US 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 provides 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 [note]H.R.Rep. No. 93-1280, 93d Cong., 2d Sess. 304, reprinted in, 1974 U.S.C.C.A.N. 4639, 5038, 5084-85[/note]. 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.
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.
We help trustees save time, reduce risk, and fulfill their fiduciary duties. What makes us unique is that trustee governance support is all we do.