As Benjamin Franklin once said, “nothing is certain except death and taxes.” While at their core, Franklin’s words ring true today, there are more things we can predict with good certainty given our access to data.
For example, employers can get a sense for potential exposure by watching for a rise in certain unique lawsuits. Now in vogue: challenging 401(k) plan sponsors for allegedly breaching their fiduciary duty. The complaints typically allege an employer breached a fiduciary duty for failing to prudently manage the investment options, allowing excessive fees, and generally failing to carry out their oversight duties with sufficient care, skill, and diligence of a prudent person. If successful, these cases can result in hundreds of millions of dollars in damages and attorneys’ fees.
The ERISA standard
The decision to establish a 401(k) plan is a business decision. Companies are free to create a plan using their independent business judgment. However, once the plan is established, decisions regarding the operation of the plan are governed by the fiduciary obligation to act in the best interests of the plan participants.
The Employee Retirement Income Security Act (ERISA) defines the 401(k) fiduciary obligations as:
- acting solely in the interest of the participants and their beneficiaries;
- acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
- carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with the matters;
- following the plan documents; and
- diversifying plan investments.
10 critical questions
Based on these requirements, answer the following questions to confirm compliance:
- Does the company have a 401(k) committee that oversees the plan?
Effective governance typically requires an appointed committee with responsibility for overseeing the plan and designation as the plan fiduciary. The committee is typically responsible for overseeing the plan investment alternatives, selecting plan administrators, and monitoring investment performance, fees, and expenses.
- Does the committee have effective governance documents?
Most committees should have a charter that grants them authority to manage the plan and sets forth how members are selected, their term lengths, and similar matters. In addition, an Investment Policy Statement (IPS) is an essential tool to establish performance criteria for performance options, actions the committee will take when performance fails to meet expectations, and processes for ongoing review. Prudent oversight also entails maintaining minutes from committee meetings documenting decision-making and compliance with the IPS.
- Does the committee have signed agreements with financial advisors, third-party administrators, and record-keepers?
Signed agreements are crucial to understanding the role of each provider, expected deliverables, precise fee arrangements, and whether the provider is a plan fiduciary.
- Have the committee members been trained?
Training on basic 401(k) concepts and operational issues helps ensure that the committee members are exercising “care, skill, and prudence” in the performance of their duties. Each committee member should understand that their obligations are to act primarily for the benefit of the plan participants and not the company.
- Does the committee conduct regular reviews of the 401(k) providers and consultants?
Committees should regularly review the fees and services provided by the plan administrator and record-keepers, as well as consultants. The assessment should confirm the quality of the services provided as well as the competitiveness of the fees charged. The committee is not required to select the lowest cost providers. However, the fees must be reasonable. Bidding out services on a periodic basis (once every three to five years) is also an effective method to ensure high-quality services with cost-competitive fees.
- Does the committee review the plan offerings on a continuous basis?
It is important to document that the committee is monitoring plan performance on a continuous basis to ensure there are no changes or events that would impact the suitability of the investment alternatives. In addition, ongoing monitoring is necessary to ensure that the plan offers a diversified mix of offerings to meet the plan participants’ needs.
- Does the committee confirm that it is using the lowest fee options for various investment alternatives?
It’s not uncommon for investment firms to offer several different classes of identical funds with different fees. The committee should have a record that confirms there are no lower fee options for the same type of fund offered by the same investment firm. The fees don’t have to be lower than fees offered by any competing firm, but they must be reasonable.
- Does the committee have documented benchmarks for investment performance?
The committee should monitor investment performance relative to established benchmarks. In addition, it’s important to place funds on a “watch list” if their performance is unsatisfactory and replace funds if such performance persists to demonstrate prudent management. Funds can also change their investment objectives over time. Accordingly, the committee should also monitor funds’ characteristics to ensure the plan is offering the level of diversification originally intended.
- Is the committee providing regular communication and educational opportunities for plan participants?
The committee should have a specific plan for providing regular updates to employees. Consider using newsletters and group meetings to explain plan operations and benefits.
- Should analysis of the plan be conducted under the attorney-client privilege?
If there are concerns about governance of the plan, the company may wish to consider conducting the governance assessment under the attorney-client privilege. That does not prevent facts about plan operations from coming to light but does allow the company to understand potential legal exposure and explore alternatives to address concerns in a confidential setting. The decision to utilize the attorney-client privilege is a case-by-case determination and should be conducted with the advice of counsel.
Franklin also once said, “There are no gains without pains.” The same can be said about compliance with the ERISA standard. Reach out to an attorney with any questions about how to effectively administer plans, and document that administration, to satisfy fiduciary duties and limit potential exposure.
Stephen Scott is a partner in the Portland office of Fisher Phillips.