Best Practices for 401(k) Plan Sponsors and Fiduciaries [CPA Journal, The]

Revealing the Impaci of Recent ERISA Litigation

The Sarbanes-Oxley Act of 2002 (SOX) requires public companies to certify to the establishment and adequacy of disclosure controls related to 401 (k) plans; this has heightened fiduciary concerns for 401 (k) plan sponsors, such as chief financial officers (CFO), chief executive officers (CEO), and other responsible plan fiduciaries (SOX, 29 USC section 1109). SOX also applies to private companies, with respect to an officer's representation of a retirement plan to the plan's auditors because it adds new white collar criminal penalty provisions mat impose sanctions on plan sponsors and plan fiduciaries for willful violations of the Employee Retirement Income Security Act of 1974 (ERISA), including a false representation that a 401(k) plan is operated in accordance with plan document terms, qualification requirements, and applicable law. (See GT Alert, Greenberg Traurig LLP, "Today's Retirement Plan Environment Leaves Much for Concern," by Jeffrey D. Mamorsky, February 2004.)

Most 401(k) plan sponsors are unable to make such representations about actual plan operation and compliance, yet they routinely sign management representation letters. These representations appear as a footnote in every plan's financial statement, but they are likely to be inaccurate in the absence of internal control procedures mat enable plan sponsors to identify inconsistencies between actual plan operation and plan documentation.

Moreover, 401(k) plan sponsors should consider the recent wave of ERISA litigation, alleging breach of ERISA fiduciary duty for inappropriate 401(k) investment options, misrepresentation of the risks of investing in employer securities, permission of excessive fees and expenses, and failure to administer plans in accordance with their terms (Haddock v. Nationwide Financial Services, Inc., D. Conn. 2006; Ruppert v. Principal Life Insurance Company, S.D. HI.; Spano v. Boeing Co., S.D. 111.; Taylor v. United Technologies Corp., D. Conn; Will v. General Dynamics Corp., S.D. HI.; Renfro v. Unisys Corp., CD. Cal.). There is an increased government enforcement effort against 401(k) plan sponsors and fiduciaries, targeting fiduciary negligence and ERISA violations ("Labor Dept Ramps Up 401(k) Plan Provider Exams," Reuters, April 25, 2012; "401(k) Fiduciary News," March 26, 2012).

Consequently, more claims will be made against 401 (k) plan sponsors and fiduciaries who previously considered themselves immune because they offer a broad selection of investment alternatives. Plan sponsor fiduciaries must practice prudence, and they must remain aware of developments in this area in order to insulate themselves from an intense regulatory focus and a new wave of ERISA lawsuits.

Plan Fiduciary Due Diligence

It is critical for 401(k) plan fiduciaries to uncover embedded fees, conflicts of interest, service ^capabilities, and contract limitations inherent in the retirement plan solutions mat are offered by nonfiduciary service providers. Plan sponsors and other plan fiduciaries cannot rely upon these providers to accept responsibility for their service model and investment fund recommendations; such providers might be compromised by plan revenues, which can adversely affect their investment and administration advice to plan sponsors and other fiduciaries.

Accordingly, plan sponsors need to become increasingly skeptical of nonfiduciary service providers that manage plan assets and plan administration; these providers are not bound by ERISA's exclusive-benefit rule or duties of loyalty and prudence. Plan sponsors do not always realize that they are ultimately responsible for plan management; moreover, 401 (k) plan fiduciaries do not always realize when they are engaging in conflicts of interest ("DoL Slaps a $5.2 Billion Plan, Mandates an Independent Fiduciary," The 401kWire, July 6, 2012). Thus, financial advisors should educate them about conflicts and should offer counsel on how to avoid such issues.

Courts have emphasized the importance of implementing and adhering to a deliberative process and focusing on the merits of employer decisions affecting plan participants (Tussey v. ABB, Inc., US. Dist Lexis 4520, W.D. Mo., March 31, 2012; Beasley v. International Paper Company, S.D. fll.; Martin v. Caterpiller, Inc., W.D. Mo.; Hecker v. Deere & Co., WD. Wis.). ERISA fee litigation cases have determined that employers must follow established processes and must act in the best interest of the plan and for the exclusive benefit of plan participants Phones Plus, Inc. v. Hartford Financial Services, D. Conn.; Abbot v. Lockheed Martin Corp., SD. LI.).

In these cases, 401(k) plan sponsors have been found to have breached their fiduciary duties to plan participants and have been assessed significant damages for failing to monitor recordkeeping costs, negotiate rebates, and prudently select and retain investment options. Many plan sponsors have relied upon nonfiduciary service providers for investment selection and fiduciary guidance in the absence of a fiduciary overlay service or discretionary vendors (Kennedy v. ABB, Inc., WD. Mo).

ERISA does not authorize suits for money damages against nonfiduciaries (Merlins v. Hewitt Assocs., 113 S. Ct 2063, 1993). Furthermore, plan participants may not recover money damages against a nonfiduciary resulting from a fiduciary's breach in reliance on a nonfiduciary who did not knowingly participate in the fiduciary' s breach of fiduciary duty (Harris Trust & Savings Bank v. Salomon Smith Barney, Inc., 530 U.S. 238, 120 S. Ct. 2180, 2000). Plan sponsors relying upon nonfiduciary service providers might find themselves defending participant lawsuits that allege violations of ERISA plan documents, and investment policy (Tussey v. ABB, Inc., U.S. Dist. Lexis 4520, WD. Mo., March 31, 2012).

Best Practices

Recently, there has been an intense government focus on fee transparency and conflicts of interest, resulting in new laws and regulations. Serving as a 401 (k) plan sponsor or fiduciary places employer representatives in a precarious position because of the inherent conflict between corporate and plan fiduciary responsibility; however, the recent wave of fiduciary lawsuits has created new best practices for 401(k) plan sponsors, such as implementing and maintaining an objective strategy with predetermined procedures for removing subjectivity, and complying with the ERISA fiduciary requirement to act solely on behalf of plan participants (Tibbie v. Edison Int'l, CD. Cal, No. CV 075359 SVW [AGRx], July 8, 2010; see ERISA section 404[a][l]; 29 USC section 1104[a][l]). There is increased government focus on fee transparency and conflicts of interest, which has led to new laws and regulations. (See Form 5500, Schedule C, Instructions; DOL Regulations section 2550.4O8b-2[a].)

Plan sponsors should keep the following additional best practices in mind:

* Revenue-sharing offset. Employers must monitor and negotiate recordkeeping fees and revenue-sharing offsets, pursuant to a deliberative process, in order to ensure that sendee providers do not retain revenue sharing that exceeds the market value of plan services.

* Investment fund replacement. Employers must document their process of evaluating the competitive market for comparable investment funds. Deleting a highperformance fund or using alternative share classes in order to create more revenue sharing and offset plan fees violates investment policy statement criteria and the exclusive-benefit rule.

* Diversion of plan assets. Employers must avoid the payment of plan fees that exceed the market costs for plan services in order to subsidize corporate services, including payroll processing, welfare benefit plans, and defined benefit plan services.

* Float. This term refers to income earned on contributions and disbursements; it is treated as a plan asset and, therefore, must be allocated to 401 (k) plan participant accounts.

* Monitoring. Employers must review custody statements monthly; compare manager performance quarterly; evaluate service provider quality annually; and scrutinize service provider contract capabilities, limitations, services, and fees against the competitive marketplace triennialry, pursuant to a deliberate and documented process.

* Fee arrangement. Because fees increase over time due to market valuations and contributions, it is imprudent to pay asset-based fees for plan services, particularly plan administration, if no additional services are provided.

* Investment policy. It is imprudent to maintain an investment policy statement without applying the criteria and satisfying the objectives therein for fund replacement and revenue-sharing application. It is more advisable to refrain from adopting an investment policy statement than to adopt one and then violate it.

* Risk snaring. A service provider should not be permitted to retain revenue sharing and charge a hard dollar fee to make up for lost revenue sharing, resulting from declining plan asset values, without making certain that the total fee is reasonable.

Best Governance

Plan sponsors might have to explain - if not defend - their actions in retaining service providers if they do not conduct a full request-for-proposal process to formally test the marketplace for retirement plan services every three years (George v. Kraft Foods Global Inc., No. 10-1469, 7th Cir.). Neither ERISA's prudence requirement nor its exclusive-benefit rule support a requirement for plan fiduciaries to conduct a competitive bidding process in order to support a fee and avoid litigation ('ERISA Litigation Update, Seventh Circuit Requires 401(k) Plan Fiduciaries to Stand Trial Where They Did Not Seek an RFP for Plan Recordkeeping Services Every Three Years," Goodwin Proctor LLP, June 15, 2011).

Recent lawsuits allege that plan sponsor boards, corporate officers, and other fiduciaries breached their duties by failing to investigate plan transactions. Plan sponsor fiduciaries should establish best practice governance standards. Plan fiduciaries have discretion in the performance of their duties, enabling them to focus on plan management rather than on avoiding litigation.

Plan sponsor fiduciaries are obligated under ERISA's fiduciary responsibility rules to identify conflicts or potential conflicts and to evaluate whether those conflicts impact a 401 (k) plan and its participants. Plan sponsors are further obligated to protect the plan from any adverse effect of a conflict; for example, a plan sponsor might appoint an independent ERISA fiduciary to evaluate the proposed plan investment or proposed service provider.

Independent ERISA Named Fiduciary

Plan sponsors are advised to retain a strong, capable, and independent ERISA named fiduciary partner to provide open architecture solutions and facilitate the identification of best-in-class service models and lower-cost, best-performhig fund lineups. These independent fiduciaries would manage retirement plans on behalf of plan sponsors as a means of protecting boards of directors, corporate officers, and other plan sponsors or fiduciaries (29 USC section 1102[c][2]; H.R. Conf. Rep. No.93-1280, 93d Congress, 2d Session 255 [1974], p. 5078).

An independent ERISA fiduciary cannot be conflicted and is legally accountable to its client (that is, the plan sponsor), which is indispensable when retaining service providers, approving fee arrangements, and selecting investment funds. Plan sponsors need advice from an advisor who has subject matter expertise in order to avoid ERISA violations; negotiated settlements; monetary sanctions; and civil liability for corporate directors, officers, and managers who fail to establish internal control procedures for monitoring operational plan compliance.

ERISA is a dynamic statute that requires an advisor to have extensive fiduciary, legal, investment, regulatory, transactional, and practical experience. Most nonfiduciary service providers merely process plan information and do not monitor compliance with plan documents and legal requirements. Many plan sponsors are unaware that the Department of Labor has jurisdiction over them, and they fail to understand their fiduciary responsibihties under ERISA (Conf . Rep. 1974).

Han fiduciaries are generally prohibited from engaging in a transaction if they have an interest in the transaction mat could affect their best judgment (ERISA sections 406,407; 29 USC sections 1106,1107). Han fiduciaries must scrupulously identify, examine, and - where possible - avoid conflicts of interest and prohibited transactions. Plan fiduciaries who permit their 401(k) plans to engage in prohibited transactions are subject to both excise tax sanctions and personal liability for any losses to the plan or personal gain from the transaction.

Plan Fiduciary Legal Landscape

Recent legal decisions underscore the importance of adopting prudent operational compliance procedures and best practice governance standards. These cases are premised on claims against fiduciaries who acted on the advice of conflicted service providers. Relying upon the advice of nonfiduciary service providers is not evidence of procedural or substantive prudence, and it offers plan sponsors no exculpatory relief (Tussey v. ABB, Inc., U.S. Dist. Lexis 45240, W.D. Mo., March 31, 2012).

Thus, plan sponsors should retain independent ERISA fiduciaries - worthy of a fiduciary mandate because they have acknowledged fiduciary status in writing and have been appointed named fiduciary in plan documentation - to consistently apply fiduciary practices and make fiduciary decisions. Plan sponsors must implement a compliance strategy for managing fiduciary liability, as well as a retirement plan solution to relieve financial and human resources (HR) managers from plan administration decisions.

As the challenging economic environment prompts more lawsuits over retirement plan benefit losses, boards, CFOs, CEOs, HR managers, and other plan fiduciaries should think carefully about the retention of advisors and attorneys with ERISA subject matter expertise, who can help manage conflicts, avoid prohibited transactions, and provide legal accountability. There is a need for highly credentialed and independent ERISA professionals - compensated by plan sponsors, not by custodians or fund companies - to serve and protect plan sponsor boards, CFOs, CEOs, corporate officers, HR managers, and other plan fiduciaries.

ERISA is a dynamic statute that requires an advisor to have extensive fiduciary legal, investment regulatory transactional, and practical experience.

Sheldon M. Getter, JD, CPA, AIF, is the managing member of Stone Hill Fiduciary Management LLC, Great Neck, N.Y.