Fiduciary Duty Under ERISA

Under the Employee Retirement Income Security Act (ERISA) of 1974, retirement plan sponsors are considered to be “fiduciaries,” meaning they have a duty to act in the best interests of the plan beneficiaries. In instances where the beneficiaries’ interests may conflict with the interests of the company sponsoring the plan, the beneficiaries’ interests must prevail.

When fiduciaries fulfill their roles properly, retirement plan participants who are deferring wages to a 401(k) or other type of retirement savings program can be assured that their investments are safe, with the knowledge that the plan sponsors are required by law to act in their best interests.

But what does it mean to be a fiduciary? And how can a busy plan sponsor ensure that they are applying appropriate fiduciary principles to every situation that arises?

Understand Core Fiduciary Duties

Any plan sponsor or administrator is considered a fiduciary under ERISA. If you are in a position to make decisions about the retirement plan, such as selecting the members of your company’s internal 401(k) oversight committee or selecting investments, you are a fiduciary. Any person in a fiduciary role must understand their duties.

Fundamentally, if you exercise any discretion over the plan, regardless of your job title, you are a fiduciary, and you must meet the following four duties:

Duty of Loyalty

A duty of loyalty means you act solely in the best interests of the beneficiaries of the retirement plan — those who have their savings tied up in the plan. Among other things, that means using plan assets only for benefits and reasonable expenses.

Sometimes companies can misinterpret this concept, thinking that something that is in the best interest of the company is, by extension, in the best interest of the beneficiaries.

For example, a shipping company included a startup pharmaceutical stock in their investment lineup. A plan participant who had worked for the shipper for 30 years logged in to their account and saw this new startup in the investment lineup and assumed it was a safe investment. They invested a portion of their savings in the startup stock and ended up losing their money. Why was the stock included in the lineup? A decision maker in the company, whose investment advisor convinced them this stock was a good bet, made sure the stock was included in the company’s plan, without vetting it to ensure it aligned with the plan’s investment criteria.

This scenario represents a huge fiduciary risk for the company, since placing a startup stock in the plan without vetting it would not be in the best interest of the beneficiaries. While this is a hypothetical example, it is emblematic of situations where company decision makers assume their actions will benefit plan participants, but they fail to abide by the rules set out by ERISA and by their own plan documents.

It’s important to remember that the federal Department of Labor (DOL), which oversees retirement plans and enforces ERISA, does not require plan sponsors to have the best performing assets in their investment lineups; rather, it requires that sponsors have a prudent process and have an investment policy that is diligently followed.

Even with a prudent process in place, companies sometimes fail to do the necessary due diligence on their investments because they don’t have the expertise. But the DOL requires that if a company does not have in-house expertise to monitor its plan’s investments, it must hire outside investment managers.

Duty of Prudence

The duty of prudence requires that a fiduciary act with the care, skill and diligence of a prudent person, particularly with regard to managing the plan’s investments and to maintaining the plan documents.

Plan documents must be reclassified approximately every five to seven years, under direction of the DOL. One company had had its plan record keeper perform the necessary paperwork, and had signed off on the revised document. At the end of the year, the CEO was shocked to find out the company owed $36,000 to its plan, due to the way the plan was rewritten. The mistake had to do with the way a plan sponsor forwards matching contributions to the plan. These contributions, which the company makes from its own funds to augment participants’ wage deferrals, can be paid out during the year as payroll happens, or they can be paid during a true up at the end of the year.

This company had always paid the matching contributions throughout the year, and the plan administrator thought they were going to continue doing so. However, the record keeper had mistakenly chosen the year-end true up option on the rewritten documents.

The company paid the contributions, and also notified DOL of the mistake, clarifying that the following year they would revert to paying throughout the year.

This was an important step. DOL looks at these kinds of mistakes more favorably if a plan sponsor finds the mistake and does a voluntary correction. As soon as you find an issue in your retirement plan, the best course of action is to identify it and correct it immediately. When it comes to retirement plan administration, process matters as much as outcomes.

Duty to Diversify

As with personal investments, the investment mix in a retirement plan must be reasonably diversified. It is the fiduciary’s responsibility to ensure that the investment lineup minimizes the risk of large losses.

Fearing the responsibility for losses, some plan administrators err on the side of too much caution, including only the safest mutual funds in their plans. While this may avoid large losses, it also could have the effect of denying plan participants the opportunity for solid growth in their investments.

Others err on the side of too much choice. For example, one company CEO had directed the inclusion of more than 50 investments in their plan’s lineup. He reasoned that he wanted employees to feel that they had every option available to them. The problem is that many plan participants don’t have the investment savvy to discern the best mix of investments when presented with too many choices. They get “paralysis by analysis.” If you log into your account looking to invest in a large cap value fund, and there are five to choose from, which one do you pick?

That’s why it’s important to have experienced investment managers — either in-house or outsourced — putting the right investment options in place for your plan beneficiaries. Experienced investment managers will choose investment options for your plan based on a set of criteria designed to deliver strong potential for growth in your plan beneficiaries’ accounts. Moreover, they understand how to vary the investment options depending on the needs and sophistication of your employee group.

Duty to Follow Plan Documents

The duty to follow plan documents means strictly operating in accordance with the plan document that the plan sponsor has signed. This includes:

  • Knowing what is in the plan document. This is an area that DOL is increasingly scrutinizing. As a plan sponsor, your document will specify that beneficiaries’ contributions be conveyed to the plan’s third-party administrator (TPA), which holds the funds, as soon as administratively possible. This means right now, not after your benefits manager gets back from vacation.
  • Getting notices to employees on time.
  • Offering investment education to your plan participants, both in group settings and individually. This helps employees understand the best way to manage their accounts to reach their retirement goals on time.

Questions?

The duty of a fiduciary to act in the best interests of the plan beneficiaries isn’t just a legal nicety. It is the law, and violations, whether intentional or inadvertent, can result in steep fines. For a fiduciary, failure can result in personal liability to restore plan losses.

If you would like to discuss the administration of your company’s retirement plan, the selection and management of investments in the plan, or the creation of an investment education program for your employees, contact an Adams Brown retirement plan advisor.