ERISA Fiduciary Responsibility: Fiduciary Reliance on Registered Investment Advisers

    Amy Barber, J.D.
    Director of Technical Services 
     

     

    Introduction

    Over the years, plan sponsors have come to rely more heavily on the support of retirement plan consultants (e.g. Registered Investment Advisers, broker-dealers, and recordkeepers). There are several reasons for this increased reliance. Primarily, plan sponsor fiduciaries are exposed to potential personal liability under the Employee Retirement Income Security Act of 1974 (ERISA)i. Operationally, plan sponsors have struggled to keep pace with changing regulatory requirements, such as fee disclosure and the requirement to benchmark recordkeeping and investment fees to ensure they are appropriate. Many plan sponsors simply do not have the additional time to adequately monitor retirement plan investments. Other plan sponsors desire an experienced and specialized consultant, and still others are looking for help with their employee education program. As a result, plan sponsors fiduciaries are increasingly seeking the help of a retirement plan consultant.

    Despite the ever increasing necessity of a retirement plan consultant, there are many plan sponsor fiduciaries that are unaware of the benefits of engaging in a relationship with a consultant who is a Registered Investment Adviser (RIA). Perhaps the greatest benefit of working with a RIA is that the RIA can help mitigate a plan sponsor’s fiduciary liability when providing investment advice to the plan sponsor regarding the investment products to be used in the plan. In addition to investment advice, RIAs should also be able to assist the plan sponsor in implementing best practices and developing strong governance processes that help ensure plan sponsors are meeting their other fiduciary responsibilities. This paper will briefly highlight why it is important to consider working with a RIA, and the evaluation criteria plan sponsors should use in their search for any consultant for their plan.

     
    Fiduciary Duties and Standards of Conduct

    Under ERISA, the fundamental duties of investment fiduciaries are: the duty to prudently select, monitor, remove and replace investment optionsii; the duty to provide investment options, which in the aggregate, constitute a broad range of investmentsiii; and the duty to provide investment options and related services which are suitable and appropriate for the particular needs and abilities of the employees covered by the planiv.

    Plan sponsor fiduciaries are held to high standards when managing their plan’s investment options. One court has said, and many have reiterated: “The fiduciary obligations of the trustees [and other ERISA fiduciaries] to the participants and beneficiaries of the plan are . . . the highest known to the law.”v  ERISA requires fiduciaries to perform their duties solely in the interests of participants and for the exclusive purpose of providing participants with retirement benefits.vi Fiduciaries must also manage their plan’s investments in accordance with the “prudent man rule.”vii Under this requirement, plan sponsors must use “the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”viii

    The prudent man rule requires that fiduciaries engage in a prudent process when selecting and monitoring a plan’s investments. Fiduciaries should engage in both substantive and procedural prudence - that is, they should determine what information is material and relevant to their job; they should examine and understand that information; and then they should make an informed and reasoned decision.

    Under the prudent man rule, fiduciaries must understand and apply generally accepted investment theories, such as the modern portfolio theory.ix As a result, they should understand concepts and terminology, such as asset classes and investment styles, correlation of different investments, volatility and expense ratios. It is important to note that a lack of familiarity with investments is no excuse, the prudent man rule is an objective standard, meaning trustees will be judged according to the standards of others ‘acting in a like capacity and familiar with such matters.’x 

    It is important for plan sponsors fiduciaries to determine whether their retirement plan consultant also has fiduciary responsibility for the recommendations they make. A RIA’s fiduciary obligations are two-fold. A RIA is a fiduciary to its clients by virtue of being a RIA. SEC v. Capital Gains Research Bureau is the seminal U.S. Supreme Court case which has long been cited for the proposition that advisers owe a fiduciary duty to their clients under the Investment Advisers Act of 1940xi. Additionally, a RIA will also be a fiduciary under ERISA when the RIA provides advice for a fee or other compensation to a planxii, or if appointed as a discretionary investment manager.xiii

     

    What Services Are Being Received for the Fee Charged?

    Plan sponsor fiduciaries are required to understand the value that is being received by the plan for the fees paid. They are not required to choose the least expensive services, but rather should ensure that they are getting value for the plan’s money.

    Approximately 75% to 90% of the expenses of a typical 401(k) plan are related to the investments (e.g., the expense ratios for the mutual funds). As a result, plan sponsor fiduciaries should be able to rely on their consultant for help in determining the reasonableness of those expenses and their impact on the investment results for the participants. Fiduciaries should expect their consultant to provide a written analysis of the fees relative to appropriate fee benchmarks. Plan sponsors should also be aware that the fees charged will vary, depending on the size of the plan. An issue often arises where a plan’s assets increase in value over time.  Plan sponsors are often unaware that the costs and available services are related to the size of the plan. As a result, they should be able to get additional services or reduced fees (or both) as the plan grows. A qualified consultant can educate the plan sponsor on the services and expenses that are appropriate for a plan of a given size and can advise the plan sponsor on opportunities as the plan grows.

    It is imperative that plan sponsors determine whether the consultant assisting them with this analysis is a fiduciary, and whether the consultant is independent of the products and vendors to the plan, in order to help ensure that the advice being provided is unbiased and conflict free.

     

    Use of Experts

    While ERISA fiduciaries are held to the standard of a hypothetical knowledgeable investor, the law “does not impose a rule that plan sponsor fiduciaries be ‘experts’ on all types of investments they make.”xiv The U.S. Department of Labor (DOL), as well as a number of courts, have taken the position that if the fiduciaries are not qualified to fulfill their duties, they are required to seek help. “However, if a fiduciary lacks the education, experience, or skills to be able to conduct a reasonable, independent investigation and evaluation of the risks and other characteristics of the proposed investment, it must seek independent advice.”xv Additionally, the DOL stated, “Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert.”xvi

    In order to obtain the greatest protection, plan sponsor fiduciaries should obtain written acknowledgment that their consultant is acting as a fiduciary, and plan sponsors fiduciaries should regularly receive and understand reports concerning the selection and monitoring of investments. As one case reported, “Moreover, [the adviser/broker] did not provide the subcommittee members with written material upon which they could base a meaningful decision with respect to his choices.”xvii

    It is just as important for plan sponsors to know whether they are truly getting advice regarding the investments in the plan in which they can reasonably rely, or whether a consultant only provides transactional services without providing fiduciary advice services. A RIA will generally provide either discretionary investment management services, or non-discretionary advisory services. In either case, the RIA will be a fiduciary to the plan in relation to the investment advice it provides. Contrast that to a non-discretionary broker-dealerxviii, who will generally not provide “advice” to the level in which they are exposed to liability as a fiduciary. Under this scenario, there is likely no “advice” in which the plan sponsor can “reasonably rely.” 

    It is imperative for plan sponsor fiduciaries to have a written agreement with all service providers describing whether the service provider is a fiduciary, the services to be provided, and the fees to be paid. It is also just as important to actually read the contract, as non-fiduciary consultants often disclose that they only follow the instructions of the plan sponsor, and specifically hold out that they are not a fiduciary. Unless the consultant explicitly agrees to provide fiduciary investment advice - the burden generally falls on the plan sponsor to prove otherwise (for example, in an expensive litigation). 

    Other criteria plan sponsor fiduciaries should consider when selecting a source for investment advice are:

     

    Is the consultant independent?

    Courts have emphasized the importance of the independence of the consultant. The court in Gregg v. Transportation Workers of America International stated “One extremely important factor is whether the expert advisor truly offers independent and impartial advice.”xix Later in the same case, the court said “Fiduciaries need not become experts in employee benefits, and may rely on independent expert advice. . . .”xx

    Based on these court decisions, plan sponsor fiduciaries are generally entitled to place greater reliance on the advice of independent investment advisers whose compensation is not affected by the advice given. In fact, unless there is an applicable “prohibited transaction exemption,” ERISA section 406(b) specifically prohibits a fiduciary from giving investment advice where that fiduciary will receive compensation as a result of the acceptance of the advice by the plan fiduciaries. 

    How is the consultant being paid for its services?

    The first step is for plan sponsor fiduciaries to obtain complete information about all payments, direct or indirect, being made to a consultant in relation to the services the consultant is providing to the plan, whether by the plan or a third party (e.g., the mutual fund complex, and insurance company or a broker-dealer.  Plan sponsor fiduciaries should make sure that a prohibited transaction does not occur as a result of the manner in which the consultant is paid.  Plan sponsor fiduciaries also have a duty to avoid prohibited transactions.xxi

    Under ERISA, the two most likely prohibited transactions are that the compensation of an investment consultant (for example, a broker or an investment adviser) is unreasonably high,xxii and that the consultant gives conflicting advice (that is, advice that results in the payment of additional, and often unknown, compensation).xxiii In order to avoid these prohibited transaction issues, the consultant should be independent (that is, not affiliated with, or compensated by, a provider) or, alternatively, the consultant should receive only a single fee based on the advice given (that is, its compensation should not vary based on the funds recommended by the adviser). 

    Does the consultant provide full disclosure, including expenses, for all funds? 

    Fiduciaries are required to know all expenses that are being paid by the plan (directly or indirectly) and to determine if they are reasonable (that is, if the plan and its participants receive value commensurate to the cost).xxiv In explaining this requirement, the DOL has said, “employers must . . . ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided. . . .”xxv

    Unfortunately, some consultants do not explicitly disclose all of the investment expenses; including their compensation and the compensation of brokers that may be assigned to the plan. Some vendors only provide disclosure on the recordkeeping fees but not the commissions paid out through insurance wrappers. As a result, those consultants place the plan sponsors in jeopardy of breaching their fiduciary duties. To ensure compliance, plan sponsor fiduciaries should insist on written full disclosure of all compensation and other payments, direct or indirect, related to the investments being recommended.

    Is the consultant qualified?

    Plan sponsor fiduciaries are required to prudently select and monitor consultants. “Failure to utilize due care in selecting and monitoring a fund’s service providers constitutes a breach of the trustees’ [i.e., the appointing fiduciary] fiduciary duty.”xxvi

    Fiduciaries should consider whether the consultant has the investment credentials, experience and expertise to warrant being considered an expert. That is, are the fiduciaries justified in relying on the expertise of the consultant based on the nature and extent of the consultant’s education and experience? Also, does the consultant have the resources (e.g., databases, computer software and staffing) to properly perform his job and to warrant reliance by the fiduciaries?  “At the very least, trustees have an obligation to (i) determine the needs of a fund’s participants, (ii) review the services provided and fees charged by a number of different providers and (iii) select the provider whose service level, quality and fees best matches the fund’s needs and financial situation.”xxvii 

    Does the consultant provide quality services that are tailored to your plan?

    Plan sponsor fiduciaries are required to determine whether the investments are suitable and appropriate for the needs of the plan and its participants.xxviii In performing that task, the plan sponsor fiduciaries and their consultant should consider the investment abilities of the participants and the needs of the plan relative to those abilities. Depending on the participants’ investment abilities, the plan’s investments and services may vary. For example, if the average participant lacks basic investment skills, the plan may need to offer a limited lineup of funds, target date funds, robust investment education or even investment advice. In making those decisions, plan sponsor fiduciaries should ensure that their consultant takes into account the investment abilities of the participants and gives proper consideration to the issues and possible solutions.

     

    Conclusion

    Whether a plan sponsor is trying to minimize costs, monitor investments or improve administrative efficiencies, all plan sponsors fiduciaries must first understand their legal fiduciary responsibility under ERISA. If you are a plan fiduciary and you don’t believe you are able to meet your fiduciary responsibilities under the prudent man rule with your current resources, you should consider working with a RIA. Working with an RIA can help mitigate your fiduciary responsibilities regarding the investment options in the plan, as well as providing assistance in implementing best practices and strong governance processes. 

    Lastly, if you are contemplating hiring any consultant for the first time, consider their independence. Make sure they are clear about their fiduciary duties and how they are compensated. Importantly, ensure they are qualified and able to provide you with full disclosure and analysis of all plan fees.

     

     

    Information herein is provided for general informational purposes and not intended to be completely comprehensive regarding the particular subject matter. Multnomah Group does not represent, guarantee, or provide any warranties (express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Receipt of information does not create an adviser-client relationship between Multnomah Group and you. Neither Multnomah Group nor our advisory affiliates provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation.

    Footnotes

    i 29 U.S.C. §1109

    ii ERISA § 404(a)(1)(B). See, e.g., the Department of Labor’s Preamble to the Final 404(c) Regulation, 57 FR 46906, 46922 (1992) (“The Department emphasizes, however, that the act of designating investment alternatives (including look-through investment vehicles and investment managers) in an ERISA section 404(c) plan is a fiduciary function to which the limitation on liability provided by section 404(c) is not applicable. All of the fiduciary provisions of ERISA remain applicable to both the initial designation of investment alternatives and investment managers and the ongoing determination that such alternatives and managers remain suitable and prudent investment alternatives for the plan. Therefore, the particular plan fiduciaries responsible for performing these functions must do so in accordance with ERISA.”) 

    iii ERISA § 404(a)(1)(C). See also, the Department of Labor’s Preamble to the Final 404(c) Regulation, 57 FR 46906, 46918-46922 (1992), which discusses the “broad range” requirement for 404(c) protection for fiduciaries. While the 404(c) fiduciary rules do not require compliance with 404(c), the logic of requiring a broad range of investment options in participant-directed plans applies equally to both sections.

    iv See, e.g., the Department of Labor’s Preamble to the Final 404(c) Regulation, 57 FR 46906, 46922 (1992) (the investment alternatives must be “suitable and prudent investment alternatives for the plan”). 

    v Donovan v. Bierwirth, 680 F.2d 263, 272 n.8 (citing Restatement (Second) of Trusts §2, cmt. b (1959)).

    vi ERISA § 404(a)(1)(A)(i).

    vii ERISA § 404(a)(1)(B).

    viii ERISA section 404(a)(1)(B).

    ix See, e.g., Laborers Nat’l. Pension Fund v. Trust Quantitative Advisors, Inc., 173 F.3d 313 (5th Cir. 1999).

    x Section 404(a)(1)(B) of ERISA

    xiSection 206 of the Investment Advisers Act of 1940 applies by its terms to all persons within the scope of the definition of “investment adviser” under the Advisers Act, including SEC-registered, state-registered and unregistered advisers. 

    xii ERISA §3(21)(A)(ii) 

    xiii ERISA §3(38)

    xiv Harley v. Minnesota Mining and Manufacturing Company, 42 F.Supp. 2d 898, 907 (D. Minn. 1999).

    xv Id at 907.

    xvi DOL Reg. § 2509.95-1(c)(6).

    xvii Liss v. Smith, 991 F.Supp. 278, 299 (S.D.N.Y. 1998).

    xviii The SEC has noted that an adviser’s fiduciary duties do not turn on whether the advice given is discretionary or non-discretionary. Brokers handling nondiscretionary accounts are generally thought to owe much more limited duties to the customer. See Lorna A. Schnase “An Investmnet Adviser’s Fiduciary Duty” updated through September 21, 2013, citing James Hamilton, J.D., LL.M, “SEC Regulation of Investment Advisers and Brokers in the Brave New World,” Practical Compliance & Risk Management for the Securities Industry (May-June 2008) (Brave New World). Citing also Investor and Industry Perspectives on Investment Advisers and Broker-Dealers, Rand Institute for Social Justice (the so-called “Rand Report”) (2008) discussing investor beliefs about whether advisers and other financial professionals were required to act in their best interest or were required to act as fiduciaries.

    xix 343 F.3d 833, 841 (6th Cir. 2003).

    xx Id at 843.

    xxi ERISA § 406.

    xxii ERISA §§ 406(A)(1)(C) and 408(b)(2).

    xxiiiERISA § 406(b).

    xxiv ERISA §§ 404(a)(1)(A)(ii), 406(a)(1)(C) and 408(b)(2).

    xxv A Look at 401(k) Plan Fees, U.S. Department of Labor, Employee Benefits Security Administration.

    xxvi Liss supra, at 300.

    xxvii Id.

    xxviii Whitfield v. Tomasso, 682 F.Supp. 1287, 1304. (E.D.N.Y. 1988).