Recent Questions from Plan Sponsor Clients Re LaRue

I’ve read about this new 401(k) Supreme Court case—how far back can employees sue us if they claim we mishandled their accounts?.

Generally speaking, the statute of limitations for an ERISA claim grounded in breach of fiduciary duty is six years from the date of the last action that is alleged to be a breach or six years from the latest date the fiduciary could have cured a breach based upon an ommission. For plaintiffs who are found to have been on notice or have had actual knowledge of a breach, however, the statute of limitations runs three years from the date he/she discovered facts sufficient to put them on notice of the alleged breach. Claims grounded in fraud are also subject to the discovery rule, and the statute runs six years from the date of discovery. Depending upon the circumstances, claims can also be brought pursuant to applicable state laws where the limitations periods would vary from state to state and from claim to claim.

Anything we can do to protect ourselves going forward?

Assuming the same facts as LaRue, where the plaintiff was a participant in an employer-sponsored 401(k) plan, there are a number of steps one can take to mitigate and/or transfer the risk of being sued for investment losses in a participant’s account. Most claims arise from either investment-related activities or the lack of prudent administrative processes and procedures. While many of the investment-related functions can be effectively delegated to third parties, the plan sponsor remains liable for the prudent selection and monitoring of service providers. It is, therefore, imperative that such decisions are documented and the factors considered are detailed in written minutes.

For example, in many of the recently-filed cases alleging excessive fees, the plaintiffs allege that the respective plan fiduciaries failed to adequately investigate fee arrangements and alternatives. Given that ERISA does not require that the plan negotiate the lowest cost arrangement, documents evidencing negotiations between the plan and its service providers would generally suffice to demonstrate that the arrangement at issue was prudently selected. The plan sponsor should also continuously monitor these arrangements to identify “hidden fees” and determine whether they are reasonable in light of the services provided. Again, the process for selecting and monitoring service providers and their respective fees should be documented and reported periodically.

The Department of Labor (DoL) has produced two guides for fiduciaries to better understand their obligations with respect to fees charged by service providers. The guides are available through the DoL’s website at:

www.dol.gov/ebsa/pdf/401kfefm.pdf

www.dol.gov/ebse/publications/fiduciaryresponsibility.html

As discussed, plan sponsors can delegate investment-related decisions to professionals, and the plan remains liable only for the prudent selection and monitoring of those individuals. An investment advisor can be engaged to select the investments that are offered to participants and to monitor the performance of those investments, and ERISA provides for the appointment of an investment manager to actively manage plan assets with discretion.

The Pension Protection Act also provides two safe harbors by which plan sponsors can insulate themselves from investment-related claims brought by plan participants: the Qualified Default Investment Alternative (“QDIA”); and fiduciary advisers. The QDIA safe harbor serves to protect plan sponsors from liability associated with the allocation of a participant’s account to a more diversified investment option when the participant fails to provide any investment directions. We recommend engaging an investment adviser to help with the selection of a suitable QDIA. The fiduciary adviser safe harbor insulates plan sponsors from liability for investment losses in a participant’s account where a fiduciary adviser is retained to provide specific investment recommendations pursuant to an eligible investment advice arrangement between the plan sponsor and the investment adviser. A comprehensive collection resources to assist plan sponsors with these safe harbors can be found at www.ppa-law.com.

Anything we can do to protect ourselves relating to any claims that might already be out there?

To the extent you suspect that a breach may have occurred, we recommend undertaking a comprehensive risk assessment that examines the plan as a whole. A risk assessment program looks for procedural prudence as it relates to investments and administrative functions and operates to detect fiduciary breaches before they result in claims. Because fiduciary exposure often begins with participant complaints either in the form of phone calls or letters from participants claiming benefits, we also recommend retaining experienced counsel to assist with drafting responses to such inquiries and to document the issues that relate to a denial of benefits. Courts do not review fiduciary decisions with 20/20 hindsight, so the proper response and documentation will go a long way in establishing that the plan sponsor’s actions were prudent and appropriate at the time they occurred.

Critical Supreme Court Ruling for Investment Professionals

On February 20, 2008, the Supreme Court issued a procedural ruling in favor of James LaRue, a defined contribution plan participant, which will allow him to seek recovery of individual investment losses caused by an alleged breach of fiduciary duty. The ruling is significant because, prior thereto, courts interpreted ERISA to provide a remedy only for systemic breaches and resulting losses to a plan as a whole. Participants and their lawyers will now be able to recoup individual losses caused by any negligent act or omission on the part of a plan fiduciary.

Wednesday's ruling is critical for investment professionals, as it opens the door to potential lawsuits for an additional 50 million American employees who have approximately 2.7 trillion dollars invested in 401(k) plans. Numerous studies have shown that the majority of investment firms and their registered and/or advisory representatives do not fully appreciate the extent of their fiduciary duties owed to ERISA plan clients. As a result, many firms have inadequate controls to avoid, detect or remedy fiduciary breaches and prohibited transactions. Moreover, the compliance challenges faced by broker-dealers and RIAs in the wake of the Pension Protection Act and increased regulatory scrutiny relating to disclosure of fees and conflicts create additional exposure and enhanced standards of care.

Fortunately, this enhanced liability can be mitigated through effective risk management initiatives. Our ERISA Plan and Investment Fiduciary Group is working with many of our existing clients to assist them in avoiding prospective exposure through the implementation of fiduciary-based training, supervisory controls and compliance procedures. Additionally, our new ERISA Plan Risk Assessment Program works directly with plan sponsors and their providers to identify and remedy fiduciary breaches and prohibited transactions. For more information on developing a compliant advisory program or plan, please contact Jason C. Roberts, Esq. at (310) 210-1679 or via email at jroberts@edgertonweaver.com.

Emerging Trends for PPA Fiduciary Advisers

Recognizing the need for professional investment advice for participants and beneficiaries of defined contribution plans, the Pension Protection Act of 2006 (“PPA”) fashioned a new category of investment specialist – the fiduciary adviser. If an adviser adheres to certain enumerated procedures relative to compensation and disclosures, he/she can now deliver individualized investment advice to plan participants. Since the passage of PPA in October 2006, broker-dealers and registered investment advisers have been scrambling to synthesize PPA’s investment advice provisions and determine how best to execute and support the fiduciary adviser business model. This post provides a brief overview of the investment advice provisions of the PPA and examines the emerging business structures being implemented by broker-dealers and registered investment adviser firms in response thereto.

In examining the various approaches undertaken thus far, it is clear that these firms view the PPA fiduciary adviser as a conduit by which to maintain and grow their assets under management through capturing participants’ household assets and rollovers. Firms are able to access participants’ assets held outside of the plan by offering a comprehensive financial planning option as part of the initial client assessment and engagement. In addition to receiving recommendations on contributions and allocations within the plan, participant assets held outside of the plan are placed into a wrap account where the adviser’s compensation is level.

With respect to rollovers, 401(k) plans perpetually loose participants with the highest balances as they retire and withdraw these assets. By becoming, or partnering with a fiduciary adviser, registered representatives and investment adviser representatives are hoping to be in the best position to offer guidance to participants who are seeking to consolidate investments and/or rollover assets into an IRA.

Pursuant to ERISA Section 3(21)(A)(ii), any person that renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of a plan, or has any authority or responsibility to do so is a “fiduciary.” The prohibited transaction provisions of ERISA and the Code prohibit an investment advice fiduciary from using the authority, control or responsibility which makes it a fiduciary to cause itself, or a party in which it has an interest that may affect its best judgment as a fiduciary, to receive additional fees. As such, in the absence of a statutory or administrative exemption, fiduciaries are prohibited from rendering investment advice to plan participants regarding investments that result in the payment of additional advisory and other fees to the fiduciaries or their affiliates. Section 601 of the PPA added a statutory exemption under section 408(b)(14) of ERISA (and section 4975(d)(17) of the Code) for investment advice rendered pursuant to an “eligible investment advice arrangement” (“EIAA”). An EIAA is a contract between the fiduciary adviser and the plan sponsor that guarantees that the adviser’s compensation will not vary on the basis of any investment option selected[1].

The fiduciary adviser must acknowledge his/her fiduciary status in writing and can only be held civilly liable for losses caused by a breach thereof on those accounts where he/she has delivered investment advice. Such breaches are also subject to civil and criminal penalties by the DOL and the IRS.

Plan sponsors, on the other hand, are relieved from liability on those accounts so long as they can demonstrate prudent selection, monitoring and compliance[2] of the fiduciary adviser. PPA does not require plan sponsors or co-fiduciaries to monitor the specific investment advice given by a fiduciary adviser to any particular recipient of the advice.

PPA allows fiduciary advisers to charge reasonable fees, which based upon the extent of the services offered, are ranging from $300 - $1,500 per participant. Many firms are allowing these fees to be deducted from plan assets or paid from participant accounts, depending upon the desired usage. For example, in plans where the majority of employees are making substantial contributions (i.e., hospitals, law firms, etc.) fiduciary adviser firms are seeking to have fees deducted from the plan thereby encouraging more participants to opt for individual advice. In plans with low average balances, where the majority of participants into qualified default investment alternatives (“QDIAs”), firms are encouraging the plan to deduct advisory fees from participant accounts. The belief is that only those with significant assets are likely to engage the fiduciary adviser, leaving the fiduciary adviser with more time to service senior employees with higher balances.

As discussed, many firms are using fiduciary advisers to reach participants’ household and rollover assets. An estimated one in ten employees that will use a fiduciary adviser has household assets averaging $150,000, and one in twenty will be in a position to rollover plan assets averaging $500,000. In order to issue a suitable recommendation, a fiduciary adviser will need to review and consider the participant’s overall financial situation including assets and investments held outside of the plan. By offering a comprehensive financial planning option to participants, some firms are betting that participants will seek to consolidate their finances and deal with a single investment professional.

According to an August 2007 study by Spectrem Group, 67 percent of individuals who completed a rollover during the two-year period through April did so with the help of a professional adviser. The same study showed that the higher the balance the more likely there’s an adviser involved in the decision. With nearly $500 billion now eligible for rollovers, which are expected to increase 10 to 12 percent annually over the next five years, firms are looking to their fiduciary advisers to be in the best position to capture their participants’ rollovers.

There are three basic business structures emerging to facilitate such relationships: 1) stand alone; 2) full service team; and 3) partnerships. The pros and cons of each arrangement is being determined by the relative expertise of the individual advisers, their average plan size (both in terms of participants and assets), preexisting affiliations and considerations relating to revenue distribution.

PPA does not prohibit advisers from acting as both plan-level and participant-level fiduciary advisers so long as their compensation is unaffected by the investments recommended by the fiduciary adviser. Under the stand alone model, the unconflicted plan-level adviser is, therefore, permitted to act as both an adviser to the plan and as a fiduciary adviser to plan participants. Given the obvious limitations on the adviser’s time, this arrangement is being employed by advisers with a book of business consisting primarily of plans with high average balances.

Alternatively, group of advisers who are able to meet the level compensation and other requirements are seeking to capitalize on their collective strengths by forming full service teams. Under this arrangement, the plan adviser practice employs one or more fiduciary advisers and/or associate advisers. Associate advisers are not parties to the EIAA with the plan sponsors but provide the administrative services under the supervision of the named fiduciary adviser. This arrangement permits the full service team to scale their business by hiring and replacing associate advisers without altering the EIAA. Because there are no restrictions on how fiduciary adviser revenue is distributed, the full service team can determine how each member is compensated and are free to dedicate their revenue towards external expenditures.

Under the partnership arrangement, a plan adviser practice has an exclusive arrangement with a fiduciary adviser practice, and each partner participates in the revenue of the other. The level compensation requirements are not violated so long as the fiduciary adviser does not recommend plan related services to participants for which a partner is paid (i.e., recommending investments to participants that are not in the current lineup that would trigger a vendor search).

By implementing any of the aforementioned arrangements, broker-dealers and registered investment advisers are looking to grow assets by building meaningful personal relationships with participants through fiduciary advisers. While nothing in PPA prohibits fiduciary advisers from managing a participant’s household assets, DOL Advisory Opinion 2005-23A (the “Deseret Letter”), cautions plan fiduciaries with respect to advising participants to take a distribution and invest the proceeds in an IRA account managed by the fiduciary. Given that PPA requires fiduciary advisers to acknowledge their fiduciary status in writing, fiduciary advisers and their respective firms should determine whether such arrangements would be in violation of ERISA section 406(b)(1), which prohibits plan fiduciaries from using plan assets in his/her own interest.

[1] PPA also includes provisions for parties in conflict to provide advice through a computer model. This second conflicted advice program is not discussed in this article.

[2] PPA requires that an independent expert conduct an audit of the fiduciary adviser to determine compliance with the provisions of Section 601 of the PPA.

DOL Warns of Further Scrutiny of Investment Advisers and Pension Consultants

The Department of Labor (“DOL”) recently announced the launch of its newest national project, the Consultant/Advisor Program (“CAP”), through its Employee Benefits Security Administration (“EBSA”) enforcement website. According to the release, CAP will focus on the receipt of improper, undisclosed compensation by pension consultants and other investment advisers. EBSA’s investigations will seek to determine whether the receipt of such compensation violates ERISA because the adviser/consultant used its position with a benefit plan to generate additional fees for itself or its affiliates. EBSA expressed its intent to investigate individual plans in order to address such potential violations as failure to adhere to investment guidelines and improper selection or monitoring of the consultant or adviser. The CAP will also seek to identify potential criminal violations, such as kickbacks or fraud.

CAP is the EBSA’s response to a May 16, 2005, SEC study, entitled Staff Report Concerning Examinations of Select Pension Consultants. The SEC Report summarizes an examination sweep into the practices of pension consultants, which focused on any conflicts of interest in their operations, and was initiated as part of the SEC’s program to identify and investigate risks in the securities industry.

The Office of Compliance Inspections and Examinations conducted a study of 24 pension consultants over a 23 month period. The findings revealed that there was indeed cause for concern because over 50 percent of the consultants in the study provided services to both clients and to money managers. Providing such services presents a conflict of interest in which the consultant stands to gain substantially through “brokerage commission recapture programs.” When offering services to both pension clients and to money managers, consultants are obligated under the Advisers Act to fully disclose all potential conflicts of interest to their clients. The SEC Report revealed, however, that most consultants do not fully disclose other business activities and some did not disclose any additional business activities. Of those consultants that engaged in disclosure, most of the disclosure was bogged down with confusing language, such that an individual with common-knowledge could not understand the potential ramifications of the disclosure. The SEC Report, therefore, concluded that consultants must have better policies and procedures in place so that consultants are inline with their fiduciary obligations to their clients.

The SEC Report, CAP and the recent spate of 401(k) lawsuits signal a widespread concern regarding the performance of consultants and a growing anti-consultant sentiment. Consequently, plan sponsors and co-fiduciaries will be expected to further scrutinize the adviser’s performance, conflicts and disclosures thereof in order to meet their duties to prudently select and periodically monitor plan consultants and investment advisers. For more information on fulfilling these duties, please feel free to contact Jason C. Roberts at Edgerton & Weaver, LLP.

E&W Launches PPA/Fiduciary Adviser Legal Resource Center

Edgerton & Weaver, LLP recently announced the launch of itsPPA Fiduciary Adviser Legal Resource Center at http://www.ppa-law.com/. The new site contains a comprehensive collection of PPA legal and compliance resources and provides convenient access to recent articles and case summaries concerning PPA fiduciary advice. The site also contains a list of E&W-approved service providers, including plan consultants, fiduciary adviser training, certification and audit providers as well as investment risk and valuation analysis professionals. The most relevant governmental links for PPA fiduciary advisers, investment managers and plan sponsors are easily accessible from the site’s homepage. For more information about the PPA Fiduciary Adviser Legal Resource Center or for assistance with establishing a PPA-compliant investment advice program or plan, please contact Jason C. Roberts, Esq. at jroberts@edgertonweaver.com.

Further Discussion on the Opportunities and Challenges for PPA Fiduciary Advisers

The PPA allows fiduciary advisers to charge reasonable fees for helping participants select specific funds within their employer-sponsored plans. The fees are deducted from plan assets or paid by the participant. Careful consideration should be given to the desired “pick-up” rate of participant advice based upon the nature of the plan being serviced. For example, in plans where the majority of employees are making substantial contributions (i.e., hospitals, law firms, etc.) the fiduciary adviser should seek to have fees deducted from the plan, which will encourage more participants to opt for individual advice. In plans where the average balance is, for example, less than $50,000 and default investments are preferred, we recommended that fees be paid for by the individual participants such that only those with significant assets are likely to engage the fiduciary adviser.

Depending upon the extent of the services offered, reasonable fees are expected to range from $300 - $1,500 per participant. Consequently, business generated from fees alone has the potential to create significant revenues. A projection developed by DALBAR, Inc. and published on www.FiduciaryAdviser.com estimates that an adviser could earn $50,000 annually from just one employer with 100 employees. A fiduciary adviser going it alone could reasonably expect to service roughly 600 employees and receive $300,000 in fiduciary fee revenue. Moreover, these revenues are easily scalable to the extent the fiduciary adviser recruits and trains advisers to additional plans.

The PPA also opens the door to additional growth through the ability to reach participants’ household and rollover assets and via referrals. An estimated one in ten employees that will use a fiduciary adviser has household assets averaging $150,000, and one in twenty will be in a position to rollover plan assets averaging $500,000. Common sense dictates that employees will seek to consolidate their finances and deal with a single investment professional. Thus, not only will fiduciary advisers and their firms benefit by establishing a presence in this newly-created market, we expect that those who fail to do so will see a measurable degree of attrition from employees who, for lack of a better term, “gave at the office.”

As with most opportunities, there are certain pitfalls that must be addressed prior to entering this market. First, the PPA requires that any advice be rendered by a qualified “fiduciary adviser” that is fully regulated by applicable banking, insurance, and securities laws. Fiduciary advisers are also subject to civil and criminal penalties by the DOL, the IRS and could be held civilly liable to the participant. Existing supervisory and compliance procedures must, therefore, be examined and updated upon the release of ongoing guidance from regulators.

The PPA further requires that the proffered advice be made pursuant to an “eligible investment advice arrangement” (“EIAA”) that is either fee neutral or based on a computer model under an “investment advice program” such as that addressed in the Department of Labor’s (“DOL”) advisory opinion 2001-09A (the SunAmerica Letter). Under the fee neutral arrangement, the adviser’s total compensation, including indirect compensation derived from the purchase or sale of securities in reliance on the proffered advice, cannot vary based on the advice given.

Recent guidance from the DOL (Field Assistance Bulletin No. 2007-01) makes clear that registered investment advisers and broker-dealers must be PPA compliant if their advisers/reps become PPA fiduciary advisers. Consequently, these firms are subject to the level compensation requirement as well. This provision is problematic to the degree that a fiduciary adviser firm shares revenues with and/or is otherwise compensated by affiliates. Although affiliates are subject to the level compensation requirement only to the extent they provide investment advice to participants, because firms must ultimately accept fiduciary liability for participant accounts, affiliated RIAs and broker-dealers seeking to enter this market should establish a separate RIA to guarantee that compensation does not vary among investment options.

Because the PPA requires advisers to act as fiduciaries, firms must scrutinize their supervisory procedures to help ensure that the proffered advice is dispensed prudently, objectively, and is being rendered for the exclusive purpose of providing benefits to the plan's participants and beneficiaries. Given that many broker-dealers have taken the position that a stockbroker is never a fiduciary and have, therefore, failed to define an appropriate standard of care, amendments to compliance materials and service agreements may also be necessary. Even where a firm has previously allowed advisers to act as fiduciaries, enhanced fiduciary-related due diligence procedures for selecting and monitoring investment options should be established. Again, we stongly recommend creating a separate PPA-compliant RIA.

The PPA also requires fiduciary advisers to provide participants with exhaustive disclosures concerning, among others, fees charged, services to be rendered, past performance and historical returns of investment options, potential conflicts, and the participant’s ability to seek advice from an independent adviser. These disclosures must be written in plain, easy-to-understand language, and are required to be made when advice is first given, and at least annually thereafter. Disclosures must also be provided upon the request of the participant and whenever there is a material change to the adviser’s fees or affiliations. Given the increased focus on excessive fees and revenue sharing (due to a flood of lawsuits against 401(k) providers), particular attention should be paid to the extent and specificity of the disclosures.

The PPA expressly places the burden of establishing compliance with the foregoing provisions on the firm and anticipates that such compliance will be reviewed as part of the required annual audit. For additional information concerning the PPA, the DOL Bulletin, or for assistance with developing procedures to ensure your firm’s compliance with the requirements set forth therein, please contact Jason Roberts by phone at (310) 937-2066 or email at jroberts@edgertonweaver.com.

DOL Bulletin Provides Guidance on PPA Compliance

On February 2, 2007, the Department of Labor (“DOL”) released Field Assistance Bulletin No. 2007-01 (the “Bulletin”) setting forth additional guidance regarding statutory exemptions for investment advice offered to 401(k) participants pursuant to the Pension Protection Act of 2006 (the “PPA”). This post summarizes the Bulletin as it relates to registered investment advisers (“RIAs”) and broker-dealers seeking to offer these services.

The Bulletin makes clear that RIAs and broker-dealers must be PPA compliant if their advisers/reps become PPA fiduciary advisers. Consequently, firms are subject to the level compensation, prudent selection, and periodic monitoring requirements contained within the PPA. The Bulletin expands upon these provisions in the following respects:

Level Compensation

The investment advice exemption created by the PPA requires that proffered advice be made pursuant to an eligible investment advice arrangement (“EIAA”), which, among other things, requires that any fees (including commissions or other compensation) received by the fiduciary adviser do not vary based upon the investment option selected. The Bulletin clarifies “level compensation” as it relates to affiliates of fiduciary adviser firms by explaining that such affiliates are subject to this requirement only if they are providing investment advice to plan participants and beneficiaries. Nevertheless, because firms must ultimately accept fiduciary liability for participant accounts, affiliated RIAs and broker-dealers seeking to enter this market should consider establishing a separate RIA to ensure compliance with the level compensation requirements as well as the fiduciary standards imposed upon PPA advisers.

Prudent Selection

The Bulletin also significantly broadens the prudent selection requirements contained in the PPA. PPA advisers are to be subjected to an objective process, designed to elicit information necessary to assess the adviser’s qualifications, the quality of services offered as well as the reasonableness of fees charged for those services. The process must avoid self dealing, conflicts of interest or other improper influence. It must also take into account the experience and qualifications of the fiduciary adviser, their registration in accordance with applicable federal and/or state securities laws, their willingness to assume fiduciary status and responsibility for the advice under ERISA, and the extent to which the advice is based upon generally accepted investment theories.

Periodic Monitoring

The Bulletin also requires plan sponsors to review the extent to which there have been any changes in the information that served as the basis for the initial selection of the fiduciary adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries is being based upon generally accepted investment theories. The Bulletin further requires plan sponsors to consider whether the fiduciary adviser is complying with the contractual provisions of the engagement and to examine utilization of the investment advice services by the participants in relation to the cost of the services to the plan. It directs plan sponsors to monitor and address participant feedback and complaints about the quality of the furnished advice.

The Bulletin expressly places the burden of establishing compliance with the foregoing provisions on the firm and anticipates that such compliance will be reviewed as part of the required annual audit. For additional information concerning the Bulletin, the PPA, or for assistance with developing procedures to ensure your firm’s compliance with the requirements set forth therein, please contact Jason Roberts by phone at (310) 937-2066 or email at jroberts@edgertonweaver.com.