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By: Jeffrey Lieberman SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP
This article identifies best practices to assist a 401(k) plan investment committee in satisfying its fiduciary obligations under the Employee Retirement Income Security Act of 1974 (29 U.S.C. § 1001, et. seq., as amended) (ERISA). The focus is primarily on steps investment committees can take to monitor plan investment options and service providers.
Plan sponsors often use an internal investment committee (the committee) to manage some or all aspects of the ERISA fiduciary responsibilities of an ERISA plan sponsor’s board of directors (the board). While the board may delegate responsibility to the plan trustee, a board more commonly delegates the duty of investment and investment service provider selection and monitoring to a committee when such delegation is not prohibited under the governing plan or trust documents.
Typically, the board’s delegation to a committee is intended to completely relinquish its ERISA fiduciary responsibilities for the selection and control of plan investments and selected service providers. Alternatively, the board may retain decision-making authority and task the committee to make recommendations to the board. The board would then decide on the ultimate selection or retention issues at hand. This alternative approach is not common, however, when the plan sponsor is a large corporation. If the board wishes, it may delegate to the same or a different committee responsibilities it retains for plan administration
When the board delegates comprehensive responsibility to a committee, it still retains some fiduciary responsibility as an appointing fiduciary. This is so regardless of whether or not the committee has been identified in governing plan or trust documents as an ERISA named fiduciary. Thus, the board should request and evaluate periodic committee reports regarding committee actions. The board may require quarterly, semi-annual, or annual reports. Annual reporting is most common
Also, to delineate the role of the committee and its responsibilities, it is helpful to prepare and have the board or committee adopt a committee charter. Charter responsibilities for an investment committee typically include:
Prudence Standard in Selecting and Monitoring Plan Investments
A committee with broad powers to select plan investment options falls within ERISA’s definition of “fiduciary” through the committee’s exercise of authority and control over the plan and plan assets. ERISA § 3(21)(A) (29 U.S.C. § 1002(21)(A)). ERISA requires that investment fiduciaries select and monitor plan investments with the care, skill, prudence, and diligence that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims (the prudence standard). ERISA § 404(a)(1) (29 U.S.C. § 1104(a)(1)); 29 C.F.R. § 2550.404a-1(a). A committee must apply the prudence standard in all of its fiduciary actions. Note that the standard is generally viewed as applying to the decision-making process and not the ultimate results of such decisions (i.e., whether the outcome was right or wrong). This concept of procedural prudence is described more fully in the Lexis Practice Advisor guidance on Fundamentals of ERISA Fiduciary Duties.
In fulfilling its duty of prudence, Department of Labor regulations enumerate standards to consider. For example, a plan fiduciary charged with investment duties must give “appropriate consideration” to its investment decisions. 29 C.F.R. § 2550.404a-1(b)(1). In applying the standard, the fiduciary should (among other items) consider:
The foregoing most clearly apply to a defined benefit plan rather than a defined contribution plan relying on ERISA Section 404(c) protections. But fiduciaries of defined contribution plans, as for defined benefit plans, should consider associated fees in choosing any investment or service provider. A committee for a defined contribution plan thus should consider:
For further discussion regarding application of the "appropriate consideration" standard, see the Department of Labor's guidance on Meeting Your Fiduciary Responsibilities, https:// www.dol.gov/ebsa/publications/fiduciaryresponsibility.html.
ERISA Section 404(c) Protections
Most 401(k) plans or employer-sponsored 403(b) annuity plans provide for participant-directed investments and seek to fall under the ERISA Section 404(c) safe harbor rules. In order to do so, the plan and its investment menu must satisfy the following conditions:
ERISA § 404(c) (29 U.S.C. § 1104(c)); 29 C.F.R. § 2550.404c-1(b).
Regardless of the fiduciaries’ intent to apply the ERISA Section 404(c) safe harbor, fiduciaries must prudently select plan investments and monitor their performance and that of accompanying plan service providers. 29 C.F.R. § 2550.404c-1(d)(2)(iv).
Overview of Investment Option Selection and Monitoring
Foremost of the investment committee’s functions is the selection of investment options from which participants and beneficiaries may choose to invest their plan contributions. The committee’s selection of the plan’s menu of investment options, including employer stock (whether or not identified in the plan document), is itself a fiduciary act and is subject to the prudence standard. Preamble to 29 C.F.R. § 2550.404c-1, 57 Fed. Reg. 46906, 46924. That standard continues to apply when the committee monitors any of its investment selections to understand whether each investment remains prudent in light of the applicable risks and overall goals of the plan. In monitoring an investment option, the committee should consider changes to the investment option, such as a change to the management team’s stated strategy, composition of the management team, fees associated with the investment, or its investment performance over a stated period of time, as well as the investment’s role in the plan’s investment goals and investment policy statement. Based on this evaluation, the committee should gather sufficient information to determine whether to retain, watch, or eliminate an investment option from the menu.
Training should be provided to investment committee members so they understand ERISA Section 404(a) and 404(c) protections and requirements, including their obligations when selecting “designated investment alternatives” under a Section 404(c) plan, and the plan’s QDIA, where applicable. Committee members are not expected to be expert on all matters related to the selection and monitoring of plan investments, but are required to exercise prudence, both in the selection of plan investments and its service providers (which may include retaining experts, like an investment adviser). ERISA § 404(a) (29 U.S.C. § 1104(a)); 29 C.F.R. § 2550.404a-5(f). In addition to reviewing plan investment options and service providers, a committee should also be reviewing service provider disclosures to the plan regarding:
See ERISA § 408(b)(2) (29 U.S.C. § 1108(b)(2)); 29 C.F.R. § 2550.408b-2; 77 Fed. Reg. 5632 (Feb. 3, 2012); 79 Fed. Reg. 13949 (Mar. 12, 2014). For an additional discussion regarding ERISA fiduciary obligations regarding service provider fee disclosures, see DOL Field Assistance Bulletin (FAB) 2012-2, which provides guidance on the participant-level fee disclosure regulations under Section 404(a)(5) of ERISA (the 404(a)(5) regulation) and the service provider fee disclosure regulations under Section 408(b)(2) of ERISA (29 U.S.C. § 1108(b)(2)) (the 408(b)(2) regulation). FAB 2012-02 (May 7, 2012).
Selection of Plan Investment Options
A committee should be able to demonstrate that it followed a prudent process in selecting, monitoring, and choosing to retain any plan investment option. Process is paramount and a committee should establish, follow, and document its process for investment selection and its ongoing review. In evaluating whether a fiduciary has acted prudently, courts often focus on the process by which the committee gathers information and makes decisions rather than focusing solely on the results of those decisions. (See, e.g., Krueger v. Ameriprise Fin., Inc., 2012 U.S. Dist. LEXIS 166191 (D. Minn. 2012)).
In this regard, when selecting a new or replacing an existing plan investment option, a plan investment committee should:
For an additional discussion regarding committee selection and monitoring of a plan’s QDIA investment option(s), see Dep’t of Labor: Target Date Retirement Funds: Tips for ERISA Plan Fiduciaries.
To offer a selection of diverse risk/rewards, a plan wishing to use the ERISA §404(c) safe harbor typically offers funds that fall into these three broad categories:
Many large plans also offer an investment brokerage window that enables participants and beneficiaries to select investments beyond those designated by the plan.
Benchmarking is a key component to monitoring existing plan investments and evaluating new ones. Although ERISA § 404(c) deems a minimum of three investments to constitute a “broad range of investment alternatives,” in practice, defined contribution plans rarely offer so few investment options. A plan may offer five or more QDIA funds alone (when relying upon the “targeted retirement date” safe harbor under 29 C.F.R. § 2550.404c-5(e)(4)(i)), in addition to offering other funds with satisfactorily diverse risk and return profiles. You will typically be looking at a plan with from seven to 15 funds and the committee will need to identify a benchmark for each. However, there is no rule limiting alternatives to any particular number
Ideally, in determining a proper benchmark the committee should seek to identify an index with attributes similar to the asset in question. Most mutual fund materials identify the benchmarking index used by that fund as is required for participant disclosures under 29 C.F.R. § 2550.404(a)-5. An investment consultant can also help the committee with this task. Typical benchmarks are Morningstar® or S&P indices established for the same asset class as the portfolio sector.
From a big picture perspective, once the committee is familiar with the different asset classes (and a few other finance fundamentals), you should be in a good position to guide the committee to appropriately consider benchmarking reports prepared by third-party experts. By reviewing these reports the committee can evaluate the performance of each of the plan’s designated investments relative to its associated benchmark. The committee should also seek reports reflecting the percentage of plan assets in each designated investment option and changes over the relative comparative periods. Such reports may illuminate the impact on the plan population should the committee choose to eliminate the investment from the fund lineup.
In addition to reviewing performance against benchmarks, fiduciaries should look at the performance data in the context of applicable macro-environmental factors. Perez v. Bruister, 54 F. Supp. 3d 629, 660 (S.D. Miss. 2014). Any of the following macro factors may have an impact on performance: inflation, unemployment, interest rates, social conditions, technological changes, legal requirements, and political climate. These factors are part of the reason why past performance is not always an indicator of future performance. These factors may be especially pertinent if the committee is evaluating an international fund’s performance.
Use of Comparative Periods
Committees should consider and evaluate each investment’s performance and fees for a sequence of comparative periods (e.g., the most recent quarter, year-to-date, 1-year, 5-year, 10-year periods, or from the shorter fund formation date through the present), also analyzing the rates of return relative to the applicable benchmark indices. In this respect, graphs and charts are useful for committee presentation. In analyzing the data, the committee with its consultant or advisor should look for any trends or sudden changes. If an asset trails the performance of an index, it does not necessarily mean that the committee should immediately remove that asset as an investment option. A committee will often use a watch list (discussed below in “Use of a Watch List”) as a monitoring tool for an underperforming investment option. Guidelines should be established as to when to place an investment option on a watch list (e.g., the investment has underperformed its benchmark for three or more consecutive periods). If a watch list option continues to underperform in a material way, the committee may need to consider removing the investment from the plan’s investment lineup entirely or eliminate new contributions and exchanges into the fund, or take other appropriate actions. Document the committee’s decision for deciding on a particular course of action.
Plan fiduciaries are required to identify, understand, and evaluate fees and expenses relative to plan investment options and service providers. Monitoring plan fees and expenses in light of the services rendered for the plan is a continuing fiduciary responsibility. Proper review of plan investment options often begins with a review of the fee disclosures provided to the plan by service providers as required by ERISA § 408(b)(2) (29 U.S.C. § 1108(b)(2)). At least annually then the committee should evaluate fee disclosures for each plan investment option, comparing the fee against a benchmark for investments in the common asset class. This objective benchmarking process should determine:
The committee should closely monitor fees for different investment alternatives. It’s not uncommon that within the same asset class, for any (higher-cost) actively managed fund, a (lower-cost) index fund is also available. A number of plans offer index fund options to allow participants to index invest in stocks, bonds, and international equities at lower fees than actively managed funds
Many fund families offer multiple share classes for their funds. While the underlying holdings of a fund may be identical, the fund’s expense ratio may be lower for a different class. For example, the committee should consider whether institutional classes of mutual funds (rather than retail mutual funds) are available to the plan from their platform provider. Failure to explore a lower institutional fee structure can attract participant challenges. (See, e.g., Tibble v. Edison Int’l, 729 F.3d 1110 (9th Cir. 2013)).
In particular, if the committee decides not to proceed with the lowest cost option, it should discuss and document its rationale in the meeting minutes. (See, e.g., Tussey v. ABB, Inc., 746 F.3d 327 (8th Cir. Mo. 2014); Moreno v. Deutsche Bank Ams. Holding Corp., 2016 U.S. Dist. LEXIS 142601 (S.D.N.Y. Oct. 13, 2016)).
Use of a Watch List
A committee may find a watch list of underperforming investment options to be a useful tool when monitoring these investments. An investment alternative is placed on a watch list when the committee determines that a closer review of a particular investment (or service provider) is warranted. Reasons for the additional scrutiny may include:
Deciding how long an investment option may remain on the watch list before being eliminated may be more art than science. It is generally inadvisable to identify a deadline in the committee charter or investment policy after which a watch list investment should be removed. This compels the committee to follow the directive even if there are special considerations that suggest flexibility. These considerations may include the number of participants or the percentage of plan assets that are invested in the challenged investment.
The Importance of Documentation and Legal Counsel
From a practical perspective, while not required, it is often advisable that an ERISA attorney attend committee meetings. The individual will be an advisor to the committee, but not an official member.
An ERISA attorney is uniquely positioned to assist the committee in developing thorough documentation demonstrating the committee’s general compliance with ERISA’s reasonable prudent person standard. As indicated above, a committee’s adherence to processes is vital and results are not necessarily controlling. Krueger v. Ameriprise Fin., Inc., 2012 U.S. Dist. LEXIS 166191, at 24 (D. Minn. Nov. 20, 2012). Written records are critical if later proof is required that the committee satisfied it fiduciary obligations.
For example, an ERISA attorney can assist the committee in ensuring that meeting minutes completely and accurately reflect the committee’s rationale for selecting certain investment options, its consideration of reports from thirdparty experts, voting records of committee members, and its discussion of risk (both with respect to a particular investment and how it would fit into an overall portfolio). Similarly, an ERISA attorney can provide committee members with ongoing fiduciary training and education.
In addition, having an ERISA attorney present at committee meetings is beneficial to timely spot and address potential legal issues. While certain matters clearly indicate the need for a legal opinion, other issues are subtler and nuanced and can easily be missed or inappropriately discounted by non-lawyers.
If the committee does not have an in-house ERISA lawyer as an advisor, trusted external legal counsel should be retained and consulted regularly.
Attorney-Client Privilege Considerations
The committee should have a baseline understanding of attorney-client privilege before engaging an attorney, whether as external counsel, as an official committee member (which is not recommended), or as non-member attorney advisor.
Attorney-client privilege protects communications between a client and its attorney from disclosure to others when the purpose of the communication is to obtain or provide confidential legal advice. An exception applies, however, when counsel provides legal advice to a client who is a fiduciary and concerns the exercise of fiduciary duties. United States v. Jicarilla Apache Nation, 564 U.S. 162 (2011) (Sotomayor, J., dissenting); Becher v. Long Island Lighting Co. (In re Long Island Lighting Co.), 129 F.3d 268 (2d Cir. 1997).
If an attorney is to be a committee member, note that the individual, in offering advice to the committee, wears the hat of a committee member and not that of the plan sponsor’s legal counsel. Thus, attorney-client privilege will not apply with respect to advice offered to the committee and could be discoverable.
The privilege also may not apply if the committee is seeking legal advice from counsel who is not a committee member. Where a committee member requests legal advice from another committee member, the advice is treated as provided to the plan. Courts have ruled that the plan participant or beneficiary can be viewed as the “true client” and attorney-client privilege is unavailable with respect to documentation existing for the discussion or advice. (See, e.g., McFarlane v. First Unum Life Ins. Co., 231 F. Supp. 3d 10 (S.D.N.Y. 2017)). Exercise caution!
As a result, including an attorney as a non-member advisor to the committee (as opposed to an official committee member) advances, but does not guarantee, preservation of attorneyclient privilege.
While not legally required, best practice militates that the committee adopt an investment policy statement (IPS) which outlines the committee’s investment philosophy and goals. The IPS should offer sufficient flexibility to react to market conditions while addressing the principles of ERISA’s prudent selection and monitoring process, addressing diversification, performance metrics analysis, reasonableness of fees and expenses, etc. An IPS should be concise and understandable.
In turn, the committee must adhere to the terms of the IPS. Taking action contrary to the IPS is generally worse than not having an IPS altogether. If no IPS exists, then whether a committee’s behavior constitutes a breach of fiduciary authority could be a question involving greater interpretation of the applicable facts. IPS violations may be used to support a plaintiff’s allegations of breach of fiduciary duty.
Using Investment Experts
The reasonable person prudent standard also applies to engaging experts.
In general, ERISA does not expect fiduciaries to be subject matter experts on all things related to investments. However, fiduciaries must prudently select and monitor experts and may not blindly rely on an expert’s advice. Perez v. Bruister, 54 F. Supp. 3d 629, 660 (S.D. Miss. 2014). Therefore, when hiring and utilizing an expert, the committee should:
Id. at 661-662.
In certain instances, the committee may appoint an external expert as an ERISA fiduciary. An advisor appointed as an investment manager may be a fiduciary if that investment manager agrees to be identified as such in writing and has the power to manage, acquire, or dispose of any plan assets. ERISA § 3(38) (29 U.S.C. § 1002(38)). That delegation generally relieves the committee of liability for the investment manager’s specific investment decisions. However, even in cases when an investment manager agrees to be a fiduciary, it is imperative that 401(k) plan investment committees adhere to ERISA’s overarching principles regarding the prudent and reasonable selection and monitoring of investment options.
Continuing education and training are imperative for committee members. Continuing education should cover ERISA fundamentals, such as fiduciary obligations and whether or not an expense is a settlor or plan expense. ERISA § 408(b)(2) (29 U.S.C. § 1108(b)(2)); 29 C.F.R. § 2550.408b-2(b). For a complete discussion of education recommendations, see the full article on Lexis Practice Advisor.
Controlling Risk through Insurance
It is best practice, and will make a spot on the committee more appealing, if the plan sponsor purchases fiduciary insurance coverage for committee members. This is different than directors and officers liability insurance, which generally covers wrongful acts, including actual or alleged errors or neglect or breach of duty on the part of directors in fulfilling their corporate duties. For more information about these policies see the complete article in Lexis Practice Advisor.
Jeffrey A. Lieberman is counsel to Skadden, Arps, Slate, Meager & Flom LLP. His practice focuses primarily on fiduciary issues under Title I of ERISA. He regularly counsels asset managers, investment advisors, banks, hedge funds, plan sponsors, pooled investment funds, sponsors of collateralized loan obligations and other securitized vehicles and servicers to such vehicles, issuers of various types of securities, underwriters, and trustees. He also advises private equity fund and other managers as to compliance with ERISA’s plan asset regulations and application of the venture capital operating company and other exceptions to the coverage of such funds under ERISA.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Employee Benefits & Executive Compensation > Retirement Plans > ERISA and Fiduciary Compliance > Practice Notes Practice Notes
For a sample board resolution creating an investment or other plan committee, see
> BOARD RESOLUTIONS: RETIREMENT PLAN COMMITTEE APPOINTMENT AND CHARTER ADOPTION
RESEARCH PATH: Employee Benefits & Executive Compensation > Retirement Plans > ERISA and Fiduciary Compliance > Forms
For a discussion of procedural prudence, see
> FUNDAMENTALS OF ERISA FIDUCIARY DUTIES
RESEARCH PATH: Employee Benefits & Executive Compensation > Retirement Plans > ERISA and Fiduciary Compliance > Practice Notes
For more information about ERISA 404(c) notice requirements, see
> KEY ERISA DISCLOSURE ISSUES INCLUDING SUMMARY PLAN DESCRIPTION (SPD) REQUIREMENTS AND OTHER DISCLOSURES CONCERNING BLACKOUT PERIODS, PARTICIPANTDIRECTED DEFINED CONTRIBUTION INVESTMENTS, AND EMPLOYER SECURITY INVESTMENT ALTERNATIVES AND PROSPECTUS REQUIREMENTS
> LIMITING LIABILITY UNDER THE ERISA SECTION 404(C) AND QUALIFIED DEFAULT INVESTMENT ALTERNATIVE SAFE HARBORS
RESEARCH PATH: Employee Benefits & Executive Compensation > Retirement Plans > ERISA and Fiduciary Compliance > Practice Notes
For a specific discussion on the service provider disclosures, see
> ERISA SECTION 408(B)(2) SERVICE PROVIDER DISCLOSURES
For a broader discussion regarding ERISA fee litigation in individual account plans, see
> 401(K) PLAN FEE REGULATION AND LITIGATION
For a sample investment policy statement for a defined contribution plan with participant-directed investments, see
> INVESTMENT POLICY STATEMENT (DEFINED CONTRIBUTION PLANS)
For guidance when selecting an investment manager, see
> INVESTMENT MANAGER HIRING CONSIDERATIONS FOR ERISA PENSION PLANS