In the last installment of this column, we discussed the responsibilities of a 401(k) plan’s investment fiduciaries. Once the afterglow of writing the column had passed, however, we realized that we had not started at the beginning. That is, although we discussed the responsibilities of the investment fiduciaries, we did not identify the members of that group.
The question “who are the investment fiduciaries?” is just as important as “what are the fiduciaries’ duties?” . . . since, in our experience, many fiduciaries don’t know they are ERISA fiduciaries— and subject to the law’s duties and potential liabilities under the “prudent expert” standard.
The importance of determining whether a person is an investment fiduciary is impossible to overstate. Fiduciaries owe the highest possible duty to plan participants and beneficiaries. Accompanying that legal obligation is the specter of personal liability for losses resulting from a breach of those duties. ERISA Section409 provides that “[a]ny 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, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary. . . .” (Emphasis added.)
We use the term investment fiduciaries to describe the group of persons who select and monitor the 401(k) plan investments. The term investment fiduciaries, however, is not defined in ERISA itself. Rather, in the investment context, the statute defines the fiduciaries as follows:
[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. [ERISA §3(21)(A).]
That definition does little to limit the number of people who may be fiduciaries. It includes both those who are designated under the plan (“named” fiduciaries) and those who undertake a fiduciary function—without having a specific title and without being appointed for that task (“functional” fiduciaries).
The Department of Labor (DOL) regulations provide some help in identifying the investment fiduciaries. The preamble to the ERISA section 404(c) regulations states:
the Department points out that the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function . . . the plan fiduciary has a fiduciary obligation to prudently select such vehicles, as well as a residual fiduciary obligation to periodically evaluate the performance of such vehicles to determine, based on that evaluation, whether the vehicles should continue to be available as participant investment options.
Thus, the identification of the investment fiduciaries focuses on the persons who designate the investment options offered to the participants. With that in mind, we turn to the classes of persons who typically serve as 401(k) investment fiduciaries.
THE PLAN COMMITTEE
For most 401(k) plans, a plan committee decides both the range of investment options and the specific investments or investment provider (for instance, an insurance carrier, mutual fund family or brokerage house) that the plan will use for those options. Alternatively, the sponsor’s board of directors or the plan committee may assign that job to specified officers (e.g., the CFO or the vice president of Human Resources). All of those functions—that is, deciding on the range of investments, deciding on the person who will make the decisions, and selecting the investment provider—are fiduciary activities.
As investment fiduciaries, the committee members must, either by knowledge and experience or by assistance from experts, be capable of prudently selecting the investments to be offered to the participants. After all, the quality of the retirement benefits of the employees—and of their standard of living after retirement—rests to a large degree on the committee members capably performing their duties. If the committee members do not have the education and experience to handle the job, then expert assistance should be provided for them. In the Ninth Circuit decision in Howard v. Shay 100 F. 3d 1484 (9th Cir. 1996), one judge said: "ERISA fiduciaries are held to the standard not of a ‘prudent lay person’ but rather of a ‘prudent fiduciary with experience dealing with a similar enterprise.’ . . . If they do not have all of the knowledge and expertise necessary to make a prudent decision, they have a duty to obtain independent advice.” (Id. At 1490.)
The ability of plaintiffs’ attorneys to exploit an unsophisticated committee member should not be underestimated. For instance, in the First Union case (which we discussed in the JPB 7.3), the plaintiffs’ complaint states:
The person who has been given the most direct responsibility for monitoring CMG was . . . a First Union Senior Vice President in the Benefits section of the Human Resources Department and a Plan Committee member (and the Committee’s Secretary). . . . [He] lacks basic knowledge concerning mutual funds and the 401(k) industry. ... Even after more than a decade overseeing the Plan and as a Plan Committee member, [he] could not identify in a recent deposition in a related case which class of Evergreen shares Plan participants are offered (until recently there was only one they could have been legally offered) or what fees and expenses participants pay for the "privilege" of investing in exclusively First Union funds. [He] did not even know the difference between the S&P 500 and the Fortune 500, and had no idea which one the Plan’s index fund tracked.
In cases where the responsibility for selecting the investment options is not assigned, it remains with the employer. In that case, the officers who are responsible for the investment decision-making become the investment fiduciaries. Corporate officers may also be investment fiduciaries because they are members of the investment committee, because they have been assigned investment responsibilities by virtue of their offices, or because they undertake that responsibility as functional fiduciaries.
Officers are not automatically investment fiduciaries, however. Only those officers who are appointed as the officials responsible for selecting available investments or who in fact select the investment providers or investment advisors are investment fiduciaries to the plan.
The board of directors typically does not select the 401(k) investments. However, the board usually appoints or ratifies the plan committee or corporate officers who choose the investments.
The DOL has stated, in ERISA Regulations Section 2509.75-8:
D-4Q: In the case of a plan established and maintained by an employer, are members of the board of directors of the employer fiduciaries with respect to the plan?
A: Members of the board of directors of an employer which maintains an employee benefit plan will be fiduciaries only to the extent that they have responsibility for the functions described in section 3(21)(A) of the Act [ERISA]. For example, the board of directors may be responsible for the selection and retention of plan fiduciaries. In such a case, members of the board of directors exercise "discretionary authority or discretionary control respecting management of such plan" and are, therefore, fiduciaries with respect to the plan. However, their responsibility, and, consequently, their liability, is limited to the selection and retention of fiduciaries (apart from co-fiduciary liability . . .).” (Emphasis added.)
Thus, the directors’ fiduciary responsibility for investments is limited to the selection and retention (that is, monitoring) of the committee members or officers who serve as the investment fiduciaries. However, the directors must fulfill those responsibilities under the high standards of ERISA. The board’s appointees select the investments which will significantly affect the participants’ retirement benefits. As a result, the board must appoint officers or committee members who are competent, by virtue of education and experience, to prudently select investments for a retirement program. Further, the board has a duty to monitor their performance. The regulation makes it clear that the directors have the fiduciary responsibility to:
1. Determine if the committee members are qualified (either on their own or with the help of internal expertise or external consultants) to make decisions about the 401(k) investment options, and
2. To monitor the performance of the committee and, if necessary, to remove and replace committee members.
The U.S. District Court decision in Martin v. Harline, in discussing similar duties, stated:
Corporate directors who appoint fiduciaries who are untutored and inexperienced in the operations of an employee benefit plan and the investment of its assets owe a special duty to the Plan to 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. . . . in circumstances where, as here, the appointed fiduciary is given considerable discretion and is unsophisticated in employee benefit matters, especially careful monitoring by the appointing fiduciary of the appointed fiduciary’s performance, and of his compliance with ERISA and plan documents, is required under ERISA. [Martin v. Harline, 15 E.B.C. 1138, 1149 (D.C. UT 1992)]
The directors’ responsibility in this regard is not purely academic. It has real world consequences. For example, in the First Union litigation, participants in the First Union 401(k) plan sued the plan committee members for alleged breaches of fiduciary duty. The committee had the responsibility for selecting the plan’s investment options. The participants alleged that the committee members breached their fiduciary duty by (1) forcing participants to invest exclusively in First Union’s own proprietary funds, and (2) allowing the plans to pay higher administrative fees than First Union’s commercial customers paid. The participants also alleged that the investment committee was staffed with persons who were not qualified to exercise independent judgment regarding the plan’s investment options.
The example demonstrates the importance of appointing committee members who have a fundamental working knowledge of investment principles, and who can rationally select and monitor investment advisors and investment alternatives. The example also demonstrates the danger of following the relatively common practice of appointing a rank-and-file employee to serve on the plan’s investment committee. Because the appointment of committee members and other plan fiduciaries is itself a fiduciary function, directors and others involved in selecting or ratifying fiduciaries must determine that all persons designated to serve in a fiduciary capacity have, at a minimum, a working knowledge and understanding of investment principles, as well as a solid grasp of the plan’s investment philosophy and guidelines.
In the context of a 401(k) plan, the employer, through its officers, controls the investment choices given to the participants. That control is a fiduciary function and the officers who exercise the control, as well as the directors who oversee their conduct, are investment fiduciaries under ERISA. Recognizing fiduciary status is the first step in recognizing fiduciary obligations to the plan and its participants.