A recent decision of the Federal Ninth Circuit Court of Appeals should give pause to anyone who administers a 401(k) plan or other employee benefit plan subject to the Employee Retirement Income Security Act (“ERISA”). In Tibble v. Edison Int’l, 10-cv-56406, 2013 WL 1174167 (9th Cir. Mar. 21, 2013), the court ruled that 401(k) plan fiduciaries breached their duty of prudence in the selection of investment options because their reliance on a consultant’s advice was unreasonable. The court said that plan fiduciaries must make certain that their reliance on a consultant’s advice is reasonably justified and they cannot “reflexively and uncritically adopt [a consultant’s] recommendations.” The court did not say how to determine whether such reliance is “reasonably justified”. Problem is, the issue will only arise when plan participants have suffered losses and, with the benefit of hindsight, a plaintiff’s lawyer will call into question the soundness of the consultant’s advice and the reliance placed on such advice by the plan administrators.
As background, ERISA, a federal law enacted into law in 1974, contains requirements for the administration of employee benefit plans. Employee benefit plans include pension plans and welfare plans. A pension plan means any plan, fund or program that provides retirement income to employees or the deferral of income for a period extending to the termination of employment. The most common employer-administered pension plan is a 401(k) plan. The term “welfare plan” means a plan that provides benefits such as healthcare benefits or long-term disability plans.
ERISA creates fiduciary duties for administrators of ERISA plans and imposes personal liability for breach of those duties. In most corporations with 401(k) plans, the plan is administered by a committee consisting of officers of the corporation. Each member of the committee is an “administrator” of the plan under ERISA and therefore has fiduciary duties.
Among the fiduciary duties of plan administrators, the most subjective is the “prudent man rule”, i.e., a fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity” would act. While this sounds like an objective standard, it is really quite ambiguous. There are “prudent men” who male speculative investments every day. Offering many of those investments to 401(k) participants would probably be a breach of a plan administrator’s fiduciary duty. Moreover, most plan administrators lack the experience and knowledge to choose among the wide range of investment options available today. Hence, most plan administrators hire a financial consultant to advise them. ERISA not only allows this, it expressly requires it: if a fiduciary lacks the expertise for a certain area then the fiduciary must obtain expert help. 29 U.S.C. §1104 (a)(1)(B). Typically, a 401(k) plan will offer a range of investment choices to plan participants and the plan administrators will hire a financial consultant to recommend this range of diversified investment options. A very important issue raised by the Tibble case is the extent to which plan administrators can rely on advice on financial consultants.
To summarize the facts, Edison International, a California utility, offered its employees investment options in the company’s 401(k) plan, including three retail-class mutual funds. Edison’s 401(k) investment options did not include lower-fee institutional-class funds available from the same investment firm. The trial court found that the Edison plan fiduciaries did not properly investigate the alternative of offering these institutional-class funds. The Ninth Circuit affirmed.
The court did not accept the plaintiffs’ argument that retail-class mutual funds are an imprudent investment option for an ERISA plan, despite the fact that institutional-class funds charge lower fees. The court emphasized that retail-class mutual funds have certain advantages, such as participant familiarity and the ready availability of public information on the fund’s performance. However, the court found that it was imprudent to not consider the option of institutional-class funds. There was no evidence that Edison or its adviser had investigated the option of institutional-class funds. Edison argued that it had acted prudently because it based its decision on advice received from Hewitt, which had been retained to provide advisory services to the plan. The Ninth Circuit rejected this argument, stating that expert advice does not absolve a fiduciary of responsibility: “Just as fiduciaries cannot blindly rely on counsel . . . or on credit rating agencies . . . a firm in Edison’s position cannot reflexively and uncritically adopt investment recommendations.”
Edison also argued that it was not liable because the plan participants who suffered losses had made their own investment decisions. This defense was based on Section 404(c) of ERISA, which precludes breach of fiduciary duty claims in situations involving decisions made by plan participants. The Ninth Circuit rejected this argument, saying that section 404(c) only protects fiduciaries from losses that are a “direct and necessary result” of a participant’s action. In other words, if the plan fiduciaries act imprudently when they create the investment options, they cannot later argue that they not liable for the participants’ losses because the participants made the wrong choices.
The Ninth Circuit opinion in the Tibble case, although 50 pages long, is not very helpful on the issue of how plan administrators should ‘investigate’ the investment options recommended by a financial consultant. What does it mean to say that a fiduciary cannot ‘reflexively and uncritically’ rely on a consultant? Presumably, it means asking questions. But does a non-expert know what questions to ask of an expert, apart from “Have you presented all the available options?” and “What else do we need to know to make an informed decision?” Of course, it will now be common to ask about institutional-class funds and other investment choices with more favorable fee structures, but that is only one issue out of many that a fiduciary could ‘investigate’. At a minimum, plan administrators should require the financial consultant to thoroughly document its advice, including reference to all the criteria that might be important to plan participants. Perhaps the company’s legal counsel should prepare a list of the challenges that have been raised by plaintiffs’ lawyers in the many published cases that have been brought against plan adminsitrators, and to question the consultant on how these challenges are address in company’s plan. Of course, all of this should be part of a written record that can later be used, if necessary, to show that a proper ‘investigation’ was conducted by the plan administrators.
To repeat a point made earlier, ERISA plan administrators have personal liability if they breach their fiduciary duty and plan participants suffer a loss as a result. If you are on the committee that administers your employer’s 401(k) plan, it would be a good idea to check the company’s indemnification provisions for officers and directors. A “prudent man” would do no less.