INTRODUCTION
XXXXX has identified some issues of concern where employee benefit plans frequently fail to comply with the regulatory requirements laid down by law. The purpose of this book is to identify the areas of deficiency, and recommend solutions to specific problems, which will enable clients to ensure compliance and thereby insulate themselves from fiduciary liability.
THE PROBLEMS
Not following written investment objectives.
ERISA law is full of cases in which trustees, sponsors and money managers are liable for not having or not following written investment objectives. For example:
In Dardaganis v. Grace Capital, the money manager ignored the trustee’s refusal to raise the % limitation on investments, and exceeded that limitation. The manager, Grace, was found to be personally liable as he signed on to personally oversee and manage the portfolio.
In GIW Industries v. Trevor Stewart, Burton and Jacobson, trustees were liable for allowing a money manager to disregard the investment objectives of a fund. Trevor Stewart invested 75% of GIW’s portfolio in long-term government bonds. GIW knew of TSBJ’s investment philosophy but hired them with no restrictions. No one at TSBJ read plan documents, knew the plan history, their cash needs or the demographics of the participants. When Trevor was terminated, they had lost over $700,000 and collected fees of $17,031.54. The court said TSBJ subjected GIW to too much market risk and liquidity risk and failed to diversify the investments. They were fined $537,000 and had to rebate their fees. The Court, then, turned around and found the Trustees jointly responsible for “allowing” TSBJ to violate the investment objectives.
Not following prudent procedures.
In the still landmark case, Whitfield v. Cohen, Miller Druck president Malcolm Cohen was personally liable for $637,412 for not monitoring the investments of the company money manager (who later turned out to be unregistered, and went belly-up), and for continuing the investment when it was clearly inappropriate for Miller Druck.
Not hiring an expert.
In Liss v. Smith, the court said, “Where the trustees lack the requisite knowledge, experience and expertise to make the necessary decisions with respect to investments, their fiduciary obligations require them to hire independent professional advisors …Failure to utilize due care in selecting and monitoring a fund’s service providers constitutes a breach of the trustee’s [i.e., the appointing fiduciary’s] fiduciary duty….Fiduciaries have an obligation to … select the provider whose service level, quality and fees best matches the fund’s needs and financial situation.”
Avoiding conflicts of interest.
In Blankenship v. Boyle, Trustees of the United Mine Workers were found to have breached their fiduciary responsibilities by letting substantial cash accumulate interest-free in a Union owned bank and directing retirement trust funds to be invested in electric utility companies in order to give the Union proxy control, forcing the utilities to buy Union mined coal. Even though the beneficiaries’ interests were clearly served because retirement contributions were directly related to Union mined coal, the trustees’ investment activities were found to clearly advance the Union’s interests first. The aid to the fund was only incidental to the Union enhancement. The court found the trustees’ activities were clearly imprudent in accumulating excess cash and in directing investments not solely in the interest of participants.
THE DUTIES AND RESPONSIBILITIES
Being a fiduciary, such as the trustee of an employee benefit plan, a trust, or a foundation or endowment carries with it enormous responsibilities. Fiduciaries have duties and responsibilities to their beneficiaries, plan participants, or recipients of the trust to which they are fiduciaries and there is a legal prescription as to the exercise of those responsibilities which is mandated by Federal and State regulations. From the IBM pension plan to the country Doctor’s sole 401(k) plan investments must be made according to specific standards of procedural prudence appropriate for investing other people’s money. Often, fiduciaries are unaware of their legal responsibilities. Even more frequently, people are unaware that they are held to be fiduciaries. The purpose of this book is to educate you, the party responsible for someone else’s money, just what your fiduciary status is, and exactly what duties and responsibilities you have according to that status. Included is a prescription for fiduciaries to follow to insulate themselves form potential liability.
In our book, we discus the Regulations, Laws, and Federal and State court cases which have been applied to the interpretation of fiduciary responsibility. If a fiduciary follows the prescription contained in our book, there is no absolute guarantee that they will never incur any liability, but at least the fiduciary will employ a prudent process. Prudence is the most essential element of compliance with fiduciary duty, for it is in showing that sound investment principles were prudently followed that fiduciaries have been found to have not breached their responsibilities to the people whose money they are responsible for when issues are in question.
Fiduciary responsibility is not rocket science; it is basically the ethical treatment of somebody else’s money. If you are the trustee of an employee benefit plan, a foundation, endowment or a common-law trust, you are probably a fiduciary, and as such have certain specific responsibilities, duties and liabilities. Generally we use ERISA as the prototype for fiduciary responsibility. However, it must be noted that ALL financial relationships in which someone else has a claim to the assets, like the beneficiaries of a trust are subject to fiduciary rules and requirements. We will examine the various regulatory requirements in the next chapter. Being a Trustee has fiduciary implications and should not be taken lightly.
Fiduciaries have to provide individualized investment advice given pursuant to a mutual understanding (read: contract) on a regular basis pertaining to valuation or recommendations as to investing for a fee. In the investment management consulting arena, this defines the money manager, and often the financial advisor, broker, or consultant. The duties of a fiduciary require unconflicted loyalty to the client first and the penalties for fiduciary breach are stiff, as discussed above. There are five general standards, which govern a fiduciaries conduct.
They must be solely in the interest of the participants and beneficiaries. Benefits must inure to the individual plan participants who have a right to monitor the activities of the fiduciary and the investments of the plan. But the trustees aren’t listening.
They must be for the exclusive purpose of providing secure benefits to participants and their beneficiaries. But the trustees aren’t listening.
They must be discharged in accordance with written instruments and documents which should include written investment objectives. Fiduciaries have the right to rely on professionals to assist them through this process. But the trustees aren’t listening. Investment duties must be discharged with the care, skill, prudence and diligence of an expert familiar with such matters. A fiduciary must consider all the facts and circumstances he or she should know are relevant to the plan’s investment objectives. But the trustees aren’t listening.
Investments must be diversified so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so. It is difficult to conceive of a situation where it would be clearly prudent not to minimize the risk of large losses. But the trustees aren’t listening.
Any plan fiduciary who breaches fiduciary responsibility rules is personally liable for losses caused by the breach. This liability extends to the owner, corporate officer, director, trustee, administrator, investment manager, and service provider. Furthermore, if a fiduciary knows or should have known of a breach by another fiduciary, he may be personally liable. Finally, a non-fiduciary who participates in, conceals or knows of a breach may be personally liable. Ignorance, lack of experience, failure to be informed or faulty communications will not be defenses. As a stark example, a trustee who is responsible for investing plan assets will have to pay out of his pocket losses to the plan as a result of imprudent investments. In a case of a failure to diversify, the fiduciary is personally liable for losses or missed opportunities resulting from the no-diversified excess. Losses may be determined by comparing the earnings from the improper investment with what would have been earned in other investments. The most profitable investment is taken as the standard. Courts will consider market advantages to holding the asset, conditions affecting price of the improper purchase and other plan assets as well as the beneficiaries’ interests. Liability may include interest and attorneys’ fees.
Courts use the comparative total return analysis to examine investment losses. The prudence of individual investment decisions is judged on the condition of the fund as a whole. The same factors that go into setting prudent investment objectives are those which are used to judge the actual asset investments. These include risk, return, liquidity, cash flow requirements, income, funding objectives and portfolio composition. The prudence of an investment is based on the time it is made, not on subsequent performance. This is why the initial selection of the investment is the most critical factor in the investment process.
Penalties may be imposed six years after the breach of duty or other fiduciary violation or three years after the party bringing the suit had actual knowledge of the breach.
A willful violation will carry personal criminal penalties and up to a 20% fine and one year in prison for reporting or disclosure violations.
Civil actions can be brought by participants, beneficiaries, fiduciaries, and the various Regulators. Losses to the plan must be restored as well as profits made from the use of plan assets. Failure to disclose information to participants will incur a substantial penalty. Injunctions, removal from duties, and placement of control over assets may be taken by the Department of labor.
While a fiduciary can purchase fiduciary insurance, it is an extremely expensive proposition. Indemnification agreements can be made, errors and omissions coverage obtained, or liability coverage purchased. These will in no way relieve the fiduciary from liability. The only way to avoid the liability is by proving that the fiduciary acted with prudence at all times.
All plans and their advisors must have bonding on officials, which at least provides protection to the plan for losses that might arise due to the dishonest activities of someone who exercises any control over plan assets.
These are some of the issues that we will discuss and provide compliant solutions for you the client. So we will examine in detail in the chapters which follow the issues and concerns, solutions and give examples of cases to support XXXXX’s complete guide to fiduciary compliance.