Posted by Joe Bert, CFP®, AIF®
There were dozens of breach of fiduciary duty lawsuits filed, settled and adjudicated in 2016 against plan sponsors, fiduciaries and investment advisors. The trend for 2017 is for this legal torrent to continue regardless of the next steps with the Department of Labor’s Fiduciary Rule.
In previous articles we have discussed the standards and practices that bind plan fiduciaries, and some steps for mitigating fiduciary risk and liability. But let us now imagine a scenario in which a lawsuit is being brought against you as the plan sponsor/plan fiduciary. Rightly or wrongly, most anyone can sue anyone else in this country at any time for any reason and for any amount. So whether the suit has merits is immaterial, as you will need to mount a defense even just to get a summary dismissal.
But let us assume that the suit moves forward to the trial phase or a lengthy settlement process. The question is now begged, who would be on the hook for this breach, you or your advisor?
This is a significant gray area that requires a lot of “if/then” statements. But broadly speaking, if you’re a plan sponsor and/or plan fiduciary there is a high-degree of certainty that you will be at least partially liable for any damages awarded and will need to pay for/mount your own defense.
However, if you have engaged an ERISA part 3(38) fiduciary and fully outsourced the investment responsibility and control to your advisor your liability is greatly mitigated. Even still, you will need to “prove” that your diligence in bringing the advisor on was above board, and that you still provided a certain degree of care over the plan assets. Generally, this is a relatively simple process that can remove you from legal exposure in the quickest and most cost-effective way possible.
Your advisor will typically be left holding the liability bucket if they have engaged in any fraudulent or clearly bad behavior. Short of playing the market with client money, this may include acts such as excessive trading, lack of diligence on plan fees, inappropriate investments or share classes, etc. These are bad behaviors that an advisor should be aware of and assiduously avoid.
However, if you have engaged a 3(21) fiduciary and/or maintain partial control of your plan’s assets from an investment perspective, the liability may rest proportionally on your shoulders alongside your advisor. Many plan sponsors believe that simply because they have an investment advisor/fiduciary they are off the hook. More often than not this is a costly misjudgment.
As an example, if you hire a 3(21) fiduciary—generally an affiliated representative of a broker-dealer—and a lawsuit is later brought against the plan by a participant for excessive fees, the advisor need only show that their actions were “suitable” under the current ERISA fiduciary standards.
As the plan sponsor/fiduciary, you are held to an even higher elevated duty of care and loyalty to the plan. If the case were dismissed against the advisor, the burden may still fall to you for the plaintiff’s claim. The argument here being that you should have exercised more diligence and control over your advisor and taken actions to prevent these excessive fees. Since you did not, and the advisor performed their duty under the suitability standard, you are left standing alone at the courthouse.
This is not a particularly extreme scenario, and your ignorance of the “type” of fiduciary you had and their responsibility to your plan is no excuse under the law.
It’s also important to note that simply because you do not believe you are a plan sponsor does not make it so. Here is a recent Department of Labor definition of how one may become a fiduciary without ever explicitly taking on that role:
“Many of the actions involved in operating a plan make the person or entity performing them a fiduciary. Using discretion in administering and managing a plan or controlling the plan’s assets makes that person a fiduciary to the extent of that discretion or control. Thus, fiduciary status is based on the functions performed for the plan, not just a person’s title.”
Plan sponsors are often complacent about their plan, and believe that they are not a fiduciary and have in some way fully outsourced their liability to an advisor. Even in the current environment of fiduciary breach lawsuits the lack of knowledge and action can be startling. This is especially true at smaller plans, which are often resource constrained, but are the most vulnerable to any potential suit. Smaller plans have increasingly become the subject of ERISA breach suits, with judgments and settlements attaching to the plan fiduciaries’ assets personally.
To avoid any gray areas, our recommendation is working with a true independent and un-conflicted 3(38) fiduciary who will contractually and explicitly obligate themselves as such. There is specific language that should be included in a contract that obligates an advisor to serve as a 3(38) and it should be clear and unambiguous as to what their and your responsibilities are to the plan. Similarly, you should ask for documented proof of your advisor’s fiduciary bonding and insurance. Do not simply take their word for it.
These actions may not completely abrogate your responsibility, but will greatly lessen the keep-you-up-at-night moments and your potential exposure to any lawsuit.
As we have said several times before, the complexities, vagaries and nuances of fiduciary rules under ERISA, combined with the severe consequences for even inadvertent violation, seem to mandate work with a true and knowledgeable fiduciary.