BOARD MEMBER RESPONSIBILITIES FOR ERISA RETIREMENT
PLAN MANAGEMENT
2005-06-27 12:00:00.0
CDT
ERISA, the Employee Retirement Income Security Act of
1974, the federal law that governs retirement plan management, does not
articulate specific fiduciary governance processes. Indeed, this absence
of a statutory example of retirement plan governance is a primary cause
for dysfunction in the private retirement plan system in this country.
Over many years, the lack of a fiduciary governance safe harbor allowed
service vendors to heavily influence the development of Plan Sponsor
fiduciary behavior. As might be expected, the very nature of having
non-fiduciary service vendors influence the evolution of the retirement
industry has been counter productive to the fiduciary intent of serving
as a guardian for long-term Trust assets.
As a practical matter,
dysfunctional fiduciary behavior was irrelevant during much of the
1980fs and 1990fs. The extended bull market effectively shielded
fiduciaries from realizing liability. However, events of the past couple
of years have created the perfect storm for retirement plan fiduciaries,
which includes members of a Plan Administrative Committee as well as
those members of the Board of Directors who appoint them. For making
such appointments, those Board members (often part of the Compensation
Committee) are called gAppointing Fiduciariesh. Thirty years of case law
have made certain duties and responsibilities of an Appointing Fiduciary
very clear. To the extent their fail to perform their oversight duties,
they may incur personal financial liability for plan losses attributable
to a breach of fiduciary duty by the Committee members they appointed.
Given their net worth, the prospect of attaching personal liability to
those Board members makes them tempting targets for plaintifffs counsel.
To limit liability exposure for those Board members with ERISA oversight
responsibilities, we recommend the adoption of a systematic approach to
ERISA fiduciary governance.
RETIREMENT PLAN ADOPTION:
THE
CREATION OF THE PROMISE AND THE LIABILITY
A company adopts a
retirement plan by virtue of a Board resolution. Also by resolution, the
Board (or a Committee of the Board) appoints a Trustee for the Plan. A
subsequent resolution appointing individuals to a Plan Administrative
Committee (PAC) to manage the day-to-day affairs of the retirement plan.
Once a plan is created, the company is typically identified as the Plan
Administrator as that term is defined in ERISA. Sometimes the PAC itself
may be appointed as the Plan Administrator.
Once appointed, the
individuals serving on the PAC become fiduciaries and are obligated to
abide by ERISAfs principles in their conduct. It is their ability to
exercise discretion over the Planfs administration and the disposition
of the Planfs assets that generates their fiduciary status. Many Board
members mistakenly believe that once the PAC is appointed, the fiduciary
duties, responsibilities and liabilities of the Board members come to an
end. As a matter of law, such an assumption is not accurate.
The
Appointing Fiduciaries have an on-going duty to monitor the PACfs
activity. In essence, they have to assure themselves that the PAC
members know what they are supposed to do, have the resources to do what
there are supposed to do and fulfill their fiduciary duties to a Prudent
Expert standard of care. It makes sense that the Appointing Fiduciaries
would have to know what is implied by the Prudent Expert standard of
care so that their monitoring efforts can correctly identify whether the
PACfs activities were appropriate ? or not. If the PAC members fail to
fulfill their duties to the required standard of care and the Plan
suffers losses that are tied back to that failure, the liability for
those losses can be personal and can fall upon the shoulders of the
Appointing Fiduciaries.
The monitoring duties of the Appointing
Fiduciaries serve as a check and balance in the retirement plan
management system. This is why it is so important. Clearly, if
substantive monitoring is implemented and documented, a credible defense
strategy is more readily constructed. In fact, the very presence of
thorough monitoring documentation by the Board will tend to deter
litigation. After all, the plaintifffs bar would rather pursue companies
that are unprepared to defend themselves i.e., the low hanging fruit,
rather than those companies who have gone to such lengths as to
establish a thorough monitoring system.
BACKGROUND: THE
CREATION OF FIDUCIARY STATUS
The fiduciary duty of Board members
to monitor the individuals they have appointed to the PAC is not a new
phenomenon. What is also not new is that this monitoring duty never goes
away. The monitoring function is on-going and requires, as a best
practice, that there be evidence of the monitoring activity. Case law is
clear on this point. Government regulatory authorities are also clear on
this point. Indeed, the Department of Labor has filed amicus curae
briefs in some of the most visible lawsuits championing the plaintifffs
point of view that the Boardfs failure to monitor the PACfs actions or
lack of actions constitutes a breach of fiduciary duty by the Appointing
Fiduciaries.
Understanding the Basic Framework
ERISA
defines a fiduciary in operational terms. For example, ERISA states that
a party is a Plan fiduciary to the extent it:
(1) exercises
discretionary authority or control with respect to management of the
plan or the management or disposition of plan assets;
(2) has
discretionary authority or responsibility in the administration of the
plan; or
(3) renders investment advice, with respect to plan assets,
for a fee or other compensation (or has the authority or responsibility
to render such advice).
While the above definitions seem
somewhat obvious, they include the more subtle circumstance in which an
individual (or organization) with the authority to exercise discretion
over the plan assets or administration did not do so when the
circumstances warranted action. From a strict liability perspective,
doing nothing, when one should do something, is the same as doing
something inappropriate in the first place.
There is a fourth
kind of definition, somewhat more subtle, as to how one creates a
fiduciary status to a retirement plan. It is applied when someone
exercises discretion over the planfs administration or assets even
though they may not have known that they did so, may not do so under
gnormalh circumstances or may have disclaimed any responsibility for
doing so. Clearly, the intent of declaring someone to be a functional
fiduciary is to capture exogenous events that may otherwise not fit
neatly into one of the three definitions above.
Mitigating
Risk: What Can An Appointing Fiduciary Do?
For Appointing
Fiduciaries, mitigating ERISA fiduciary risk is a two-fold exercise.
First and foremost, an Appointing Fiduciary should promote a fiduciary
culture and governance system that shines a bright light on the business
relationship every service vendor has to the retirement Plan. Naturally,
all service vendors have self-interest embedded in their products or
services. In a fiduciary context, the purpose of shining a bright light
is to put that self-interest gon the tableh. Only then can plan
fiduciaries determine whether that self-interest is reasonable,
tolerable or does harm to plan participants. If PAC members do not know
what a vendorfs self-interest is, they cannot be in a position to assess
the appropriateness of the business relationship the vendor has to the
retirement Trust. Without that analysis, neither they nor the Appointing
Fiduciaries are in a position to honor the duty of loyalty required of
an ERISA fiduciary.
Secondly, the Appointing Fiduciaries should
encourage a system of documentation that will serve as evidence to
anyone looking over the PACfs shoulders that the Plan Sponsorfs
fiduciary duties have been properly executed to a Prudent Man (the
language ERISA uses) standard of care. This standard of care is often
misunderstood. It is often mistaken for some kind of assessment of
character ? as though the prudence of the PAC membersf personalities
would, by itself, be sufficient to meet the standard. We call this
circumstance the gcbut wefre good people herech mistake. The Prudent Man
standard of care requires that PAC members are knowledgeable as to the
duties required of them and how to carry out those duties They are
either supposed to be Prudent Experts in all elements of plan management
or they are supposed to hire them. Hiring a Prudent Expert whose
self-interest conflicts with the best interests of the plan participants
is inconsistent with the required standard of care.
Unfortunately, neither ERISA nor the Department of Labor
articulates a safe harbor against fiduciary liability. They both address
fiduciary conduct by articulating principles rather than processes. Our
advice to Appointing Fiduciaries on how to avoid liability, in an
environment with no safe harbor, is to focus on being very practical.
The higher the standard of conduct exemplified by the Plan Sponsor, the
greater the likelihood that the risk of liability exposure has been
contained. As might be expected, plaintifffs counsel likes to pursue low
hanging fruit. Therefore, the higher up on the tree your governance
system puts you, the better your protection against the threat of
litigation.
When it comes to ERISA fiduciary liability the
success of plaintifffs counsel is directly related to whether there is
documentation that illustrates the fiduciariesf use of prudent processes
in their decision-making. This is a dramatically different focus on
liability containment from the more commonplace notion that poor
investment performance generates liability. Assuring good investment
performance results is not a fiduciary duty. Said differently, poor
investment performance, in and of itself, is not a sufficient basis by
which plaintifffs counsel can successfully sue a Plan Sponsor for breach
of fiduciary duty. Rather, those companies that fail to establish
prudent processes or fail to establish thorough documentation of their
use, are the ones rightfully characterized by plaintifffs counsel as
glow hanging fruith.
What Can An Appointing Fiduciary Do?
Below are a few simple guidelines for Appointing Fiduciaries to
assure themselves that a sound fiduciary governance structure and system
are in place.
1. The Appointing Fiduciaries set the tone for the
fiduciary culture of the Plan Sponsor. Let it be known that the PAC
members are expected to exercise courage and conviction in the face of
any influence which does harm to the best interests of the plan
participants. If it is expected of them, PAC members are more likely to
conduct themselves with an intention consistent with those values.
Alternatively, if you communicate that ggood enough is sufficienth you
will allow room for expediency to be master of plan governance rather
than purposeful intent.
2. Historically, most PAC members have
not been trained to serve as plan fiduciaries. They do not know what is
required to exemplify a Prudent Expert standard of care. As you can
imagine, defending the fiduciary conduct of a PAC member is more
difficult when the PAC has not received substantive ERISA fiduciary
training. Such training will lead to higher quality decision making by
the PAC members. Inexpensive training is available through Financial
Executives International, the largest association of finance officers in
the country (at www.fei.org/erisa).
3. PAC members must become
well versed in the distinction between the exercise of gsound business
judgmenth and the exercise of gsound fiduciary judgmenth. This is the
heart and soul of the problem often referred to as gthe wearing of two
hatsh. What might pass for the exercise of sound business judgment is
often insufficient to rise to the standard of conduct required of a
retirement plan fiduciary. The inability to draw this distinction
generates litigation risk for all fiduciaries.
4. PAC members
must be able to identify and use qualified unconflicted advisors in the
fulfillment of their duties. The Committee must be provided with
adequate resources to do the job. All too often, PACs operate with a
loose governance structure and too few resources. Committee charters are
often lacking. Further, individual PAC members are not held accountable
for the fulfillment of specific statutory duties. The lack of personal
accountability generates a dysfunctional governance structure. Without a
clear governance structure, there is too much reliance on plan vendors
to guide critical issues in plan management.
5. Establish a
process to shine a bright light. Typically, the largest Plan vendors
disclaim their fiduciary status in their client service agreements. To
disclaim such status the non-fiduciary vendor in effect states that they
are legally entitled to represent their self-interest first when doing
business with the Plan. Vendor self-interest is the very influence which
PAC members are supposed to guard against. To make matters worse, mutual
fund companies, the largest plan vendors, are granted a statutory
exemption from plan fiduciary status. Their self-interest, often not
readily apparent, must be identified and challenged if a fiduciary is to
uphold their role of guardian.
Tolerating the imposition of
vendor self-interest leaves PAC members and those members of the Board
of Directors who serve as Appointing Fiduciaries open to personal
liability. The only way to avoid such exposure is to shine a very bright
light on a vendorfs business relationship with the Plan and Plan
Sponsor. Implement and document a thorough process to examine the
self-interest of all service vendors.
6. An independent
investment advisor could be retained to provide the Committee with the
advice it needs to oversee the Planfs investments. Alternatively, the
Appointing Fiduciaries could retain an independent fiduciary to manage
the plan in its entirety. The independence of an advisor is not always
obvious. For example, even if the consulting advisory firm is not
economically tied to the planfs investments, an investment advisor
appointed from the same consulting firm engaged in a health and welfare
or compensation consulting project is NOT independent. Their lack of
independence comes from a reluctance to say or do anything that would
jeopardize the revenue from other consulting engagements.
The
Public Company Accounting Oversight Board (PCAOB) came into existence
after intimate auditor involvement in the corporate scandals of the past
few years. One of its goals has been to identify conflicts-of-interest
for CPA firms that provide a multitude of services to publicly traded
companies or their executives. There is no PCAOB equivalent in the
employee benefit consulting industry. Therefore, we recommend that no
consulting firm with other Plan Sponsor consulting engagements be used
to provide investment advisory services to the retirement planfs
fiduciaries.
7. The Appointing Fiduciaries should assure
themselves that the PAC has a governance system in place that documents
PAC activities. That governance system should be comprehensive and at a
minimum, address all statutory fiduciary functions. The documentation
created by the system should be clear enough so that an independent
observer, reviewing a record of the PACfs activity two years from now,
could follow the thought process and understand the fiduciary basis for
the decisions made. The quality and thoroughness of the governance
systemfs documentation are fundamental to building an effective
deterrent to the threat of ERISA litigation.
8. At least
annually, the PAC should issue a summary of its activities to the
Appointing Fiduciaries. The appointing Board member(s) should review and
approve that report. The review and approval of the report should be
documented (in Board minutes).
SPECIAL NOTE OF CAUTION: ERISA
and SOX The Sarbanes-Oxley (SOX) legislation has altered the business
landscape and defined new standards for corporate governance. While SOX
contained a couple of provisions which explicitly impacted qualified
retirement plans, it was the requirements for internal controls under
SOX ˜404 that has the most dramatic impact for plan management
practices. The internal controls for an ERISA retirement plan invoke
core fiduciary principles applied to the terms and conditions
articulated in the planfs governing documents. Historically, this area
of ERISA compliance is problematic for Plan Sponsors. Though operational
compliance with the planfs governing instruments has always been a
statutory duty under ERISA, prior to the passage of SOX, failure to
achieve that compliance was a manageable challenge. After SOX, failure
to delineate and test the retirement planfs internal controls can be a
catastrophic event.
Now, a CFO and CEO who sign off on a
companyfs financial statements will violate SOX provisions if the
internal controls of the retirement plan have not been defined and
tested. Plan vendors (the major brand names) are not responsible for the
retirement planfs internal controls. They are responsible for their own
internal controls. A Plan Sponsorfs internal controls begin with payroll
processing and the assurance that the information gathered on plan
participants satisfies the requirements outlined in the planfs governing
documents.
The best way to assure the retirement planfs internal
controls is through a comprehensive fiduciary examination. The
comprehensive examination is an audit-like activity that seeks to
uncover discrepancies in operational compliance or the fiduciary
governance of the plan. Once identified, such discrepancies can be
amended and best practices can be adopted. Such an audit-like function
requires specialized skills and should be implemented through outside
counsel. It should not be implemented by an individual or organization
that has an existing relationship with the Plan or the Plan Sponsor. The
audit report is prepared for outside counsel and therefore should be
protected by attorney client privilege. If you wait until an IRS or DOL
audit discovers such operational defects, the Plan Sponsor and the plan
fiduciaries may be subject to ominous penalties, fines and sanctions,
including SOX violations, which can be criminal in nature.
