What is the Baseline for A Committee to Act in the Best Interest of its Participants? (Part 3)

This is the sixth 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.

In my last two posts (Bests #4 and Bests #5), I discuss the NYU case and the “bad” and “good” behavior of committee members. I concluded my last post with the point that process matters. Of course, it was unspoken that I was referring to a good process. This article discusses the fundamentals of a good process and the lessons learned from the NYU decision.

  • The NYU committee met quarterly.

There isn’t a prescribed timing for fiduciary meetings; the requirement is that plan fiduciaries, usually committee members, meet with the frequency necessary to properly do their job. Some aspects of the job, such as review of investments, may require more frequent meetings . . . at least annually, although quarterly would, under ordinary circumstances, clearly satisfy the requirement. An exception would be if a significant change occurred between meetings, for example, the sale of the mutual fund manager, the resignation of the mutual fund manager (where the fund was managed by a single manager), or other changes that could immediately impact an investment.

On the other hand, the monitoring of service providers may not require the same frequency. Absent extraordinary circumstances, annual reviews should ordinarily satisfy the fiduciary requirement (and, even there, it may not need to be that often). Of course, there are some exceptions for unusual events. One of those would be where an employer is receiving complaints from participants that, if valid, would raise concerns about the quality of the service provider, or the timely delivery of the services.

In any event, quarterly meetings are a reasonably good practice for risk management purposes.

  • The committee used an adviser with expertise with similar plans.

There is not a requirement that plan committees use advisers. Instead, it is a best practice. However, if committee members lack the expertise needed to prudently select and monitor a plan’s investments and to evaluate their expense ratios (including share classes), the committee members need to obtain that expertise from another source. Needless to say, good risk management dictates that the source be independent of the investments, in the sense that the source of information not be related to the mutual fund management company or to an organization that receives money from the mutual funds.

If an adviser has conflicts of interest, the committee has the added burden of identifying the conflicts and determining whether the participants will be adversely affected by those conflicts. It’s beyond the scope of this article to fully discuss the selection of advisers, but a starting point is that, when an adviser is paid directly by the plan or the employer, the potential of conflicts is reduced (and perhaps eliminated). On the other hand, where the adviser is paid from the investments, there is an obvious conflict, in the sense that the adviser is incentivized to recommend mutual funds or other investments that provide higher compensation. That’s not to say that all commissioned advisers (or other advisers who receive third party payments) will succumb to the conflicts. However, committee members need to know that they have a legal duty to understand and evaluate conflicts of interest.

  • The committee adopted and followed an investment policy statement.

There is not a legal requirement to have an investment policy statement (IPS). However, it is a best practice. A well-prepared IPS will describe the steps to be followed by a committee in evaluating the quality and costs of the investments. In effect, it will walk committee members through the process of investment selection and monitoring. As a part of that, the IPS should have specific criteria for different types of investments. However, at least in my view, an IPS should specifically state that the provisions are “guidelines” for the committee and that the expectation is that the committee will use its judgment and discretion, as opposed to strict adherence to the guidelines. That reflects my view that a qualitative analysis cannot always be defined by numbers and percentages. In fact, the court in the NYU case said the same, when it discussed the difficulty of benchmarking one of the investments.

These are important steps in a prudent process. However, the committee in the NYU case also made some mistakes. Based on the judge’s description, some of the committee members were not engaged and did not see themselves as being responsible for making fiduciary decisions. Instead, they viewed themselves as providing information and administrative services to the committee. Those people should not have been on the plan committee. Committee members should understand that they are fiduciaries and owe duties of prudence and loyalty to the participants. There is nothing wrong with having administrative personnel attend the meetings, but there is something wrong with a fiduciary that has a ministerial mindset.

The NYU case covered a number of issues, some of which are not discussed here. However, the discussions in this article, and the preceding two articles, are a primer for plan committee members. Advisers should help them understand the good and the bad of the NYU case.

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The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

What is the Baseline for A Committee to Act in the Best Interest of Its Participants? (Part 2)

This is the fifth of a 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 advisers, and plan sponsors, including 401(k) and 403(b) committees.

This is my second article about the case of Sacerdote v. New York University. As I discussed in my last post, the Court’s opinion pointed out the deficiencies in the understandings and conduct of some committee members. However, the Court ultimately ruled in favor of the plan fiduciaries and against the plaintiffs. Why was that?

Despite the deficiencies (or “bad practices”) of some committee members, others on the committee were engaged and knowledgeable. Obviously, that was an important factor. However, there was more than that. The Court noted that “Between [the adviser’s] advice and the guidance of the more well-equipped Committee members . . . , the Court is persuaded that the Committee performed its role adequately.

In other words, while the involvement of the more informed and better engaged committee members was critical, the committee’s use of a knowledgeable adviser was also important. I can tell you that it was a well-regarded advisory firm with considerable expertise with retirement plans. It’s not clear that, absent the work of the adviser, NYU would have won the case.

One of the claims in the lawsuit was that NYU did not use RFPs as often as it should have. As explained by the Court, “Plaintiffs assert that more frequent RFP processes for both Plans would have exerted competitive pressure on recordkeeping vendors, resulting in either a reduction in fees by an existing vendor or a better deal altogether.” While there were a number of factors reviewed by the Court, one of the important ones was that the committee had successfully negotiated for reductions in recordkeeping fees. As explained by the Court, “In addition, plaintiffs ignore that over the course of several years, NYU’s recordkeeping fees consistently decreased as NYU obtained repeated rate reductions.

Plan committees should benchmark their service providers or issue RFPs on their service providers at appropriate intervals. But that begs the meaning of “appropriate intervals.” A common benchmark is for the costs of service providers to be reviewed every three years. However, the legal requirement is that the plan expenses for service providers be monitored at appropriate intervals. More precisely, that means that they should be monitored when a change in circumstances suggests that monitoring could result in lower costs for comparable services. That could occur as a plan grows or as the competitive marketplace reduces the expenses of service providers.

While the law does not require that committees select the lowest cost providers, committees should use RFPs, benchmarking, and negotiations to ensure that their plans are reasonably priced as compared to comparable plans (for example, plans of a similar size and with similar average account balances).

Another claim was that the committee failed, in its monitoring process, to remove two underperforming funds that allegedly had high fees and poor performance. The Court disagreed, noting that the plan’s adviser provided regular reports on the funds, that the committee discussed the funds at multiple meetings, and that the process was consistent with the plan’s investment policy statement. With regard to one fund – a real estate fund, the Court found that the structure of the fund was designed to be more conservative than a common REIT benchmark. In a sense, the Court concluded that a committee could prudently select a more conservative investment alternative, which might have a lower overall return, if the committee felt that it was appropriate for the plan and the participants.

The second fund was a widely-diversified equity fund including both domestic and international securities. The Court noted that it was “challenging to find an appropriate benchmark.” The Court then went on to say “The Committee focused on the difficulties with benchmarking that the [investment] presented due to its composition. It determined that, as a result of these benchmarking difficulties, the [investment] was one that warranted ‘specialized discussions.’ Such discussions occurred.

While the Court looked at a number of benchmarks, and considered other factors, it appears that the committee’s attention to the unique nature of the fund, the on-going discussions in that regard, and the assistance of the adviser were critical factors. The moral to this part of the story is that a given benchmark may not tell the whole story, and that committee discussions, with help from an investment adviser, can provide better insights than the use of a benchmark (and particularly of a benchmark that does not directly apply to the investment under consideration).

In reflecting on this decision, I have several thoughts. My next post will discuss those. For the moment, though, an important point is that committee processes really matter. Prudence is about the process. This decision confirms that. Committees should have robust discussions about plan investments, service providers, and expenses. The discussion should be documented in committee minutes.

All in all, this decision is a “laboratory” about fiduciary responsibility. There was good and bad, and both provide important information to advisers and committee members.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.