ERISA’s rules require that, when selecting and monitoring plan investments, fiduciaries use “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 in the conduct of an enterprise of a like character and with like aims.” (Emphasis added.) The phrase “familiar with such matters” means that the standard is that of hypothetical person who is knowledgeable about selecting investments for the purpose of accumulating retirement benefits.
To satisfy that standard, fiduciaries must engage in a prudent process. That is, they must: determine what information is needed to make an informed decision; gather, examine, and understand that information; and then make a reasoned decision based on that information. While this process is straightforward, it may seem daunting to many fiduciaries because it requires an understanding of sophisticated investment concepts and an analysis of detailed information about investments. For example, US Department of Labor (DOL) guidance and court cases make it clear that fiduciaries are expected to understand and apply generally accepted investment theories (such as modern portfolio theory) and prevailing investment industry practices (such as the quantitative and qualitative analysis of the mangers of mutual funds).
Fortunately, although fiduciaries are held to the standard of a knowledgeable investor, they do not need to have that expertise personally. If they lack the knowledge to manage their plan’s investments prudently, they may seek advice; in fact, the law requires that they get help. The DOL, as well as a number of courts, has taken the position that fiduciaries that are no qualified to fulfill their duties are required to seek assistance from competent sources.
However, as with investments (and any other fiduciary decisions), fiduciaries are required to engage in prudent processes for selecting and monitoring their advisers. One court explained: “Whether a fiduciary’s reliance on an expert adviser is justified is informed by many factors, including the expert’s reputation and experience, the extensiveness and thoroughness of the expert’s investigation, whether the expert’s opinion is supported by relevant material, and whether the expert’s methods and assumptions are appropriate to the decision at hand.” In other words, the fiduciaries must satisfy themselves that the adviser is competent and the advise is well-founded.
A number of court cases have analyzed the process and criteria for selecting investment advisers under ERISA. The following list is drawn from cases and other sources:
Is the adviser qualified? Fiduciaries should consider whether the adviser has the appropriate investment credentials, experience, and expertise. For example, fiduciaries should evaluate the adviser’s:
- Experience with other ERISA plans;
- Education, experience, and industry credentials;
- Registration with appropriate regulatory authorities;
- Past performance with investments of the type contemplated
Does the adviser provide full disclosure of fees and expenses? Fiduciaries are required to know all expenses that are being paid by the plan, directly or indirectly, and to determine if they are reasonable (that is, whether the expense is competitive in the marketplace and whether the plan and its participants receive value commensurate with the cost). Fiduciaries are not required to choose the least expensive services; rather, they should ensure that they are getting adequate value for the plan’s money.
Is the expert independent? Courts have emphasized the importance of the independence of the expert. While fiduciaries are entitled to rely on the expertise of their qualified advisers, courts appear to permit greater reliance on independent investment advisers who compensation is not affected by the advice given and whose recommendations are not limited (e.g., to investments managed by their employer or an affiliate). However, that does not mean that fiduciaries cannot rely on advice that affects the adviser’s compensation or is limited to certain investments. Instead, the effect is to limit the degree of reliance. For example, if the compensation of an adviser can be affected by the advice given, prudence would require that the fiduciaries understand the nature and amount of that compensation and take it into account in evaluating the advice rendered.
If an adviser is selected and monitored properly, and if the advice is evaluated and understood, fiduciaries will have gone a long way, and perhaps all of the way, to satisfy ERISA’s fiduciary standards and provide quality benefits to participants.