Best Practices: Why Wait Until After You are Sued?
This is the 13th of a new series of articles titled “The Bests.” The series focuses on Best Interest and Best Practices. Those topics give me flexibility to discuss a range of subjects that affect both service providers, including advisors, and plan sponsors, including 401(k) and 403(b) committees.
I am surprised that, after all of the fiduciary litigation against 401(k) plan sponsors, many plan sponsors and their committees have not taken the basic steps to minimize the risk of being sued, or if sued, of being liable. In most of the settled cases, the plaintiffs’ class action attorneys require that certain conditions—or “best practices”—be adopted by the plan fiduciaries. And, in settlement after settlement, those conditions are, by and large, the same. That raises the obvious question, why haven’t plan committees reviewed these cases and instituted the practices required by the settlement agreements?
I don’t know the answer to that question. However, here are examples of the conditions imposed in a recent settlement, together with my comments. Hopefully, plan sponsors and advisors will, where needed, implement these steps.
In a recent case, the defendants—the committee members and the company—settled for $24,000,000 in damages. Here are the conditions imposed in the settlement agreement:
- The plan fiduciaries will engage a consulting firm to conduct a Request for Proposal (RFP) for investment consulting firms that are unaffiliated with the plan sponsor and, as a result of that search, will engage an investment consultant to provide independent services to the plan.
As I look at it, there are two parts to that requirement. The first is that the plan fiduciaries, which I will refer to as the “committee,” should prudently select and monitor its service providers, including its investment consultants or advisors. An RFP is just one approach to doing that. There are other ways to prudently select advisors, consultants and other plan service providers. However, regardless of the method, the process requires analysis of the competency of the consultant to provide services for a plan of that type and that size.
The second is that the agreement requires that the consultant be independent from the plan sponsor. In other words, plan fiduciaries should receive independent and unbiased advice. The consultant should have a loyalty to the plan and the participants, and not to the sponsoring company.
- After being selected, the investment consultant must evaluate the plan’s investments and provide the fiduciaries with an objective evaluation of those investments.
The obvious purpose for hiring the consultant is to get independent advice about the selection, monitoring, removal and replacement of the plan’s investment options. While a number of factors should be considered in monitoring investments, two of the most important are the quality of the investment managers and the reasonableness of the expense ratios relative to the size of the plan. On that latter point, larger plans are able to choose lower-cost investments than smaller plans can.
- Another condition is that the committee members participate in an education session regarding their ERISA fiduciary duties.
While many 401(k)-focused advisors and ERISA attorneys provide fiduciary education to plan committees, I believe that the number of committees that actually receive education, both initially and on an ongoing basis, is fairly small. In that regard, I recommend training by both the plan’s advisor and its ERISA attorney. While plan advisors are familiar with the selection of investments and the pricing of plan services, the approach of attorneys is somewhat different. An overly simplified way of viewing the difference might be to say that advisors educate plan committees on what to do, while attorneys focus on what not to do.
I recommend two types of fiduciary education. The first is an introduction to fiduciary responsibility. Every committee member would receive that basic training. Then, as new members join the committee, they would also receive that training. The second type is an annual update about current developments. For example, what are the current issues in fiduciary litigation and what should the committee members do to avoid problems in those areas? What are the current hot buttons for DOL investigations? For example, the DOL is focusing on whether committees are taking appropriate steps to keep track of former employers who have balances in the 401(k) plans.
- The settlement agreement goes on to require that all payments from the investments (including 12b-1 fees, sub-TA fees, or other compensation that any of the investments pay to the plan’s recordkeeper) be restored to the accounts of the participants.
In other words, all revenue attributable to the plan’s investments must be paid to the accounts of the participants who held the investments that made the payments. This is sometimes referred to as “equalization.”
Plaintiff’s attorneys are concerned that, where the recordkeeping expenses are paid, partially or entirely, through the investments, the costs are not transparent and may not be properly monitored. The belief is that, where the expenses are obvious, plan committees will do a better job of monitoring the reasonableness of those expenses. There is also a concern that, since the revenue varies from investment to investment, some participants may be bearing a greater cost for the recordkeeping services than others are.
I should point out that equalization is not legally required under current interpretations of the law. However, it is a good way to mitigate fiduciary risk. For example, a claim could be that the more expensive investments in the plan paid more money for the recordkeeping charges and, therefore, the participants who held those investments were over-charged for recordkeeping services.
If plan committees implemented the steps described in this settlement agreement, they will go a long way towards limiting their liability . . . and probably towards producing a higher-quality, lower-cost 401(k) plan for the employees. These aren’t the only steps that should be taken, but they are a good start.
Forewarned is forearmed. The plaintiff’s attorneys are paying attention to these issues; you should be, too.