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How to Properly Mitigate Risk for Plan Fiduciaries

The Tussey v. ABB ruling raises the importance of implementing a fiduciary 'circuit-breaker' for plan sponsors that wish to off-load fiduciary responsibility for the selection, monitoring, and replacement of a plan's investment options.

W. Scott Simon, 08/02/2012

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.  

In this month's column, I continue to mine the riches provided by federal district court judge Nanette Laughrey in her 81-page opinion handed down in Tussey v. ABB, Inc. in late March. A fiduciary governance issue raised in that opinion is the subject of this column. Advisors with plan sponsor clients that wish to mitigate their fiduciary risk can bring this issue to their attention and provide a solution.

A Brief Review of the Case
Before getting to these issues, a brief review of the case is in order. Defendant ABB, Inc. (ABB) sponsored a number of retirement plans (totaling $1.4 billion in 2000), two of which were the subject of the Tussey lawsuit: the Personal Retirement Investment and Savings Management Plan and the Personal Retirement Investment and Savings Management Plan for Represented Employees (collectively, PRISM Plans), both 401(k) plans.

Plaintiff Ronald Tussey and others sued ABB, three ABB entities that were responsible in part for running the PRISM Plans, as well as other defendants for damages and injunctive relief. Two of these three ABB entities were (1) the three-member Employee Benefits Committee of ABB, Inc. (EB Committee), which is the named plan administrator pursuant to section 3(16) of the Employee Retirement Income Security Act (ERISA), appointed by the ABB board to oversee all employee benefits programs at ABB; and (2) the Pension Review Committee of ABB, Inc., (PR Committee), which is a named fiduciary of the PRISM Plans pursuant to ERISA section 402(a), responsible for selecting, monitoring, and replacing the PRISM Plans' investment options. (Alternatively, a named fiduciary could delegate such duties to a "discretionary" trustee pursuant to ERISA section 403(a) or to an ERISA investment manager pursuant to ERISA section 3(38).)

Did ABB, Inc. Fail to Mitigate Risk for Its Plan Fiduciaries?
In any 401(k) plan, the board of directors (BOD) of the company sponsoring the plan has the ultimate legal responsibility (and any potential related liability) for the plan. Even so, ERISA provides that a BOD may delegate fiduciary duties to various entities to mitigate some of that risk. It appears that ABB, Inc. did this in Tussey by, for example, naming the PR Committee as a named fiduciary and then delegating to it responsibility to select/manage/replace the investment options of the PRISM Plans. So far, so good.

However, note this language in Judge Loughery's opinion: "Changes to the [PRISM Plans] investment line-up must be approved by the Employees Benefits Committee and ABB, Inc." The word "approved" here seems to imply that not only the EB Committee but also ABB, Inc. itself had veto power over any "changes" made by the PR Committee in the plans' menu of investment options. If that's true, it would cancel out the discretionary authority delegated by ABB, Inc. to the PR Committee as a named fiduciary to select, monitor, and replace the investment options offered by the PRISM Plans. In turn, that would terminate whatever fiduciary protection the PR Committee had provided to the EB Committee and to ABB, Inc. concerning the investment options offered by the PRISM Plans. The effect of this would be for the EB Committee and ABB, Inc. to reassume fiduciary responsibility and liability instantly for the discretionary decision-making associated with the plans' investment options.

After all, ABB, Inc. (through its BOD)--the delegator of discretionary authority for the plans' investment options--cannot have it both ways. Either that delegation in Tussey is complete or it's not. A plan sponsor cannot transfer fiduciary responsibility for its plan's investments to another entity and then expect to retain a veto power over the prudence of the investments made by that entity. Once the legal responsibility delegated to the PR Committee was terminated, that responsibility (and related potential liability), as noted, reverted instantly to the EB Committee and to ABB, Inc.

What If ABB, Inc. Had Delegated Fiduciary Responsibility Without a Veto?
But what if ABB, Inc. had, in fact, "properly" delegated fiduciary responsibility (as well as any potential related liability) to the named fiduciary PR Committee? That is, what if changes to the menu of investment options in the PRISM Plans were not subject to the veto of the EB Committee and ABB, Inc.? If that were the case, the discretionary authority delegated by ABB, Inc. to the named fiduciary PR Committee to select, monitor, and replace the investment options offered by the PRISM Plans would be retained. And that, in turn, would legally protect the EB Committee and ABB, Inc. from liability for the PR Committee's decisions concerning the prudence of the investment options offered by the PRISM Plans (assuming, of course, that the initial decision by the EB Committee and ABB, Inc. to retain the PR Committee was prudent and continued to be so).

Or would it?

It wouldn't, in my view. In Tussey where the PR Committee was delegated the discretionary authority to select, monitor, and replace the menu of investment options in the PRISM Plans but the delegating fiduciary retained a veto, it's clear that no legally effective delegation transpired to protect the "higher-ups": the EB Committee and ABB, Inc. But that would have also been true even had the delegating fiduciary not retained a veto. Here's how it should have been done.

The Fiduciary Circuit-Breaker: How to Properly Mitigate Risk for Plan Fiduciaries
In cases where a plan sponsor wishes to off-load fiduciary responsibility (and potential related liability) for the selection, monitoring, and replacement of a plan's investment options, it can do so by delegating same to a named fiduciary pursuant to ERISA section 402(a), to a discretionary trustee pursuant to ERISA section 403(a), or to an investment manager pursuant to ERISA section 3(38). But in all such cases, the delegating fiduciary will retain a monitoring duty to ensure that the initial selection of the delegatee was prudent and that retention of the delegatee continues to be prudent.

There is, however, a more legally protective way for a plan sponsor that wishes to mitigate the risk of its fiduciaries for selecting, monitoring, and replacing plan investment options. Rather than delegating such duties to some committee of the BOD and have the committee itself make decisions concerning the plan's investment options, instead give the committee the authority to hire, for example, an investment manager(s) that would itself then select the menu of investment options. That legally protects the delegating fiduciary such as a named fiduciary (i.e., a "higher-up") from potential liability for imprudent investment decisions made by the investment manager. This serves, in effect, as a "fiduciary circuit-breaker." If the committee makes the selections, though, the circuit-breaker is not in place and liability could lead all the way back up the chain of command to the BOD.

Here's how this fiduciary risk mitigation solution would look in abbreviated form:

--The BOD of a company sponsoring a 401(k) plan creates a committee and appoints its members.

--The committee is appointed with the authority, for example, to search for and retain, for example, an ERISA 3(38) fiduciary investment manager to select, monitor, and replace investment options in the plan.

--Should the committee choose to retain an investment manager, the responsibility and related liability for the selection/monitoring/replacement decisions concerning the investment options in the plan is legally off-loaded from the shoulders of the committee and the sponsor (through its BOD) onto those of the investment manager.

--This also means that the BOD would not have fiduciary responsibility and the related liability for monitoring the prudence of the investment manager. Instead, that responsibility and liability would inhere in the committee.

--The result, in sum, is creation of a fiduciary circuit-breaker that legally mitigates the risk of the BOD because the BOD (1) would not be responsible and liable for the investment, monitoring, and replacement decisions concerning a plan's investment options (instead, the 3(38) investment manager would be); nor (2) would the BOD be responsible and liable for monitoring the prudence of the investment manager (instead, the committee would be).

--Note, however, that the BOD would still retain the fiduciary responsibility to make sure its appointment of the committee was, and continues to be, a prudent one. This residual oversight of the committee would include such tasks as ensuring that committee members are properly appointed, are (and continue to be) qualified to serve, and that the committee is carrying out the duties that it was delegated to perform.

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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