Knowledge. Shared Blog

October 2019

Know the Rules: How Plan Sponsors Can Work to Prevent Fiduciary Failures

In our latest Plan Talk podcast, Retirement Director Ben Rizzuto explains why it’s critical for plan sponsors to have a deliberate and documented process in place – and a clear understanding of ERISA rules – to help avoid unintentional fiduciary breaches.

Tune in to our Retirement Series: Plan Talk for conversations that motivate, inspire and improve your everyday.

Key Takeaways

  • In this podcast, we look at several key lawsuits involving plan sponsor fiduciary breaches to identify common themes.
  • The breaches identified in these cases include excessive recordkeeping costs, failure to follow a plan’s investment policy statement and prohibiting transfers out of company stock, among others.
  • Through a detailed analysis of each case, Ben Rizzuto offers important insights to help plan sponsors avoid common “Fiduciary Failures.”
View Transcript Expand

Ben Rizzuto: Welcome to Plan Talk from Janus Henderson Investors. I’m Ben Rizzuto.

If you go back to 2000, you will see that over 200 fiduciary breach lawsuits have been filed against companies within the Fortune 1000, the Fortune Global 500 and the Forbes list of America’s Largest Private Companies, and this has led to over $6 billion in settlements.

Obviously, there has been no shortage of these types of cases, but right now we have three cases in particular that are quite noteworthy since they will be heard by the Supreme Court during this term. Based on what happens, this could lead to some major effects in our industry.

Those cases are the Thole v. U.S. Bank, Sulyma v. Intel, and Jander v. IBM.

Briefly, the Thole v. U.S. Bank case concerns if a participant in a defined benefit pension plan may bring suit to restore plan losses under Section 502(a)(2) of ERISA or seek injunctive relief under Section 502(a)(3) of ERISA without alleging individual harm.

The Intel v. Sulyma case gets into the idea of actual knowledge, in that a plaintiff must have “actual knowledge” – rather than constructive knowledge – of a breach for the clock to start on the three-year statute of limitations.

Finally, IBM v. Jander could impact “stock-drop” cases and the relatively high standard that the Fifth Third Bancorp v. Dudenhoeffer decision put into place for participants who sue plan sponsors for continuing to offer company stock as an investment option after it has dropped in value.

With those cases on the docket, I wanted to review some other cases – cases that we highlight in our Fiduciary Failures program.

I’ll start the way I start most conversations around this subject: with a story about golf.

Now, I don’t play golf. In fact, I don’t particularly like golf. But even though that is the case, I have found that it can teach us some valuable lessons concerning plan sponsors’ fiduciary responsibility. Now golf, like ERISA, has some obscure rules within it, so let’s look at two of those golf rules: Rule 13.3 and Rule 12.2.

Rule 13.3 reads that a player is entitled to place his feet firmly in taking his stance, but he or she must not build a stance. Not knowing this rule actually affected Craig Stadler way back in 1987 at the Andy Williams Open. You see, Craig had a particularly difficult shot that he had to take from his knees, so he put a towel down on the grass to avoid getting his pants dirty, which seems like a good thing to do. But, in doing so, he built a stance and did not put the penalty down on his scorecard, and this led to his disqualification.

The second rule is rule 12-2. Now, this deals with golf ball identification. Let’s say you go to an event and your hosts give each attendee a free sleeve of golf balls. Immediately after the event, you and a friend go out to the first tee, you tee off using those golf balls you just received, and unfortunately both golf balls end up in the same bunker. You walk up, and you find that not only are they in the same bunker, but they actually sit right next to each other. Now remember, since these are the golf balls you just received, you find that they are the same brand, model and the same number, you can’t discern whose golf ball is whose. Based on this rule, both balls are considered lost. Each of you is penalized a stroke and you’re forced to go back and tee off again.

So, what does this have to do with 401(k) plans and fiduciary failures? Well, I think it highlights how important knowing the rules is and how important having a process in place is. If you think about it, if Craig Stadler would have known [the rule], he would have probably gotten his pants dirty. And if you would have made sure you had the appropriate pre-tee-off process, which included marking your golf ball, well, you wouldn’t have been penalized.

The same goes for the lawsuits we look at in this program. These lawsuits occurred because people didn’t know the rules and didn’t have a process in place. And because of this, they were penalized.

The lawsuits we discuss include:

  • Beesley v. International Paper
  • Spano v. Boeing
  • Abbott v. Lockheed Martin
  • Tussey v. ABB
  • Bell v. Anthem
  • Tibble v. Edison
  • White v. Chevron

As well as those, we also look at several 403(b) cases, which include:

  • Divane v. Northwestern
  • Sacerdote v. New York University

What’s interesting and quite important for plan sponsors is that if you were to sift through all those legal briefs, you would find a number of similarities among those cases. Not only between cases on the 401(k) side of things but between 401(k) and 403(b) cases.

So, what are those common themes? What were the common alleged fiduciary breaches?

Well, they include: Excessive recordkeeping costs, using “retail” or expensive share classes, failure to follow a plan’s investment policy statement, alleged improper investments, using plan assets to benefit the company, prohibiting transfers out of company stock and delayed deposits of participant salary deferrals.

The point is that we see a number of issues. All of them are important, and all of them are issues that plan sponsors and plan advisors need to be aware of. In thinking about those common themes, it’s important to review what the DOL, ERISA and the courts have said so that we can appropriately navigate around these issues. So today I’d like to give you an overview of the ideas and lessons that came from these cases and are within these Fiduciary Failures program, as well as provide some updates that plan sponsors and advisors should be aware of.

1. Excessive Recordkeeping Fees

First, let’s start with the idea of excessive recordkeeping costs. In many cases, these costs are paid through revenue sharing. Technically, this revenue is embedded in the operating expense of a mutual fund and, technically, it’s the fund company [that] sends that compensation to the record-keeper, but it’s really the participant at the end of the day that chooses that particular fund that is incurring that internal operating expense and thus paying for recordkeeping.

The first lesson learned from these cases is that the courts have said quite emphatically there is nothing wrong with revenue sharing.

The problem, however, in many lawsuits and where companies got into trouble is that they didn’t understand the amounts of revenue sharing that were going across the different service providers, nor did they have a true understanding of how their plan fees compared to similarly sized plans.

For example, in the ABB case it was found that the company did not understand how much they were paying services providers, never did a benchmarking exercise and never attempted to negotiate lower fees. The court found by comparing the ABB plan to other plans that the fees were excessive given the size of the plan and given what other similarly sized plans were paying.

So, all in all, there is nothing wrong with revenue sharing as a mechanism to compensate the record-keeper. But the key takeaway is that the plan needs to understand the revenue-sharing arrangements, who is being compensated, how much are they being compensated and whether or not the compensation is reasonable for the services that are being rendered.

So what can plan sponsors do to make sure they protect themselves from this?

First, they need to understand and document how much is being paid, the parties that are being paid and the services that they are providing. Second, they should go through a benchmarking exercise to determine how plan fees compare to those of similarly sized plans or other plans within the same industry. Finally, going through an RFI or RFP every three to five years is a way to get an idea of market rates and possibly negotiate lower fees.

2. Using Retail or Expensive Share Classes

From there, it’s important to move on to our next issue. We’ll discuss the idea of investment costs, specifically, the idea of using retail or “expensive” share classes. Now, the reason that there are so many share classes out there is because they offer different amounts of revenue sharing, so they’re useful based on the economics of a plan.

It’s common for a plan sponsor to want to allocate the costs to participants and pick a share class where there is enough revenue sharing built in to offset the recordkeeping costs dollar for dollar.

The lesson from these cases is that the courts have said that there’s absolutely no requirement that companies use the least expensive share class. However, like revenue sharing, they need to have a deliberate and documented process for why it is that they chose the share class they did.

We have seen numerous cases in this area.

For example, in the Tibble v. Edison case, the court did in fact determine that the company breached its fiduciary duty because the selection process did not switch to lower-fee institutional share classes once they became available. But the thing to note is that the court did not rule that retail funds were imprudent, it only said that based on the size of the plan and other details specific to this company and its plan that this change should have been made. What it highlights is that plan sponsors need to be proactive in their knowledge about what share classes are available and that share class choices will depend on the individual facts and circumstances surrounding your plan.

On the other hand, we’ve seen cases like Hecker v. Deere and Patterson v. the Capital Group, which were both dismissed, and both offer clear guidance on the idea of lowest-cost funds.

In Hecker v. Deere, the court noted that “Nothing in ERISA requires a fiduciary to scour the market to find and offer the cheapest possible fund” (which might, of course, be plagued with other problems). And in Patterson v. The Capital Group case, the court reaffirmed this idea by saying, “Unquestionably, fiduciaries need not choose the cheapest funds available to the exclusion of other considerations.”

More recently – and quite interestingly – we saw a case like the Bell v. Anthem case. In that case, allegations included that plan fiduciaries selected and retained high-cost and poor-performing investments compared to available alternatives. Those high-cost investments were actually provided by Vanguard. In fact, one fund cited had an annual fee of just four basis points, but according to the complaint, an otherwise identical two-basis-point version could have been obtained by an investor with the size and sophistication of the Anthem plan. Therefore, an alleged breach occurred when Anthem continued to offer that four-basis-point version.

What’s important to note here, especially for those folks out there that say low-cost, passive funds are automatically better and are a de facto safe harbor, is that you can see that even those low-cost funds can become issues.

As far as an action plan, when it comes to fees and share classes, the first thing to remember is that ERISA does not say that you have to go out and find the least expensive option. Rather, you need to pay reasonable fees, so you need to document and rationalize what you are receiving for the fees you’re paying. Along with that, plan sponsors should review the share classes they have selected for the plan menu and also review what share classes are available to the plan through the record-keeper. Finally, if a plan sponsor has both active and passive funds in the plan lineup, it may be a good idea to consider using fee equalization through your record-keeper to make sure one participant population isn’t subsidizing the recording costs of another.

3. Failure to Follow the Plan’s Investment Policy Statement

A third issue is that of the investment policy statement. The IPS provides a road map for plan sponsors and investment committees to outline investment goals, select those investments, monitor those investments and overall implement a repeatable process and framework for the management of the plan.

Now, those seem like good ideas, and the adoption of an IPS has become a best practice, but it’s interesting to note that ERISA does not require a plan to have one.

While .4that may be the case, remember that not only does it provide the basis of a prudent fiduciary process, but it will also be one of the first things the DOL asks for should your plan be audited. So I would suggest that plans adopt an investment policy statement, but remember, once you adopt an IPS, you need to make sure you follow it

In many court cases, we have seen how plan sponsors didn’t do this. For example, in the case of ABB, their investment policy statement specifically read that when selecting a mutual fund that offers various share classes, they would select the share class that provides the lowest cost of participation. Based on that sentence alone, ABB violated their IPS in their case because they used a more expensive share class.

The lesson here is that having an investment policy statement and not following it is probably worse than not having an investment policy statement at all. Along with that, investment committees should make sure to review their IPS on an annual basis to ensure that every member understands what it entails. Finally, it’s important to review the wording used in the IPS to make sure that it isn’t too specific or that it paints an investment committee into a corner with regards to an action it may take or makes it easy to run afoul of the IPS based on decisions it makes.

4. Alleged Improper Investments

Next let’s move on to improper investments. In this area, we see a lot of debate as to what is proper versus improper. Sometimes, it’s seen sector funds be part of cases, at other times it might be that a plan sponsor offered only a money market fund versus offering a stable value fund.

For example, in the International Paper case, we saw that the company replaced its large-cap blend index fund with an actively managed fund of funds. Obviously, going from an index fund to a fund of funds structure has higher fees. That was one issue. Along with that, the new investment failed to outperform its benchmark, so this also turned up as part of the class action lawsuit. Based on the settlement, the company agreed that in addition to having an active large-cap option, they would also have a passive option. So, this shows one way how plan sponsors might remedy this type of issue by providing their participants with choice.

In other cases, companies have been required to bring in an independent fiduciary to review plan investments to see if the funds in question (for example, a science and technology fund in the Spano v. Boeing case) were appropriate for inclusion or not.

The point and the action plan here goes back to the idea of having a process in place. First, make sure you are putting each fund through the same due diligence process, and make sure that you are continually monitoring plan investments. Then, if concerns arise, make sure you document how the investment committee is taking action on the fund and the reasoning behind that action.

5. Prohibiting Transfers Out of Company Stock

We touched on the idea of company stock at the beginning, specifically with the IBM versus Jander case. But I wanted to quickly provide a little more information on this topic. Obviously, not all plans out there are those of publicly traded companies. And, of course, not all plans out there have company stock as an investment option. The main point that I want to make here is that offering company stock is perfectly fine, but from the employer’s perspective, it’s allowing participants the ability to diversify out of it that is going to be most important and going to help guard against these so-called stock-drop lawsuits.

6. Participant Salary Deferral Allegations

One final thing that I want to take a look at is salary deferrals. Now, remember, the rule of thumb is that salary deferrals need to be deposited into the retirement trust as soon as administratively feasible but no later than the 15th of the following month. In the case of ABB, it was alleged that the service provider was inappropriately using salary deferrals for their benefit. Also, in the International Paper case, there were allegations that the company was not getting those funds into the trust fast enough.

Overall, what this issue does is it serves as a helpful reminder that money – as it finds its way from payroll into the trust – is still considered an asset of the plan and ultimately assets of plan participants. So, we need to treat it with care.

Also, not only is this an issue that has come up in fiduciary breach cases, it’s notable that this is an issue that is also a high priority for the Department of Labor. So even though you might not get sued, being audited by the DOL is not something we want to occur either. So again, this serves as a great reason to work with your payroll provider to make sure money is being deposited into participant accounts in a timely and consistent manner.

So, there were six specific issues that plan sponsors need to be aware of and how they can help guard against them popping up in their retirement plan. Along with those specific issues, I also wanted to provide a more general but equally important tip – that being fiduciary training.

Now, just like there’s nothing in the regulations that says you have to have an investment policy statement, there’s nothing in the regulations or ERISA that says your investment committee needs to have fiduciary training. Now, while this may be the case, we’re finding that this is becoming a best practice. According to the Plan Sponsor Council of America, several DOL auditors have requested proof or documentation regarding whether or not the investment committee has gone through some type of formalized training. I feel that by going through this training on a continual basis, investment committees are able to continually educate themselves on trends within the industry, whether at the participant, plan design or legal levels. By doing this, not only do plan sponsors help to ensure their retirement plan evolves over time, but investment committees make sure they don’t find themselves as part of these fiduciary breach cases.

So, to finish our brief review of these well-known cases and common issues, let’s return to the golf course, where you’ll remember we started talking about a couple of the more obscure rules of golf.

In each case, the penalty that was incurred wasn’t because anyone inherently wanted to do something wrong. No, those penalties occurred because we didn’t know the rules and we didn’t have a process in place.

The same goes for the companies we cover in our Fiduciary Failures program. No one wanted to make these mistakes, but these mistakes, these cases, and the eventual fines or settlements occurred because they didn’t know the rules and they didn’t have a process.

Remember, ERISA rules apply to every company that has a retirement plan – doesn’t matter if it’s a billion-dollar plan or a million-dollar plan – and that’s another point to reinforce here. Even though a lot of these cases deal with large companies, remember that these cases are now moving downstream as more and more relatively small plans are being sued for similar issues. So, plan sponsors need to remember that these issues can occur in any size plan.

As I mentioned, a lot of the information I covered today comes from our Fiduciaries Failures program.  So, if you’d like to learn more about this program, please let me or your Janus Henderson representative know, and if you’re interested in hearing more about these types of fiduciary issues or other retirement plan trends, be sure to subscribe to the Janus Henderson Radio channel wherever you access your podcasts.

Now, one other thing I wanted to let you know about that I’m really excited about is our new Marching to a Million program. This program focuses on helping millennials get and stay on track when it comes to saving for retirement. It includes a series of podcasts, videos and educational resources that provide positive and instructive stories from real millennials that are actively engaged in the savings process.

These resources, I think, should be really helpful to get younger participants better engaged within the retirement plans we work with, so definitely check out the Marching to a Million webpage on the Janus Henderson website.

So, until next time, I’m Ben Rizzuto, and you’ve been listening to Plan Talk.

 

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