Could these current legal cases have been avoided?
Last month I described in detail how it's possible to insulate the sponsor of a qualified retirement plan such as a 401(k) plan--the "sponsor" actually being represented collectively by real flesh and blood humans who serve as trustees and other named and functional fiduciaries of the plan--from virtually all day-to-day fiduciary investment risk as well as operational/administrative risk to which they would otherwise be subject for sponsoring the plan.
In this month's column, I'll discuss two recent, ongoing lawsuits, one involving a very large publicly traded company and one involving a relatively small law firm, and show how they could have avoided the costs (and needless time and heartbreak) associated with the litigation by simply retaining a professional named independent fiduciary. I'll also explain why very few plan sponsors have never even heard of the kind of significant risk mitigation described in this series--much less understand how they can benefit powerfully from it.
Summary of the Previous Columns in this Series
Before delving into the meat of this month's column, I thought it might be helpful to first summarize briefly the broad powers and duties that may be delegated by plan sponsors under the Employee Retirement Income Security Act of 1974 (ERISA).
A "named fiduciary" under ERISA section 402(a) is typically the board of directors of a plan sponsor. This provision is normally not spelled out in the plan document but is an implied, inherent duty that gives the plan sponsor the power to appoint all other fiduciaries. ERISA section 402(a) is the originating power and authority under ERISA that allows a plan sponsor to choose whether it wishes to retain all or some fiduciary duties, or off-load them to other fiduciaries.
Under ERISA section 402(a), the board of directors of a plan sponsor has the power to delegate limited scope duties to a specialized fiduciary responsible for administration of the plan (ERISA section 3(16)), one responsible for selecting, monitoring and (if necessary) replacing the investment options offered in the plan (ERISA section 3(38)), one responsible for trustee duties defined in the plan (ERISA section 403(a)) or one responsible for a narrowly defined jurisdiction where discretion can be exercised such as the prudence of holding company stock (ERISA section 3(21)). There are a few sophisticated techniques where the board of directors can delegate even the inherent 402(a) responsibility, but that's beyond the scope of this series.
Alternatively, a plan sponsor has the power to "wrap up in a package with a beautiful bow" all the preceding duties and delegate them to a professional full-scope, independent named fiduciary pursuant to ERISA section 3(21). Instead of liability for retaining some (or all) such duties or instead of liability for parceling out some (or all) such duties to specialized fiduciaries on its own, the plan sponsor can simply off-load liability for such duties by delegating them all to a full-scope ERISA section 3(21) fiduciary. No muss, no fuss, for the plan sponsor. The only liability retained by the sponsor in these circumstances is a residual oversight duty.
Upon acceptance of this delegation from a plan sponsor, a full-scope ERISA section 3(21) fiduciary can then turn around and delegate each of the preceding duties to specialized fiduciaries (for purposes of efficiency and risk management). This kind of 3(21) fiduciary has the burden to ensure that the specialized fiduciaries to whom it has delegated these duties are prudent in carrying them out since it is the full-scope 3(21) fiduciary (not the plan sponsor) that will suffer the consequences if they are carried out imprudently. As a result of this, the plan sponsor is insulated from virtually all day-to-day fiduciary investment risk as well as operational/administrative risk.
Braden v. Wal-Mart Stores, Inc.
The first recent, ongoing lawsuit I'd like to discuss is Braden v. Wal-Mart Stores, Inc. which is currently on appeal to the 8th Circuit Court of Appeals. At the time Braden was filed, the Wal-Mart 401(k) plan had more than 1 million participants (purportedly the largest 401(k) plan in the U.S. based on number of participants) who collectively invested over $10 billion in the plan. The plan apparently offered ten investment options: seven mutual funds, a common/collective trust, a stable value fund and Wal-Mart common stock.
Braden (a Wal-Mart employee) alleged that (1) the seven mutual funds (primarily actively managed) were all retail priced but even for retail funds were excessively overpriced and (2) revenue-sharing fees accruing to Merrill Lynch (the plan trustee) influenced and therefore corrupted the process by which the plan's investment options were made available to plan participants. Another (nearly unbelievable) allegation is the existence of an agreement between Wal-Mart and Merrill Lynch which provides that compensation paid by the plan is confidential, that neither party may disclose that compensation to plan participants and that if any such disclosures were made, Merrill Lynch would resign as trustee.
Wal-Mart's company motto is "Save money. Live better." One of Braden's allegations, as noted, was that all seven mutual fund investment options were priced at retail, not institutional--and were excessively priced even for retail class shares. One would think that those at Wal-Mart in charge of the company's 401(k) plan would grind Merrill Lynch exceeding fine on the prices of those funds. If they had, Wal-Mart (and the participants in the Wal-Mart 401(k) plan) would have saved money and, as a result, they could have lived better (now and in retirement). You'd also think that Wal-Mart would be just a tad embarrassed by paying retail on $10 billion.
In a friendly gesture to help out one of the world's largest companies, I make this offer: I will personally assemble a highly sophisticated team of service providers to the Wal-Mart 401(k) plan which will provide its 1 million participants with a world class retirement plan--all for significantly less than what they are currently paying for the cost of the mutual funds alone. The offer includes payment for the whole enchilada: the services of a professional ERISA section 3(21) named fiduciary who will accept appointment for all day-to-day investment and administrative/operational responsibilities and liabilities, fees for all investment options, investment advisory fees, custodial costs, record-keeping costs and all other costs.
The terms of this offer don't require compliance with ERISA section 404(c) (since a full-scope ERISA section 3(21) fiduciary would be in charge) so no money from Wal-Mart corporate coffers or the pockets of plan participants need be expended. There would be none of the nonsense of commissions, revenue-sharing costs or 12b-1 fees. What's more, the bid-ask spread costs, market impact costs and trading costs of the investment options offered by the Wal-Mart 401(k) plan would all be kept very low since the plan's investment options would be institutionally priced, automatically rebalanced model portfolios of passively managed mutual funds comprised of thousands and thousands of securities covering approximately one-fifth of the world's countries. These portfolios would be built according to the principles of modern portfolio theory which, in a twist of fate, has provided the theoretical and practical underpinnings of not only ERISA (for 35 years) but also the Uniform Prudent Investor Act and its sundry fiduciary progeny.
My offer would also include hitting the eject button for plan providers such as the trustee (you know, the fiduciary that held in trust all $10 billion in the Wal-Mart 401(k) plan!) that allegedly rope-a-doped Wal-Mart into agreeing in writing (under threat of the trustee resigning!) to purportedly avoid divulging how much revenue-sharing the trustee was actually receiving off the backs of those 1 million participants. (With fiduciaries like that, who needs enemies?)
Implementation of my offer--with a bow to 1980s jargon--is a win/win/win. It's a win for participants in the Wal-Mart 401(k) plan (or participants in any 401(k) plan) because they need pick only one very low cost, broadly diversified model portfolio which, relative to other investment options, will stand them in good stead through thick and thin. It's a win for Wal-Mart (or any plan sponsor) because it gets to off-load virtually all fiduciary responsibility (and therefore virtually all fiduciary liability) to a full-scope ERISA section 3(21) named fiduciary. And gosh, it's even a win for Merrill Lynch because it gets to follow through on its threat to resign. But my offer is of limited duration and will soon expire, so hurry and make that call; operators are standing by.
Shartsis Friese v. JP Morgan Chase & Co.
The second ongoing lawsuit involves a relatively small law firm, not a giant publicly traded company. Earlier this month, a U.S. district court judge in northern California issued a denial of motion for summary judgment in Shartsis Friese v. JP Morgan Chase & Co.
Shartsis Friese LLP is a San Francisco-based law firm of nearly 60 attorneys. The firm, according to its Web site, "represents more than 300 investment advisers and investment fund managers." The gist of the case is a dispute with JP Morgan Retirement Services over the correct formula for determining the amount of contributions that the firm's employees were required to make to their defined benefit plan.
This is another example where a full-scope ERISA section 3(21) independent named fiduciary could have been utilized by a plan sponsor to protect itself and the plan participants--and, ironically, even JP Morgan Retirement Services. An expert independent fiduciary would understand how actuarial funding methods work and would ensure that the formulas in the plan document were being applied properly. An expert fiduciary could have been given the responsibility to ensure that the terms of the plan were being adhered to and the plan's service providers were being monitored properly.
The perfect time to appoint an independent fiduciary is when a plan sponsor does not have the expertise or time to monitor the plan's service providers. Delegation of fiduciary responsibility and risk to a trained professional allows a law firm such as Shartsis Friese LLP to avoid spending its partners' money on otherwise needless litigation and it means much less stress and worry for a firm's partners, associates, and support staff. Any retirement plan should be a benefit, not a (financial and emotional) burden.
There's just no good reason why a law firm or any other kind of business should ever have to fool around with the many moving parts of a 401(k) plan. I have been retained as an expert in the Fortune 500 arena and it was shocking to see close-up how many in that milieu have no better handle on how to run a 401(k) plan competently than the smallest companies. How else to explain, for example, the spectacle of many such companies with billions of dollars in their 401(k) plans offering plan participants retail-priced investment options? The behavior that leads to such spectacles, which has an impact on the lives of millions of plan participants, must be characterized as nothing less than imprudent per se.
Why the Widespread Ignorance over Risk Mitigation
If many of the fiduciary sponsors of qualified retirement plans that have the responsibility to provide participants with prudent 401(k) plans have little motivation or knowledge to do so, then the non-fiduciary plan providers that dominate the retirement plan industry have none. Why should such providers want to educate sponsors about anything that will cost them profits and expose them to the added risks of assuming real fiduciary responsibility?
The law of ERISA is clear that professional fiduciaries fully conversant with the ins and outs of ERISA laws and procedures ideally should run qualified retirement plans including 401(k) plans. And yet many, many (non-fiduciary) service providers in the retirement plan industry force (fiduciary) plan sponsors into an imprudent business model featuring 401(k) plans with investment options bearing high (and hidden) costs and woefully inadequate diversification of risk. No wonder very few plan sponsors have ever heard of the kind of significant risk mitigation discussed in this series that's always been open to them under ERISA.
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