The term “fiduciary” gets used a lot these days; sometimes, we suspect, without a true understanding of what the term means and how fiduciary responsibility applies to our industry. It’s a corner of the retirement plan industry that can be a little murky.
This month’s newsletter is designed to shine a light on fiduciary responsibility, which is really all about liability. In short, a person or entity determined by law to have fiduciary responsibility for a retirement plan can be held liable for any breaches in obligations related to that plan.
Clearly, it just makes good business sense to know who has fiduciary responsibility for a plan—and exactly what that responsibility means.
Use our newsletter to gain an understanding of this aspect of plan management. It’s an important—and often complex—issue. Then give us a call ; we’re here to answer any questions you might have.
Many employers establish retirement plans without beingfully aware of their fiduciary responsibilities. It is imperative to knowwhether you are a fiduciary and, if so, what your responsibilities are becausethere are risks for the unwary. A fiduciary that breaches any obligation or dutycan be held personally liable to make good any losses incurred by the planresulting from the breach, even if the breach was made unknowingly. Pleadingignorance or inexperience will not be adequate defense.
The Employee Retirement Income Security Act of 1974 (ERISA) imposes rigorousstandards for fiduciaries—those who manage a retirement plan and its assets.Therefore, it is important that all fiduciaries be aware of theirresponsibilities and understand and comply with ERISA's fiduciary provisions.
Following is a general overview of who the plan's fiduciaries are, theirrequired duties and steps to limit liability.
WHO OR WHAT IS A FIDUCIARY?
You become a fiduciary under ERISA by title or by action including thefollowing:
- Being named in the plan document or being appointed as a fiduciary;
- Exercising discretionary authority or control over plan assets and/or the management of the plan; or
- Providing investment advice for a fee.
Every plan must have at least one fiduciary named in the plan document(either a person or an entity). Many times the plan sponsor is the namedfiduciary. If the plan sponsor keeps some or all of those duties, its officersor principals who perform those duties are ERISA fiduciaries.
Further, the appointment of a fiduciary is itself a fiduciary act. So,whoever appoints the officers or committee members has a duty to prudentlyselect those persons and to periodically review their work to make sure they aredoing their job. Typically it is the board of directors or corporate presidentwho appoints the fiduciaries. As a result, the board members or the presidentare also fiduciaries.
In general, professional service providers offering legal,accounting/auditing or third-party administration services are not consideredfiduciaries because they do not exercise discretion or control over the plan.
The primary duty of all ERISA fiduciaries is to act in the sole interest ofthe plan and its participants and beneficiaries. You must:
- Act with the care, skill, prudence and diligence of a prudent person who is familiar with retirement plan matters;
- Follow the plan documents;
- Pay only reasonable plan expenses;
- Diversify plan investments; and
- Avoid conflicts of interest and self-dealing in directing plan transactions.
Expertise in a variety of areas is required of fiduciaries. Fortunately, youcan act to limit potential exposure by relying on competent outside advisors toassist with complicated matters. Your obligations do not end with the selectionof a service provider because ERISA imposes an ongoing duty to monitor withreasonable diligence the providers in order to ensure that they are meeting theplan's expectations.
CONSEQUENCES OF A FIDUCIARY BREACH
In addition to being held personally liable for a fiduciary breach, you maybe personally liable to restore plan losses resulting from violations as well asforfeit any realized profits. The DOL will also assess a civil penalty againstyou and, in extreme cases, you may be subject to criminal penalties.
You can be held liable for both your direct actions or for the actions ofco-fiduciaries. If you become aware of an improper action on the part of aco-fiduciary and do nothing, you also become liable for that breach.
Regardless of how well the fiduciaries in a plan perform their duties, it isinevitable that mistakes can be made. Several self-correction programs areavailable for correcting errors. However, self-correction is not available forall violations.
STEPS TO LIMIT LIABILITY
There are actions that can be taken to demonstrate that your responsibilitieswere carried out properly as well as other ways to limit liability which aredescribed below.
Documenting Decision-Making Processes
In order to demonstrate that you acted prudently, you should fully documentin writing the process used in making fiduciary decisions.
For example, an Investment Policy Statement can provide importantdocumentation that demonstrates you are meeting your responsibilities regardingplan investments. It is a written guideline which outlines the process forselecting, reviewing and changing the plan's investments. Although ERISA doesnot specifically require an Investment Policy Statement, it is one of the firstthings that the DOL will ask to see when they audit a plan and will want proofthat it was followed.
Monitoring Plan Expenses
The prudent fiduciary must understand what expenses are being charged andwhat services are being provided for those fees. Thanks to the fee disclosureregulations, you are no longer in the dark about how much compensation planproviders are receiving from various sources, directly or indirectly. It's agreat thing because you have the duty to only pay reasonable expenses and thatwas often hard to analyze when the plan providers didn't have to disclose theirfees.
The problem is that with this added information comes added responsibility.So it's not important enough to get the fee disclosures—you have to benchmarkyour fees to determine whether they are reasonable. You are not required to paythe lowest fees, but you have to determine whether the fees you are paying arereasonable for the services you are provided.
Letting Participants Direct Their Accounts
Another way to limit liability is to allow participants to direct their ownaccounts. ERISA Section 404(c) allows fiduciaries to transfer investmentresponsibility to participants who direct the investment of their accounts.Generally, you are not liable for losses resulting from the participant'sexercise of investment control if all of the ERISA 404(c) rules are satisfied.However, you retain responsibility for the selection and monitoring of theinvestment alternatives that are made available to the participants.
Much of the recent litigation in this area has involved the fiduciary'sfailure to monitor investment menus after initial selection. Therefore, youshould review the menu on an ongoing basis and document your actions in the sameway the initial selection was documented.
There are a number of 404(c) requirements including offering a broad varietyof investments so the participant can diversify; giving the participantssufficient information to make informed decisions about their investments; andparticipants must be able to transfer money between options at least quarterly.
There are also very specific disclosure requirements including general planinformation about how to manage and change their investment options and fulldisclosure on any plan administration and/or individual expenses that might bepaid out of their account.
Avoiding Prohibited Transactions
ERISA prohibits fiduciaries from engaging in a variety of transactions thatare inherently tainted by conflicts of interest. Specifically, you may notengage in transactions with the plan in which you use plan assets for your owninterest, act for a party whose interests are adverse to the plan or planparticipants or receive compensation from a party dealing with the plan.
Bonding and Insurance
ERISA requires that every fiduciary of the plan and every person who "handlesfunds or other property of such a plan" are required to be bonded. The amount ofthe bond is 10% of the amount of the plan's assets as of the beginning of theplan's fiscal year. Unless the plan holds company stock, the maximum amount ofthe bond is $500,000. The bond protects the plan, not the fiduciary, againstloss by reason of acts of fraud or dishonesty on the part of persons required tobe bonded.
You can obtain fiduciary liability insurance that provides coverage forexpenses such as legal defense or monetary judgments. These policies differbased on features such as deductibles, exclusions, etc., so it is important towork with a property and casualty agent who understands the nuances of ERISAfiduciary liability.
Fiduciaries are responsible for overseeing the administration of the plan andshould be familiar with the plan's terms, loan policy, etc. There are manyaspects to plan administration including:
- Enrolling and covering the right employees;
- Timely correction of problems with regard to testing failures or operational issues;
- Authorizing distributions and loans;
- Timely deposit of employee contributions; and
- Complying with reporting and disclosure requirements.
Timely Deposit of Employee Contributions
Deposits must be made as soon as they can reasonably be separated from thecompany's assets, but no later than the 15th business day of the month followingthe month withheld. The 15th business day of the month following withholding isnot a safe harbor and many times funds can be segregated within days of beingwithheld. For plans with under 100 participants there is a "safe harbor"—if thedeposits are made within seven business days of withholding, they are consideredto be timely.
Reporting and Disclosure Requirements
Fiduciaries are subject to a number of reporting and disclosure requirements.One is the annual filing of Form 5500 with the DOL. Form 5500 is a governmentmandated return comprised of a main document and, in some cases, multipleschedules that report information relating to the plan and its operation.
Other disclosures must be made to the plan participants. A summary plandescription (SPD), which is a "plain English" summary of the plan's provisions,must be provided to new participants and, in general, every five years. Afterthe SPD is distributed, you must continue to make participants aware of materialchanges to the plan through explanations called summaries of materialmodifications. Also required is a summary annual report which is a snapshot ofthe financial schedules attached to Form 5500.
It is important for fiduciaries to focus on all aspects of maintaining theplan including the selection and monitoring of investments and serviceproviders; paying reasonable expenses; and overseeing the administration of theplan. Decision-making processes should be put in place and actions documented inwriting demonstrating that these processes were followed.
Fiduciary duties are myriad and complex. Fortunately, you can seek guidancefrom competent outside advisors who have experience with these complex rules.
This newsletter is intended to provide generalinformation on matters of interest in the area of qualified retirement plans andis distributed with the understanding that the publisher and distributor are notrendering legal, tax or other professional advice. Readers should not act orrely on any information in this newsletter without first seeking the advice ofan independent tax advisor such as an attorney or CPA.
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