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Employers must be vigilant on 401(k) options


A new decision by the U.S. Supreme Court has upped the fiduciary ante for employers that offer defined contribution retirement plans.

THE LAW: The Employee Retire­ment Income Security Act (ERISA) requires employers that offer retirement plans that include investment options to monitor those options with an eye to protecting employee/beneficiary interests. Employers may be liable for damages employees suffer from imprudent investments or investments with excessive fees or costs.

The Uniform Prudent Investor Act requires informing employees if an investment that was previously considered prudent becomes imprudent due to “changed circumstances.”

WHAT’S NEW: The Supreme Court recently issued a unanimous ruling that signals changes in ERISA compliance. The case, Tibble v. Edison International (U.S. Supreme Court, No. 13-550, 2015), involved a holding company for several energy companies. Edison operated 401(k) plans for about 20,000 employees.

A group of current and former plan beneficiaries sued, alleging Edison violated its fiduciary duty of prudence when it offered the “retail class” shares of three mutual funds instead of the “institutional class.” “Retail class” shares carry higher costs.

The plaintiffs filed the suit in 2007 alleging Edison violated ERISA in funds it added to the plan in 1999 and 2002. A federal district court ruled Edison did violate its fiduciary duty, but that the plaintiffs could only seek damages for the 2002 funds because ERISA only provides a six-year window for such claims.

Decision appealed

The plaintiffs appealed to the 9th Circuit, arguing that they could sue as long as the 1999 funds were in the plan. The U.S. Department of Labor filed a brief in the case, asking the court to recognize a “continuing violation” argument, where each time a beneficiary suffered a loss because of a plan administrator’s fiduciary failure, the six-year period started over again.

The 9th Circuit did not buy the “continuing violation” argument, ruling that only “changed circumstances” would allow for a “full diligence review” of investment options. A failure to meet its fiduciary duty during a “changed circumstances” review could start the six-year clock moving again.

Supreme Court decision

The Supreme Court agreed to hear the question of whether beneficiaries could sue under ERISA after the six-year period had expired. The High Court did not address this issue head on. Instead, it remanded the case to the 9th Circuit for that court to determine whether Edison met its fiduciary obligation to conduct “regular review” of its investment options. The decision also failed to address the “continuing violation” theory advanced by the DOL.

HOW TO COMPLY: The Supreme Court remanded the case, so the story is not over yet. Employers should monitor the 9th Circuit’s decision to understand all the ramifications.

‘Changed circumstances’

The Supreme Court’s decision was short on specifics, but indicated that it expected employers and plan administrators to proactively honor their fiduciary duties under ERISA. In particular, the court’s emphasis on the Uniform Prudent Investor Act, means that plan administrators must be familiar with its content and the specific investments it covers.

While the court didn’t provide much detail, it did seem to indicate that employers and plan administrators cannot just wait for a “changed circumstances” scenario to arise before examining investment options.

Plan administrators should take a broad view of what constitutes “changed circumstances.” Any significant change in an investment’s risk factors or costs should trigger some sort of review.

Administrators should develop guidelines for when to re-evaluate individual investments and when a full diligence review is in order outside the normal review schedule. Employers should ask for a plan administrator’s guidelines and have them reviewed by their attorney to avoid any liability.

Any “full diligence” review should include a market analysis to determine if substantially similar investment options could be offered in a lower-cost form. That should help deter similar legal challenges to the one Edison International faced.

Put regular reviews in place

Employers conducting a regular review of investment options should have criteria for selecting, monitoring and removing funds offered under 401(k) plans. Mutual funds and other investment options should be reviewed for the level of fees charged to the fund, the performance of the funds against their appropriate benchmarks and the fiduciary’s adherence to the plan’s investment policy statement.

Again, all this must be documented to show that the employer regularly reviewed the investment options and uniformly applied selection and removal criteria to all options.

DOL looking for due diligence

The fact that the DOL filed a brief in this case indicates it is closely monitoring defined contribution plans to ensure plan fiduciaries are getting the best possible options for plan beneficiaries.

In particular, investigators are looking at the issues raised in this case concerning fees.