ERISA §404(a)(1)(B) re Duty to Balance Risk and Return
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)
So how might the overworked HR Director or CFO create a record that they were “prudent” when balancing the risk and return objectives of their investment decision? A prudent trustee will integrate a discipline of playing the devil’s advocate when each investment decision is being considered. They will ask their advisors and co-trustees, “What would need to go wrong to have this decision we are considering do injury to the plan participants?”
- What would need to happen for our decision to hold exclusively long-term bonds in the portfolio end up doing injury to the plan participants? Answer: Interest rates could go up, which would result in the loss of value of the long term bonds. (GIW Industries v. Trevor, et al)
- What would need to happen for our decision to hold the plan assets in real estate mortgages do injury to the plan participants? Answer: The geographic region where 80% of the mortgages are concentrated could experience economic turmoil. (Brock v. Citizens Bank of Clovis)
- What would need to happen for our decision to buy the highest performing annuity for the plan do injury to the participants? Answer: The insurance company that is producing those high returns is doing so by holding a consecrated allocation of junk bonds. (Bussian II)
A Prudent Process
Besides playing the devil’s advocate for each investment decision, a prudent trustee will also integrate the following policies as they seek to balance the risk and return characteristics of the plan assets.
- Have the trustees considered the proposed investment in the context of their duty to diversify? (H.R.Rep. No. 93-1280, 93d Cong., 2d Sess)
- Have the trustees considered the proposed investment in the context of their duty to pay only reasonable fees? (Tussey v. ABB, Inc.)
- Have the trustees considered the proposed investment in the context of the instructions in the plan document and associated governance materials? (Marshall v. Teamsters Local 282 Pension Trust Fund)
- Have the trustees considered the proposed investment in the context of the advice given by qualified experts? (Keach v. U.S. Trust Co.)
When Bad Things Happen to Good People
By answering these five questions (What could go wrong?, Is the plan diversified?, Is the fee fair?, Is this action prohibited by the plan governance documents?, and What do the experts say?), the trustees will have created the record that they have acted prudently as they have sought to balance the risk and return characteristics of the investment decision in question. If it turns out the trustees’ investment decision, despite their best efforts, ends up causing injury to the plan beneficiaries, the investment committee will have created the record that they acted with the “care, skill, prudence and diligence” that is required of them.