April 15, 2015
For 401(k) plan sponsors, the selection of the investment options made available in the plan and the fees paid from the plan assets are fiduciary responsibilities. Most business conflicts risk only business assets, but both personal liability and criminal penalties are possible under the Employee Retirement Income Security Act (ERISA), the federal law that generally governs 401(k) plans. ERISA requires 401(k) fiduciaries to exercise the knowledge and experience of a “prudent expert” when selecting the investment options available in a 401(k) plan and ensuring that the expenses paid from the plan, including mutual fund expense ratios, are reasonable. A case currently before the U.S. Supreme Court, Tibble v. Edison Int’l, emphasizes the importance of handling these responsibilities appropriately, the high cost of failing to do so, and the highly technical and complicated nature of ERISA.
Because of the amount at stake for breaches in these plans, it is critical to determine whether, and when, fiduciary breach lawsuits may be filed. The lower courts in Tibble have already determined that the use of more-expensive retail class shares of mutual funds rather than cheaper, otherwise identical institutional share classes was sufficient evidence of a fiduciary breach, regardless of whether the fund(s) were actually a good choice for the plan. In fact, the Tibble trial judge specifically cited this difference in cost as evidence that the fiduciaries did not conduct a thorough investigation of the alternatives when they made the decision to add the funds, as Edison presented no evidence that the fiduciaries specifically considered different share classes and costs when making their decision.
The Supreme Court is now determining whether the damages will include all six retail mutual fund options or only the three funds added less than six years before the lawsuit was filed. The lower court decisions said there was a blanket exemption for the three earlier funds. If the Supreme Court reverses or modifies this ruling, imposing a “continuing duty” to monitor 401(k) investment options, this could mean that each subsequent failure to remove or replace these funds when the fiduciaries should have done so is a separate breach on which the fiduciaries may be subject to suit. This would render the “statute of limitations” in the law essentially toothless. In contrast, a blanket exemption would reward a “lazy” fiduciary who retains existing long-term funds as “safe” choices regardless of their quality if they were added more than six years prior, and it could gut the fiduciary standards, which are not time-limited in the law. Stripped to essentials, this case now turns on when a failure to act appropriately becomes a breach that triggers the right of participants to sue.
The willingness of Edison International and/or its insurers to litigate this to the U.S. Supreme Court level for only three fund choices, an extraordinarily expensive proposition, hints at the dollars potentially at risk, which could easily be in the millions. Damages exceeding any fiduciary insurance coverage could even come from the personal assets of the 401(k) investment committee members. Businesses with 401(k) and other employee benefit plans should ensure they have sufficient specific ERISA fiduciary and plan administration coverage to cover and defend them in the event of a lawsuit or government audit. More importantly, they should take steps to identify risks and protect themselves, such as adopting a good investment policy and acting in accordance with that policy, educating themselves on the various choices and considerations when presented with options, and documenting the evidence considered and the reasons for making the choices.
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