*Excerpts from a report by Oppenheimer Funds and OGI Global Trust. PlanPerfect is not affiliated with either OppenheimerFund or OGI Global Trust
The Employee Retirement Income Security Act of 1974 (ERISA) is designed to protect the retirement assets of workers who participate in an employer-sponsored qualified plan. ERISA sets the rules that plan fiduciaries must follow to ensure that workers’ and retirees’ plan assets are properly managed.
Some ERISA rules have evolved over time. In 2012, for example, ERISA rules changed about fee disclosures and what plan information must be disclosed to participants. ERISA also clarified the rules about who is and who is not a fiduciary, and spelled out a fiduciary’s responsibilities in greater detail.
What is ERISA?
Under ERISA, plan sponsors are required to disclose certain information about the plan to participants and report certain plan information to the government. Plan sponsors also must meet minimum standards of conduct in managing plan assets and operations. ERISA contains civil enforcement provisions and penalties for noncompliance to help ensure that plan assets are protected and participants receive their benefits.
Who is a Fiduciary?
Under ERISA, an individual or entity that administers an employee benefit plan or manages plan assets is a fiduciary to that plan. The plan sponsor is always a fiduciary to the plan.
The Roles & Responsibilities of Fiduciaries
- Delegation of Responsibilities – A plan sponsor may hire non-fiduciary service providers such as record keepers and third party administrators (TPAs) to help the plan sponsor meet its fiduciary responsibilities. The plan sponsor may also hire or appoint other fiduciaries to delegate responsibilities such as investment selection. If the plan sponsor properly delegates certain fiduciary responsibilities to other fiduciaries, the plan sponsor will not be liable for breach of those responsibilities.
- Appointment—The trustee is appointed by the plan sponsor to assume legal title to the plan assets and typically to provide annual trust of account statements. The plan sponsor may choose to act as trustee for the plan or may appoint an outside entity such as a trust company.
- Directed vs. Discretionary Trustee—Many 401(k) plan trustees act as directed trustees, which means they distribute assets and accept and hold contributions only when specifically instructed by a plan fiduciary. Alternatively, a trustee may be engaged to assume a broader role, with discretionary authority to select plan investments or perform certain plan administrative functions.
- The plan administrator is responsible for day-to-day plan administrative decisions. TPAs and record keepers are generally not considered ERISA 3(16) administrators because they perform services at the direction of the ERISA 3(16) fiduciary.
Investment Advisor (ERISA 3(21))
- Plan Sponsor Appointment—The plan sponsor has fiduciary responsibility for the prudent selection of the investment advisor and an ongoing fiduciary responsibility to evaluate and implement the investment advisor’s guidance and recommendations. The plan sponsor shares fiduciary responsibility for plan investment decisions with the investment advisor.
- Even if the advisor is not appointed as a fiduciary, the advisor can be subject to the ERISA fiduciary standards if he or she exercises discretionary control over the plan’s management or assets. Advisors who provide investment advice for a fee are considered ERISA 3(21) fiduciaries.
- An advisor is not required to be an ERISA fiduciary to provide investment support.
Investment Manager (ERISA 3(38))
- Full discretionary responsibility for selecting/monitoring plan assets
- Eligible Entities—Only a bank, insurance company, or registered investment advisor can serve as an ERISA investment manager.
- Plan Sponsor Responsibility—The selection of the investment manager is a fiduciary function. Once the investment manager is selected the investment manager is solely responsible for investment decisions, relieving the plan sponsor of liability related to investment selection and performance.
What are a Plan Sponsor’s Fiduciary Responsibilities?
A sponsor’s responsibilities include:
- Acting solely in the interest of the plan participants (and their beneficiaries)
Fiduciaries are required to disclose conflicts of interest.
- Carrying out duties prudently – A fiduciary must carry out his or her duties with the care, skill, prudence, and diligence that a prudent person familiar with the matter at hand would use. Prudence consists of two elements: proper investigation and documentation.
- Diversify investments – The plan investments menu must be diversified to reduce the risk of large investment losses.
- Follow the terms of the plan documents – The plan documents serve as the foundation for plan operations. Interpretation of plan terms and operational oversight is a fiduciary function, and not following the terms can be a fiduciary breach.
- Paying only reasonable plan expenses – The plan fiduciary must hire and monitor service providers ensuring only reasonable fees are paid from plan assets for plan services and investments.
- Monitoring for prohibited transactions – ERISA prohibits a fiduciary from allowing the plan to engage directly or indirectly in any prohibited transaction between it and a party-in-interest.
- Responding to inquiries – Plan sponsors must fully and accurately respond to all inquiries from a participant or beneficiary. Misleading communications, misrepresentation, or omissions may constitute a breach of fiduciary duty.
- Being “bonded” – Fiduciaries must ensure that a fidelity bond, a type of insurance that covers a plan’s assets, is in force in accordance with ERISA.
Consequences of Not Meeting Fiduciary Responsibilities
If a fiduciary doesn’t follow the basic fiduciary standards of conduct, the Department of Labor (DOL) has authority to enforce rules through civil and criminal actions. Participants and other plan fiduciaries have the right to initiate lawsuits to impose liability for breach of fiduciary responsibilities.
Under ERISA, fiduciaries are personally responsible liable for plan losses caused by a breach of their fiduciary responsibility and may be required to restore plan losses or pay expenses related to correcting of inappropriate actions. Unless the fiduciary clearly limits the scope of his or her fiduciary role, the fiduciary may also be responsible for actions of other plan fiduciaries.
Fiduciaries may also be responsible for co-fiduciary breaches if they fail to take corrective actions once they become aware of a breach.
Minimizing Fiduciary Risk
Committee and Outside Support to Plan Management
Plan sponsors can fulfill their fiduciary duties by assigning particular functions to an individual, committee or outside providers. A committee can help formalize a prudent decision making process and document the steps taken to follow the process. Plan sponsors can also engage the services of retirement plan participants.
- Plan administrative committee—Some plan sponsors appoint a plan committee to oversee the retirement plan’s operations. A plan administrative committee can manage the plan investments, plan operations, or plan sponsors can establish a separate investment committee.
- Investment committee—A formal investment committee assumes fiduciary responsibility for investment oversight and potentially broadens the expertise applied.
- Investment expertise—Many plan sponsors engage an investment professional’s expertise to assist the sponsor in meeting their fiduciary obligations regarding selecting and monitoring plan investments. The advisor may or may not be an ERISA fiduciary; each plan sponsor must evaluate the type of investment support needed and the reasonableness of the fees charged for those support services. Advisors may also be called on to help the plan sponsor hire and monitor third party service providers.
- Administrative and operational support—Most plan sponsors engage the services of a third party administrator or record keeper to provide administrative support. Selecting these administrative service providers is a fiduciary function. The due diligence process for selecting a service provider typically involves looking a number providers, comparing the same variables with respect to each candidate, and benchmarking whether the fees are reasonable for the services provided.
- Other support services—An attorney may be hired to advise the plan sponsor, prepare or submit plan correction material with regulatory enforcement actions, and draft plan documents. Accountants may be hired to plan audits or perform various calculations regarding deductions or annual contributions.
Secure Favorable Service Arrangements with Key Providers
Once a plan sponsors identifies key providers, the sponsor should have a clear understanding of the scope of services that each provider will deliver. The plan sponsor should review each service arrangement to ensure it provides the depth of support and performance standards that the sponsor needs to fulfill their fiduciary responsibilities.
Roles and Responsibilities—key elements to consider
- Is the scope of the services defined in the service agreement consistent with the plan sponsor’s discussions with the service provider and aligned with the plan’s needs?
- Are there any limitations on the service that will be problematic?
- Does the plan sponsor understand what their responsibilities are under the service agreement?
Fiduciary Status—key elements to consider
- If a service provider is a fiduciary, they are required to acknowledge that status in writing.
- The plan sponsor should make certain they understand the scope of their fiduciary support.
- The plan sponsor should have a clear understanding of their fiduciary responsibilities versus service providers.
Performance Standards & Warranties—key elements to consider
- Are there promised service standards for critical functions?
- What is the plan sponsor’s recourse under the service agreement if these standards aren’t met?
- Does the service provider offer any warranty backing up their assurance that their services or products meet regulatory standards?
Liability Limitations—key elements to consider
- If the service provider makes an error, what are the plan sponsor’s rights?
- Some service providers limit their liability to a dollar threshold or to correcting only certain types of errors. Plan sponsors should ensure they understand how the plan will be “made whole” if there are mistakes or delays.
Fees—key elements to consider
- Ensure that all fees are reasonable and services are necessary for the plan’s administration.
- Compare the fees being charged with fees assessed by other service providers for comparable services.
ERISA Section 404(c) Protection
ERISA Section 404(c) provides a set of requirements that a plan sponsor can choose to follow to effectively transfer the potential liability of associated with investment decision making responsibilities to employees who participate in an ERISA retirement plan.
The key elements for compliance with ERISA Section 404(c) are the:
- Right of participants to choose from a broad range of investment options.
- Opportunity for participant’s to “exercise control” over their accounts.
According to the DOL, the “broad range” requirement is satisfied if three conditions are met:
- The first is “opportunity.” Participants should be offered a reasonable opportunity to affect the level of return and degree of risk to which their accounts are subject.
- The second is “choice.” Participants should be offered the opportunity to choose from at least three investment alternatives that are diversified and are materially different in risk and return characteristics.
- The third is “diversification.” Participants should be offered the opportunity to diversify to reduce the risk of large losses. The investment options offered should span the risk/return spectrum.
The “exercise control” requirement can be satisfied if participants are provided the opportunity to transfer among their investment options at least quarterly.
In addition, for participants to make informed decisions on their investment options, the plan sponsor must provide sufficient information about the investments offered under the plan, including statement to participants that the plan is designed to comply with ERISA 404(c) and plan fiduciaries may be relived of liability for any losses as a result of participants investment instructions.
Under ERISA 4(c), the plan sponsor must:
- Prudently select and monitor investment options.
- Provide appropriate investment choices and information enabling participants to make educated decisions.
Such information includes, but is not limited to:
- A description of each investment option, including risk and return characteristics.
- Identification of any investment managers.
- Procedures for participant investment instructions.
- Restrictions on any voting or tender rights available to participants.
- A description of any and all fees and expenses charged to participants under any investment option.
- Document that participants are being furnished al such information.
Minimizing Investment Risk
There are a number of avenues plan sponsors can explore to help manage their fiduciary risk with respect to plan risks.
Investment Policy Statement
An important tool for managing fiduciary risks relative to investments is the Investment Policy Statement. An IPS is a written policy that defines the criteria for selecting and monitoring investment options for the plan. The IPS both demonstrates the prudent process used for investment decisions and provides a consistent set of actions to follow during periodic investment reviews.
The IPS should be reviewed at least annually and updated as needed to adapt to changes in the plan demographics as well as economic and financial industry developments.
An IPS will typically include the following elements:
- The plan sponsor’s criteria for selecting and monitoring investments.
- The timing for investment performance reviews.
- The rationale for deciding when to replace investments not performing well or no long suit the plan’s participants.
ERISA requires plan fiduciaries to provide sufficiently diverse investment menu to minimize risk of large investment losses to plan participants and beneficiaries. Plan sponsors should select a robust and varied investment lineup that allows for a variety of asset allocation strategies for participants with varying investment goals, risk tolerance, savings time frames and diversification needs.
Plan sponsors should work with their investment experts to assemble an investment menu that is sufficiently diverse to meet the plan demographic needs yet is not so broad as to overwhelm participants.
Using investment experts to assist with selecting the investment menu and providing participant investment menu and providing participant investment services is an important step in managing your fiduciary exposure.
Qualified Default Investment Alternatives
A plan must also select a default investment for plan contributions made by participants who have not made an investment selection, such as participants who are automatically enrolled in the plan. If a plan sponsor chooses an investment that meets the requirements of a Qualified Default Investment Alternative (QDIA), the plan will be relieved of fiduciary liability for participant losses.
Four investment vehicles qualify as a QDIA:
- Life cycle or target date funds
- Professionally managed accounts
- “Balanced funds”
- Capital preservation products
To obtain fiduciary relief for QDIA investment, plan sponsors must provide a written notice to participants describing the circumstances under which a participants describing the circumstances under which a participant’s account may be invested in a QDIA, the participant’s right to select an alternative investment, a description of the QDIA and explanation of where to obtain additional information. Information on the QDIA, such as a prospectus, must also be provided to participants or made available via web link.
ERISA 408(b)(2) Service Provider Disclosure Rules
The DOL’s service provider disclosure regulations highlight the plan fiduciary’s responsibility to monitor the fees paid to service providers from plan assets. The rules are designed to ensure that the plan fiduciaries receive the information they need to assess the reasonableness of the provider contract or arrangement and identify potential conflicts of interest before entering into a service relationship.
It is important to keep written records of when each disclosure was received, when it was reviewed, and analysis used to determine whether the fees are reasonable, including any benchmarking information and a summary of experts consulted and their recommendations.
Service Provider Checklist
- Are the services necessary for the administration of the plan?
- Are the fees reasonable for the service provided?
- Has the plan sponsor documented the process used to select (or review) service providers and the reasons the plan sponsor selected each particular provider?
- Has the plan sponsor compared the service provider’s performance and fee schedule to other providers?
- Does the service provider need to be licensed? If so, is the license current?
- Has the service provider delivered the services described in the service agreement?
- Does the plan sponsor have plan participant comments or complaints regarding the services when reviewing existing service providers?
- Establish and document prudent practices and policies
- Line up the right support team
- Secure favorable service arrangement with key providers
- Explore opportunities to reduce investment risk
Does the plan sponsor have the following documents to demonstrate due diligence?
- Investment Policy Statement
- Plan documents
- Summary Plan Description
- Adoption agreement (if applicable)
- Plan amendments
- Board resolutions
- Investment monitoring reports
- Non-discrimination testing results
- Signed form 5500
- Compliance documentation
- Plan communications to employees
- Proof of ERISA fidelity bond
ERISA Section 404(c) Checklist
Employers seeking to offer a plan complying with ERISA 404(c) should be able to answer yes to the following questions:
- Are at least three diversified investment choices provided, each with materially different risk/return options?
- Can participants choose their own investments from the options available?
- Can each investment option be classified as a “prudent” by plan fiduciaries?
- Can participants change their investment allocations and transfer among accounts at least once every calendar quarter?
Have plan participants been provided with
- A statement that the plan intends to comply with ERISA Section 404(c)?
- Description of each investment option and all fees and expenses charged to participants under each option?
- Identification of the plan’s fiduciary?
- Directions on how to select investments and change investment selections?
- Investment prospectus?
- Access to regular account statements?
Considerations When Hiring a Fiduciary Advisor
- Is the financial advisor committed to the retirement plan market?
- How long has the advisor worked with retirement plans?
- What relevant retirement credentials does the advisor have?
- Does the advisor have experience with retirement plans similar to the plan’s size? And plan requirements?
- Does the advisor work in a team or alone?
- Can the advisor provide references?
- What services does the advisor provide?
- Will the advisor assume fiduciary responsibility? What is the scope of the fiduciary responsibilities will the advisor assume?
- Will the advisor be a “named fiduciary?”
- Does the service agreement provide specific service and payment details?
- In the event that something goes wrong, how will the advisor make the plan “whole?” Does the advisor carry insurance?
- Does the advisor provide a written/documented process for decision- making?
- Is the process replicable?
- What are the plan goals and how will achievement of those goals be measured?
- What are the fees?
- Are fees associated with services easily identifiable?
- Are the fees reasonable for the services provided