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Business as Unusual: Fiduciary Do’s and Don’ts

Plan sponsors often gloss over the reality that they are ERISA fiduciaries – or think that if they have hired an advisor, they’ve basically hired a stand-in for that responsibility. But there’s another mistake that even the most well-intentioned make – with remarkable frequency, based on what I hear.

In the marketplace, it’s normal – even expected – that firms extend more favorable terms and/or discounts to those who do business with them across various offerings. But those “normal” practices can cause you trouble when it comes to doing business with ERISA-governed plans. Here’s how:   

If you make decisions regarding the plan or plan assets, you’re an ERISA fiduciary.

If you have discretion in administering and managing the plan, or if you control the plan’s assets (such as choosing the investment options or choosing the firm that chooses those options), you are a fiduciary to the extent of that discretion or control. Ditto if you are able to hire individuals that control or direct the investment of those assets.

Plan decisions you make as an ERISA fiduciary – including hiring those who provide plan services – must meet certain criteria.

With regard to what a fiduciary must do, the Employee Retirement Income Security Act, or ERISA, sets out a number of requirements for plan fiduciaries in what are generally referred to as the “prudent man” rule, the duty of loyalty and the “exclusive benefit” rule. 

Taken in their entirety, this means that plan fiduciaries must carry out their duties as would “a prudent man engaged in a like capacity and familiar with such matters,” to act “solely in the interest” of plan participants and to act for the exclusive purpose of providing retirement benefits to participants. Those duties include the selection and monitoring of providers – and those must be done for the exclusive benefit of participants and beneficiaries. Failing to do so constitutes a breach of your fiduciary duty – and this has been the underlying allegation in just about all of the recent litigation regarding ERISA plans.

There are also certain things you can’t do as an ERISA fiduciary.

Fiduciaries may believe that, in order for a conflict of interest to exist, the fiduciary must somehow act in a manner that is bad for the plan, but ERISA outlines a number of actions that fiduciaries may not take, generally referred to as “prohibited transactions.” 

The transactions that constitute an unlawful exchange between a plan and a party in interest, or prohibited transaction, involve the sale, exchange or lease of property; lending of money or other extension of credit; furnishing of goods, services or facilities; or a transfer or use of plan assets. A disqualified person who takes part in a prohibited transaction must correct the transaction and must pay an excise tax based on the amount involved in the transaction. 

Note that if a conflict of interest is precluded under ERISA's prohibited transaction rules, the fiduciaries cannot, as a matter of law, allow the plan to become a party to the transaction – even if the action were otherwise reasonable or profitable to the plan. There are exemptions to some of these prohibited transactions, but without that, fiduciaries are absolutely prohibited from entering into a contemplated transaction – even if doing so could otherwise be considered “prudent.”

Businesses make “relationship” deals all the time – ERISA-governed plans can’t.

Remember that as an ERISA fiduciary you have a legal obligation to act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them.  

So, let’s say the local financial institution, currently bidding on the opportunity to manage your plan’s assets, wants to acknowledge the “value of the expanded relationship” by extending a more favorable interest rate, or to expand the firm’s existing line of credit were they to be awarded the plan business.  From a customary “doing business” standpoint, this probably wouldn’t raise any red flags – but then, ERISA isn’t “customary” – and from that standpoint, there are red flags aplenty. 

The clear intent of the offer is to reward the decision to award the plan business to the financial institution, or at least to acknowledge that the financial institution is willing to view its business holistically. That said, when it comes to dealing with an ERISA plan, fiduciaries must make those decisions in isolation – solely is the operative word here – and a decision to transfer plan assets in exchange for better banking terms for the company fails that test.

Specifically, it violates 406(b)(1) and (3) because the responsible fiduciary has dealt with the assets of the plan for the benefit of an entity other than the plan participants and beneficiaries. Nor does it matter that as employees of the firm there might be some incidental benefit from the enhanced LOC. Why? Because the decision wasn’t made for the exclusive purpose of providing benefits, nor was it solely in the interest(s) of plan participants and beneficiaries. 

What could be worse?

Worse – imagine a situation where the fees or services offered to the plan by the financial institution aren’t the top choice of the plan fiduciaries/committee. Again, in a “customary” business transaction, it’s not unusual to consider the entire relationship, to weigh the breadth of services and costs in totality. 

But ERISA isn’t customary – and if better options were readily available, and there is no specific plan benefit justifying the transfer, the plan fiduciaries have run afoul of the duty not only to act prudently, but to do so for the “exclusive purpose” of providing the retirement benefits to plan participants and beneficiaries. And, depending on the nature of the transaction, they may well have run afoul of ERISA’s prohibited transaction restrictions.

Remember that your liability as an ERISA fiduciary is personal.

There are any number of things that can go wrong in running a workplace retirement plan. That’s why it’s important to hire experts – and to keep an eye on them. But don’t forget that ERISA fiduciaries – and your decision as a committee member means that you’re one - can be held personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions. 

The bottom line: When it comes to dealing with ERISA plans, plan fiduciaries are well-advised to consider if anyone other than the participants benefits as a result of the selection of a service provider or an investment decision. And if so, to tread carefully – very carefully. 

Note: For a more extensive analysis on the subject, I am indebted to the work of Fred Reish who has on this topic, as on many others over the years, provided excellent insights, including this one.

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