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How Not to Operate a 401(k) Plan

Recent ERISA case offers key takeaways for plan fiduciaries that receive revenue in exchange for providing services to their own retirement plan.

W. Scott Simon, 05/05/2016

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.

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To keep myself from going cross-eyed permanently, I thought it might be a good idea to take a break from reading the 1,023 pages of the new conflict of interest rule issued on April 6 by the U.S. Department of Labor (DOL) plus the widespread commentary it has generated.

Instead, I'd like to write about a case that crossed my desk last week. Apart from the case's startling facts, what caught my eye was the name of the defendant: City National Bank (CNB). Back when I practiced law in Los Angeles, I had the opportunity at one point to interview for a job in CNB's legal department in Beverly Hills. CNB was known as "The Bank to the Stars" for its many ties to the movie industry--perhaps in the most literal sense when CNB purportedly advanced the ransom money that Frank Sinatra paid to (successfully) rescue his kidnapped son. I didn't get the job at CNB, but throughout that process was very impressed with the professionalism of all I had come into contact with there.

So imagine my surprise when last month a federal district court judge nailed CNB for incomplete record-keeping concerning the bank's own 401(k) plan--sloppiness that one would expect more from a mom-and-pop business operating a plan. The judge found that the bank had engaged in self-dealing (among other things), which is strictly verboten under the Employee Retirement Income Security Act of 1974, as amended (ERISA).

The Facts
In April 2015, the DOL filed a complaint against a number of defendants concerning the City National Corporation Profit Sharing Plan (the Plan). (As of Dec. 31, 2014, the Plan had $660 million in assets with just over 4,300 active, retired, and separated participants as well as beneficiaries.) The Plan is a 401(k) defined contribution plan created for the benefit of employees of CNB and those of City National Corporation (CNC), and funded by employee and employer contributions. CNC is the parent company of CNB. City National Asset Management (CNAM), a division of CNB, provided investment advisor services to Plan participants. City National Securities, Inc. (CNS), a wholly owned subsidiary of CNB, provided broker-dealer services.

In April 2000, CNC and CNB agreed that CNB would provide trust and record-keeping services to the Plan. This agreement permitted CNB to receive "reasonable fees" for its services based on published fee schedules or as agreed to by CNC and CNB. The fee schedules also allowed CNB to receive "additional reasonable compensation" for its services in the form of mutual fund revenue-sharing payments garnered from mutual funds offered as investment options in the Plan.

According to the Plan documents, CNC was the Plan's "Sponsoring Employer," named fiduciary, and Plan Administrator with the authority to control and manage the Plan's operation and administration. Also pursuant to them, CNC appointed a Benefits Committee to take actions to administer the Plan as it deemed appropriate in its sole discretion, including selecting the Plan's investment options. The Plan's trust agreement identified CNB as the Plan's Trustee and, in that capacity, CNB was entitled to "reasonable compensation for its services" at a rate to be agreed upon by CNB and the Benefits Committee.

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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