By Sheldon M. Geller, Esq.
Investment advisors need to protect 401(k) plan sponsor boards, corporate officers, and other plan fiduciaries from an increasingly active and ERISA-sophisticated bar. Recent court decisions have identified issues that investment advisors should consider to effect prudent plan management and protect their 401(k) plan clients from significant fiduciary liability. Plan sponsors are at risk and thus investment advisors need to insulate them from a new wave of ERISA lawsuits, regulatory oversight, and legislation.
Investment Advisory Services
Court decisions have found that 401(k) plan fiduciaries have breached their duties to plan participants and been assessed significant damages for failing to monitor record-keeping costs, negotiate rebates, and prudently select and retain investment options. Many plan sponsors have relied on non-fiduciary service providers for investment selection and fiduciary guidance in the absence of a fiduciary overlay service or discretionary vendor.
It may be a conflict of interest for plan sponsor fiduciaries to rely on a non-fiduciary service provider to accept responsibility for their service model and investment fund recommendations. Plan sponsors should become increasingly skeptical of non-fiduciary service providers’ managing plan assets and plan administration. Investment advisors need to educate plan fiduciaries who may not recognize a conflict of interest.
Investment Advisor Due Diligence
There will be more claims against 401(k) plan fiduciaries who previously considered themselves immune because they offered a broad selection of investment alternatives. It’s critical for investment advisors to have the requisite skills and knowledge to uncover embedded fees, conflicts of interest, service incapability, and contract limitations inherent in the retirement plan solutions they offer their 401(k) plan sponsor clients.
Courts have emphasized the importance of implementing and adhering to a deliberative process and focusing on the merits of employer decisions affecting plan participants. ERISA fee litigation cases emphasize that employers must follow established processes and act in the best interest of the plan and for the exclusive benefit of plan participants. Accordingly, 401(k) plan sponsors rely on their investment advisors to establish these processes, to effect procedural prudence, to avoid conflicts, and to document decisions.
Investment advisors need to become experts qualified in fiduciary standards of care and assessment. Most firms providing retirement plan administration services don’t guarantee the completeness or accuracy of their services; they process the information plan sponsors provide to them. Most employers don’t have the internal controls in place to ensure operational compliance with plan terms in order to satisfy ERISA.
Consequences of noncompliance consume company staff time, increase legal costs, and expose plan sponsors to liability and monetary sanctions. The current regulatory environment makes it difficult for an investment advisor to adequately represent plan sponsor interests unless the advisor is an ERISA fiduciary.
Plan Fiduciary Best Practices
Recent case law imposes new best plan practices on plan sponsors. Plan sponsors must implement and maintain an objective strategy with predetermined procedures to remove subjectivity and comply with ERISA’s requirement for fiduciaries to act solely on behalf of participants.
1. Revenue sharing and record-keeping fees: Employers must monitor record-keeping fees and revenue sharing pursuant to a deliberative process demonstrating that committee decisions are in the best interest of plan participants. Service providers may not retain revenue sharing that far exceeds the market value of plan services.
2. Revenue sharing and fee offsets: Employers must negotiate revenue-sharing rebates with service providers to reduce administrative costs if a marketplace comparison determines that mutual fund expense ratios are excessive and unreasonable.
3. Selection and de-selection of investments: Employers must document the process for evaluating the competitive market for comparable investment funds. Deleting a fund that’s performing well or using alternative share classes to create more revenue sharing to offset fees violates investment policy statement criteria and the exclusive benefit rule. Fund replacements must provide a reasonable investment advantage to participants.
4. Subsidization of corporate services: Employers must avoid the payment of fees that exceed the market costs for plan services in order to subsidize corporate services, including payroll processing, welfare benefit plan and defined benefit plan services.
5. Float income: Float, the income and interest earned when contributions and disbursements are held temporarily during the transfer process, constitutes plan assets and therefore must be allocated only among 401(k) plan participant accounts.
6. Fiduciary monitoring criteria: Employers must review custody statements monthly, compare manager performance quarterly, evaluate service provider quality annually, and scrutinize service provider contract capabilities, services, and fees triennially.
7. Asset-based fees: It’s imprudent to use asset-based fees to pay for administration services as fees increase even though no additional services are provided.
8. Risk sharing: It’s imprudent to enable service providers to charge hard-dollar fees to replace lost revenue-sharing that results from declining plan asset values without determining the revenue-sharing amount, the market cost of comparable services, and whether using revenue sharing to pay plan fees is in the participant’s best interest.
9. Investment policy statement: It’s imprudent to maintain an investment policy statement without adhering to its fund-replacement criteria and revenue-sharing application because plan sponsors will be held liable for the failure to comply with same.
Plan Fiduciary Best Governance
Plan sponsors may have to explain, if not defend, their actions in retaining service providers if they don’t conduct a full request-for-proposal process to formally test the marketplace for retirement services every three years. Neither ERISA’s prudence requirement nor ERISA’s exclusive benefit rule supports a rule of law requiring plan fiduciaries to conduct a competitive bidding process to support a fee and avoid litigation.
Recent lawsuits have alleged that plan sponsor boards, corporate officers, and other fiduciaries have breached their fiduciary duties by failing to investigate plan transactions. Investment advisors need to help plan-sponsor fiduciaries identify conflicts or potential conflicts and evaluate whether those conflicts impact the 401(k) plan and its participants. Further, investment advisors need to help plan sponsors protect the plan from any adverse effect of a conflict of interest.
Strong ERISA Fiduciary Partner
Plan sponsors are advised to retain investment advisors who can be strong fiduciary partners to provide open architecture solutions that facilitate identifying best-in-class service models and lower-cost, best-performing fund lineups. ERISA anticipated that independent fiduciaries would manage retirement plans on behalf of plan sponsors, protecting boards of directors, corporate officers, and other plan sponsor fiduciaries.
An independent ERISA fiduciary cannot be conflicted and is legally accountable to its plan-sponsor client, which is indispensable when retaining service providers, approving fee arrangements, and selecting investment funds. Plan sponsors need advice from an advisor who has subject matter expertise to avoid ERISA violations, monetary sanctions, and civil liability for corporate directors and corporate officers who fail to establish internal control procedures for monitoring operational compliance.
As the challenging economic environment prompts more lawsuits over retirement plan benefit losses, boards, CFOs ,and other plan fiduciaries should think carefully about the retention of advisors and attorneys who have ERISA subject matter expertise to manage conflicts, avoid prohibited transactions, and provide legal accountability. There is a need for highly credentialed and independent ERISA professionals compensated by plan sponsors, not by custodians and fund companies, to serve and protect plan sponsor boards, CFOs, CEOs, corporate officers, HR managers, and other plan fiduciaries.
Sheldon M. Geller, Esq., CPA is a consultant in Muttontown, N.Y.
