Fiduciaries, Look to the Law of Trusts as Your Guide

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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In its unanimous opinion in Tibble v. Edison International in 2015, the U.S. Supreme Court reminded all of the fundamental, underlying foundation from which the Employee Retirement Income Security Act of 1974, as amended (ERISA) originates: the common law of trusts. The court observed: "We have often noted that an ERISA fiduciary’s duty is 'derived from the common law of trusts…' In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts."

The Prefatory Note to the 1994 Uniform Prudent Investor Act (UPIA) states, in part: "[ERISA], the federal regulatory scheme for pension trusts enacted in 1974, absorbs trust-investment law through the prudence standard of ERISA 404(a)(1)(B), 29 U.S.C. 1104(a). The Supreme Court has said: ‘ERISA’s legislative history confirms that [ERISA’s] fiduciary responsibility provisions 'codif[y] and mak[e] applicable to [ERISA] fiduciaries certain principles developed in the evolution of the law of trusts.' Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 110-11 (1989) [footnote omitted]."

In effect, ERISA "federalized" the common law of trusts. The legislative history of ERISA explains that the law governing qualified retirement plans is tied closely to trust investment law. (See the preamble to ERISA regulations section 2550.404a-1 and the accompanying discussion.)

The standard of trust investment law has been described this way: "By declaring that all retirement … assets are held in trust … [participants and their beneficiaries] are guaranteed the highest standard of conduct in the management and investment of assets for retirement that the law can establish. A trustee … carries the greatest burdens of care, loyalty and utmost good faith for the beneficiaries to whom he or she is responsible." The trust law standard is "the highest known to law." [Donovan v. Bierwirth, 680 F.2d 263, 272 (2d Cir. 1982).]

ERISA section 404(a)(1)(A), which sets forth the fiduciary duty of loyalty, provides that a "fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan."

The duty of loyalty with its ancient lineage is the most elemental because it underlies all other fiduciary duties, requiring plan fiduciaries to give undivided loyalty to plan participants by complying with the "sole interest" and "exclusive purpose" rules.

These rules, derived from trust law, require that fiduciaries of ERISA-governed retirement plans such as 401(k) plans, for example, provide participants (and their beneficiaries) with retirement benefits generated by investment options that are selected, monitored and replaced in the sole interest of participants for that exclusive purpose, and which incur only reasonable costs.

Section 5 of the UPIA defines the duty of loyalty in this way: "A trustee shall invest and manage the trust assets solely in the interest of the beneficiaries."

Commentary to section 5 notes: "The duty of loyalty is perhaps the most characteristic rule of trust law, requiring the trustee to act exclusively for the beneficiaries [which, in the retirement plan setting, are participants (and their beneficiaries)], as opposed to acting for the trustee’s own interest or that of third parties."

Section 404(a)(1)(B) of ERISA, which sets forth the duty of prudence (otherwise known as the prudent man standard), provides that "a fiduciary shall discharge his duties with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."

Commentary to section 5 of the UPIA explains the interplay in ERISA law between the duties of loyalty and prudence: "The concept that the duty of prudence in trust administration, especially in investing and managing trust assets, entails adherence to the duty of loyalty is familiar. ERISA [section] 404(a)(1)(B)…extracted in the Comment to Section 1 of [the UPIA], effectively merges the requirements of prudence and loyalty. A fiduciary cannot be prudent in the conduct of investment functions if the fiduciary is sacrificing the interests of the beneficiaries."

Because the trust law standard underlies ERISA, the assets held in the account of participants in, say, a 401(k) plan aren't the participants' in a legal sense; rather, they actually belong to the trust. The assets are held in trust and managed by the plan trustee (whose conduct is governed by the laws of ERISA fiduciary responsibility) on behalf of the participants (and their beneficiaries) who are beneficiaries of the trust.

While the Tibble court's (uncommonly brief) 10-page decision focused on the procedural issue in the case--the statute of limitations--it also discussed two substantive issues: the duty to monitor and the duty to be cost-conscious.

The Duty to Monitor The court discussed the critical importance of the monitoring function in ERISA-governed plans, such as 401(k) plans. A plan fiduciary has an ongoing duty under ERISA to monitor the investment options in a retirement plan--a duty which is distinct from, and in addition to, the fiduciary's duty to be prudent when making the initial selection of plan investment options.

In support, the court cited the Restatement (Third) of Trusts (Restatement): "[A] trustee's duties apply not only in making investments but also in monitoring and reviewing investments, which is to be done in a manner that is reasonable and appropriate to the particular investments, courses of action, and strategies involved. §90, Comment b, p. 295 (2007)."

The court also referenced the UPIA which "confirms that '[m]anaging embraces monitoring' and that a trustee has 'continuing responsibility for oversight of the suitability of the investments already made.'"

The Duty to Be Cost-Conscious The importance that fiduciaries of 401(k) plans be cost conscious was given renewed emphasis by the Tibble court. The court drew on the Restatement in noting: "Implicit in a trustee's fiduciary duties is a duty to be cost-conscious." [Section 88, comment a.] Further, a trustee is to "incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship." [Section 90(c)(3).]

The Tibble court cited additional instructive language from the Restatement: "cost-conscious management is fundamental to prudence in the investment function," and should be applied "not only in making investments but also in monitoring and reviewing investments." [Section 90, comment b.]

The court also quoted commentary to section 7 of the Uniform Prudent Investor Act: "Wasting beneficiaries' money is imprudent. In devising and implementing strategies for the investment and management of trust assets, trustees are obliged to minimize costs."

John H. Langbein, the reporter for the UPIA and the Sterling Professor of law emeritus and Legal History at Yale University law school, describes the nexus among ERISA, the common law of trusts and the Uniform Prudent Investor Act: "ERISA has always been interpreted with a strong eye on the common law, and it is therefore quite clear that the Uniform Prudent Investor Act will powerfully affect the federal courts in their interpretation of ERISA."

Fiduciaries to ERISA-governed retirement plans would be well advised to keep these high standards in mind as they go about protecting plan participants and their beneficiaries.

The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.