If we printed every article, treatise, white paper, etc. that has been written about being a retirement plan fiduciary, the pages would probably fill the Grand Canyon. All of it more or less attempts to answer two fundamental questions:
- Who are plan fiduciaries?
- What are their responsibilities?
While there is plenty of ambiguity and gray area when digging into the fiduciary weeds, both of these questions can be answered, at least at a high level, in pretty understandable terms.
ERISA and its regulations provide that the following individuals are plan fiduciaries:
- Anyone who makes plan-related decisions (or has the ability to do so) without approval from anyone else; or,
- Anyone who provides investment advice to the plan and/or its participants and receives compensation for doing so.
Both of these leave room for interpretation, but both are generally interpreted broadly. Let’s take a look in a little more detail.
Many people think of this only in the context of investment decisions such as determining when a fund on the investment menu should be replaced. However, it extends to all types of plan-related decisions, including approving a participant distribution request, deciding to postpone depositing employee 401(k) deferrals, and just about anything in between.
And an individual does not have to be granted specific authority to make decisions. The CFO of the company might be the person with the stated authority to decide when deferrals get deposited. As long as the payroll clerk (who doesn’t have any decision-making authority) follows the instruction of the CFO, the CFO is a plan fiduciary while the clerk is not. However, if the clerk takes it upon him or herself to postpone a deposit, the clerk becomes a fiduciary with respect to that decision even though he or she didn’t have the authority to make the decision in the first place.
The reverse is also true. Let’s assume that the CFO does not utilize his or her authority to come up with a process to ensure timely deposit of 401(k) deferrals, assuming that the payroll clerk will take care of it. Because the CFO has the authority, he or she is still a fiduciary even though s/he does not actually exercise that authority.
Being a plan fiduciary is kind of like being a parent. Either you are one or you aren’t. If you are a parent, you do not cease to be just because someone else you work with also happens to be a parent. Similarly, if the payroll clerk in the above example becomes a de facto fiduciary by virtue of the decision to delay a 401(k) deposit, that does not mean the CFO is no longer a fiduciary.
On the surface, this one is also pretty obvious. If a person provides investment advice either at the plan level (e.g. helping create the investment menu) or at the participant level (e.g. helping individual participants decide how to allocate their investments) and gets paid for it, that person is a fiduciary. And, payment need not be in cash. If the advisor receives anything of value in exchange for the advice, that is enough to trigger fiduciary status.
From there, we delve in to what exactly constitutes investment advice. For example, generically explaining general investment concepts such as the merits of having a well-diversified portfolio or the disadvantages of making impulsive investment changes based on a 30-second news report is not advice; it is education. It typically requires some sort of recommendation customized to the plan’s or participant’s individual situation for the communication to cross the line into advice. But, as you might imagine, there is quite a bit of gray area there.
Another ambiguous area relates to recommendations regarding plan rollovers. Simply explaining to a participant what his or her options are on termination of employment and the mechanics of a rollover vs. a cash distribution is typically non-fiduciary education. However, suggesting that a particular participant would be better off by rolling over to a particular IRA custodian is usually considered advice. If the person giving that advice will receive payment (fee or commission from the IRA), he or she is a fiduciary.
Plan fiduciaries have certain responsibilities and are held to a heightened standard of care. That is true regardless of whether a person realizes he or she is a fiduciary or not.
Another reason it is important is a concept known as co-fiduciary liability. In a nutshell, it means that each fiduciary is responsible for the acts (good or bad) or the failures to act of other fiduciaries to the same plan. That liability is said to be “joint and several” which is just a fancy way of saying that all fiduciaries of a given plan are 100% liable for any damages to the plan regardless of how involved they are in the event that caused the damages. The objective of that rule is for all plan fiduciaries to hold each other accountable rather than adopting the “it’s not my job” attitude toward some aspect of plan management.
There is also the fact that a person’s fiduciary status dictates how things unfold in the event of a dispute or litigation. Fiduciary litigation takes place in federal court and is primarily focused on making the plan whole for any losses. Litigation involving non-fiduciaries, on the other hand, takes place in state court and can include damage awards to parties other than the plan, such as the plan sponsor.
All of those concepts make it pretty important to know who the fiduciaries are.
Now that we’ve covered the “who,” let’s turn our attention to the “what.” We will see a similar pattern – things look pretty clear-cut on the surface but can get a little more ambiguous depending on specific facts and circumstances.
For starters, guidance from the Department of Labor lists the following responsibilities that apply to plan fiduciaries:
- Act solely in the interest of plan participants and their beneficiaries with the exclusive purpose of providing benefits to them
- Carry out duties prudently as someone who is an expert in the field would
- Follow the plan documents exactly as written (unless inconsistent with ERISA)
- Diversify plan investments
- Pay only reasonable expenses
In practical terms, one of the chief responsibilities of a plan sponsor in its capacity as a plan fiduciary is to prudently select the plan’s service providers – the third party administrator (TPA), recordkeeper, investment advisor, etc. When it comes to this job, the first and last bullet points (above) really come into play.
Let’s start with the last bullet point – paying only reasonable expenses. Over time, many in this industry have come to the mistaken belief that “reasonable” equals “cheap.” The reality is that reasonableness is more a question of value that which number on a spreadsheet is more or less than another.
For example when selecting a TPA, one TPA might charge a really low fee, but they provide only stripped-down services that push back on the plan sponsor to determine who the highly compensated employees are and basically upload the pre-screened census into the TPA’s system. The TPA then simply pushes a few buttons and their system prints a series of reports that rearrange what the sponsor uploaded. A second TPA collects raw payroll data from the plan sponsor, reviews it to determine who is eligible for the plan, identifies HCEs and then runs the various tests using the allowable methods to find the one that yields the best results. This TPA is likely more expensive than the first one but provides much more comprehensive services.
Similarly, one recordkeeper may note in a proposal that its services are free when what they mean is that they get paid by revenue sharing generated by the underlying investment options rather than invoicing the plan sponsor. In those situations, the revenue sharing used to pay the recordkeeper fees actually reduces the investment returns that the plan participants receive. Connecting the dots, what is really happening with that “free 401(k) plan” is that the participants are paying the fees in a way that is hard to see. In order to gauge whether a particular recordkeeper is a reasonable choice with respect to fees, it is critical to understand all source of compensation that recordkeeper receives – revenue sharing, direct billed fees, amounts deducted from participant accounts, etc. Once that is determined, it is back to reviewing the value the plan receives in exchange for the fees paid.
Selecting an investment advisor for the plan has its own unique considerations in addition to those described above. It is pretty common to hear people throw around the terms 3(21) and 3(38) in conjunction with investment advisors. Both refer to sections of ERISA. In short, a 3(21) advisor makes investment recommendations that the plan sponsor must approve, while a 3(38) investment manager makes the investment decisions and implements them without requiring separate sponsor approval.
3(21) AdvisorAn advisor who makes recommendations that the plan sponsor must approve.
- 3(38) Advisor An investment manager who makes investment decisions and implements them without requiring separate sponsor approval.
Neither option is better or worse, they are just different, and each plan sponsor should understand which version they are getting for the fees being paid. It is important to keep in mind that both types of advisors are required to act as prudent experts, not just with respect to investments in general, but with respect to investments in an employer-sponsored retirement plan.
Plan fiduciaries must discharge their duties solely in the best interest of participants. That means there cannot be any conflicts of interest, and a fiduciary cannot derive any personal benefit from his or her dealings with the plan. That is true even if the decision being contemplated is otherwise a prudent one and also applies to any person in which the fiduciary has an interest (typically family members).
Maybe a business owner is looking to hire a new investment advisor for her company’s 401(k) plan, and it just so happens that her father is in that line of work. Assuming the father is qualified to do the work, it may be fine to hire him for the plan but he could not collect any compensation for doing so. The reason is that a fiduciary is generally considered to “have an interest” in his or her family members, and making a plan decision that results in a financial benefit to a family member calls into question the motivation for the hiring decision.
We’ve seen several other variations on the theme. One involves a prospective investment advisor promising free individual financial planning services for the business owner if selected to advise for the plan. Another can come into play when a plan is considering its bank or an affiliate to act as plan recordkeeper. If that financial institution were to offer a discounted interest rate on the company line of credit in exchange for being awarded the recordkeeping business, it would be a prohibited transaction. Even though that institution might otherwise be a prudent selection, the fact that the company would derive a financial benefit from the choice makes it problematic. And the fact that the institution would even make such an offer probably calls into question whether they have the necessary expertise to begin with.
Taking it outside the context of selecting service providers, consider a situation when an employee is suspected of stealing money from the company. The employee is fired and asks for a distribution of his or her plan account. If the plan sponsor (in its role as a fiduciary) was to delay or stop the distribution request from being processed, it would most likely be a fiduciary problem. Why? Because the sponsor would be acting in the interest of the company rather than for the exclusive purpose and in the best interest of plan participants. It would be a different discussion if the suspected theft was from the plan itself, but if it is from the company, it should have no bearing on plan decisions.
The rules do not require anyone to have a crystal ball to predict the future. Rather, the key to success in making fiduciary decisions is to always follow a prudent process to review and understand the options, weigh the pros and cons against any applicable benchmarks, and make the decision that is truly in the best interest of the plan as a whole and not just any single participant.
When it comes to selecting a plan service provider, plan sponsors should go through a due diligence process to review and benchmark the services and fees being proposed. They can lean on many experts in the industry to help guide the process, as well as using tools such as our TPA Due Diligence Checklist.
Historically, plan sponsors in the small and middle marketplace have relied on investment advisors to take the lead in selecting other service providers. The advisor screens candidates based on their industry knowledge and relationships (and sometimes biases). The best advisors focus first on services offered to ensure a client’s needs will be met, while others look primarily or solely on out-of-pocket fees. It might save a few dollars in the near term, but often leads to problems down the road when the service is not there and/or mistakes are made.
The buzzword currently on everyone’s lips is cyber security. It may be quite the trend at the moment, but that does not mean it isn’t an important part of the due diligence process. After all, lax data security protocols could lead to participant identity theft, fraudulent payouts of plan assets, or worse.
You may be surprised at the number of fraud cases in the retirement plan world. Security measures such as multi-factor authentication for participant logins were once considered a nuisance or going overboard. They are now widely considered baseline security requirements. When doing your due diligence, look for companies that had the foresight to protect their clients’ data by implementing security measures like this before it become an industry standard.
If a plan sponsor asks the right questions of prospective service providers and follows a due diligence process, it is well on its way to carrying out their duties prudently.
Speaking of the due diligence process...
Make sure you're asking the right questions of your potential service providers. Our TPA Due Diligence Guide not only outlines key questions, but also provides our answers. We call it the "DWC Approach" and offer it up as a reference to how a top-tier TPA operates. Download it today!