What to do to Protect Yourself as an
Advisor or Plan Sponsor
Marcia S. Wagner, Esq.
Introduction
I.
Fiduciary Duties Under ERISA
II.
Fiduciary Risks and Potential Liability
III.
Fiduciary Protection
I. Fiduciary Duties Under ERISA

An ERISA plan must have at least 1 fiduciary.

Typically, plan sponsor is the plan’s Named
Fiduciary.

Plan’s advisor is also a fiduciary if advisor
provides investment advice.

Person is not a fiduciary if such individual or
entity only performs ministerial functions.
3
Definition of Fiduciary

“Fiduciary” includes the following:
◦ Person with discretionary authority over management
of plan.
◦ Person with authority over disposition of plan assets.
◦ Advisors who provide investment advice for a fee.
◦ Person with discretionary authority with respect to
plan administration.
4
Definition of Investment Advice

Person provides investment advice if:
◦
◦
◦
◦
◦
Advice on value or advisability of investments…
…is provided to plan on regular basis…
…under mutual understanding that advice will be…
…primary basis for investment decisions…
…and based on particular needs of plan.

Investment “education” is not fiduciary
advice.

To be deemed an investment advice fiduciary,
advisor must receive fee for services.
5
Functional Test for Fiduciary Status

Functional test
◦ Formal appointment is not required to become a plan
fiduciary.
◦ Fiduciary-like conduct is sufficient to confer fiduciary
status on a person.

Financial advisors can include RIAs or brokerdealers.
◦ RIAs typically provide investment advice as plan
fiduciaries.
◦ Many broker-dealers do not intend to provide
investment advice, but they can “accidentally”
become functional fiduciaries.
6
Fiduciary Responsibilities

Fiduciary standard of care under ERISA.

Must act solely in interest of plan participants:
◦ Exclusive purpose of providing benefits to plan
participants.
◦ Carrying out duties prudently.
◦ Following terms of plan document unless inconsistent
with ERISA.
◦ Diversifying plan investments.
◦ Paying only reasonable plan expenses.
7
Focusing On Specific Duties

Exclusive purpose of providing benefits
◦ Primary responsibility to act solely in interest of
participants.

Carrying out duties prudently
◦ Must manage plan assets with care, skill, prudence
and diligence…
◦ …that a prudent person acting in a similar situation…
◦ …and familiar with such matters would exercise.
◦ Duty of prudence focuses on process.

Following terms of plan document
◦ Must obey unless inconsistent with ERISA.
8
Focusing On Specific Duties (cont’d)

Diversifying plan investments
◦ Must diversify plan’s investments in order to minimize
risk of large losses.

Paying only reasonable plan expenses
◦ Must ensure fees paid to plan’s providers are
reasonable.
◦ Separately, prohibited transaction rules also require:
(1) service arrangement must be reasonable,
(2) services must be necessary, and
(3) compensation must be reasonable.
◦ ERISA 408(b)(2) reg’s will require providers to deliver
fee disclosures to plan sponsors (July 2011).
9
Fiduciary Protection Under ERISA 404(c)

ERISA Section 404(c)
◦ Plan sponsor is responsible for participant-directed
investments unless plan complies with ERISA 404(c).
◦ Many plans fail to comply with ERISA 404(c)
requirements operationally.

Conditions of ERISA Section 404(c)
◦ Participant must exercise independent control.
◦ Plan menu must have broad range of investment
options.
10
ERISA 404(c) Conditions

Exercising independent control
◦ Participant must have reasonable opportunity to give
investment instructions, and have enough information
to make informed decisions.

Broad range of investment options
◦ Participant must have reasonable opportunity to
materially affect investment return, choose from at
least 3 options, and diversify investments.

Duty to select/maintain investment menu
◦ Must manage investment options in accordance with
duties of prudence and diversification.
11
II. Fiduciary Risk and Potential Liability

Fiduciary liabilities
◦ ERISA permits participants to bring lawsuits against
fiduciaries who breach their duties.
◦ Responsible fiduciary is personally liable for losses
resulting from breach of duties.
◦ Other types of relief may be available from court.

DOL penalty for fiduciary breach
◦ 20% civil penalty by DOL under ERISA 502(l).
◦ DOL has discretion to reduce or waive penalty.

IRS may impose also impose excise taxes
under prohibited transaction rules.
12
Co-Fiduciary Liability

ERISA 405(a) imposes co-fiduciary liability on
Fiduciary #1 for a breach by Fiduciary #2 if:
◦ Fiduciary #1 knowingly participates in breach by
Fiduciary #2,
◦ Fiduciary #1 fails to discharge its duties, enabling
breach by Fiduciary #2, or
◦ Fiduciary #1 knows of breach by Fiduciary #2, but
does not make reasonable efforts to remedy.

Thus, a fiduciary who becomes aware of
another fiduciary’s bad acts must take
reasonable action.
13
Breaches Prior To or After
Being a Fiduciary

Ordinarily, fiduciary is not liable for breach
committed before/after becoming fiduciary.

However, fiduciary must take steps to
remedy breach if he or she becomes aware
of breach.
◦ Must take action if new fiduciary becomes aware of a
breach which occurred previously.
◦ Co-fiduciary liability arises if no action is taken to
correct such breach.
14
Liability Relating to Duty to Pay
Reasonable Plan Expenses Only

Increased interest in 401(k) fees has resulted
in lawsuits against employers and providers.

Types of claims made by participants in class
action lawsuits:
◦ Plan fiduciaries failed to monitor indirect
compensation from plan’s investment providers to
other service providers (e.g., revenue sharing).
◦ Selection of inappropriate share class (i.e., use of
“retail” instead of cheaper “institutional” share class).
◦ Fees not adequately disclosed to plan participants.
15
Recent Developments
in 401(k) Litigation

First generation of 401(k) fee lawsuits
launched against plan providers.
◦ Haddock v. Nationwide Financial Services
Investment provider sued over its receipt of fees
from mutual funds offered under annuity contracts
◦ Ruppert v. Principal Life Insurance Company
Complaint that fiduciary standards breached by
service provider’s receipt of revenue sharing
payments from mutual funds
◦ Phones Plus, Inc. v. Hartford Financial Services
Complaint that The Hartford received revenue
sharing payments for services that it was already
obligated to provide to its plan clients
16
Second Generation of Fee Litigation Cases

The Main Thrust – dozens of lawsuits filed
against plan sponsors.
◦ Class actions brought on behalf of participants.
◦ First cases brought by small St. Louis litigation firm.
◦ Defendants are large employers, company officers
and plan committees.

New Tactics – another round of lawsuits filed
against plans sponsors and providers.
◦ Allegations that revenue sharing payments to other
providers should have been used for benefit of
participants.
17
Recent Wins for Defendants

Courts generally reluctant to dismiss 401(k)
fee suits before factual findings are made.

Exception: Hecker v. Deere
◦ Deere & Company sponsors 401(k) plan
administered by Fidelity, with Fidelity funds and
brokerage window.
◦ Suit filed against employer and Fidelity for
(1) excessive fees in investment options, and
(2) failure to disclose revenue sharing.
◦ 7th Circuit affirmed motion to dismiss (2009).
◦ Court was influenced by plan’s brokerage window
providing access to 2,500 mutual funds.
18
Hecker v. Deere (cont’d)

Plaintiffs (with support of DOL) ask 7th Circuit
for rehearing, but petition is denied.
◦ Court issues addendum clarifying that ERISA
404(c) protection does not automatically protect
fiduciaries who select overpriced funds.
◦ However, Deere still implies that maintaining a
liberal number of investment options can help.
◦ U.S. Supreme Court declines to review (2010).

Other defendants in other 401(k) fee cases
have also successfully defended themselves.
◦ Court opinions typically rely on Deere.
19
Recent Wins for Plaintiffs

Braden v. Wal-Mart Stores, Inc.
◦ As 401(k) sponsor, Wal-Mart selects retail mutual
funds for plan’s menu.
◦ District court dismisses plaintiffs’ claims.

Circuit court overturns dismissal by lower
court (2009).
◦ Given its large size ($10B), the Wal-Mart plan could
have selected institutional fund shares.
◦ Majority of plan’s funds charged 12b-1 fees.
◦ Poorly performing funds were retained.
◦ Revenue sharing payments made to trustee.
20
Braden v. Wal-Mart (cont’d)

Circuit court’s analysis
◦ Wal-Mart offered limited menu only.
◦ Plan fiduciary has duty to furnish material fee-related
information to participants.
◦ Wal-Mart must demonstrate fees are reasonable.

Plaintiffs in other 401(k) fee cases have won
monetary settlements.

Tibble v. Edison International (2010) is one of
first 401(k) fee cases to go to trial.
◦ Plaintiffs win on judgment, and court rules retail
funds were imprudently selected for plan menu.
21
Implications of 401(k) Fee Cases

Unclear whether cases will result in
significant recoveries for plaintiffs.

Victories for plaintiffs could result in exposure
for many similar 401(k) plans.

Additional lawsuits likely.

Litigation publicity will increase regulatory
and legislative pressure.

Non-monetary settlement terms are likely to
become “best practices” for plans generally.
22
III. Fiduciary Protection

ERISA bond protects plan only.
◦ ERISA 412 requires bonding for every person who
“handles” plan funds.
◦ Must cover 10% of plan assets, subject to $500,000
maximum ($1M if plan holds employer securities).
◦ Exemption for broker-dealers.

Fiduciary liability insurance
◦ Protects plan or fiduciaries.
◦ Generally covers trustees, plan sponsor and their
employees.
◦ May be purchased by plan or plan sponsor.
23
Professional Liability Insurance

Protects plan consultants and advisors.
◦ Also referred to as “E&O” insurance.

Coverage for certain claims typically excluded.
◦ Claims arising out of impropriety of plan’s payment of
service fees.
◦ Claims arising from late trading or market timing.
◦ Claims arising from soft dollar or revenue sharing.

Exclusions can be modified by negotiation.

Dollar limits on policy coverage may apply.
24
Contractual Limitation on Liability

Limitation on liability provisions

Indemnification of service providers

DOL position in Adv. Op. 2002-08A
◦ Contract must not limit provider’s liability for its fraud
or misconduct.
◦ Limitation on liability for negligence may be
permitted.

Due diligence procedures
◦ Assess reasonableness of relationship as a whole.
◦ Document assessment in consideration of plan’s
potential risk of loss due to limitation on liability.
25
Fiduciary Investment Reviews

Investment Policy Statement (IPS)
◦ Written IPS can help demonstrate compliance with
ERISA fiduciary standards.
◦ IPS should include clear standards.

Continuous monitoring
◦ Investments should be reviewed regularly.
◦ Plan fiduciaries must understand analysis.

Replace funds that do not meet criteria.
◦ IPS can help with decision-making process.
26
Fiduciary Investment Reviews (cont’d)

Documentation of fiduciary reviews
◦ Documentation can help demonstrate fiduciary
prudence.

Utilize independent investment expert.
◦ Can provide valuable reports, analysis and
recommendations.
◦ Fiduciaries should always consider whether advice is
conflicted.

Evaluating expense ratios/fees
◦ Fiduciary review should take into account all fees and
expenses.
27
Best Practices Arising from
401(k) Fee Litigation

Plan sponsors are beginning to adopt “best
practices” with respect to 401(k) fees.
◦ Plan fiduciaries are judged by their processes.
◦ Financial advisors should be prepared to assist plan
sponsors implement best practices.

Developing process to understand fees.
◦ Plan sponsors must make effort to learn how much
plan and participants are actually paying.
◦ There are many types of indirect fees
(e.g., soft dollars, sub-transfer agency fees, 12b-1
fees, sales charges, revenue sharing and float).
28
Best Practices Arising from
401(k) Fee Litigation (cont’d)

Comparing fees against benchmark
◦ Establish objective process to assess
(1) qualifications of providers,
(2)
quality of services, and
(3) reasonable of fees in light of services provided.

Benchmarking services
◦ Can assist employer identify any “hidden” fees.
◦ Equips employer with tool to be used as part of
prudent review process.
◦ Provides competitive pricing information.
29
Best Practices Arising from
401(k) Fee Litigation (cont’d)

Documenting reviews of providers and fees
◦ Review of provider’s fees should be properly
documented.
◦ Documentation should demonstrate thoughtful
process.
◦ Solicit bids when considering a new provider, and
document bid process.

Conducting fiduciary audit
◦ Hire independent third party to audit plan’s external
fiduciaries.
30
Best Practices Arising from
401(k) Fee Litigation (cont’d)

Fiduciary manual
◦ Helps plan fiduciaries better understand their
responsibilities under the plan.
◦ Fosters ERISA compliance and can serve as a
reference guide for fiduciary duties.
◦ Can serve as compliance tool for monitoring
providers.

Disclosure to participants
◦ In light of pending rules and current litigation
environment, ensure meaningful fee disclosures are
provided to participants.
31
Fiduciary Relief Offered by Certain
Platform Providers

Program intended to share or relieve investment
responsibilities of 401(k) plan sponsor.
◦ First Approach
(1) Independent firm prepares “premier” list of funds
from provider’s platform;
(2)
Sponsor selects funds from pre-approved list; and
(3) Independent firm agrees to serve as co-fiduciary;.
◦ Second Approach
(1) Provider has model list of options from broad
range of investment categories;
(2)
Sponsor must select funds for each category;
(3)
Provider guarantees compliance with certain aspects
of ERISA prudence requirement.
32
Fiduciary Relief Offered by Certain
Platform Providers (cont’d)

Program provides some assurances to plan
sponsor.

“Fine print” should be examined closely.

Questions to ask platform provider:
◦ Standards for conduct?
◦ Aspects of fiduciary duties/liability not covered?
◦ When does relief apply?
◦ Does sponsor ever have to indemnify provider?
◦ Fees
◦ Notice for removal of investment option from line-up
33
Conclusion

Fiduciary protection is available from many
sources:
◦ ERISA bond (protecting plan)
◦ Fiduciary liability insurance (protecting sponsor)
◦ Professional liability insurance (protecting advisor)
◦ Contractual limitations on liability
◦ Fiduciary investment reviews
◦ Best practices arising from 401(k) fee litigation
◦ Fiduciary relief offered by certain platform providers
34
What to do to Protect Yourself as an
Advisor or Plan Sponsor
Questions and Answers
Marcia S. Wagner, Esq.
A0044780