IBEW/NECA Employee
Benefits Conference
Legal Update
Naples, Florida
January 2013
Shane N. Kramer
Potts-Dupre, Difede & Hawkins, CHTD.
Prudent Investment Decisions
Under ERISA
Back to Basics
Potts-Dupre, Difede & Hawkins, CHTD.
Example
2007 Manager Selections
Potts-Dupre, Difede & Hawkins, CHTD.
#1
Manager A
Manager B
Manager C
11%
18%
-12%
Potts-Dupre, Difede & Hawkins, CHTD.
#2
Manager A
Manager B
Manager C
11%
18%
-12%
High Yield Fixed
Income
Large Cap Value
(lower-mid
quartile)
Alternatives:
Comics, Baseball
Cards, and
Poker Players
big-name firm
niche, no-name
firm
(top quartile)
family-owned
firm
Potts-Dupre, Difede & Hawkins, CHTD.
#3
Manager A
Manager B
Manager C
11%
18%
-12%
High Yield Fixed
Income
(lower-mid quartile)
Large Cap Value
Rare Comics, Baseball
Cards, and Poker
Players
big-name firm
family-owned firm
transparent process
secretive process
(top quartile)
Potts-Dupre, Difede & Hawkins, CHTD.
niche, no-name firm
transparent process
#4
Manager A
Manager B
Manager C
11%
TOTAL LOSS
-12%
Recommended by
consultant &
selected with
thorough due
diligence and
analysis
Recommended by
consultant &
selected with
thorough due
diligence and
analysis
picked by throwing
darts
Potts-Dupre, Difede & Hawkins, CHTD.
What’s the Takeaway?
ERISA regulates
are irrelevant
{Well, mostly…}
Potts-Dupre, Difede & Hawkins, CHTD.
The Moral?
High Stakes
• “The fiduciary obligations of trustees [and other
ERISA fiduciaries] are . . . the highest known to law.”
Donovan v. Bierworth, 680 F.2d 263, 272 (2nd Cir. 1982)
+
• Possibility of personal liability:
–
–
–
–
Restore losses to plan
Return ill-gotten gains
Equitable or remedial relief (such as removal)
Civil penalty (20% of amount recovered under ERISA §
502(l))
= … a lot of exposure!
Potts-Dupre, Difede & Hawkins, CHTD.
Fiduciary Protection
• Fiduciary Insurance
• Use of Plan Assets, where appropriate
• Proactive avoidance / Self-help
– Focus on process
– Delegation (getting off the fiduciary hook)
Potts-Dupre, Difede & Hawkins, CHTD.
Fiduciary Framework:
ERISA § 404(a)(1)
•
•
•
•
Duty of loyalty – Exclusive Benefit Rule
Duty of care – Prudent Expert Rule
Duty of diversification
Duty to follow plan documents to extent
consistent with ERISA Title I and Title IV
Potts-Dupre, Difede & Hawkins, CHTD.
Who’s on the Fiduciary Hook?
• Functional test under ERISA § 3(21)(A) – your
title is not determinative:
– Do you have discretion or control over plan
assets?
– Do you render investment advice for a fee?
– Do you have discretionary responsibility in the
administration of the plan?
Potts-Dupre, Difede & Hawkins, CHTD.
What is the “Prudent Expert”
Standard of Care?
ERISA § 404(a)(1)(B)
[A] fiduciary shall discharge his duties with
respect to the plan . . . with 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
Potts-Dupre, Difede & Hawkins, CHTD.
Prudence and Investment Duties
DOL Reg. § 2550.404a-1b
• The prudent expert standard is satisfied if the
fiduciary:
– Has given “appropriate consideration” to the
facts and circumstances the fiduciary knows (or
should know) are relevant to the investment (or
investment course of action), including the role it
plays in the investment portfolio
AND
– Has acted accordingly
Potts-Dupre, Difede & Hawkins, CHTD.
How Do I Give
“Appropriate Consideration”?
Step 1:
Make a determination that the investment is
reasonably designed to further the purposes of
the plan, taking into consideration the risk of
loss and opportunity for gain (or other return) of
the investment
Potts-Dupre, Difede & Hawkins, CHTD.
And…
Step 2:
Consider the investment in light of the
portfolio’s:
– Diversification
– Liquidity and current return relative to the plan’s
anticipated cash flow requirements
– Projected return relative to the plan’s funding
objectives
Potts-Dupre, Difede & Hawkins, CHTD.
Summary
• Statute: A fiduciary’s conduct is judged on a snapshot
basis against what a competent, impartial, informed
investment professional might do
• Regulations: A fiduciary should thoroughly investigate
and analyze the F&Cs surrounding the investment
– Consider the nature of the plan / diversification / liquidity /
goals / etc.
– Then, determine on the merits that it benefits the plan
• But . . . What if fiduciary doesn’t have the necessary
expertise or time?
Potts-Dupre, Difede & Hawkins, CHTD.
“. . . a pure heart and an
empty head are not enough.”
• Good faith and ignorance are no defense
• If you have an empty head…
– You’re not alone!
– But, you must obtain the assistance of a qualified
expert
-- William Shakespeare
Self-Help
• Read to stay current and anticipate issues
• Use your consultant, counsel, actuary, investment staff , etc.
• Own the process: engage and ask probing questions
• Document your process
• Fiduciary investment training?
• Review plan text and trust documents - know your role
• Review Investment Policy Statement/Guidelines regularly
–
–
Fiduciary road map
Follow it!
Potts-Dupre, Difede & Hawkins, CHTD.
IPS/General Guidelines Essentials
•
Funding policy
•
Goals and objectives
•
Risk/return guidelines
•
Permitted asset classes and subclasses/styles
•
Selection & monitoring of asset
managers
•
Reporting and communications
•
Procedures for reviewing performance
relative to appropriate benchmarks
•
Voting of proxies
•
Target asset mix, diversification, &
rebalancing
•
Review of fees for reasonableness
•
Liquidity considerations
•
Review of IPS/Guidelines
•
Role of independent consultant;
actuary; custodial bank; etc.
•
Trustee / board / executive committee
meetings
•
Lay out ERISA prudence requirements
Potts-Dupre, Difede & Hawkins, CHTD.
How to Get Help, Prudently, Of Course
• Non-Discretionary Investment Adviser
– “3(21)” fiduciary
• Discretionary Investment Manager
– “3(38)” fiduciary
Potts-Dupre, Difede & Hawkins, CHTD.
Non-Discretionary Investment Adviser
• Evidence of thorough investigation and good
process
• Not a shield to liability
• If you retain discretion and control, you are on
hook for investment decision
Potts-Dupre, Difede & Hawkins, CHTD.
Requirements for Reliance
• Investigate credentials and probe independence
– Is expert qualified to make recommendation?
– Is expert conflicted?
• Provide expert with complete and accurate information
• Evaluate recommendation before following it
– No rubber-stamp approval
• Create paper trail
Potts-Dupre, Difede & Hawkins, CHTD.
Discretionary Investment Manager
• Plan fiduciary is on hook for selection and
monitoring
• Investment manager is on hook for actual
investment decisions
Potts-Dupre, Difede & Hawkins, CHTD.
Delegation Requirements
– Must have discretion to manage plan assets
– Must be registered investment advisor, bank or
insurance company
– Must acknowledge fiduciary status in writing
Potts-Dupre, Difede & Hawkins, CHTD.
Checklist:
Sample Criteria For Hiring A Manager
• Experience with benefit
plan clients / AUM
• Reputation / references
• Organizational structure /
financial health
• Performance (absolute /
relative / consistency)
• Qualifications of key
individuals
• Appropriate registrations
• Willingness to be on
fiduciary hook
• Investment process
• Investment style
• Communications &
reporting / transparency
• Litigation or enforcement
actions
• Fees
• Bonding / Insurance to
cover the fund
• QPAM status
Potts-Dupre, Difede & Hawkins, CHTD.
Sample Checklist For
Periodic Monitoring
Review managers at reasonable intervals
• Were there any material changes in the status
of hiring criteria?
• Was the mandate satisfied?
• Did performance meet the needs of the plan?
• Were there any compliance issues?
– (e.g., guidelines / contractual / legal )
• Was the reporting to expectations?
Potts-Dupre, Difede & Hawkins, CHTD.
Review
• ERISA Prudence is flexible and based on CONDUCT
• Process is key and results are irrelevant (mostly)
• Self-help
–
–
–
–
–
Education
Use expert(s) when necessary
Be deliberate with due diligence
Make reasoned and independent decisions
Create a paper trail
Potts-Dupre, Difede & Hawkins, CHTD.
Potts-Dupre, Difede & Hawkins, CHTD.