More Fiduciary Basics

Once a new retirement plan is operational, fiduciaries should know how to avoid prohibited actions, mitigate fiduciary exposures and correct plan errors.

Regulations under the Employee Retirement Income Security Act require plans to avoid conflicts of interest and self-dealing. Plan fiduciaries must avoid business transactions prohibited by ERISA, to prevent dealings with parties who potentially could exercise improper influence over the plan, unless a transaction has been exempted.

The regulations have two aspects: 1) Who is a prohibited party? and 2) What are the prohibited transactions?

The Department of Labor’s ERISA publication, “Meeting Your Fiduciary Responsibilities,” explains that prohibited parties—also known as parties in interest—include the employer, any employee unions, plan fiduciaries, service providers, statutorily defined owners, officers and relatives of parties in interest.

Prohibited transactions between the plan and parties of interest include leases, sales and exchanges; loans and credit arrangements; furnishing facilities, goods or other services; using plan assets for their own benefit; and transactions involving the employer’s securities or real estate. Fiduciaries also cannot work on both sides of a transaction and receive compensation or consideration from the party doing business with the plan.

The regulations exempt some prohibited transactions, but fiduciaries should be sure that an exemption applies in their specific situation.

“When you’re dealing with an ERISA plan and engaging in a transaction, or a new investment course of action, or an administrative contract or hiring a service provider, you always have to think about these prohibited transaction rules,” cautions Marla Kreindler, a partner in the employee benefits and executive compensation practice of law firm Morgan Lewis. “Then you have to zero in on whether there’s an exemption that will allow you to proceed. Quite often, there are exemptions, but there certainly are not exemptions for all types of what would otherwise be prohibited transactions. Particularly when a transaction involves conflicts of interest, there’s less likely to be prohibited transaction exemptions that are available now.”

Engaging in a prohibited transaction can be costly. The Department of Labor may impose civil and criminal penalties, and the plan could lose its tax-qualified status. The IRS can levy excise tax penalties ranging from 15% to 100% of the amount involved, and the plan’s fiduciaries can incur substantial personal financial liability.

Mitigating Fiduciary Risk

Mitigation strategies can help reduce the risk of fiduciaries’ unintentional errors. Benjamin L. Grosz, a partner in Ivins, Phillips & Barker, Chartered, cites several actions that fiduciaries can take. It is usually beneficial to have a plan committee with at least three members who meet regularly, and the committee should document its process and decisions, he suggests.

“One of the best risk mitigation strategies for fiduciaries is to adopt and follow a prudent process when managing the plan,” Grosz emphasizes. “Think about establishing an investment policy, how you choose your plan vendors, get bids, evaluate services and fees. Bring in the right experts to help if it’s outside of your area of expertise. When you have plan vendors, evaluate them regularly and make sure you’re following the plan procedures and provisions.”

Fiduciaries should also ensure the plan is complying with required disclosures. These disclosures include ERISA Section 408(b)(2), which requires many service providers to disclose compensation and potential conflicts of interest to plan fiduciaries. Grosz also recommends that plans with an ERISA Section 404(c) design that shifts investment risks to participants ensure they meet the section’s provisions to qualify for the available liability protection.

Fidelity bonds and fiduciary liability insurance are two additional risk management strategies. Claire Bouffard, a counsel at Morgan Lewis, explains that ERISA requires plans to have a fidelity bond to protect participants against fiduciaries’ acts of dishonesty and embezzlement. Fiduciary liability insurance is optional, but worth considering.

“The litigation climate is quite hostile,” says Bouffard. “We’ve seen a huge increase in plaintiffs bringing breach of fiduciary duty litigation. It spiked in 2020, but continues fairly strong. Many companies purchase fiduciary liability insurance to cover them in the event of these types of litigation.”

Kreindler points out that the fidelity bond and fiduciary liability insurance can be part of errors and omissions coverage, but she cautions that an E&O policy might not include the fidelity bond or the fiduciary liability insurance. Consequently, it is important for plan sponsors to review their insurance to determine if the policies provide the desired coverage.

Plan Corrections

Grosz says mistakes happen in plan administration, but fiduciaries should correct them promptly and not “push them under the rug.” Some plans work to avoid the risk of the IRS, DOL or a plan’s auditors finding problems by proactively seeking out errors. Those plan sponsors may engage Grosz’s firm to audit their plans to help identify problems and take steps to correct them and prevent their recurrence.

Bouffard says several correction programs are available if a plan makes or discovers an error, depending on what happened. If there is a prohibited transaction, plans can correct some issues via the DOL’s Voluntary Fiduciary Correction Program. It was recently updated for certain common prohibited transactions, such as late remittance of participant deferrals and loan-repayment and loan-related failures.

For what Bouffard calls operational failures, such as not following the plan document or not having a document, fiduciaries can generally correct those through the Employee Plans Compliance Resolution System.

“We expect that system to be updated in the relatively near future as a result of the many changes that have been made by [the SECURE 2.0 Act of 2022] around making self-corrections widely available,” Bouffard says.

More on this topic:

	ERISA Rules of the Road
	Does Outsourcing Impact the Need for Fiduciary Education?
	Fiduciary Basics for New Plan Sponsors