Mitigating Fiduciary Risk in a Down Market
Virtually all investment options in employer-sponsored 401(k) and other retirement plans have been affected by recent market issues. ERISA requires that plan fiduciaries act with the care, skill, prudence and diligence of an expert in the marketplace and for the exclusive benefit of the participants and beneficiaries with respect to ERISA plan investments. Plan fiduciaries must act quickly and prudently to deal with the market issues and to protect the plan assets. Prudence is largely a matter of process, and doing nothing is not an option. In assessing a plan fiduciary’s prudence in a particular action, a court will examine the decision-making process and how the fiduciary went about reaching a decision, as opposed to the result of the decision.
Many of the actions involved in operating a plan make the person or entity performing them a fiduciary. Using discretion in administering and managing a plan or controlling the plan’s assets makes that person a fiduciary to the extent of that discretion or control. Thus, fiduciary status is based on the functions performed for the plan, not just a person’s title. A plan’s fiduciaries will ordinarily include the trustee, investment advisors, all individuals exercising discretion in the administration of the plan, all members of a plan’s administrative committee (if it has such a committee), and those who select committee officials. The key to determining whether an individual or an entity is a fiduciary is whether they are exercising discretion or control over the plan or the plan assets.
Plan fiduciaries should consider the following suggestions in the current market environment:
Analyze impact, review procedures and get advice: Plan fiduciaries should have a detailed investment policy, conduct frequent and detailed investment reviews, and hire professionals as necessary to give advice regarding the procedures and the actual investment performance. While ERISA does not explicitly require that plan sponsors adopt an investment policy, a fiduciary should have a thoughtfully developed process for selecting investment options; should follow that process; and should periodically review and, if necessary, revise the process.
The investment policy, if properly designed, shows that the plan has in place a reasonable strategy for selecting, monitoring and, when necessary, altering plan investments. If the investment policy is reasonable, and if the policy is followed, the plan fiduciary will generally have complied with ERISA’s fiduciary duties, even if investments did not perform as well as expected. If the plan does not have an investment policy, it may be difficult to demonstrate that the fiduciary complied with ERISA’s procedural demands. Additionally, any flaw in the investment policy or procedures or failure to periodically review and update the investment policy can result in fiduciary liability.
Plan fiduciaries are required to fulfill their duties in light of "the circumstances then prevailing," meaning that they must take current market conditions into account. It does not mean that they should ignore the plan’s investment policy, but a prudent fiduciary will consider how current conditions could affect the plan’s investments. Waiting until the next regularly scheduled meeting of the plan fiduciaries might not be considered prudent in light of the market’s volatility. Even if the plan fiduciaries decide that no action is necessary, evidence that they engaged in such an evaluation will show that they are acting prudently in light of current circumstances.
Plan fiduciaries must engage in a prudent selection process when choosing plan advisors. It is important to review the credentials and tenure of advisors, know their reputation and client portfolio, and make sure that they are sufficiently invested in the plan. That means they should call or send information quickly when market issues arise, make recommendations to hold special meetings or take action between meetings if market conditions dictate a quick response and generally take an active role rather than just appearing at quarterly meetings with information.
The bottom line to staying on top of the situation is to have solid procedures, quality expert advice, sufficient detail to really understand the investments and make informed decisions, detailed documentation and meeting notes to reflect the discussions and decisions and fiduciaries who take the job seriously. Remember that the issue is not necessarily whether the fiduciary made the "right" decision, but whether the fiduciary was prudent and diligent in conducting a review ("procedural due diligence") and made a choice that a reasonable, prudent person similarly situated could have made.
Do your homework by monitoring your appointees and other fiduciaries: Plan sponsors and plan fiduciaries often select a vendor or advisor and then switch to "autopilot," expecting the vendor or advisor to fulfill its duties to the plan with no further input or oversight. A prudent plan fiduciary will never become too complacent or comfortable with the vendors, advisors or employees assigned to handle tasks. It is important that plan fiduciaries understand the role of each person or entity providing services to the plan and check from time to time to verify that they are performing appropriately.
Fiduciaries should maintain a current "matrix" of duties, responsible parties and delegations. This matrix should be updated regularly when the parties or their duties change. The plan sponsor should verify that appropriate indemnification provisions have been negotiated and are in signed agreements. This documentation is essential to the plan sponsor and other plan fiduciaries understanding their roles and responsibilities.
The plan’s "fidelity bond" must cover losses to the plan by fiduciaries (so the sponsor/administrator must be certain that the bond covers all individuals who may cause a loss, unless a special exception applies). However, the plan’s fidelity bond does not cover liabilities of the plan fiduciaries. In many instances, plan fiduciaries do not have insurance to cover the expenses and judgments or settlements against them, placing those individuals or entities at extreme risk. Some do not even have an indemnification in place for protection. This is the ultimate example of "better safe than sorry." Employees of the plan sponsor serving in a fiduciary capacity should carefully consider any uncovered exposure they may have and take action to mitigate this exposure.
Plan fiduciaries may not rely blindly on the investment advice they receive. Instead, they must review, evaluate and understand the advice. The plan fiduciary must: investigate the expert’s qualifications; provide the expert with complete and accurate information; and make certain that reliance on the expert’s advice is reasonably justified under the circumstances.
A plan fiduciary is not justified in relying wholly upon the advice of others, since it is the fiduciary’s duty to exercise his own judgment in light of the information and advice received. After carefully reviewing the advice provided by their experts, plan fiduciaries must determine whether that advice is well-founded and is appropriate for their plan and, if so, take measures to implement the advice.
Educate plan participants: The average employee probably does not understand "market corrections" and "rebounds" and may not heed the advice to "remain calm." An individual who sees a 50 percent drop in his or her plan account may panic or become angry, and could seek revenge by calling the government or an attorney. While comfort in numbers is not always the best defense, in the current situation most plans—and investments in general—are in the same unfortunate situation of suffering significant losses.
A typical 401(k) plan gives participants the opportunity to choose funds from a broad range of investment alternatives. These plans are often designed to be ERISA Section 404(c) plans, under which plan fiduciaries are not liable for losses that result from participant investment elections. While meeting the minimum Section 404(c) disclosure requirements is critical, it is still advisable for employers to further educate and reassure plan participants during these challenging economic times. Employees are bound to be nervous about their retirement assets and silence may only increase their apprehension. From a practical perspective, better-educated participants should make better investment decisions, resulting in greater job satisfaction and financial security. The message that plan participants must understand is that, despite best efforts, plan fiduciaries are like all types of investors: They probably could not have prevented this market situation or the losses being suffered by plan investments.
But if your money was invested with Madoff: If a plan fiduciary is in the unfortunate situation of having plan assets invested in a fund or with an individual or entity that is involved in a scandal, or if in any situation the fiduciary is concerned about liability or ramifications of actions, the best course is always to seek legal counsel before taking action. "Better safe than sorry" definitely applies in this case.
Plan fiduciaries should consider any steps available to make the plan participants whole, such as participating in lawsuits. However, fiduciaries should weigh the costs to the plan against the potential for recovery in such lawsuits before participating.
Fiduciary responsibility: It is always critical to understand who serves in a fiduciary role for a plan and to whom fiduciary obligations have been delegated. It’s important to know whether an appropriate written delegation or administrative agreement has been executed and the responsibilities of each person or entity. But those issues become even more critical in situations where the risk of litigation increases.
We are in such a time now. It’s not hard to imagine an employee who is upset that he lost 50 percent of his money and is certain that someone didn’t do their job right. His thinking might go like this: "I’ll sue everyone and get the right one eventually." If the roles and delegations are clear, it is more likely that the individuals and entities have appropriate indemnifications and insurance to deal with the liability. No one is happy when they discover that they have liability with no indemnification or insurance.
Although employers have many important issues to face due to the turbulent market conditions, it is important to be diligent and prudent in conducting fiduciary business and to confirm that all plans and arrangements are being administered in compliance with legal requirements. Plan fiduciaries should ensure that they are properly documenting the decision-making process and that they are obtaining professional advice when necessary. Plan fiduciaries should also make sure they are properly indemnified and insured in the event they are sued.
The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.