Heavy is the head that wears the crown.
While people who work with retirement plans are not monarchs, some do occasionally wear a rather heavy fiduciary "hat", a hat that traces its origins back to the time of kings, to medieval English courts.
People may put on this fiduciary hat intentionally or have it thrust upon them. Either way this hat brings with it special duties and risks, including personal liability.
'Tis a weighty hat indeed.
The goal of this article is to help retirement plan practitioners better understand fiduciary roles and duties. Specifically, this article seeks to provide a basic understanding of:
1. what a fiduciary is, including duties and liabilities;
2. how someone becomes a fiduciary; and
3. some best practices to help avoid unintentionally taking on fiduciary responsibility and to limit exposure.
I. What is a fiduciary and why do you keep talking about hats?!
A. What is a fiduciary?
To fully understand what a fiduciary is, it helps to understand that this is an ancient term. The word comes from a Latin word meaning reliance, trust, and faith. As noted above, the concept of a fiduciary relationship we see in ERISA is rooted in medieval English courts. These courts, originally overseen by a church official, decided matters based on what was fair and just, not contractual terms. It is impossible to separate the concept of a fiduciary relationship from a sense of fairness and a focus on good stewardship. To be a fiduciary, is to be an expert who puts an inherently vulnerable person's interests first.
Because of this, fiduciaries are held to a higher standard and subject to greater liability than ordinary service providers. Fiduciaries are supposed to put their clients' interests ahead of their own, to act impartially, to be an expert/prudent, and to follow the rules. In short, fiduciaries are supposed to concern themselves with doing the right thing and helping others flourish.
These duties can be summarized as duties of loyalty, prudence, and obedience. In practice, these duties require fiduciaries to do things like ensure fees paid by a plan are reasonable, monitor service providers, diversify investments, and put what is best for participants above self-interest.
As an example, under ERISA, employers must separate employee contributions from their general accounts as soon as reasonably possible. This requirement is tied to the duty of loyalty and the requirement that plan assets not work for the benefit of the employer.1 By holding employee contributions longer than necessary, an employer violates its duty of loyalty and gains an indirect benefit at the expense of participants, a sort of constructive loan. Allowing employers to gain the benefit of this float without cost strikes against the foundations of fiduciary duties.
Sometimes these duties have bright-line rules and other times they are based around facts and circumstances.
B. When do fiduciary duties attach? (why I keep mentioning hats)
I keep mentioning hats because there is a doctrine in ERISA known as the "two hats" doctrine. This doctrine metaphorically uses hats to explain when someone must act as a fiduciary and when they are allowed to not act as a fiduciary.
Fiduciary status does not apply to everything that fiduciary does. It is situational. As an analogy, I am a father to my children and I can choose to act fatherly towards children when I do things like help out with scouting or youth sports; however, I do not act in that role when I socialize with my peers. My role as a father shifts with my activity.
Moving back to ERISA, we can think of there being a fiduciary hat and a non-fiduciary hat. When we wear the fiduciary hat, we are supposed to pay attention to duties of loyalty, prudence, and obedience, but sometimes, that hat may come off. For example, employer fiduciaries are allowed to terminate retirement plans, decrease employer contribution formulas, and increase vesting schedules for future participants even though these acts arguably make participants worse off financially. This is because employers do not wear the fiduciary hat while making these decisions but are instead acting as employers.
C. How is fiduciary liability unique?
Another way fiduciaries are different from other service providers is their liability. Not only can fiduciaries be held personally liable for breaching their duties, but they can also be liable for other fiduciaries' breaches. This is known as co-fiduciary liability.2
Generally, this co-fiduciary liability can apply if a fiduciary:
1. knowingly participates in or conceals another's breach,
2. enables a breach through his own separate breach, or
3. knows about a breach and fails to make "reasonable efforts" to correct it.
Additionally, when a plan uses multiple non-directed/discretionary trustees,3 trustees can have even greater exposure. Specifically, to avoid co-fiduciary liability, such trustees must use "reasonable care" to actively prevent the other trustees from breaching their duties.
Luckily for fiduciaries, there are limits on co-fiduciary liability. Specifically, named fiduciaries may avoid co-fiduciary liability under points 2 and 3 above for duties they have allocated to other people according to ERISA § 405(c).
Additionally, if the plan uses an investment manager (i.e., a fiduciary under ERISA § 3(38)), trustees can avoid the special co-fiduciary liability and liability under 2 and 3 above for that investment manager's investment or asset management decisions.
To better understand fiduciary/co-fiduciary liability, one must understand when fiduciary status applies. To do this, looking at the source of the fiduciary relationship/what type of fiduciary the person is acting as can be helpful.
II. How does someone become a fiduciary and when does that status apply?
People may voluntarily become fiduciaries or become one through their actions. Regardless, when acting as a fiduciary, that person must meet their duties of loyalty, prudence, and obedience.
For example, an employer who is a "named fiduciary" must wear its fiduciary hat when doing things like selecting a service provider, assessing the reasonableness of fees paid for with plan assets, monitoring the performance of other fiduciaries, etc., but the employer may switch to the non-fiduciary hat when doing things like choosing plan provisions or terminating the plan (i.e., "settlor" acts).
Additionally, different realms of responsibility apply to different types of fiduciaries and it is possible for one person to hold multiple fiduciary roles.4 The types of fiduciaries listed in ERISA are outlined below.
It is important to note, that a fiduciary can be liable for breaches that occur outside of its realm of responsibility. As an example, if a trustee knows that an accidental fiduciary has committed a breach, that trustee must make reasonable efforts to remedy the breach or risk liability under ERISA § 405(a)(3).
III. What are some ways I can limit fiduciary liability and avoid becoming a fiduciary?
A. Not using plan assets to pay fees
As noted earlier, named fiduciaries can limit liability by allocating fiduciary duties to others; however, this allocation does not absolve them of their responsibilities because they still must both monitor whomever they allocate authority to and adhere to their fiduciary duties when selecting a provider.
When allocating authority like this, the source of funds used to pay the service provider can impact potential financial exposure. Specifically, if the provider is paid from plan assets, then fiduciaries must ensure those fees are reasonable. Lawsuits based around the reasonableness of fees are common these days. Because of this, it can be helpful to compare providers by analyzing not only flat and per capita charges paid from plan assets, but also investment fees paid by participants.
B. Avoid discretion
Another way to avoid accidental fiduciary liability exposure is to ensure service contracts do not provide authority to exercise discretion and then ensuring operational processes reflect that lack of discretion. Simply stating that someone is not a fiduciary and does not have discretion over plan administration or assets is not enough. If someone possesses or exercises authority or discretion over plan administration or assets, then that person is a fiduciary under ERISA § 3(21).
C. Document processes and reasons for deviations from processes
A fiduciary's duty to act prudently is often subject to facts and circumstances. By writing down processes and deviations from those processes, fiduciaries can show how they fulfilled their duties, identify areas where they can improve, and provide justification for things that might otherwise be considered a breach.
For example, determining if an employer has separated employee contributions from its general assets as soon as reasonably possible, the DOL will often look at that employer's historical schedule. If there is a pay period with a longer than normal delay, the DOL might claim this additional time is unreasonable even if it is shorter than the deadline listed in 29 C.F.R. § 2510.3-102(b)(1). Having a record of why the delay happened gives the employer the opportunity to show that the delay was reasonable. If a delay happens because a payroll person is sick, the pay period involved a different type of pay (e.g., bonus instead of normal pay), or of a switch to a new payroll software, the employer should explain that in a note and then add that note to its plan's file.
Conclusion
Whether worn on deliberately or accidentally, to wear the fiduciary "hat" means taking on serious obligations and risking serious consequences; however, by being aware of when fiduciary status applies, documenting processes, and sticking to those processes, retirement plan service providers can more safely put on the fiduciary "hat".
While not a crown, by wearing this hat, we are able to go beyond our normal day-to-day of nondiscrimination testing, distribution processing, etc., and force ourselves to meet a higher standard, help the vulnerable, and consciously choose to help our neighbors flourish. By wearing the hat, we can be noble.