CAPTRUST Vice President | Financial Advisor
- Tibble v. Edison—Supreme Court Clarifies Duty to Monitor Investments
- Tussey v. ABB—The Saga Continues
- DOL Study Finds Annual Plan Audits Lacking
- Equitable Relief for SPD Issues
- Cases and Developments We Are Following
Tibble v. Edison—Supreme Court Clarifies Duty to Monitor Investments
In a long-awaited case, the Supreme Court of the United States held that fiduciaries of ERISA-covered retirement plans have an ongoing duty to monitor plan investments. The court rejected fiduciaries’ use of ERISA’s six-year statute of limitations as a shield when sued for offering retail share classes of mutual funds when less-expensive institutional share classes of the same investments were available.
The court did not define what ongoing investment monitoring should include. However, it noted that ERISA’s prudence standard, which is sometimes referred to as a “prudent expert” standard, would apply. Tibble v. Edison (S.Ct. 2015)
Key takeaways from this case are:
- Plan fiduciaries should periodically review the share classes of the investments included in their plans. Practically, plan fiduciaries should have a thoughtful answer to the question, “Why did you believe it was in participants’ best interests to use the share classes of the investments you were using?”
- Although this decision confirmed the obligation for periodic share class reviews, it also sets a framework for the timing of other review items. Some monitoring, like plan recordkeeping cost and competitiveness, would likely have a longer interval—two to three years—between reviews. Meanwhile, other issues, like the departure of a critical investment manager, could have a shorter reasonable period for review and action—perhaps a few weeks or months.
In Tibble v. Edison, a multi-billion dollar plan 401(k) plan included six investments whose expense ratios were challenged as being too high. The plan offered retail rather than institutional share classes, even though the plan would have qualified for less expensive institutional share classes. The district court found plan fiduciaries liable for breach of fiduciary duty in failing to use less expensive share classes for three of the funds. The court dismissed claims for the three other funds because they were selected more than six years before the lawsuit’s filing and were barred by ERISA’s six-year statute of limitations. The U.S. Court of Appeals for the Ninth Circuit affirmed dismissal based on the statute of limitations, noting that after investment selection there is a duty to undertake a further review only when there has been a change in circumstances that might trigger a review.
Reversing the Ninth Circuit’s decision, the Supreme Court found that basic trust law, the fundamental underpinning of ERISA, imposes a continuing duty on plan fiduciaries to review the investments for which they are responsible. Turning to the question of what level of review is required, the Supreme Court pointed out that the key reference point is ERISA’s prudence standard of the “care, skill, prudence and diligence that a prudent person acting in a like capacity and familiar with such matters would use.
The Supreme Court sent the case back to the Ninth Circuit to determine whether an appropriate review was undertaken. It is notable that on the three claims that did not have a statute of limitations defense, the court found the fiduciaries liable at the district court level, which may presage the outcome of the claims sent back for reconsideration.
Tussey v. ABB—The Saga Continues
The case of Tussey v. ABB continues to work its way through the courts. The 2012 district court decision made the following findings:
- Plan fiduciaries overpaid revenue sharing to Fidelity, their 401(k) plan recordkeeper. ABB used this excess revenue to fund corporate expenses, including payroll processing and health plan administration services also handled by Fidelity. The court found plan fiduciaries liable for $13.4 million. This aspect of the decision has not been changed on appeal.
- Fidelity was initially found to have breached its fiduciary responsibility to the plan by retaining $1.7 million of float interest revenue and not crediting it back to the plan. This decision was appealed and reversed.
- Plan fiduciaries did not follow the terms of the plan’s investment policy in the replacement of the Wellington Balanced Fund with the Fidelity Freedom Funds target date series. The replacement funds underperformed the original balanced fund, resulting in losses of $21.8 million for which plan fiduciaries were liable. On appeal, the court concluded that the district court applied the wrong standard of review. The district court substituted its own judgment for the plan fiduciary committee’s rather than beginning with the presumption that the fiduciary committee was correct and then deciding whether it was wrong. The case was sent back to the district court for reconsideration.
Upon reconsideration, the district court concluded that plan fiduciaries had breached their responsibility in the replacement of the Wellington Balanced Fund. Their decision was found to have been motivated by the revenue sharing produced by the Freedom Funds and used to pay for corporate services, rather than the best interests of 401(k) plan participants and beneficiaries.
In its reconsideration, the district court noted several elements that led to its conclusion that there had been a fiduciary breach:
- The decision to replace the Wellington Balanced Fund with the Fidelity Freedom Funds was not made by the plan fiduciary committee. Rather, it appears that ABB executives made the decision in their corporate officer capacities.
- Using the Freedom Funds, which had less than five years of performance history at the time, required an exception to the plan’s investment policy statement. Even so, a significant portion of plan assets were mapped from a longstanding well-performing plan investment.
- “[T]here are too many coincidences to make the beneficial outcome for ABB serendipitous, particularly considering the powerful draw of self-interest when transactions are occurring out of sight and are unlikely to ever be discovered.”
Even though a breach was proven, the plaintiffs failed to establish their damages, which would be based on the performance of the Freedom Funds as compared to other available target date funds, rather than the Wellington Balanced Fund. As a result, the court entered a judgment in favor of the defendants, confirming the “no harm no foul” aspect of these cases. Tussey v. ABB Inc. (W.D. Mo. July 9, 2015).
DOL Study Finds Annual Plan Audits Lacking
Most plans with 100 or more participants are required to have an annual audit performed by an independent qualified public accountant and filed with the annual Form 5500. From time to time the U.S. Department of Labor (DOL) conducts studies assessing the quality of employee benefit plan audits. The results of its current study were poor, particularly for auditors who conduct fewer than 25 audits a year.
Audit quality studies since 1989 have shown an overall increase in the error rate.
Many plans may conduct a limited scope audit, through which the auditor may rely on data submitted by other regulated firms. The auditor need not re-analyze that data, which has presumably already been subject to adequate audit scrutiny. The percentage of limited scope audits has increased from 48 percent in 2001 to 83 percent in 2013, and the DOL has associated the increase in limited scope audits with more errors in plan audits.
The DOL study offered recommendations, which could reduce the number of firms performing these audits (and increase the cost of audits):
- Amend ERISA to impose a penalty of $1,100 per day on accountants who submit an audit rejected due to an audit deficiency.
- Amend ERISA to change the definition of “qualified public accountant” to impose more requirements and qualifications for auditors, and allow the Secretary of Labor to issue regulations on auditor qualifications.
- Amend ERISA to eliminate limited scope audits.
Plan fiduciaries would be well advised to inquire about their auditor’s experience and determine if plan audits are a material part of the auditor’s practice. It is also a best practice for plan fiduciaries to be aware of the outcome of annual plan audits.
Equitable Relief for SPD Issues
ERISA requires that plan administrators issue a summary plan description (SPD) to plan participants. SPDs are to be accurate and complete enough to let participants know their rights and obligations under the plan and written in language understandable by the average plan participant. As previously noted, in the case of CIGNA Corp. v. Amara (S. Ct. 2011) the U.S. Supreme Court reversed prior decisions that had concluded that, in the event of a conflict between a plan document and SPD, the SPD would control. Following Amara, the plan document controls. This case also expanded the range of relief judges can award in ERISA cases to include equitable remedies. Erroneous SPD cases continue to work their way through the courts with judges finding creative remedies favoring plan participants:
- Pension SPD Failed to Disclose Benefit Exclusion—Apension plan provided active employees an enhanced benefit if they retired from active employment. According to the plan document, the enhanced benefit was not available if the participant was not an active employee at the time of his or her retirement, but the SPD did not reference this limitation. The court of appeals affirmed denial of the enhanced benefit under the plan because the participant had not met the plan document’s express requirements. However, the participant was permitted to amend his lawsuit to seek an equitable remedy in place of the enhanced benefit referenced in the SPD. Pearce v. Chrysler Group, LLC Pension Plan (6th Cir. 2105)
- Disability Plan SPD Granted Seven Percent Annual Benefit Increase—The SPD for a disability plan provided an annual seven percent increase in disability benefits. A participant sued after being denied a seven percent increase, and the district court ruled in favor of the plan and the insurer because the plan document did not support the seven percent annual increase. On appeal, the court ruled that it is a fiduciary duty to accurately reflect a plan’s terms in the SPD, which the plan sponsor breached. The case was sent back to the district court to determine an appropriate equitable remedy based on the misstated SPD, calculate damages, and evaluate class action issues. Stiso v. International Steel Group (6th Cir. 2015)
These cases show the importance of taking care to assure that SPDs—and other participant communications—are accurate.
Cases and Developments We Are Following
- White House Supporting State-Sanctioned Mandatory IRAs—As reported in the first quarter, Illinois adopted a law requiring employers with 25 or more employees who do not sponsor a retirement plan to enroll their employees in a state-run individual retirement account (IRA) program with an automatic 3 percent after-tax deferral. Similar programs have been approved by the legislature or are in the lawmaking process in California, Oregon and Connecticut and 20 other states are reportedly evaluating similar programs.
President Obama announced at the White House Conference on Aging in July that the DOL will propose regulations to help state adoption of mandatory IRAs by the end of the year. Legislation mandating IRAs has also been proposed at the national level.
- QDRO Entered After Death—In an unusual case demonstrating the flexibility of the judicial process, a state court entered a qualified domestic relations order (QDRO) after the plan participant, whose benefits were being divided, had died.
A retirement plan participant divorced his first wife in 2008, remarried in 2009, and died in 2012. When the participant died, his second wife had been named as the beneficiary on his four pension plans. Although the divorce agreement from 2008 provided that the first wife would receive 50 percent of the participant’s pension benefits, a formal QDRO, which ERISA requires to divide pension benefits, was never entered. Following the participant’s death in 2102, the judge who oversaw the divorce entered a QDRO nunc pro tunc—retroactively. Both the first and second wives claimed the pension benefits. The plan sponsor filed an interpleader action so a district court would resolve the dispute. Following a district court order enforcing the QDRO, the case was appealed. The United States Court of Appeals for the Second Circuit affirmed, so the first wife received a portion of the pension plans as agreed in the divorce proceedings. Yale New Haven Hospital v. Nicholls (2nd Cir 2015).
- Supreme Court to Hear Equitable Tracing Case—Under ERISA, if a benefit plan pays health or other benefits that are later also recovered from another party, the participant must repay the plan. In some instances, plans seek reimbursement from the participant when a later recovery is made. This comes up most often in the case of accidental injuries like car accidents and is referred to as equitable tracing. The U.S. Courts of Appeal are divided on whether equitable tracing requires that the recovery from the third party still be in the possession of the participant. The Supreme Court agreed to resolve this conflict in Montanile v. Board of Trustees (U.S. Cert. Granted 2015).
- Drumbeat for DC Plan Distribution Annuities Continues—As part of the DOL and Treasury Department’s “joint initiative to encourage the prudent consideration, offering, and use of lifetime income alternatives, including annuities, in retirement plans,” the DOL has issued Field Assistance Bulletin (FAB) 2015-02. This FAB expands on the DOL’s 2008 safe harbor regulation on the selection and monitoring of annuity providers for defined contribution plans. (July 13, 2015).
The new FAB reiterates the safe harbor regulation’s rules and provides examples of plan fiduciaries’ obligations if they provide either immediate annuities or deferred longevity annuities. The key points of the guidance are:
Fiduciaries must follow the safe harbor annuity selection rules in their initial annuity provider choices.
Fiduciaries must periodically monitor the financial stability of the annuity provider and its annuity costs and make any appropriate changes.
Fiduciaries’ responsibility for monitoring annuity providers ends when the annuity provider is no longer offered for new purchases, not when the annuity payout has been completed.
Consistent with Tibble v. Edison, the FAB acknowledges that, “The frequency of periodic reviews to comply with the Safe Harbor Rule depends on the facts and circumstances. For example, if a 'red flag' about the provider or contract comes to the fiduciary’s attention between reviews… the fiduciary would need to examine the information to determine whether an immediate review is necessary….”