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Fiduciary Update | November 2014

Drew McCorkle
CAPTRUST Vice President | Financial Advisor

CAPTRUST’s Fiduciary Update goes beyond the headlines to take a closer look at recent court cases with potential implications for ERISA retirement plan sponsors. We also highlight several emerging regulatory issues that have recently come to light.


Case #1: Tatum v. RJR Pension Investment Committee (4th Cir. 2014)

JR Nabisco has undergone several corporate transactions over the years, and ultimately separated into two companies. One result of this was that the 401(k) plan for tobacco company employees held nonemployer stock of Nabisco, the food company. The tobacco company plan mandated inclusion of Nabisco stock, but froze it to new investments. The plan also gave an investment fiduciary committee responsibility for plan investment matters.

Recent years have seen significant litigation on employer stock issues, and plans with employer stock are facing a higher level of scrutiny. The decision was made to eliminate Nabisco stock from the tobacco company plan, and the liquidation occurred when the share price was at all-time lows. Within a year, there was a bidding war for Nabisco, and the share price reached all-time highs. Plan participants who were disappointed at missing the run-up in the share price sued, alleging a breach of fiduciary responsibility in liquidating Nabisco stock from the plan.

A working group of RJR employees — but not the investment fiduciary committee — made the decision to eliminate Nabisco stock from the plan. The decision was approved by a member of the fiduciary investment committee, but not by the committee. Although the working group did not have the authority to make this decision, by exercising discretion over the plan’s investments as employees of the company, the company became a functional fiduciary. (The individual members of the working group who made the decision would also likely be fiduciaries; however, claims were not made against them.)

The court then evaluated the process used to decide Nabisco stock should be liquidated. It found that the working group discussed the matter for only 30 to 60 minutes, assumed without evaluation that RJR did not want the Nabisco stock in the plan, and made the decision without giving the matter proper consideration. There was no evidence that the fiduciaries investigated, analyzed, or considered the circumstances regarding the Nabisco stock and whether it was appropriate to liquidate.

Deciding that ERISA’s fiduciary responsibilities had been breached, the court noted that:

Fiduciaries, at the time of the transaction, must engage in appropriate methods to investigate the merits of the investment;

Fiduciaries must engage in a reasoned decision-making process, consistent with that of a prudent man acting in a like capacity (using outside experts as necessary); and 

Although prudence requires more than a “pure heart and an empty head,” courts have readily determined that fiduciaries who appropriately investigate the merits of an investment decision prior to acting easily clear the ERISA prudence bar.

After the stock liquidation was announced, some participants objected and the decision was reconsidered. However, the liquidation decision was maintained, largely due to concerns about the fiduciaries’ liability to participants who had already liquidated the Nabisco stock from their accounts based on the liquidation announcement. What would be in the best interests of participants and beneficiaries in the tobacco company plan was not considered. The court found that it was “clearly improper” for the fiduciaries to consider their own potential liability as part of the reason for not changing course on their decision to liquidate the Nabisco stock.

Holding employer stock in 401(k) plans has come under increasing scrutiny, so consideration of eliminating nonemployer stock could be expected. Indeed, elimination of Nabisco stock from the tobacco company plan may have been the right decision for plan participants. However, because the plan’s fiduciaries did not employ (or could not prove) a prudent and thorough process, they could not defend their decision.


Case #2: Edison v. Tibble (9th Cir. 2013)

In Edison v. Tibble, a plan fiduciary committee was sued for offering retail share classes of mutual funds in a large 401(k) plan that could have used less-expensive institutional share classes of those investments. The committee offered three reasons for using the more-expensive retail share classes:

The retail share class had a longer history;

Participants would be confused by a change in share classes; and

The institutional share class was not available unless a minimum initial investment was made.

The district court rejected the first two arguments and noted that expert testimony indicated that minimum investment requirements would be waived if requested. More broadly, the district court found that the fiduciary committee did not meaningfully consider the availability of lower-cost share classes of the investments in the plan. The plan fiduciaries were liable for the extra costs of retail funds that were unnecessarily used in the plan. Claims with respect to some of the retail investments in the Edison 401(k) plan were dismissed because they were added to the plan more than six years before the suit was filed. As a result, ERISA’s six-year statute of limitations had expired.

The district court decision was affirmed on appeal in a strongly worded opinion saying, “The district court found an utter absence of evidence that Edison considered the possibility of institutional classes for the funds litigated — a startling fact considering that supposedly the ‘expense ratio’ was a core investment criterion.” Emphasizing the importance of process, the court of appeals went on to say, “[H]ad Edison made a showing that [its advisor] engaged in a prudent process in considering share classes, this might have been a different case.” The court of appeals agreed with dismissal of claims relating to share classes of funds that had been in the plan for more than six years.

The case was then appealed to the Supreme Court on the statute of limitations question. The argument against dismissal of these claims is that with every fiduciary committee meeting, there was a renewed decision to retain the more-expensive retail share class — what is referred to as a “continuing violation.” Because of this, the statute of limitations begins again with each committee meeting. The U.S. Department of Labor (DOL) weighed in to support the continuing violation theory, arguing energetically that plan fiduciaries have an ongoing obligation to monitor plan investments and fees and make appropriate adjustments. 

The decision in this case could create significant exceptions to ERISA’s statute of limitations, potentially exposing fiduciaries to more extensive claims. It could also change the obligations of newly appointed fiduciaries, requiring them to address the past errors of their predecessors.


Case #3: Soland v. George Washington University (D.D.C. 2014)

Richard Soland was a professor in George Washington University’s Engineering school for nearly 30 years, and then retired. Not long after his retirement, the school offered a retirement incentive program to other employees that was more generous than the one Soland had negotiated. Regretting his earlier decision, he sued the university to receive the more generous retirement incentive benefit, alleging that the university knew the richer retirement program was imminent and had a duty to tell him.

Soland discussed retirement with his department head and eventually negotiated a retirement package that was finalized in the spring of 2008. The broader retirement incentive program was apparently germinating in 2007 and 2008 and in the process of being developed in the summer of 2008 and into 2009. It was announced to the faculty in late October 2009.

The court noted that there are two views among the U.S. circuit courts on when plan sponsors and fiduciaries are obligated to tell employees about impending changes to their benefit programs:

Serious Consideration Test. With this approach, if a change is well defined and under discussion by the group with the authority to implement it, it must be disclosed if the participant inquires. This is the more prevalent approach.

Material to the Participant Test. Here, courts consider whether there is a substantial likelihood that a reasonable person in the participant’s position would have considered the undisclosed information important in making a decision to retire. This applies to misrepresentations, and does not create a general duty to disclose future changes.

The court found that Soland did not meet the requirements of either of these standards and denied his claim. This is a developing area, and courts may differ on the level of participant inquiry required to trigger an obligation to disclose.

It is important for plan sponsors and fiduciaries to be aware that potential issues lurk in this area and prepare themselves to mitigate possible problems.


Case #4: Santomenno v. John Hancock Life Insurance Company (3rd Cir. 2014)

Selecting and offering a limited menu of investments at the service provider level does not create fiduciary status or responsibility. Fiduciary responsibility rests with the individual fiduciaries who select the investment lineup to be offered in their plans. 

Consistent with other courts that have considered this issue, the U.S. Court of Appeals for the Third Circuit found that John Hancock was not a fiduciary to its 401(k) client plans when it offered them a preselected menu of investment options from which individual plan fiduciaries chose the particular investments to use in their plans. Participants argued that John Hancock was a fiduciary because it had discretion over plan assets by selecting the investments in the overall menu and because it had the authority to change those investments from time to time. The court found that the individuals at the plan-sponsor level who decided which investments to make available to participants are the responsible fiduciaries to the plan — not the service provider. 

The participants claimed that John Hancock, as a fiduciary, breached its duty to plan participants by overcharging for its services. In addition to finding that John Hancock was not a fiduciary with respect to plan investments, the court also found that service providers are not fiduciaries in the negotiation and setting of their fees. Fiduciary responsibility lies with the plan fiduciaries who negotiate and agree to contract terms on behalf of plans and plan participants. This and similar decisions are a reminder that fiduciary responsibility ultimately lies with those acting in a fiduciary capacity at the plan-sponsor level concerning both investments and fees.

DOL Guidance on Lost Participants in DC Plans

The Department of Labor (DOL) issued a field assistance bulletin on plan fiduciaries’ responsibility to locate lost participants when terminating defined contribution plans. Although this guidance does not specifically address the obligations of fiduciaries for ongoing plans, it is a strong indication of the DOL’s views in this context as well. Although the decision to terminate a plan is a plan
sponsor (or “settlor”) decision, properly distributing plan assets is a fiduciary function. Under this guidance, to find
lost participants, plan fiduciaries must, at a minimum, do
the following:

Use certified mail to send notices;

Check plan-related resources;

Consult known beneficiaries of the missing participant; and 

Use free electronic search tools.

Consistent with the facts-and-circumstances nature of ERISA prudence, this guidance also suggests that fiduciaries take other reasonable steps (including those that include a cost) if circumstances warrant. This guidance also affirms the DOL’s preference for keeping retirement assets in retirement accounts (e.g., IRAs) when liquidating the assets of a terminating plan. (Paying assets allocable to a lost participant to the Internal Revenue Service by applying 100 percent income tax withholding was specifically rejected.) DOL Field Assistance Full Bulletin: No. 2014-01;

DOL Issues RFI on Self-Directed Brokerage Windows

The DOL has issued a request for information about self-directed brokerage windows in participant-directed retirement plans. This information is being sought to help the DOL decide whether regulations in this area are needed. 

If a self-directed brokerage window is properly designed, plan fiduciaries are not responsible for the quality of the investments available through the window. However, plan fiduciaries are responsible for monitoring the plan features and services they put in place. It is therefore appropriate for fiduciaries to receive periodic reports on whether the brokerage window is functioning properly and whether there have been participant complaints. Evaluation of the types of investments used in the brokerage window may also provide a useful indication of the types of investments participants are seeking outside the plan’s core lineup. 

Signature Authority on Corporate Accounts Triggers Fiduciary Status

Approximately $230,000 paid by plan participants for health insurance premiums was not properly segregated from corporate assets and used to pay for benefits, but rather was held in the plan sponsor’s checking account. The plan sponsor’s CEO was sued alleging breach of his fiduciary responsibility to the health plan’s participants. He sought to have the case dismissed because he was not involved in the administration or accounts of the health plan, and as a result was not a fiduciary. The DOL, who brought the suit, argued that by having signature authority over the corporate checking account that improperly held plan assets, the CEO exercised discretion over plan assets and became a fiduciary to the plan. The court agreed with the DOL and refused to dismiss the claims against the CEO in the Perez v. Geopharma, Inc. (M.D. Fla. 2014) case.

GAO Recommends DOL Regulation on Managed Accounts

The General Accountability Office (GAO) conducted an evaluation of managed accounts in 401(k) plans, and issued a report titled, “401(k) Plans: Improvements Can Be Made to Better Protect Participants in Managed Accounts.” The study reviewed the practices of eight managed account providers and found:

Different approaches to managing 401(k) accounts; 

Different fees; 

Acknowledgement of different fiduciary roles; and 

The actual or potential lack of disclosure about fees and investment performance.

Although not highlighted in the GAO report, plan fiduciaries whose plans offer managed accounts would seem to have a duty to prudently review services and fees when the program is included in the plan, and periodically monitor that it is functioning properly. Report:

Embezzler Recovers Plan Account

Todd Thomas was an accountant for James S. Bostwick, PC, and in the course of his work, he embezzled nearly $20 million. His employer was awarded a civil judgment for $19.8 million, and a criminal conviction and an $8.7 million restitution order were also entered. Before termination of his employment, Thomas participated in his employer’s profit sharing plan, and accumulated an account balance of approximately $21,000. The profit sharing plan was later terminated, and Thomas’s former employer retained the $21,000 allocable to him in partial satisfaction of his multimillion-dollar liability to the company. 

In the case of Thomas v. Bostwick (N. D. Cal. 2014), Mr. Thomas sued to recover the withheld $21,000, and won. Even though he had a liability to his former employer of nearly 1,000 times the amount of his profit sharing account balance, ERISA’s antialienation rules prevented the former employer from seizing it. Generally, the only time plan assets can be reached by debtors is when they are in the process of being paid out of the plan or when the participant’s wrongdoing causes losses to the plan holding his or her plan account. 

This article is intended to be informational only. CAPTRUST does not render legal, accounting, or tax advice. Plan sponsors requiring such advice should consult the appropriate legal, accounting, or tax advisor.