Fiduciary Responsibilities

Review, Training & Best Practices

1 TRUST LAW HISTORY & BACKGROUND

History & Background

» 12th Century England

• Crusaders would title land to others in his absence with an understanding it would

be conveyed back to him upon his return. This often did not happen.

» The Lord of Chancery – Courts of Chancery

• Owner in Title legal owner Trustee

• Owner in Equity beneficial owner Beneficiary

» Common law that transferred to the legal framework in the United

States

• Trust law is state law and not federal

• Therefore 50 states = 50 different trust laws

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History & Background

» The Employee Retirement Income Security Act of 1974 (“ERISA”)

• Preemption of state laws uniform system of regulatory oversight

• Add protections for benefit plan participants and beneficiaries, such as minimum

participation and vesting requirements, government reporting, and required

disclosures to participants and beneficiaries

• Clarify fiduciary roles and responsibilities regarding benefit plans

• Incorporated many trust concepts (fiduciaries and fiduciary duties)

» Evolution of qualified plans

• Prior to the 1980’s most plan sponsors offered either a Defined Benefit Plan or a

Profit Sharing Plan (1978 – Ted Benna “discovers” the 401(k) in the tax code).

• Defined Benefit Plans (Pension Plans) are expensive

• Defined Contribution (DC) Plans became more popular

» 401(k) Plans

» 403(b) Plans

» 457 Plans

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2 ERISA Exemptions and State Law

ERISA Exemptions/Exceptions

» Plans sponsored for government employees (“governmental plans”)

» Plans sponsored for employees of churches and church-related or

affiliated organizations (“church plans”), unless such a plan elects

ERISA coverage

» Nonqualified retirement plans maintained for a “select group of

management or highly compensated employees” (i.e., “top-hat” plans

such as SERPs, restoration plans, and deferred compensation plans)

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State Fiduciary Rules

» Governmental plans are not subject to ERISA. Nonetheless most

states have adopted fiduciary rules that apply to governmental plan

fiduciaries, some of which are similar to ERISA.

» At least 31 states have adopted fiduciary standards that are derived

from ERISA‘s prudent man standard, 15 of which have adopted the

ERISA prudence standard verbatim.

» Whether by virtue of statutorily imposed prudence rules or the prudent

investor rule under general trust law, governmental plan fiduciaries

must generally act prudently and in the best interests of their plan

participants.

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Uniform Management of Public Employees Retirement Systems Act

» The Uniform Management of Public Employees Retirement Systems

Acts tracks the ERISA fiduciary duty language as well.

» At least two states have adopted the uniform rules. Further, while the

prudent man rule has long since been considered an ERISA

requirement, it has a much longer history as part of general trust law.

» The prudent investor rule is an extension and clarification of the

traditional, so-called “prudent man rule” originally articulated by the

Massachusetts Supreme Judicial Court and now followed by most

states.

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Virginia

» Virginia--VA Code Ann. Section 51.1-124.30(C)—―The Board shall discharge its duties with respect to the Retirement System solely in the interest of the beneficiaries thereof and shall invest the assets of the Retirement System with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person 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.

» ERISA Prudent Man Rule – A fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity” would act. This rule is derived from the common law of trusts. This is an objective standard based upon how a person with experience and knowledge of a certain area would act in a given situation. If a fiduciary lacks the expertise for a certain area then the fiduciary must obtain expert help. 29 U.S.C. §1104 (a)(1)(B).

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3

FIDUCIARY

OBLIGATIONS

Non-Fiduciary Actions

» Two (2) Categories – “Settlor” and “Ministerial” Actions:

» “Settlor” actions (actions that are plan design-related, as opposed to plan management/administration-related)

– Courts and the DOL have said that a decision to establish, amend or terminate a benefit plan is a settlor act, not a fiduciary act

– However, implementation of a settlor act may and usually does involve fiduciary actions, for example

– Board decides to terminate a DB plan- this decision is a settlor act

– But now the termination must be implemented, and this will involve certain fiduciary actions such as communicating the termination to participants and selecting an annuity provider

» Settlor actions may also include certain plan-related financial decisions, such as

– Determination of employer contributions to the plan, provided such amount satisfied applicable ERISA minimum funding requirement and/or the terms of the plan

– Determination of actuarial assumptions and methods for accounting treatment and possible also for ERISA funding purposes

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Non-Fiduciary Actions

» “Ministerial” actions are certain plan-related actions that are carried

out by people “who have no power to make any decision as to plan

policy, interpretations, practices or procedures …” (DOL Regulation

Section 2509.75-8, Q-D-2)

• Application of rules determining eligibility for participation or benefits

• Calculation of services and compensation credits for benefits

• Preparation of employee communications material

• Preparation of reports required by government agencies

• Calculation of benefits

• Orientation of new participants advising participants of their rights and options

under the plan

• Processing of claims

• Making recommendations to others

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Fiduciary (def.) under ERISA

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ERISA section 3(21)(A): a person is a fiduciary with respect to a plan to

the extent he/she:

Exercises any discretionary authority or control over plan management

Exercises any authority or control over plan assets

Renders, or has any authority or responsibility to render, investment

advice for a fee, OR

Has any discretionary authority or responsibility over plan

administration

ERISA requires plans have a named fiduciary, but liability extends beyond that.

ERISA’s Duties/Obligations

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Loyalty /

Exclusive Purpose

Prudence / Care

Diversification

Obedience

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FIDUCIARY

ACTIONS

1. Appointment/Selection

» Act of appointing or selecting individuals or organizations to carry out

actions can be a “fiduciary act” – even if the role the party is to carry out

is not a fiduciary role.

• Appointees/selectees Can be internal or external parties.

» Key Examples:

– Board creating and/or delegating authority or duties to benefit plan committee(s)

and/or senior management.

– Selecting service providers:

– Internal delegation of roles between various departments:

– HR, finance, treasury, legal, payroll, etc.

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2. Exercising Control Over Plan Assets

» What duties are involved in this action?

• Exclusive Purpose/Loyalty

• Prudence/Care

• Diversification

» Examples of these acts?

• Determination of investment policy.

• Selection, monitoring and replacement of investment managers and advisors.

• Selecting and monitoring of investments.

• Setting or making recommendations as to asset allocation; especially with regards to

customary QDIAs (i.e. target date funds, risk-based portfolios, custom portfolios, etc.).

• Approval of fees and expenses paid from the plan assets.

• Purchase of annuities to settle benefits (DB plans).

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3. Interpreting Plan Provisions

» Duty of Obedience

» Examples of these acts:

• Determining eligibility for plans and for benefits

» Disability pension benefits,

» Approval/denial of benefit plan claims

• Determining accrual of benefits

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4. Communications

» Duty of Obedience - Duty of Loyalty

» Timely and accurate communication of employee benefits to

employees

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» Examples:

• Delivering Summary Plan Descriptions, Summary of Material Modifications, etc. in a timely fashion.

• Delivering SOX notices when required in a timely fashion.

• Ensuring 404(a)(5) notices are accurate and delivered in a timely fashion.

5. Plan Administration

» Duty of Obedience - Duty of Care – Duty of Loyalty

» What are we talking about here? The day-to-day operation of the plan

» Examples:

• Participant disclosure (404(a)(5))

• Overall compliance

• Claims processing (and perhaps also adjudication),

• Recordkeeping and financial tracking/accounting,

• Document and record retention,

• Selecting and monitoring of service providers and vendors, and

• Amending plans (do you know when your next restatement is required?)

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Allocating and Delegating Duties/Acts

» Responsibility for duties and acts originate with the plan sponsor

» Majority of fiduciary duties are usually delegated to one or more benefit plan-related committees (these are usually not Board-level) such as – Overall decision-making within the committee’s scope of responsibilities, delegation to/appointment of other

parties to carry out certain functions, serving as the official “plan administrator”, monitoring of decisions and delegations/delegates, plan interpretation, sometimes deciding whether to amend a plan, sometimes claims adjudication, overall plan compliance

» Then, typically the committee(s) delegate day-to-day duties to internal and external parties – Internal: HR, finance, treasury, legal, payroll

– External: actuaries, accountants, attorneys, consultants, record keepers, investment managers/advisors, TPAs, vendors

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PLAN SPONSOR/

BOARD COMMITTEE(S)

DAY-TO-DAY PARTIES/

RESPONSIBILITY

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FIDUCIARY

LIABILITY

Liability for Fiduciaries

Civil liability

» Personal exposure for plan losses and/or profits made as a result of the breach

» “Equitable” remedies, such as restitution, constructive trust and/or removal as fiduciary

» Additional penalty equal to 20% of amount recovered in DOL-initiated court action or settlement with DOL

Criminal liability (partial list)

» Up to $100,000 fine and/or 10 years imprisonment for “willful violation” of ERISA Title 1, Subtitle B, Part 1 (primarily, the reporting/disclosure requirements) – If an entity (e.g., plan sponsor) is convicted, fine can be up to $500,000

» Penalties and/or imprisonment for theft, embezzlement, mail fraud, wire fraud, etc.

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Liability for Fiduciaries

“Co-fiduciary” liability

» In addition to liability for one’s own actions as a fiduciary, a fiduciary

can also be liable as a “co-fiduciary” for a breach by another fiduciary

in the following situations:

– Participating knowingly in, or knowingly undertaking to conceal, an act or omission

by another fiduciary, knowing such act or omission is a breach;

– By a failure to fulfill ERISA standards of fiduciary performance, enabling another

fiduciary to commit a breach of duty; or

– Having knowledge of a breach of duty by another fiduciary and failing to take

reasonable efforts under the circumstances to remedy the other fiduciary’s breach

» Co-fiduciary liability cannot generally be avoided through

apportionment or delegation of fiduciary duties - appointing fiduciary

retains duties of prudence and monitoring

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Liability in Real Dollars

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Tussey v. ABB

$36.9 Million

Beesley v. Int’l

Paper

$30.0 Million

Kanawi v.

Bechtel Corp.

$18.6 Million

Martin v.

Caterpillar,

Inc.

$16.5 Million

Will v. General

Dynamics

Corp.

$15.2 Million

Braden v. Wal-

Mart Stores,

Inc.

$13.5 Million

George v.

Kraft Foods

Global, Inc.

$9.5 Million

6 MITIGATING FIDUCIARY RISK

Mitigating Fiduciary Risk

Fiduciary liability can be addressed via:

» Good governance

» Electing and complying with ERISA 404(c) regarding 401(k) plans

» Taking advantage of other ERISA relief provisions that apply in certain situations – Default funds (satisfying “qualified default investment alternative”, or “QDIA”,

requirements)

– “Mapping” of funds

– “Blackouts”

– See Bidwell v. UMC

» Carrying insurance on internal fiduciaries

» Bonding of those who handle plan funds (to the extent required by ERISA section 412)

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ERISA Section 404(c)

» 404(c) Provides Fiduciary Relief to Plan Sponsors

» 404(c) regulations are lengthy and formidable, but they provide the

basic overarching guidelines to assist employers in complying with the

requirements so they can avail themselves of the 404(c) relief.

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404(c) Requirements

"Broad Range of Investment Alternatives" Required

» Opportunity to choose from at least three investments that:

• Are diversified

• Have materially different risk and return characteristics

• In the aggregate, enable the participant to achieve risk and return characteristics at

any point within the range "normally appropriate for the participant."

• Each of which, when combined with the other alternatives, tends to minimize,

through diversification, the overall risk of the portfolio

• Opportunity to diversify the investments to minimize the risk of large losses, taking

into account the nature of the plan and the size of participant accounts

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404(c) Requirements

» Information must be generally sufficient to enable the participant to

make informed investment decisions

• Participant must be provided certain information on request – narrative of annual

operating expenses, prospectus, value of shares or units, etc.

• Information must be provided before the participant makes an investment

» Participants must be given the opportunity to change their investments

as often as the volatility of the investment requires ("general volatility

rule")

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Managing Responsibility

» Plan Sponsors should maintain compliance with the Uniform Fiduciary

Standards of Care.

» What do you need to comply with this?

1. Know standards, laws, and trust provisions

2. Diversify assets to specific risk/return profile of client

3. Prepare investment policy statement

4. Use “prudent experts” and money managers – document due diligence

5. Control and account for investment expenses

6. Monitor money managers and service vendors

7. Avoid conflicts of interest and prohibited transactions

» Ignorance of laws/standards or failure to have a process does not

absolve you from liability 31

Establish a Process

» ERISA does not mandate that you establish a fiduciary process for

monitoring your plan, but:

• Plan sponsors have fiduciary responsibility whether oversight is conducted or not

• Relying on the vendor does not cover your fiduciary obligation; in fact many vendors

reject this in their contracts (Deere case stated Fidelity was not a fiduciary)

• Board of Directors can be personally liable if process and procedures are not set up

correctly

• DOL auditors ask for plan Investment Policy Statement upon audit despite it not

being an explicit requirement*

» Overwhelming amount of case law looks for a process and focuses less on the actual merits of the

process.

• Risk to plan sponsors has increased with more visibility in the public as well as

decreased asset values

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Phase One - Advisor

» Pick a qualified Fiduciary Advisor

• Conduct an RFP for their services

• Use advisors who sign on in writing to be a plan investment fiduciary

• Evaluate depth of organization and size of team

• Obtain copies of advisor’s fiduciary insurance coverage

• Review the advisor’s ADV for conflicts of interest

• Conduct interviews and check references

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Phase Two – Establish a Committee

» Establish a Committee with a Committee Charter

» Identify purpose and responsibilities of the Committee (what decision-making authority they have and on what issues)

» Identify members of the Committee

» Select members who understand fiduciary obligation and have background in plan oversight • Typical Committees have a finance, operations and human resources staff member, with some

companies including legal counsel and a benefits staff member – committees of more than 5 can often be ineffective.

• Consider rotating members every 3 years

» Identify who has responsibility to select and replace members (will there be a term?)

» Insulate Board members from fiduciary responsibility

» Execute and place in fiduciary notebook (electronic)

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Phase Three – Committee Parameters

» Identify/State Plan and Committee Purpose

» Determine the purpose of the plan based on your organizational goals, employee demographics, and what the objectives of the Committee will be: • Do you want to use it for a recruiting tool, or just to offer a plan?

• Do you want to offer the best plan as compared with your peer group?

• What type of plan will best meet the retirement needs of your employee demographics?

• Do you want employees to have multiple choices or managed asset allocation strategies or both?

• Will you hire a fiduciary advisor to assist the Committee; what type?

• Establish a fiduciary notebook (paper or electronic)

• Determine Annual Objectives (create a “business plan”, for example)

» Educate employees twice per year in person

» Educate via other modes (web cast/teleconference twice per year)

» Include any legislative updates or plan amendments that need to occur

» List out necessary compliance communications that must be done

» Schedule compliance testing updates and 5500 updates

» Review plan document annually

» Conduct a fee analysis annually

» Conduct a vendor comparison every 3 to 5 years

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Phase Four - IPS

» Establish the Investment Policy Statement

» Provides the investment objectives and monitoring processes for the plan

» Committee members execute the IPS

» Allow some flexibility in the oversight language

» Review IPS every few years to ensure applicability

» Make sure everyone is comfortable with your investment “watch list” and removal procedures

» This needs to be followed! • Common mistake is not following the IPS

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Phase Five – Committee Meetings

» How often should the Committee meet and what is the best format?

» Meet regularly – what is regularly?

» Create an agenda, and stick to it: • Cover prior open items

• Approve minutes

• Discuss plan administration/compliance

• Investment review

• Employee education

» Take meeting minutes – fine line between being overly specific and not detailed enough

» Distribute materials in advance. Meetings are more effective when members come prepared.

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Phase Six – Investment Reporting

» Institute An Investment Reporting Process

» A summary of the capital markets

» A tested process for ranking and rating plan options

» Information about plan assets and how participants have diversified

assets

» Information regarding plan usage, participation and asset allocation

broken out by various demographic criteria

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Phase Seven – Overall Plan Oversight

» Monitor fees and expenses and disclosure to participants

» Monitor revenue sharing and service provider agreements

» State 404(c) compliance and make sure steps are followed

» Act promptly! Don’t delay when decisions are made

» Get counsel – hire an investment advisor and ERISA counsel

» Consider Using a 3 (38) Fiduciary Advisor

» If you suspect that another fiduciary is not doing his or her job, take steps to address the problem and document those steps

» Purchase fiduciary insurance

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Phase Eight – Follow-Up Items

» Delegate one person to be in charge of follow-up items

• Either the plan advisor or in an in-house representative

• Single point of contact works best

• Complete minutes from meeting as soon as possible or have advisor create for

Committee review

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Phase Nine – Committee Notebook

» Create a Committee Notebook (SageView Document Vault)

» Include:

• Committee Charter

• Investment Policy Statement

• Annual employee compliance notices & when delivered

• Meeting Minutes

• Annual Business Plans

• Plan Document and amendments

• Plan Testing Results (4 prior years)

• Copy of 5500’s and auditors report (4 prior years)

• Prior 4 meetings for investment reviews

• Samples of employee education or calendar of education delivered to whom and

when

• 404(c) Compliance Checklist

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Thank You