Compliance April 9, 2021

Interpreting Prudence and Loyalty Under ERISA

ERISA attorneys explain the meaning behind both terms and what plan fiduciaries can do to meet the requirements.
Reported by

The Employee Retirement Income Security Act (ERISA) requires plan fiduciaries to act with prudence and loyalty, but what do those terms actually mean for plan sponsors?

According to Charles Field, partner and co-chair of Sanford Heisler Sharp’s Financial Services Litigation Practice Group in San Diego, under the duty of loyalty, employers must act solely in the interest of participants, for the exclusive purpose of providing benefits to participants and defraying reasonable expenses when administering their plan.

Get more!  Sign up for PLANSPONSOR newsletters.

“Courts have said that this fundamental duty requires fiduciaries to act with ‘an eye single’ to the interests of participants and beneficiaries,” Field explains. “This means fiduciaries must avoid and mitigate conflicts of interest when selecting and monitoring a plan’s investments and in any other dealings with the plan.”

ERISA includes complex prohibited transaction rules, such as Section 406, that are designed to prevent self-dealing, notes David Klimaszewski, a partner at Culhane Meadows PLLC in Dallas. The Internal Revenue Code (IRC) also contains a rule in Section 401(a)(2) that requires plan assets be used “for the exclusive benefit” of participants and their beneficiaries.

For example, providing goods and services that are overly priced or perform poorly are common instances of prohibited transactions. Plan sponsors using plan assets for quid pro quo deals to benefit themselves or dealing exclusively with friends and family while eschewing more established market participants are other examples of how plan sponsors could put their own interests above those of plan participants, Field says.

In addition, financial institutions—including banks, brokers and investment advisers—that offer their own products and services to their company’s plan will always face duty of loyalty questions, he adds.

When it comes to the duty of prudence, ERISA says fiduciaries are to act with “the care, skill, prudence and diligence of a prudent person acting in a like capacity and familiar with such matters,” Field says. “Courts have said that prudence dictates that fiduciaries vigorously and independently investigate and regularly monitor each of the plan’s investment options with the skill of a prudent expert.”

For example, a prudent decisionmaking process would include evaluating the reasonableness of a plan’s service provider fees by comparing them against the marketplace. While the duty does not require a fiduciary to obtain the cheapest option, a fiduciary that fails to consider competitive bids runs the risk of being charged with an imprudent process, Field notes.

A prudent expert would also want to measure an investment option’s performance relative to both a recognized benchmark and investments within a comparable peer universe.

“While a fiduciary is not required to get the absolute best performance, investment options that consistently underperform their benchmarks and peers over an extended period of time expose fiduciaries to claims that their process is tainted by a failure of effort or competency,” Field continues.

It’s worth noting that ERISA’s prudent-man standard is a bit more flexible than what common law states, Klimaszewski adds. “ERISA fiduciaries may take into account more than just investment performance, such as the plan’s cash flow, upcoming distributions or the liquidity of the investments,” he points out.

Klimaszewski goes on to explain that prudence and loyalty apply to all fiduciary decisions made by the plan sponsor, but they’re most important when selecting service providers and choosing investments.

Selecting the right service provider, whether it be a trustee or third-party administrator (TPA), is crucial. In this case, the plan sponsor must investigate providers before making a decision and consider all the costs and the quality of services provided, including responsiveness and accuracy, Klimaszewski says.

When considering investments, most 401(k) plans allow participants to choose how they’d like to invest their plan benefits. “In this case, a fiduciary—often the plan sponsor—chooses which investment alternatives to make available to participants,” he says. The fiduciary/sponsor should therefore establish a process for evaluating different investment alternatives and a procedure for monitoring the performance of each alternative, Klimaszewski advises.

Investing April 8, 2021

What to Know Before Adding an SDBA to Your Plan

Self-directed brokerage accounts offer a multitude of options to the hands-on investor, but there are pros and cons of allowing retirement plan participants to use them.
Reported by

As more participants engage with their investments and take a more hands-on approach, sources say self-directed brokerage accounts (SDBAs) are becoming increasingly popular.

The accounts allow investors who are enrolled in a defined contribution (DC) retirement plan to access mutual funds, stocks, bonds, exchange-traded funds (ETFs) and more. SDBAs allow participants to select investments outside of the core menu lineup, explains Nathan Voris, senior managing director of business strategy at Schwab Retirement Plan Services. “It provides a window for 401(k) participants to access a much broader component of the market versus what has been a traditional core menu for the 401(k),” he says.

Get more!  Sign up for PLANSPONSOR newsletters.

For participants to invest in an SDBA, their retirement plan would first have to offer it as an investment option, says Renée Pastor, founder and wealth manager of the Pastor Financial Group, who specializes in 401(k) management. Plan sponsors would work with their consultants to learn more about their recordkeeper’s options for due diligence and ultimately add the platform as an option, Voris notes.

Then, the participant would fill out an application to enroll online with the recordkeeper. “Most recordkeepers have one or more SDBA providers on their platform. In the same way that a 401(k) provider or recordkeeper offers advice on managed accounts and target-date funds [TDFs], a brokerage window is one of those tools that really every recordkeeper has,” Voris says.

Because SDBAs do not add much additional cost to the plan sponsor and can be offered as an added benefit and choice to the participant, more employers are adopting the investment option, Pastor says. “Some SDBAs can open up to almost anything: individual stocks, bonds, ETFs. Some of them open up to larger mutual fund windows,” she says.

However, this level of accessibility is contingent upon plan sponsors, she notes. Employers can select the range of investments SDBAs offer, but even limited investment choices in an SDBA offer more than the plan menu itself, Pastor points out.

Flexibility at the participant level is another reason why DC plan sponsors may offer the option, especially for investors looking to engage with their finances, Voris says.

“This is a space for participants who want more flexibility, are more engaged with their retirement savings and want to invest beyond what is offered in the core menu,” he says. Additionally, many participants who leverage a brokerage window have a financial adviser who is attached to the feature.

However, plan sponsors should consider implementing some barriers in offering an SDBA, Voris says. One popular disadvantage are the accounts’ fees, which may be higher than the plan’s core menu.

“What you don’t want is a window that is assessing fees that may be above and beyond what the average 401(k) participant is paying,” Voris says. Yet he adds that more trading and other administrative fees are decreasing as providers lower or remove maintenance charges. Still, he recommends that sponsors check in with their recordkeepers and providers to assess whether fees are reasonable when considering the option.

Another concern is which participants will use the brokerage window. Voris notes a common worry among employers is that participants will use the option to day trade, though Schwab’s data shows SDBA users traded approximately 14 times per quarter in 2020. Some plan sponsors are also concerned about emotional investors or those who lack the discipline to manage their portfolios during market volatility.

In these scenarios, Pastor says she believes it’s up to employers to take action, such as by allowing participants to hire a third-party financial adviser for help. “Plan sponsors need to go a couple of extra steps beyond just offering the SDBA,” she says.

«