ERISA 1104(a)(1)(B) re Duty to Prudently Delegate

ERISA 1104(a)(1)(B) re Duty to Prudently Delegate

A trustee has a duty to prudently invest the plan assets on behalf of the beneficiaries. However, few trustees actually take on this complex responsibility alone. In most cases the trustee will hire a third party and delegate these investment duties.

When investment advisory functions are delegated a trustee is responsible for: 1) prudently selecting the vendor; and 2) periodically reviewing the “particular investment or investment course of action” that has been suggested by the vendor. Merely delegating investment duties does not absolve the trustee of responsibility if the vendor invests the trust assets imprudently.

Reliance upon an investment professional’s opinion in making trust investment decisions may be justified if the trustee has taken steps to confirm several factors including: 1) the expert’s reputation and experience; 2) the extensiveness and thoroughness of the expert’s investment process; 3) whether the expert’s opinion is supported by relevant material; and 4) whether the expert’s methods and assumptions are appropriate to the decision at hand (Bussian v. RJR Nabisco Inc., F. 3d 286 – Court of Appeals, 5th Circuit 2000).

Few trustees take the modest amount of time needed to DOCUMENT that they have established a procedure to consider these four factors at the time the delegation occurs and periodically throughout the relationship. The plan’s named trustee and the investment or fiduciary committee that supports them are encouraged to create a short, simple record that demonstrates they have recognized this duty to prudently delegate and have taken steps to periodically monitor their agent’s compliance with this delegation.

Following is a link to a series of questions that can be used by the plan’s investment committee to create this record.

Anodos helps trustees (ERISA, individual, and endowment) save time, reduce their personal risk, and fulfill their fiduciary duties.  We do this by helping the trustee conduct audits of the money managers to whom investment duties have been delegated.  Fiduciaries have an affirmative duty to provide ongoing and independent oversight of the money managers.  What makes us unique is that we do not manage money or sell insurance.  Doing fiduciary audits, benchmarking studies, and performance attribution is all we do.

ERISA §1104(a)(1)(c): Duty to balance risk and return with Alternative Investments

ERISA §1104(a)(1)(c): Duty to balance risk and return with Alternative Investments

Prudence not Prescience

Trustees are required to make hard investment decisions. They are to take into consideration the risk of loss and the opportunity for gain associated with each particular investment or investment course of action. ERISA trustees are required to balance the risk and return of each investment decision under conditions of uncertainty. Because ERISA trustees do not have a crystal ball some of their investment decisions, in hindsight, are questioned by disgruntled plan participants. Fortunately, the fiduciary duty of care “requires prudence, not prescience” (DeBruyne Equitable Life Assur).

What is “Alternative”?

At times the plan’s money manager may identify so-called “Alternative” investments that they feel will contribute to a superior risk-adjusted return of the portfolio. But what is an “Alternative” investment? Is a REIT an alternative? Is a structured note an alternative? Is an MLP an alternative? For the sake of this writing we will define an “Alternative Investment” as any investment where: (1) the underlying holdings are not clearly identified or valued daily (lack of transparency); and/or (2) the investment cannot be liquidated within a 3-day settlement (lack of liquidity).

Policy re “Alternative Investments”

In those instances when an “Alternative” investment is recommended by the money manager a prudent trustee will establish a distinct series of procedures to monitor whether the risk and return outcomes expected from these more opaque products are realized. A prudent trustee will ask the money manager to provide the following documentation for the plan’s governance library:

  1. A description of the investment,
  2. The term of the investment,
  3. The timeline of capital contributions,
  4. A summary of the fees that the manager or their affiliated companies will receive by introducing us to this particular investment or strategy, and
  5. Anticipated risk/return characteristics of the investment as measured by a ratio to the S&P 500.

José M. Jara, an attorney at Fisher Broyles in New York City, wrote a fantastic article entitled ERISA fiduciary considerations when incorporating alternative investments in your pension plan’s portfolio which does an excellent job of connecting the dots between an ERISA trustee’s duties and the oversight and monitoring of Alternative Investments. A link to José‘s article follows:

Click Here for ERISA Article

 

Onward,

Josh Yager, Esq., CFP®, ChFC®
805-899-1245
jyager@anodosadvisors.com

 

Anodos helps trustees (ERISA, individual, and endowment) save time, reduce their personal risk, and fulfill their fiduciary duties.  We do this by helping the trustee conduct audits of the money managers to whom investment duties have been delegated.  Fiduciaries have an affirmative duty to provide ongoing and independent oversight of the money managers.  What makes us unique is that we do not manage money or sell insurance.  Doing fiduciary audits, benchmarking studies, and performance attribution is all we do. 

ERISA §1104(a)(1)(C) re Diversification

DiversificationUS Code §1104(a)(1)(C) states, “A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries… by diversifying the investments of the plan so as to minimize the risk of large losses…”

The court in Marshall v. Glass/Metal (D. Haw. 1980) noted, “Ordinarily the fiduciary should not invest the whole or an unduly large proportion of the trust property in one type of security or in various types of securities… since the effect is to increase the risk of large losses….”  The court went on to say that a “commitment of 23% of the Pension Plan’s total assets to a single loan subjects a disproportionate amount of the trust assets to the risk of a large loss.” However, neither the statute nor the courts provide clear guidelines on how much is too much. Surely there are circumstances where having 25% of the plan assets in a single investment (like a Treasury bill) would be considered prudent or having less than 20% of the plan assets in one investment would be considered imprudent. There just isn’t a bright-line the trustee can rely upon to know if they have or have not fulfilled their duty to prudently diversify the plan assets.

Fortunately, the court in Liss v. Smith gave us a handy dandy checklist. The court asserted, “In making the determination as to whether the diversification requirement was breached… the Court is to consider (1) the purpose of the plan, (2) the amount of plan assets, (3) financial and industrial conditions, (4) the type of investment, (5) the distribution as to geographical location, (6) the distribution as to industries, and (7) the dates of maturity.”

Where a plan has 10% or more of the plan assets concentrated in any once security the trustee is advised to create a record, using the seven factors of consideration noted in Liss v. Smith, of why their decision to hold this concentrated position is prudent. The code does not prohibit the concentration of the plan assets in any particular security. It merely obligates the plan trustees to exercise care, skill, prudence, and diligence when the trust assets are so concentrated. The admonition then is to create a record demonstrating why the trustees did what they did and when they did it. Write the memo.

And 401(k) trustees, beware. You also have this duty to diversify.  A 401(k) trustee has a duty to confirm that the investment options made available to the participants are themselves reasonably diversified. A 401(k) trustee is not responsible for the acts of a knucklehead participant who puts all of their assets in a fund option that exclusively holds commodities. However, the trustee can be held liable if that particular investment option is itself not reasonably diversified. (See Unisys I (3rd Cir. 1996) and GIW Indus. (11th Cir. 1990).)

As you can see, there is no simple rule to follow, but by documenting and implementing principles and procedures for diversification, ERISA trustees can demonstrate the fulfillment of their duties.

Following is a link to a series of important ERISA cases that every trustee should be familiar with.

Download: ERISA Case Briefs

 

Onward,

Josh Yager, Esq., CFP®, ChFC®
805-899-1245
jyager@anodosadvisors.com

 

Anodos helps trustees (ERISA, individual, and endowment) save time, reduce their personal risk, and fulfill their fiduciary duties.  We do this by helping the trustee conduct audits of the money managers to whom investment duties have been delegated.  Fiduciaries have an affirmative duty to provide ongoing and independent oversight of the money managers.  What makes us unique is that we do not manage money or sell insurance.  Doing fiduciary audits, benchmarking studies, and performance attribution is all we do. 

Johnny Depp v. TMG: What are a business manager’s duties of care?

Johnny Depp v. TMG: What are a business manager’s duties of care?

business manager's duties of care

The Question: What standard of care and what attendant duties does a business manager owe to their client?

The Answer: It depends on what roles and services the business manager fulfills for their client. A good argument can be made that the business manager owes a similar fiduciary standard of care to their clients as a trustee owes to the beneficiaries of a trust.

The Lawsuit: On January 13, 2017 Johnny Depp filed suit against his long-time business manager TMG arguing that the business manager failed to act prudently and in good faith in the administration of Mr. Depp’s assets.

The Legal Principle: The outcome of this case will likely turn on what standard of care and what specific duties the business manager owed to their client. Depp has argued that the business manager owes him a fiduciary standard of care and his actions, or inaction, should be judged against the “skill, care and diligence of other business managers, accountants and financial advisors [who deliver similar services to other] high net worth individuals under similar circumstances in similar communities” (paragraph #99 of Depp Complaint).

The Argument: Clearly, it is far too early to pass judgment on the claims or counterclaims of either party. But Mr. Depp’s complaint does provide the road map that will be used to argue that a business manager owes a fiduciary duty of care to their clients. Depp proposes three legal theories: Professional Care (paragraph #99), Fiduciary Duties of an Agent/Delegatee (paragraph #106) and finally, Fiduciary Duties of a Trustee (paragraph #113).

The Solution: A well-designed governance process, whether for really wealthy A-list entertainers or clients of more modest size, will include the following elements:

  • Clear definition of the investment objectives including (a) the projected annual contributions and distributions of the portfolio, (b) the targeted return for the portfolio net of all fees, and (c) the desired terminal value of the portfolio.
  • Documentation of the capital owner’s unique investment principles which inform the manager’s implementation strategy.
  • The availability of monthly performance data consistent with best-practice standards from which the portfolio’s actual return and risk characteristics can be calculated.
  • A written fee agreement with the investment manager that is consistent with industry norms for a portfolio of comparable size and complexity.
  • A written declaration by the investment manager acknowledging the standard of care they owe the client (fiduciary standard or suitability standard) and any conflicts of interest that may exist between the manager and client.
  • A series of blended benchmarks with comparable risk and return characteristics against which to compare the portfolio.
ERISA §1104(a)(1)(A)(ii) re Duty to Incur Reasonable Fees

ERISA §1104(a)(1)(A)(ii) re Duty to Incur Reasonable Fees

It is fundamental to a trustee’s duties to ensure that expenses incurred by the plan are fair and reasonable. However, when a plan is using one vendor to provide a bundled solution representing various services, determining whether the plan is paying “fair fees” is difficult. But just because it is hard does not mean it should not be done.

“ERISA imposes upon fiduciaries twin duties of loyalty and prudence, requiring them to act solely in the interest of [plan] participants and beneficiaries and to carry out their duties with the care, skill, prudence, and diligence under the circumstances” (Braden v. Wal-Mart Stores, Inc., 588 F.3d 585, 595 (8th Cir.2009)).

Being able to define who is being paid what by whom and whether these payments are fair and reasonable is implicit in the trustee’s duty of prudence under ERISA §404a-1 and is specifically required by the U.S. Code §1104(a)(1)(A)(ii).

A plan trustee does not have a duty to “scour the market to find the fund with the lowest imaginable fees” (Hecker v. Deere & Co., 569 F.3d 708, 711 (7th Cir.2009)). But the trustee DOES have a duty to determine whether the fees being incurred for the various services provided are reasonable and appropriate.

Some trustees erroneously believe that if the plan is a self-directed 401k, with various products with differing fees available to the participants, a fee study is not needed. The court in Tussey said this belief is misplaced. Trustees for all plans, be they self-directed 401k plans, defined contribution plans, or defined benefit plans, are bound by this same duty to incur only reasonable expenses.

At the heart of Tussey v. ABB, Inc., 746 F. 3d 327 – Court of Appeals, 8th Circuit 2014 is the argument that the “revenue sharing” fee agreement with the bundled service provider can, in some cases, unfairly compensate the vendors – in this case, Fidelity. The plaintiffs in Tussey argued that as the plan assets increased, the “revenue sharing” fees paid to Fidelity increased with no additional services being provided to the plan, which effectively resulted in more fees being paid for the same recordkeeping services. (Tussey v. ABB Inc., on remand to the district court following the 8th Circuits 2014 decision)

Fortunately, the case of Tussey gave us a roadmap for what a fiduciary should be checking. A prudent fiduciary will do the following: “(1) calculate the amount the plan was paying the vendor for services through revenue sharing, (2) determine whether the vendor’s pricing is competitive, (3) adequately leverage the plan’s size to reduce fees, and (4) make a good faith effort to prevent the subsidization of administration costs of the sponsor’s corporate services with plan assets” (Tussey v. ABB, Inc).

A prudent ERISA fiduciary will create a record that demonstrates an understanding of their duty to pay only reasonable fees and that a procedure has been adopted and executed which incorporates the four-part procedure outlined in Tussey.

Download: DOL Guidelines for ERISA Plan Trustees

Onward,

Josh Yager

Anodos helps plan trustees develop, maintain, and manage their governance processes. Our support helps trustees and plan committees save time, reduce their personal risk, and fulfill their duties of care. What makes us unique is that providing fiduciary governance support is all that we do. We don’t manage money, sell insurance, or accept revenue sharing fees. We don’t have a horse in the race.

An ERISA Trustee’s Duty of Loyalty

An ERISA Trustee’s Duty of Loyalty

It’s hard to be an ERISA trustee. Many plan trustees have other pressing corporate responsibilities and few have the time or experience to become fiduciary governance experts. But fiduciary governance need not be a complicated subject.

Good fiduciary governance, whether done for a massive $10 billion pension plan or a small 401k with a couple dozen participants, comes down to a few fairly simple processes.

At its core there are six central duties an ERISA trustee is obligated to fulfill. For each of these six duties of care a fiduciary committee will adopt a policy that addresses each of these distinct duties. Finally, the fiduciary committee will identify several procedures or audits that can be conducted each year which test whether the policies, inspired by the statutes, have been fulfilled. The duty informs the policy which informs the procedures which are tested annually to demonstrate that the policy and the duty have been fulfilled.

Case Study re Duty of Loyalty

Following is an example of how this governance process would be followed for an ERISA trustee’s duty of loyalty. The US Code directs, “A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries.”  This is called the fiduciary’s Duty of Loyalty or the Sole Interest Rule. This language is echoed in the Code of Federal Regulations at §2550.404a-1(a).

In response to this affirmative Duty of Loyalty, a Fiduciary Committee would first establish a policy that says something like, “It is the policy of the XYZ Co. Fiduciary Committee to discharge its duties with respect to a plan solely in the interest of the participants and beneficiaries.”

Next, the Fiduciary Committee would establish a series of procedures or audits to test if this particular duty is being fulfilled. A review of case law and recent writings on the Duty of Loyalty will identify several areas where further investigation is deserved:

1)   Loyalty by the Committee to the plan participants:

  • To fulfill this Duty of Loyalty, the Fiduciary Committee has requested that every member of the Fiduciary Committee submit a written declaration that they have received no other compensation or benefit from any party for services they have provided to the plan. (No gifts, no trips, no personal perks, no cash, etc.)

2)   Loyalty by vendors to the plan:

  • To fulfill this Duty of Loyalty, the Fiduciary Committee has requested that every vendor who provides services to the plan submit a written declaration that they have received no other compensation or benefit from any party other than the plan itself for services the vendor has provided to the plan.
  • Note, the DOL and the SEC are both working on new definitions and rules related to vendors and advisors who provide products and services to ERISA plans. Big changes are on the horizon.

3)   Loyalty by the plan sponsor to the plan:

  • To fulfill this Duty of Loyalty the Fiduciary Committee has engaged [CPA FIRM] to conduct a financial audit of the plan assets. The auditor made the following findings:
    • All eligible employees have the same opportunity to participate;
    • The assets of the plan are fairly valued;
    • The contributions to the plan have been made in a timely manner;
    • The accounts of the participants are fairly stated;
    • Benefit payments were made according to the terms of the plan;
    • There have been no transactions made which are prohibited under ERISA; and a copy of the auditor’s findings and recommendations have been included in the Fiduciary Committee’s compliance library.

Further, there are additional tests that demonstrate the Duty of Loyalty has been fulfilled.

  • A Policies and Procedures Manual has been adopted and followed.
  • The Fiduciary Committee has created an inventory of parties (employees and vendors) who owe fiduciary duties to the plan.
  • The members of the Fiduciary Committee have received educational training on the “two-hat rule” (USC §1002(21)(a)), which defines when an employee of the plan sponsor is and is not acting in a fiduciary capacity to the plan and its beneficiaries.

Following is a link to a eBook we developed which gives a comprehensive review of an ERISA trustee’s duties and the checklist of information that should be included in their governance records.

Always feel free to shoot me an email or give me a call if you have further questions about governance best practices for ERISA trustees.



Free Ebook: Fiduciary Governance for an ERISA Trustee or “Why Size Doesn't Matter”