ERISA Fiduciary Responsibilities
—A Primer for Plan Sponsors
Abigail B. Pancoast
Senior Counsel, Lincoln Financial Group®
The information contained in this article is intended to provide general information, does not
constitute tax or legal advice, and does not purport to be complete or cover every situation.
Please consult with your own independent legal and tax advisor(s) for more information about
your specific situation. This material was prepared to support the promotion and marketing of
retirement products. Lincoln Financial Group® affiliates, their distributors, and their respective
employees, representatives, and/or other insurance agents do not provide tax, accounting, or legal
advice. Any tax statements contained herein were not intended or written to be used, and cannot
be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Please consult your
own independent advisor as to any tax, accounting, or legal statements made herein.
Who is an ERISA Fiduciary?
Before discussing specific fiduciary duties,
it is useful to consider who is an ERISA
fiduciary. Under ERISA, a plan fiduciary
is person or entity who:1
• Exercises discretionary authority over
plan management,
• Exercises any authority or control over
plan assets,
• Has discretionary authority over plan administration, or
• Gives investment advice to the plan
or a plan participant for a fee.
ERISA requires that the plan have at
least one fiduciary (either a person or
an entity) named in the plan document
or through a process described in the
plan document (the “named fiduciary”).2
The named fiduciary must have the
authority to control and manage the
operation of the plan. The plan can
identify the named fiduciary as one or
more committees made up of employees
of the employer sponsoring the plan.
Alternatively (and more commonly in
the case of small employers), the plan
could provide that the named fiduciary
is simply the employer itself. Often, the
ERISA § 3(21)(A).
ERISA § 402(a)(1).
3
ERISA § 405(c).
1
2
named fiduciary will not have the time or
expertise necessary to properly carry out
its responsibilities. To address this, ERISA
permits named fiduciaries to delegate
most fiduciary functions to other service
providers.3 As discussed further below,
this does not absolve the named fiduciary
from responsibility for the delegated
functions because the named fiduciary is
still responsible for the prudent selection of
the service provider and ongoing oversight
of the service provider’s actions.
In addition to named fiduciaries and their
delegates, there may be individuals or
entities that are fiduciaries because they
perform fiduciary functions even though
they are not named as such (“functional
fiduciaries”). This is because formal
appointment is not required for fiduciary
status; rather, fiduciary status is determined
based on what the person or entity
actually does with respect to the plan.4
Thus, for example, a person or entity who
manages the investment of plan assets,
makes discretionary decisions regarding the
operation of the plan, or gives investment
advice for a fee to the plan or plan
participants would be an ERISA fiduciary
whether or not designated as such.
With the exception of named fiduciaries,
ERISA fiduciaries generally are only
fiduciaries with respect to the specific
functions they are performing. For example,
the person who is a fiduciary by virtue
of managing plan assets would only be
a fiduciary with respect to the assets
managed and only in its capacity as an
investment manager. It would not be a
fiduciary with respect to the plan as a
whole and would not have fiduciary duties
other than those related to the investment
management of the assets for which it
is responsible.
The Significance of Being a Fiduciary—
Basic Standards of Conduct
Fiduciary status is important because it
carries with it high standards for conduct
and potential personal liability if these
standards are not met. These standards of
conduct require a fiduciary to:7
• Act solely in the interest of plan participants
and beneficiaries with the exclusive purpose
of providing benefits to them and paying
reasonable plan expenses (the “duty of
loyalty”),
• Act with the care, skill, prudence, and
diligence of a prudent person who is familiar
with retirement plan matters (i.e., act as
a “prudent expert”), and
• Diversify plan investments to avoid
large losses.
Duty of Loyalty. The duty of loyalty is
a command to avoid conflicts of interest
and self-dealing. It means that fiduciary
decisions must be made without favoring
the interests of the fiduciary or any other
third party over the interests of participants
and beneficiaries. However, plan fiduciaries
are not prohibited from taking actions that
incidentally benefit the employer as long
as the duty of loyalty standard is otherwise
met.6 This duty also forms the basis for
some of ERISA’s prohibited transaction rules
that forbid a fiduciary from engaging in
transactions with plan assets in a manner
that would benefit the fiduciary. This duty
also places an affirmative obligation on plan
fiduciaries to pay only reasonable expenses
from the plan.
Duty of Prudence. According to the
U.S. Department of Labor (DOL), the duty
of prudence is one of a fiduciary’s most
central responsibilities under ERISA.7 This
rule forms the basis for the courts’ and the
DOL’s emphasis on “procedural prudence.”
Procedural prudence means that a fiduciary
that follows a careful and thorough process
in making a fiduciary decision should
not generally be liable for violating the
prudence requirement even if the decision
results in a loss to the plan. Procedural
prudence is particularly important in the
context of investment decisions because
investment decisions can so often have poor
outcomes that are not anticipated. In order
to be prudent, the decision-making process
must involve sufficient investigation and due
diligence to allow the fiduciary to make an
informed evaluation and decision. Because
of the focus on process, documenting
decisions and the basis for them is critical
for the fiduciary to be able to defend those
decisions if they are ever challenged.
Another important aspect of the prudence
requirement is the requirement that the
fiduciary act as a prudent expert in carrying
out its duties. This means that either the
fiduciary must be knowledgeable and
expert in all aspects of plan administration
This is made clear in the definition of an ERISA fiduciary, which describes fiduciary status in terms of actions, not titles or appointments.
ERISA § 404(a).
6
Lockheed v. Spink, 116 S. Ct. 1783 (1996).
7
DOL Publication, “Meeting Your Fiduciary Responsibilities,” available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html.
4
5
or rely on outside experts.8 Since plan
fiduciaries usually do not have the expertise
necessary to administer a plan, they must
rely on outside providers to meet the
prudent expert requirement. However,
the plan fiduciary still retains some
responsibility for the actions of these service
providers and continues to be responsible
for the decisions it makes when relying
on expert advice.9 Therefore, engaging
in a procedurally prudent process when
selecting these experts, and once selected,
monitoring their performance, is critical.
Duty to Diversify. In some sense, the duty
to diversify investments is a subset of the
duty of prudence. The fact that it is listed as
a separate duty gives emphasis to the critical
importance of the investment functions
of ERISA fiduciaries. Proper investment
diversification requires consideration of
factors such as the purpose of the plan and
the type of plan, the amount of plan assets,
plan demographics, and general economic
conditions. In the context of a participantdirected 401(k) plan, diversification means
having a diversified investment menu for
participants to choose from. In general, the
duty to diversify prohibits the investment
of a substantial portion of plan assets in
a single investment or a single type of
investment. However, there are exceptions,
for example, for plans designed to invest
primarily in employer stock. In addition, a
plan may invest large amounts in insurance/
annuity contracts, provided the insurance
company’s assets are adequately diversified
or in pooled investments or mutual funds
where the pooled funds or mutual funds
are themselves adequately diversified.10
Finally, plan fiduciaries can be relieved
of the diversification requirement where
participants elect to direct the investment
of their accounts.11 Here, however, the plan
must offer a “broad range” of investment
alternatives for the participant to choose
from, so that participants can diversify their
investments if they so choose.12
Fiduciary Functions and Application
of ERISA Standards
What emerges from the basic definition of
who is an ERISA fiduciary and the standards
of conduct applicable to ERISA fiduciaries
is that fiduciary functions can be divided
into two broad categories: (1) plan asset
investment management and (2) noninvestment-related plan management, i.e.,
general plan administration. These two
general functions encompass a wide variety
of activities, each of which may have its
own set of considerations and issues. The
following discusses several of the most
important activities that a fiduciary is
responsible for in each of these categories
and how to ensure that they are carried out
in accordance with ERISA’s requirements.
Plan Investment Management
Of all of the functions that a plan fiduciary
undertakes, plan investment management
probably receives the most attention. This
attention is deserved; proper investment
management is critical for a plan to have
sufficient assets to fund the benefits
that participants expect and plan for in
their retirement. A failure to properly
manage plan assets can lead to unjustified
investment losses and/or insufficient
See ERISA § 402(c)(2), which provides that a plan may provide that a fiduciary may employ “one or more persons to render advice with
regard to any responsibility such fiduciary has under the plan.”
See, e.g., Donovan v. Cunningham et al., 716 f2d 1455 (5th Cir. 1983) (holding that fiduciaries need not become experts in valuation of
closely held stock but are entitled to rely on expertise of others; however, fiduciaries are responsible for insuring that information upon
which the expert’s opinion is based is complete and up to date); Donavan v. Mazzonla, 716 F 2d 1226 (9th Cir. 1983) (reliance
on counsel’s advice, without more, cannot be a complete defense to an imprudence charge).
10
HR Conf. Rep. No. 92-1280 (House Conference Report to ERISA) at 305.
11
ERISA § 404(c)(1).
12
DOL Reg. § 2550.404c-1(b)(1)(ii).
8
9
investment returns. An ERISA fiduciary’s
investment management function includes
selecting the investment vehicles in which
plan assets will be invested and designating
the allocation of plan assets among the
various investments. In the case of a plan
in which participants are permitted to
direct the investment of their individual
accounts, this function means selecting the
investment options that will be available for
participants to choose from.
The three fiduciary duties discussed
above, the duties of loyalty, prudence,
and the duty to diversify, all apply to the
investment management function. The
duty of loyalty dictates that decisions
relating to the investment of plan assets
must be made free of conflicts of interest.
Thus, for example, a fiduciary investing
plan assets in companies that the fiduciary
has a substantial ownership interest in or
hiring a relative as an investment advisor
would generally be a breach of this duty.13
The duties of prudence and the duty to
diversify require prudent selection of plan
investments that are adequately diversified,
and/or the selection of service providers
to assist with this function. Of all of these
duties, the prudence requirement gets the
most attention because fiduciaries can never
be sure at the outset that an investment
decision will be a good one. Without the
benefit of hindsight, the best insurance
against potential liability for investment
decisions that turn out poorly is to be able
to demonstrate “procedural prudence” in
making those decisions in the first place.
The Importance of Procedural Prudence.
DOL regulations provide that when
making investment decisions, the duty of
prudence requires the fiduciary to give
“appropriate consideration” to the facts
and circumstances that the fiduciary knows
or should know are relevant to a particular
investment or investment strategy, including
the role that the investment (or strategy) will
play in the plan’s portfolio, and the fiduciary
must act in accordance with the conclusions
that were reached after that appropriate
consideration has been undertaken.14
Consideration of facts and circumstances
that the fiduciary should know about means
that it is insufficient to consider only readily
available information about the merits of
the investment if additional information can
be found through thorough investigation
and due diligence. “Appropriate
consideration” includes a determination by
the fiduciary that a particular investment or
investment strategy is reasonably designed
to further the purposes of the plan, taking
into consideration the risk of loss and the
opportunity for gain associated with the
investment.15 Consideration should also be
given to (1) the diversification of the overall
investment portfolio, (2) the liquidity of the
investment relative to the liquidity needs of
the plan, and (3) the projected investment
return in relation to the objectives of the
plan.16 If the fiduciary can demonstrate that
a decision-making process was followed
that incorporated these considerations,
most courts would find that the decision
was prudent even if the investment turns
out to have performed poorly. For example,
in Donovan v. Cunningham,17 the court
said that the test of prudence “is one
of conduct, not the performance of the
investment. The focus of the inquiry is
how the fiduciary acted in his selection
of the investment and not whether his
See, e.g., Lowen v. Tower Asset Management, 829 F. 2d 1209 (2d Cir. 1987) (investment advisory firm invested significant portion of plan
assets in companies in which advisory firm members had substantial equity interests); International Brotherhood of Painters v. Duval, 925
F. Supp. 815 (D.D.C. 1996) (fund’s financial consultant was trustee’s family member).
14
DOL Reg. 2550.404a-(1)(b)(1).
15
DOL Reg. 2550.404a-(1)(b)(2).
16
Id.
17
716 F2d 1455 (5th Cir. 1983).
13
investments succeeded or failed.” This is an
illustration of a court’s application of the
“procedural prudence” concept. In other
words, the decision-making process is more
important than the outcome: if the fiduciary
engages in procedurally prudent process,
the investment decision will generally be
respected no matter the actual investment
outcome.18
More recently, courts have also weighed in
on the prudence requirements applicable
to 401(k) plan fiduciaries when selecting
investment options to make available to
participants. At issue in these cases is
not just investment performance of the
fund options but also whether the fees
associated with the funds are excessive
(of course these two issues are related
since fund-level fees can reduce potential
investment return). In general, the courts
have held that the prudence analysis is the
same; that is, the focus has been whether
the process for selecting investment options
was prudent, not on the performance of the
funds selected or the level of fees charged.
For example, in Kanawi v. Bechtel Corp.,19
the court held that even though some of
the funds available in Bechtel’s 401(k) plan
underperformed their benchmarks, because
the plan fiduciaries regularly reviewed the
performance of the funds and considered
alternatives, they did not breach their
fiduciary duties in the selection of funds
for the plan because “test of prudence is
one of conduct and not performance” and
“[i]t is easy to opine in retrospect that the
Plan’s managers should have made different
decisions, but such 20/20 hindsight musings
are not sufficient to maintain a cause of
action alleging a breach of fiduciary duty.”
Similarly, in Taylor v. United Technologies
Corp.,20 the court held that because the plan
fiduciaries’ process for selecting investment
options gave appropriate consideration
to the fees and expenses charged by the
mutual fund managers, the participants’
claims that the selection of those
investment options was imprudent failed.
It is important to note that some courts
have attempted to distinguish between
procedural and “substantive” prudence.
Substantive prudence looks at the results
of the decision-making process in addition
to the process itself. For example, in
Braden v. Wal-Mart Stores, Inc.,21 the court
indicated that a fiduciary’s investment
option selection process could be found
deficient if the fiduciary could have selected
equivalent funds that were less expensive. In
contrast to traditional procedural prudence
analysis, this focuses on the results of the
fund selection process (i.e., the funds that
were actually selected), rather than limiting
the evaluation to the appropriateness of
the process itself. As a practical matter,
however, engaging in a procedurally
prudent process is still the best defense
against potential challenges to fiduciary
decision-making because it is much more
likely that such a process will yield a
substantively prudent result.
Adopting an Investment Policy Statement.
So how does a fiduciary implement a
procedurally prudent process for making
investment decisions? One of the best
ways to do this is to create a written
process for making these decisions and
then documenting that this process was
followed. In the context of investment
decisions, the way to do this is by adopting
an investment policy statement. An
investment policy statement is a set of
guidelines for fiduciaries to follow when
For an example of what happens when a prudent process is not followed, see De Costa v. Rodrigues, 46 EBC 2594 (9th Cir. 2009) (plan
administrator who failed to undertake any due diligence or make even minimal inquiries into the plan’s investment that he authorized
breached his fiduciary duties).
19
590 F. Supp. 2d 1213 (N.D. Cal. 2008).
18
making investment decisions, such as
investment objectives and strategy (e.g.,
growth, capital preservation, balanced),
target asset allocation mix, performance
benchmarks, fees/expenses, and liquidity
targets. In the case of a plan in which
participants direct the investment of
their individual accounts, the investment
policy statement would include such
items as the types of funds that should be
included in the investment fund lineup, the
minimum criteria for fund option inclusion,
performance benchmarks for each fund
option, and the process for evaluating and
replacing existing fund options if necessary.
Having an investment policy statement and
documenting that it was followed in making
investment decisions not only provides
legal protection to fiduciaries in the event
a decision is challenged, it increases the
likelihood that sound investment decisions
will be made, thereby reducing the chance
of challenges in the first place.22
Hiring Outside Service Providers.
Another important way fiduciaries can
ensure prudent investment decisions is to
seek the assistance of experts. Because
proper investment management requires
a high level of specialized expertise that
employers and other fiduciaries don’t
usually have, the “prudent expert”
requirement discussed above effectively
mandates that most plan fiduciaries obtain
the advice of outside experts or delegate
this function to outside experts rather than
doing it on their own. As with the hiring
of any plan service provider, hiring an
outside investment expert is itself a fiduciary
function subject to ERISA’s duties of loyalty
and prudence. In the case of the duty of
loyalty, this means ensuring that the outside
experts are free of conflicts of interest.
Thus, for example, the expert should either
be independent of the investment product
providers for the plan (e.g., mutual funds or
insurance companies) or the compensation
arrangements should be structured so the
expert’s advice or management functions
cannot affect the amount of its and its
affiliates’ compensation.23 In addition, the
fiduciary must pay only reasonable expenses
from the plan. Therefore, to the extent
that an investment service provider’s fees
will be paid from plan assets, the fiduciary
must carefully evaluate them to determine
that they are reasonable. This generally
involves comparing the fee estimates of
multiple potential service providers and
understanding what services are included in
those fee estimates.24
As with the making of investment decisions,
the duty of prudence requires the fiduciary
to obtain and evaluate relevant information
about potential service providers and act
accordingly. Relevant factors to consider
might include items such as: professional
qualifications and experience, fee structure,
business practices, affiliations, financial
condition, and liability insurance coverage.25
It also means ensuring that the service
arrangement terms are reasonable. For
example, ERISA generally requires that
service agreements be terminable on short
notice and without penalty.26 In addition,
the service provider will want to ensure
that the fiduciary and the service provider
have the same understanding of the scope
of services to be provided. To ensure
Not only are investment policy statements useful for creating a defense record in the event a fiduciary is sued over an investment decision,
the investment policy and documentation that was followed is helpful in the event of a DOL audit of the plan.
23
In addition to a possible breach of fiduciary duty by a hiring fiduciary and the investment expert (who may also be a fiduciary as discussed
further below), receipt by a fiduciary of additional compensation as a result of investment advice or management function is a prohibited
transaction under ERISA and the Internal Revenue Code, subject to excise taxes and other penalties. See DOL Reg. § 2550.408b-2(e)(1).
24
See DOL Publication, “Meeting Your Fiduciary Responsibilities,” available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.
html. See also the discussion above relating to recent litigation involving 401(k) plan investment-level fees.
25
Id.
26
DOL Reg. § 2550.408b-2(c).
22 these issues are adequately covered and
to provide a record of the arrangement,
agreements should be in writing. Once a
provider is selected, the duty of prudence
also requires monitoring the service
provider’s performance, reading the reports
they provide, reviewing actual fees charged,
periodic review of policies and practices,
and following up on problems that come to
the fiduciary’s attention.27
To ensure that all appropriate due diligence
is performed and all relevant factors are
considered, the fiduciary should establish
a written process for service provider
selection and monitoring (similar to the
investment policy statement for investment
decisions) and document that this process
was followed for each service provider
retained. If the decision is ever challenged,
the fiduciary will be much more likely to
prevail if it is able to point to the process
and a record that the process is followed. In
addition, such a process helps ensure that
the same criteria are applied in evaluating
similar service providers so that the fiduciary
can properly compare them.28
Investment Service Provider Hiring
Considerations. In addition to the general
fiduciary considerations discussed above,
below are some important factors for a
fiduciary to consider when making outside
investment expert hiring decisions.
1. Investment advice or investment
management? A plan fiduciary seeking
investment expertise can obtain essentially
two levels of service. If the plan fiduciary
retains the investment management duty
but seeks expert advice, the investment
advisor will not manage (i.e., direct the
purchase, sale, etc. of) plan assets but
rather simply provide advice, which
the fiduciary may or may not follow in
performing the separate management
role. Alternatively, the fiduciary might
delegate the entire investment management
function out to an expert, in which case
the investment manager would have actual
authority to direct investment transactions.
If the fiduciary delegates this function
to an investment manager who (1) is
an investment advisor registered under
the Investment Advisors Act of 1940, a
bank or an insurance company, and (2)
acknowledges in writing that it is an ERISA
fiduciary with respect to the plan (a socalled “ERISA Section 3(38) investment
manager”), the fiduciary generally will not
be liable for the investment decisions of
the investment manager.29 However, the
appointing fiduciary will remain responsible
for the proper selection of the investment
manager and for monitoring the manager’s
performance to determine whether its
continued engagement by the plan is
appropriate.
One circumstance in which a fiduciary
might want to hire an investment manager
is if the plan has an automatic enrollment
feature or otherwise has a need for a
default investment option for participants
who fail to give affirmative investment
directions with respect to their individual
accounts. Under ERISA, a fiduciary generally
will not be responsible for losses that result
from investment in a “qualified default
investment alternative” (QDIA), provided the
participant was first given the opportunity
to direct the investment of his account
and he failed to do so and certain other
EBSA Publication, “Meeting Your Fiduciary Responsibilities,” available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html.
In this regard, the DOL suggests that, when evaluating potential service providers, fiduciaries should ask each one for the same information and subject each one to the same requirements for consideration. See DOL Publication, “Meeting Your Fiduciary Responsibilities,”
available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html.
29 See ERISA § 3(38) (defining an investment manager) and ERISA § 405(c)(2) (providing that the named fiduciary will not be liable for the
acts of a designated fiduciary but will remain responsible for the selection and oversight of the designated fiduciary).
27 28
requirements are met.30 A QDIA must
generally be managed by either an ERISA
Section 3(38) investment manager or a
registered investment company (i.e., be
a mutual fund).31
Therefore, if the plan fiduciary wants
to use an investment option other than
a registered mutual fund as the plan’s
QDIA, an investment manager is generally
necessary.
2.Are the services for the plan or
participants? If the plan is one in which
participants direct the investment of their
individual accounts, the plan fiduciary
may wish to make available to participants
an investment expert to advise and/or
manage their accounts if they so elect.
Given the increasingly complex nature of
retirement investing and the fact that most
plan participants do not have the time or
expertise (or interest, for that matter) to
manage this on their own, many employers
find this service to be an essential feature
of their retirement programs. If this is
done, the plan may be receiving two
tiers of investment management and/or
advice services—one for the plan fiduciary
and one for the participants. For many
plan fiduciaries who are not themselves
investment experts, retaining both levels of
service will be important to ensure proper
fund lineup selection and monitoring at
the plan level and to offer a resource to
participants who need help investing their
plan accounts.
Some plans will make available “investment
education” to participants instead of
investment advice or management services.
Investment education is information about
retirement investing in general, rather than
investment recommendations that are
tailored to an individual participant. Under
DOL guidance, such information is not
considered investment advice and therefore
the provider of the education will not be
considered an ERISA fiduciary based on
providing that information.32 Investment
education can include tools such as asset
allocation models that are generated based
on information provided by the participant.
Such models must be based on generally
accepted investment theories and meet
several other requirements, mostly aimed
at making clear that the models are not
directed at any particular individual (i.e., are
not individualized investment advice). The
DOL has made clear that the selection of a
provider of investment education is a fiduciary
function. Therefore, as with any other service
provider, the fiduciary will be responsible
for the proper selection and oversight of an
investment education provider.
3.The investment advisor/manager is also
an ERISA fiduciary—but… Whether an
investment service provider is providing
advice or management services, the service
provider will generally be considered to
be an ERISA fiduciary. The provider of
advice is an ERISA fiduciary because it
is providing investment advice for a fee
or other compensation. The provider of
management services is an ERISA fiduciary
because of its authority and control over
plan assets. While these service providers
are fiduciaries and therefore can themselves
be held liable for their breaches of fiduciary
duty, it is very important to keep in mind
that, under ERISA, their fiduciary status
does not remove the responsibility of the
fiduciary who hires them. For example, as
noted above, most courts have held that a
fiduciary will not be insulated from liability
merely by relying on the advice of experts.33
Therefore, relying on the investment
advice of an investment expert will not
ERISA § 404(c)(5).
See DOL Reg. § 2550.404c-5. Alternatively, the QDIA can be managed by the employer or the plan’s named fiduciary. However,
for reasons previously discussed, this is often not a viable option.
33 See, e.g., Donovan v. Cunningham et al., 716 F2d 1455 (5th Cir. 1983).
30 31 necessarily relieve the fiduciary of potential
liability even though the investment expert
providing the advice is also a fiduciary. The
only way that a fiduciary can relieve itself
of potential liability for plan investment
decisions is to hire an ERISA Section 3(38)
investment manager as described above.
While using outside investment expertise
in any form makes liability less likely by
helping the fiduciary make better decisions,
and the investment expert can also be held
liable for its own actions, it is important
to understand the limits of the hiring
fiduciary’s protection from liability when it
hires investment experts.
4.Investment diversification
considerations. When selecting an
investment provider, it may be important
to consider whether the provider’s product
offerings can allow the plan’s investment
portfolio to be adequately diversified. This
generally is more of a concern for plans in
which participants direct the investment
of their individual accounts. These plans
often want to be able to work with a single
provider to offer the plan’s investment
options. Therefore, the fiduciary should
ensure that the provider offers access to a
fund lineup that will allow a participant to
diversify his or her account sufficiently to
avoid large investment losses. In addition,
many plan fiduciaries will want to take
advantage of the fiduciary liability “safe
harbor” found in ERISA Section 404(c).
ERISA Section 404(c) generally provides
that the plan fiduciary will not be liable for
losses resulting from individual participant
investment decisions so long as the
participant can choose from among a
“broad range” of investment options and
certain other requirements are met.34
34 35
DOL Reg. § 2550.404c-1(b)(1).
DOL Reg. § 2550.404c-1(b)(3).
A fiduciary who wants to use this fiduciary
safe harbor will want to make sure that
the investment provider’s product offering
includes a sufficiently broad range of
investment options. In general, this means
that the product offering must: (1) have
at least three investment alternatives,
(2) each with unique risk and return
characteristics that (3) in the aggregate
allow the participant to create a personally
appropriate investment portfolio that (4)
minimizes risk through diversification.35
Non-Investment Plan Management
and Administration
As previously noted, ERISA fiduciaries
include individuals or entities who
exercise discretionary authority over plan
management and administration. Noninvestment- related plan management and
administration includes functions such
as: maintaining a written plan document,
maintaining the plan’s funding vehicle via a
trust or insurance contract, recordkeeping of
plan financial activity, Form 5500 reporting
to the DOL, providing certain information
to plan participants (e.g., summary plan
descriptions, benefit statements, etc.),
and maintaining operational compliance
with applicable legal requirements (e.g.,
plan coverage and nondiscrimination
requirements, minimum distribution
requirements, etc.).
Hiring Outside Service Providers. Some
of these activities (e.g., recordkeeping,
preparing Form 5500, coverage, and
nondiscrimination testing) do not involve
the exercise of discretion or authority and
thus are not necessarily in themselves
fiduciary functions. However, determining
who will perform these activities and
ensuring that they are done properly are
fiduciary functions subject to ERISA’s
fiduciary standards.36 Many of these
activities require specialized professional
expertise, systems, or other physical
capabilities that plan fiduciaries don’t have.
In some cases, the plan fiduciary might be
able to perform the activity but does not
have the time or it is simply more costeffective to outsource it. In these cases,
fiduciaries must obtain service providers to
assist them with these functions.
In hiring providers to perform these services,
the duties of loyalty and prudence apply in
the same manner as when hiring investment
service providers. Thus, for example, the
duty of loyalty would generally prohibit the
hiring of a firm that the fiduciary has an
ownership interest in, such that the fiduciary
gains a personal financial benefit from the
service relationship. Likewise, the duty of
prudence involves the same procedural
prudence considerations discussed above
when selecting and monitoring noninvestment service providers.
Non-Investment Service Provider Hiring
Considerations. Some examples of
important plan administration activities
that often require the assistance of an
outside service provider are below, along
with a discussion of some of the specific
considerations that should be given in the
hiring of service providers to perform these
activities.
1. Plan Document Preparation. ERISA
requires that a plan be established
and maintained pursuant to a written
instrument.37 This means not only
establishing the written document at the
inception of the plan, but also reviewing
it and updating it periodically to ensure
continued compliance with applicable law
and consistency with plan operations.38
Because retirement plans are subject to
so many legal requirements and these
requirements are always changing,
maintaining the plan document requires
substantial legal and technical expertise.
For this reason, many employers hire
attorneys or consultants to help them
draft and maintain their plan documents.
In addition, many service providers have
developed standardized “prototype” plan
documents that individual employers can
adopt for a relatively nominal charge,
thereby avoiding the expense of writing
an individually designed plan document.
The service provider sponsoring the
standardized document, then, generally has
the responsibility to update the document
for changes in the law.
Some important factors to consider in
retaining a document preparer include the
following:
• Should an attorney/consultant or the sponsor of a prototype document be used? If
the plan has unusual or complex terms,
it may not be possible to use a prototype
document. In that case, it may make sense
to retain an attorney or other expert to
draft an individually designed document
even though this will generally cost more
than using a prototype document. On the
other hand, if the plan has simple and/or
commonly used terms, the less expensive
prototype option may make more sense.
• If an attorney is used, the fiduciary should ensure that he or she is licensed to practice law
and is expert in the necessary areas of the law
(e.g., ERISA and the relevant tax-qualification
rules of the Internal Revenue Code).
See DOL Publication, “Meeting Your Fiduciary Responsibilities,” available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.
html.
37
ERISA § 402(a)(1). Initial establishment of the plan document may not be a fiduciary/plan administration function. However, keeping the
document updated and current often is the responsibility of the plan fiduciary.
38
In addition to the duties of loyalty and prudence and the duty to diversify, ERISA requires fiduciaries to comply with the terms of the written
plan documents, but only to the extent that the documents are consistent with the requirements of ERISA. ERISA § 404(a)(1)(D). Thus, it is
important to keep the document compliant with applicable law and plan operations so that the ERISA fiduciary can meet this requirement.
36
• If a prototype document is used, the fiduciary should ensure that it has a current favorable opinion letter from the IRS and that the
document provider commits to keeping that
letter current by updating the document for
future changes in the law.
• Often the person providing document
services will also prepare certain required
participant disclosure documents that are
based on the plan terms, such as the summary plan description. The same considerations for determining whether a service
provider is qualified to provide document
services should be applied here. If a prototype document provider is used, it may
make sense to ask to see a sample of these
disclosure documents.
• As part of the plan fiduciary’s ongoing
monitoring and oversight duties, all documents should be reviewed for accuracy.
2.The Form 5500 Audit. An ERISA-covered
plan is required to file an annual report
on Form 5500 with the DOL that includes
detailed information about the plan and
its operation. If the plan is a “large”
plan (generally a plan with at least 100
participants), the plan is required to file
audited financial statements with the
Form 5500 each year. The audit must be
performed by a licensed independent
qualified public accountant.
Some important considerations when
retaining an auditor include the following:39
• ERISA requires that the auditor be licensed
or certified as a public accountant by a state
regulatory authority. The fiduciary must
therefore ensure that the auditor has a current license/certification.
• ERISA requires that the auditor be independent. This means that the auditor should
39
40
not have any financial interest in the plan or
the plan sponsor that would affect its ability
to render an unbiased opinion about the
financial condition of the plan.
• The auditor should have experience in auditing employee benefit plans in particular.
Employee benefit plan audits require the
auditor to consider factors that are unique
to employee benefit plans (that might not
be required for audits generally). Examples
of factors that auditors need to consider are
(1) the timeliness of plan contributions, (2)
whether benefit payments are made in accordance with plan terms, (3) whether there
are any issues that might affect the plan’s
qualified status, and (4) whether there are
any potential prohibited transactions. The
need for specialized experience with employee benefit plan audits may justify any
extra cost that may be incurred in retaining
an auditor with this experience.
3.Recordkeeping. The administration of a
defined contribution plan such as a 401(k)
plan requires the separate accounting of
financial activity in individual participant
accounts.40 In today’s plan administration
environment, this requires the allocation
and crediting of contributions and earnings,
the processing of distributions and other
transactions, and the reconciliation of
these transactions all on a daily basis. Most
employers and other fiduciaries do not have
the physical or systems capability to perform
these functions.
Some important considerations when
retaining a recordkeeper include the
following:
• Can the recordkeeper track individual account financial activity on a daily basis?
So-called “daily valuation” is not a legal
requirement, but it is now generally what
DOL Publication, “Selecting An Auditor For Your Employee Benefit Plan” available at http://www.dol.gov/ebsa/publications/selectinganauditor.html.
In the case of a defined benefit plan, the participant’s accrued benefit payable at retirement is tracked instead of an individual account. The tracking
of individual accounts or accrued benefits is necessary, for example, for the dissemination of required participant benefit statements and the proper
distribution of participant benefits when participants become entitled to payment. It’s also necessary to perform various compliance functions, such
as keeping contributions/benefits within maximum limits, top-heavy testing, and nondiscrimination testing.
plan sponsors and participants expect.
• Will the recordkeeper also perform certain
compliance tests necessary for the operation of a retirement plan and will it assist
with the preparation of the Form 5500?
Many compliance tests required to maintain
a plan’s tax-favored status, such as topheavy testing, nondiscrimination testing,
and testing for compliance with contribution limits, rely on the financial activity
tracking functions of the recordkeeper.
These tests, as well as the valuation and reconciliation of plan assets and financial activity are also necessary for the completion of
the Form 5500. Therefore, the record-keeper will often perform these functions as part
of its recordkeeping services. If the recordkeeper will perform these services, the plan
fiduciary must evaluate the recordkeeper’s
qualifications in these areas.
• Will the recordkeeper assist with participant
enrollment in the plan? Section 401(k) plans
and plans that provide for participant investment direction generally require participants
to be able to actively enroll in the plan by
making a salary deferral election and/or
directing the investment of their accounts
among the available investment options.
Since employers are generally not equipped
to perform this function, it is usually important that the recordkeeper or some other
service provider be able to do this.
• Will the recordkeeper assist with the administrative requirements for plan distributions?
Distributions from tax-qualified retirement
plans must generally be preceded by a
notice to the receiving participant informing
him or her of the applicable distribution and
rollover options and the tax consequences
of these options. In addition, some plans
require special notices to be provided to
participants who are married at the time of
41
Edmonds v. Hughes Aircraft Co., 145 F 3d 1324 (4th Cir. 1998).
distribution. Once distribution occurs, it is
required to be reported to the participant
and the Internal Revenue Service on a Form
1099R. If the recordkeeper will perform
or facilitate these functions, the fiduciary
will need to evaluate the recordkeeper’s or
other service provider’s qualifications and
capabilities with respect to these functions.
Conclusion
Administration of an ERISA-covered plan is
an extremely complex endeavor that must
be performed by fiduciaries in accordance
with one of the highest standards of
care existing in the law.41 But with the
right process and the help of qualified
service providers, even fiduciaries with
the most limited time and little or no plan
administration expertise should be able to
meet ERISA’s exacting requirements.
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