potential claims against my client relating to the management of its 401(k) plan, which is designed to provide eligible employees of my client with financial security in retirement.” The letter is marked at the top as attorney advertising, and it is obvious that this is a total fishing expedition. That said, this is just one example of how a plan sponsor can become enmeshed in a costly process that can take a substantial amount of time and resources to resolve. There are, of course, other ways that this sort of scrutiny can be triggered, including just a single discontent employee raising questions about retirement plan returns or expenses, or a governmental agency like the Internal Revenue Service or the DOL making an inquiry.
So what is the point? While there is certainly no way to ensure that an employer won’t become a target, the best way to avoid becoming deeply involved is to pay close attention to the responsibilities that ERISA places on plan fiduciaries and to vigorously work to meet these responsibilities. We will focus briefly here on an oft-litigated area; namely, fiduciary duties in connection with plan investments.
The first issue requiring attention is the appointment of the plan investment committee. Every retirement plan will provide for the appointment of the committee to which plan administrative and investment duties will be delegated. Some plans will have a single committee perform all functions, while others will have an administration committee and an investment committee. In truth, in most cases were plan provides for the appointment of separate committees, plan sponsors often have the same individuals appointed to both committees. Plan sponsors should choose committee members carefully. It should not be viewed as a job that simply needs to be filled with bodies; rather, thought should be given about the composition of a committee and plan sponsors should select individuals who are both interested in serving and who are likely to have an understanding of the subject matters that will be addressed by the committee. Committee members must be appointed in accordance with the specific provisions set forth in the plan document regarding the size of the committee and how members are appointed. It is common practice for a Board of Directors or Board of Trustees to appoint committee members, and they may be appointed to serve for specified term or for an indefinite period of time. Among ERISA’s many requirements are that a plan must be in writing and must be administered in accordance with its terms. In all cases, therefore, it is important to follow the specific requirements of the plan document.
Committee members will be fiduciaries and they should receive training so that they understand their responsibilities and so that they also understand that under ERISA, fiduciary liability is personal liability. Committee members as well as other plan fiduciaries often are indemnified by the plan sponsor, although plan assets may not be used to provide that indemnification. In addition, it is common for a plan sponsor to maintain fiduciary liability insurance to protect plan fiduciaries and to protect the plan sponsor in the event of a violation of ERISA, but it is important that any such policy be reviewed carefully to ensure it provides adequate protection.
There is no specific requirement in ERISA as to how often a committee should meet. That said, it is important that an investment committee meet frequently enough to ensure that it is closely monitoring investment alternatives offered to participants under the plan. With some smaller plans, investment committees should certainly meet at least twice a year, with more frequent quarterly meetings actually being of value to allow investment alternatives to be monitored more closely and to mitigate potential liability in the event of a downturn in the market. With larger plans, best practice would be to hold formal committee meetings at least quarterly, with special meetings being called if circumstances warrant committee action prior to the next regularly scheduled meeting.
Regardless of the size the plan, it certainly is wise for an investment committee to use outside experts both to select investment alternatives that will be offered to plan participants and to monitor their performance. In a traditional defined benefit pension plan where individual accounts are not maintained for plan participants, it is common for a plan to retain the services of an investment manager which can assume fiduciary responsibility for retirement plan investments, with the committee’s principal responsibility being one of monitoring performance. In the typical individual account 403(b) or 401(k) plan, the use of investment advisors to assist the committee becomes critically important.
In many cases where prototype plan documents are used, the prototype sponsor will provide services that will include proposing a broad selection of investment alternatives that may be offered to plan participants, along with monitoring performance of those investment alternatives and reporting back to the committee at committee meetings. In many of these cases, the service provider specifically eschews any responsibility as a plan fiduciary, and merely holds itself out as providing information and alternatives and leaving all decision-making to the committee. While these arrangements are certainly cost-effective, they do not provide a significant level of protection to committee members because in most cases, committee membership is not comprised of investment professionals with sufficient training or expertise to make investment decisions.
Best practice would dictate that in addition to utilizing the services of the prototype sponsor/recordkeeper to track investment performance and report to the committee, the plan should retain the services of an independent investment advisor which acknowledges its fiduciary status and which actually makes specific recommendations to the committee as to the investment alternatives that should be offered to participants. In these cases, the investment advisor should be paid on a flat fee basis and should not have any other interest in any of the investment alternatives it recommends to the committee from time to time. There are many aspects to selecting and monitoring investment alternatives offered to plan participants that are simply impractical for most investment committees to monitor without help. An experienced independent investment fiduciary will not just monitor investment returns of selected funds against benchmark investments and competing funds, but such a professional will also ensure that plan participants are buying the most preferential share classes and will monitor experience and continuity of fund managers. Based on this expertise and analysis the independent advisor can advise the committee of compliance with the plan’s investment policy statement and recommend changes when appropriate. Failures associated with these sorts of issues are fodder for plaintiff lawyers looking to make a case against plan sponsors.
At this point it would be helpful to understand an often-discussed provision of ERISA; namely, section 404(c). In a nutshell, this provision allows plan fiduciaries to avoid fiduciary liability for investment decisions made by plan participants if certain requirements are met. It is commonly relied on by plans; however, it is important to understand its requirements and also to understand its limitations. In order for fiduciaries to avail themselves of this provision, plan participants must be offered a broad selection of plan investment alternatives that may be traded frequently. A plan must utilize a so-called qualified default investment alternative that is approved in DOL regulations as an investment for plan assets where a participant has not made a valid investment election. In addition, plan descriptive materials such as the summary plan description must specifically advise participants that section 404(c) of ERISA is being utilized by the plan to limit fiduciary liability for investment decisions made by participants. It would be uncommon today with any prototype plan offered by a provider not to purport to incorporate provisions complying with section 404(c). That said, plan fiduciaries must recognize that this is not a get out of jail free card that will permit them to ignore the strict fiduciary requirements of ERISA. Even though liability can be mitigated for the specific investment decisions made by participants when they pick among investment alternatives offered to them, plan fiduciaries always have an ongoing responsibility to monitor the performance of those investment alternatives that are offered to participants to ensure that those investment alternatives satisfy the strict requirements of ERISA. There is no way to avoid this ongoing responsibility; therefore, plan fiduciaries should not believe that their responsibilities are eliminated by section 404(c).
A plan committee should adopt an investment policy statement (“IPS”). Although technically not required by ERISA, it certainly is best practice to adopt a detailed IPS that describes the investment strategy of the plan, the process by which plan investment performance will be measured, and how frequently reviews will occur. An IPS generally will describe criteria for putting particular investment alternatives on a committee watch list and criteria for replacing those alternatives based on performance criteria set forth in the IPS. The IPS itself should be reviewed periodically to ensure that it continues to reflect the investment strategies of the plan and the needs of plan participants. There is something to keep in mind, however, when it comes to the IPS. Although it certainly is best practice to maintain an IPS, it is very important that the IPS be followed by plan fiduciaries. If a claim is made against the plan and the criteria in the IPS were not followed by the committee, this certainly could help bolster the likelihood that the claim will succeed.
Another critical area to avoid fiduciary liability in connection with plan investments is the ERISA reporting and disclosure requirements. While the best known requirement involves providing plan participants with a summary plan description (SPD) that satisfies the many statutory and regulatory requirements, a critical newer requirement for participant-directed individual account plans is the requirement under section 404(a) of ERISA to provide participants annually plan-level information such as fees and expenses that may be charged to their accounts, and investment-level information such as fees and expenses associated with the various investment alternatives offered by the plan. This disclosure is intended to permit participants to make informed investment decisions and must include information that will permit participants to compare the investments offered by the plan by providing performance and benchmark data in a comparative chart format. In most cases the prototype plan sponsor or the third party plan administrator will prepare these statements, although they also can be prepared by the independent investment advisor to the investment committee.
While this article has briefly touched on some issues where plan sponsors are increasingly facing scrutiny and liability in connection with retirement plan investment alternatives offered to participants, this is just one of the areas where sponsors should be vigilant. For example, ERISA permits most expenses incurred in connection with the operation of a retirement plan to be passed through to participants and charged against their account balances. In any case where expenses are not paid by the plan sponsor but are charged to participants, great care must be taken to determine that these expenses are both reasonable and necessary. Best practice often involves going through a detailed RFP process when selecting the plan recordkeeper and independent investment advisor. To the extent that a plan sponsor chooses to pay expenses with its own assets, there are no fiduciary concerns because no plan assets are involved. Similarly, as touched on at the beginning of this article, care must be taken in the selection of service providers and in all other transactions that involve plan assets to ensure that plan fiduciaries are not engaging in any so-called prohibited transactions with parties in interest. Thus, while paying close attention to issues surrounding investment alternatives offered to plan participants is critical, it is just one component of the broad range of fiduciary duties imposed by ERISA.
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