ERISA Fiduciary Basics for Defined Contribution Plans Presentation
ERISA Fiduciary Basics for Defined Contribution Plans Presentation to CIEBA Members March 2015 Marla J. Kreindler Morgan Lewis 77 West Wacker Drive Chicago, IL 60601 312. 324. 1114 mkreindler@morganlewis. com www. morganlewis. com Julie K. Stapel Morgan Lewis 77 West Wacker Drive Chicago, IL 60601 312. 324. 1113 jstapel@morganlewis. com
Overview of Today’s Training v ERISA and DC Plan Overview v Special Investment Option Considerations: Target Date Funds, Company Stock and Stable Value v Fiduciary Status and Duties under ERISA v DC Plan Disclosures and Monitoring v Fiduciary v. Settlor Functions v Fee Arrangements and Related Topics v DC Plan Fiduciary Safe Harbors © Morgan, Lewis & Bockius LLP 2
Agenda ERISA and DC Plan Overview © Morgan, Lewis & Bockius LLP 3
What Is ERISA? • Employee Retirement Income Security Act of 1974 • Enacted in response to high-profile plan sponsor bankruptcies and widespread corruption in the management of employee benefit plan assets • Imposes fiduciary standards on those with discretionary authority or control over employee benefit plans and their assets (i. e. , fiduciaries) • Includes anti-conflict-of-interest rules and also prohibits transactions with a wide range of parties involved with the plan unless an exemption applies • Allows plan participants, plan fiduciaries and the Department of Labor to bring suit to enforce ERISA’s provisions © Morgan, Lewis & Bockius LLP 4
What Are ERISA-Covered Defined Contribution Plans? • Defined contribution (or “DC”) plans provide participants a benefit upon retirement based upon the contributions to each participant’s plan account and the investment returns on those contributions – In contrast, a defined benefit (or “DB”) plan provides participants a benefit upon retirement based upon a specified formula • Examples include 401(k), profit-sharing, ESOPs, stock bonus plans and 403(b) plans. • Institutional DC plans typically allow for participant direction of investments. • ERISA governs private sector DC plans, but not – Nonqualified private DC plans, such as SERPs or “top hat” plans – Governmental and certain church DC plans • Today’s focus will be 401(k) plans subject to participant-directed investments. © Morgan, Lewis & Bockius LLP 5
401(k) Plan Structure Overview Plan sponsor Participants and Beneficiaries 401(k) Plan Managed account, advice or education provider Trustee Fiduciary committee(s) Investment consultant © Morgan, Lewis & Bockius LLP Investment options (multiple) Auditor Recordkeeper (if different from trustee) 6
Role of the Trustee • The trustee generally acts as a “directed trustee. ” • The trustee will act upon proper direction from— – Participants (in a participant-directed plan) – The named fiduciary – The plan administrator – Investment managers • A directed trustee is still an ERISA fiduciary – DOL guidance that there are some circumstances that requiring over-riding directions • The trustee and the recordkeeper may be the same (or related) entities or separate © Morgan, Lewis & Bockius LLP 7
Types of Investment Options • Investment options in DC plans can take several forms and many plans offer a combination of these types of investment options: – Registered investment companies (i. e. , “mutual funds’”) – Collective trusts – Separately managed accounts – “White label”/custom investment options – Insurance products © Morgan, Lewis & Bockius LLP 8
Agenda Fiduciary Status and Duties Under ERISA © Morgan, Lewis & Bockius LLP 9
Definition of Fiduciary • Under ERISA, the term “fiduciary” is broadly defined to include any person who: – Exercises discretionary authority or control over management or disposition of plan assets – Renders investment advice for a fee – Has discretionary authority or responsibility for plan administration • Includes those named as fiduciaries in governing documents • Includes those responsible for appointing other fiduciaries • But a person can be a fiduciary even if not named as such in governing documents—based on function, not title © Morgan, Lewis & Bockius LLP 10
Examples of Fiduciaries • Committees assigned or exercising fiduciary functions • Individual members of the committees and investment and benefits staff who have discretionary authority or control over the administration and management of the plans? • The trustee (but generally only to a limited extent in the case of directed trustees) • Managers of separately managed accounts and collective investment trusts • Some investment consultants © Morgan, Lewis & Bockius LLP 11
Examples of Non-Fiduciaries • The employer as “settlor”/plan sponsor (the extent of fiduciary responsibility is often based on the governance structure) • Recordkeeper • “Managers” of mutual funds (or certain private funds) offered under the 401(k) plan • Some consultants • Attorneys • Auditors © Morgan, Lewis & Bockius LLP 12
Four Basic Fiduciary Duties • Duty of loyalty (exclusive benefit rule) – Act solely in the interest of, and for the exclusive purpose of providing benefits to, participants and beneficiaries and defraying reasonable expenses of administering the plan. • Duty of prudence (so-called “prudent expert” standard) – Act with the care, skill, prudence, and diligence then prevailing that a prudent man 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 • Duty to diversify – Diversify the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. • Duty to follow plan terms – Act in accordance with the documents and instruments governing the “plan” insofar as such documents and instruments are consistent with the provisions of ERISA. © Morgan, Lewis & Bockius LLP 13
Prudent Process • Duty of prudence does not require a fiduciary to guarantee outcomes, but can be demonstrated by the use of a prudent process to make and monitor decisions. • Sometimes referred to as “procedural prudence”—the ability to demonstrate that the fiduciary followed a prudent process in making a fiduciary decision. • Document, document. • Regular meetings of fiduciary committees – Meeting “books” and agendas – Resolutions – Minutes © Morgan, Lewis & Bockius LLP 14
Fiduciary Training • Good fiduciary risk-management tool • Some fiduciary liability policies require it • Consider a policy to require training for new members as they join fiduciary committees, and periodically after that © Morgan, Lewis & Bockius LLP 15
Consequences of Breach of Fiduciary Duty • Breach of Fiduciary Duty – Personal liability for fiduciary breaches and losses • Corporate indemnifications • Fiduciary liability insurance • Potential limits on exculpation form plan assets – Obligation to restore profits received and opportunity costs – Other equitable and remedial relief (e. g. , removal from fiduciary position) and additional penalties • Monetary penalties to DOL equal to 20% of the recovery amount • Criminal penalties for failure to make 401(k) contributions, willful violations of reporting and disclosure requirements, kickbacks, bribes, and embezzlement • Reputation risk © Morgan, Lewis & Bockius LLP 16
Proposed Department of Labor Re-Definition of Fiduciary • Now referred to as the “conflict of interest rule” • Currently at the Office of Management and Budget, the final step before being released as a proposed rule • Released by May? (could be sooner) • DOL is seeking to expand fiduciary status for those providing non-discretionary investment advice • Expected focus on distributions to participants, including advice regarding rollovers • May have more impact on financial service providers than plan sponsors but could affect how services are delivered to plans or require additional administrative burdens and costs © Morgan, Lewis & Bockius LLP 17
Agenda Fiduciary vs. Settlor Functions © Morgan, Lewis & Bockius LLP 18
Fiduciary vs. Settlor Functions • Settlor functions generally include the adoption, amendment, and termination of the plan. • Officers of the plan sponsor may wear both “hats”—having both settlor and fiduciary responsibilities. • In contrast to fiduciary functions, settlor functions can be carried out in the best interests of the plan sponsor. • Fiduciary expenses can be charged against plan assets; settlor expenses generally cannot. © Morgan, Lewis & Bockius LLP 19
What Decisions Are Fiduciary and What Decisions Are Not? Settlor Actions Fiduciary Actions • The decision to have autoenrollment • The selection (and monitoring) of investment options under a DC plan • The decision to offer matching contributions or nonelective contributions • Negotiating contracts for services to be paid for with plan assets • The decision to terminate a plan • The appointment of other plan fiduciaries • Certain reporting and disclosure obligations Note that even when the decision may be a settlor function, carrying out that decision may be a fiduciary function. © Morgan, Lewis & Bockius LLP 20
Agenda DC Plan Fiduciary Safe Harbors © Morgan, Lewis & Bockius LLP 21
Section 404(c) Safe Harbor • Section 404(c) of ERISA – Applies to DC plans that permit participant-directed investments – Protection from liability for investment decisions made by participants if certain conditions are met • Multiple components (notice, opportunities to change elections, broad range of investment options) • May not relieve liability for prudent selection and monitoring of investment options © Morgan, Lewis & Bockius LLP 22
Section 404(c) Safe Harbor • Three Key Components of Section 404(c) Compliance – Offer a broad range of investment alternatives • At least three • Each must be diversified • Each must have materially different risk and return characteristics – Offer each participant a reasonable opportunity to give investment instructions – Provide each participant with specified information about the investment alternatives to allow the participant to make informed choices • Much of the same information as required by the Section 404(a) participant disclosures © Morgan, Lewis & Bockius LLP 23
Qualified Default Investment Alternative Safe Harbor • Default Investment Alternative (QDIA) Rules – Like Section 404(c), applies to DC plans that permit participantdirected investment – Protection for “default” investments made in the absence of participant direction (e. g. , auto-enrollment) under specific conditions • May not protect from liability for prudent selection and monitoring of the QDIA – Very useful safe harbor—may be used in mapping (without needing to establish comparability) in addition to auto-enrollment © Morgan, Lewis & Bockius LLP 24
Qualified Default Investment Alternative Safe Harbor • Key components of QDIA compliance – The investment alternative is a QDIA • Life cycle or target date funds • Balanced funds • Managed accounts • Not stable value or money market (subject to grandfathering) – Participant has the opportunity to direct the investment, but did not – Notice (prior to first default investment and annually) © Morgan, Lewis & Bockius LLP 25
Qualified Default Investment Alternative Safe Harbor • In Bidwell v. University Center, Inc. , the Sixth Circuit held that the QDIA safe harbor protected plan fiduciaries who default participants to the QDIA in a re-enrollment. 685 F. 3 d 613 (6 th Cir. 2012). – Participants 100% invested in stable value prior to re-enrollment challenged move to QDIA lifecycle fund. – Participants did not make investment elections despite notices made via first class mail. – Appellate court confirmed that QDIA safe harbor applied, despite an earlier affirmative election into stable value fund ü Helpful support for use of the QDIA safe harbor in re-enrollments © Morgan, Lewis & Bockius LLP 26
Safe Harbor for “Like-to-Like” Mapping • Additional safe harbor for changes in investment options under Section 404(c)(4) of ERISA. • Safe harbor protection if the participant does not make an affirmative instruction and assets are “mapped” to a new investment option that has risk and return characteristics “reasonably similar” to those of the terminated investment option. • Notice of the change is required at least 30, and no more than 60, days before the change in investment options. • In some plan changes, there may not be a “reasonably similar” remaining option. But mapping to QDIA is also available. © Morgan, Lewis & Bockius LLP 27
Agenda Special Investment Option Considerations: Target Date Funds, Company Stock Funds and Stable Value © Morgan, Lewis & Bockius LLP 28
Target Date Funds • Target date funds are investment options in which the asset allocation changes over time to become more conservative as retirement nears. • Regulatory focus on target date funds, as large amounts of assets flow into them. • In 2013, DOL issued “Tips” for fiduciaries on target date funds. • Special Considerations: – How to monitor – Fees – Participant communication/education © Morgan, Lewis & Bockius LLP 29
Fifth Third Bancorp v. Dudenhoeffer, 133 S. Ct. 1656 (June 25, 2014) • Fifth Third Bancorp v. Dudenhoeffer—Recent Supreme Court case addressing a “stock drop” case • Rejected the “presumption of prudence” of offering employer stock in a plan designated as an ESOP – Most circuits had previously adopted this “presumption of prudence”, meaning a fiduciary was protected in continuing to offer company stock absent extreme events • Result is that company stock funds may need to be reviewed differently because no presumption. • But not a “blank check” for plaintiffs in stock drop cases; Court specified conditions plaintiffs must meet. © Morgan, Lewis & Bockius LLP 30
Implications of Dudenhoeffer • Consider limits on investment in company stock funds or role of company stock • Consider plan document language • Consider the role of an independent fiduciary or monitoring • Consider the composition of your fiduciary committee © Morgan, Lewis & Bockius LLP 31
Stable Value Fund Considerations • Structure of stable value funds can vary widely • Insurance products – Insurance company general account investment through a group annuity contract – Insurer provides guarantee, owns and manages assets • Synthetic products – – Issued by bank or insurance company “Wraps” portfolio of fixed income securities 3(38) Investment Manager manages pool of fixed income securities May be affiliate of wrap contract issuer • Separate accounts • Pooled funds © Morgan, Lewis & Bockius LLP 32
Agenda DC Plan Disclosures and Monitoring © Morgan, Lewis & Bockius LLP 33
Section 408(b)(2) Fee Disclosures • New regulations in 2012 requiring fee and related disclosures from “covered service providers” in DB and DC plans • Requires disclosure of direct and indirect compensation, and compensation paid among affiliates and subcontractors • Failure to make required disclosures can result in a prohibited transaction (Section 408(b)(2) is the prohibited transaction exemption generally covering service provider relationships) © Morgan, Lewis & Bockius LLP 34
Section 408(b)(2) Fee Disclosures • Service providers to DC plans are also required to include certain information needed for the participant disclosures (which we’ll discuss next) • Requires service providers to make disclosures and potential for more administration by plan fiduciaries • DOL considering further refinements (e. g. requiring a summary disclosure) © Morgan, Lewis & Bockius LLP 35
Participant Disclosures • Section 404(a)(5) participant disclosures are required to be provided by the plan administrator to 401(k) plan participants. • Initial disclosures were required by August 30, 2012. • Three categories of disclosures – General plan information – Plan administrative expenses – Investment information • Performance • Fees and expenses • Other investment-related disclosures © Morgan, Lewis & Bockius LLP 36
Participant Disclosures • Some of the disclosures annually; others quarterly • Consequence of noncompliance is breach of fiduciary duty. • 401(k) recordkeepers generally support this requirement • Reporting and disclosure is a continued focus of some degree of ERISA litigation on fees and expenses • Who has responsibility for coordinating disclosures when an investment manager has been appointed or a “white label” fund has been established? © Morgan, Lewis & Bockius LLP 37
DC Plan Monitoring—Monitoring Service Providers • Periodic performance and fee reviews • Use of standard agreements with investment managers and consultants as a risk-management tool – Can also save time and money in negotiating agreements – Help support consistent terms across service provider relationships • Tools for monitoring performance ü Investment policy ü Periodic meetings ü Reporting ü Diligence (especially for investments with less transparency) ü Use of third party advice ü Contractual terms © Morgan, Lewis & Bockius LLP 38
Agenda Fees Arrangements and Related Topics © Morgan, Lewis & Bockius LLP 39
Recordkeeping Fee Arrangements • Some plans pay recordkeeping fees through the use of revenue sharing payments. • Trend in recent years towards a per-participant (per capita or asset-based) recordkeeping fee. – Corresponds to move to “white label funds, ” collective investment trusts and other more institutional types of investment structures • It may not be practical to eliminate all revenue sharing so various practices have developed to support it. © Morgan, Lewis & Bockius LLP 40
Revenue Sharing • Arrangements in which plan recordkeepers or other providers receive payments from investment providers for recordkeeping or other administrative services. – Sometimes referred to as “ 12 b-1 fees, ” a reference to SEC Rule 12 b-1, which governs some of these arrangements. • Some or all of the recordkeepers’ fees may be paid through revenue sharing. • ERISA requires service provider arrangement and fees to be reasonable. • 2013 DOL Advisory Opinion on revenue sharing • Revenue sharing practices have been the focus of ERISA litigation. © Morgan, Lewis & Bockius LLP 41
Revenue Sharing and ERISA Accounts • Revenue sharing may also be credited directly to participant accounts or to white label fund, in addition to being used to pay recordkeeping fees and/or paying plan expenses directly. • Revenue-sharing may also be credited to an account and then later used to pay permissible plan expenses or allocated to participant accounts. – Sometimes referred to as an ERISA account. • Considerations for ERISA accounts – Plan asset status (see 2013 Advisory Opinion) – How to allocate to participant accounts or expenses © Morgan, Lewis & Bockius LLP 42
Fee and Expense Litigation • Multiple lawsuits against plan fiduciaries alleging excessive fees and expenses in DC plans. • Some high-profile wins for plan sponsors; others have settled or have claims proceeding. • Nature of claims have evolved over time – “Retail” vs. institutional share classes – Excessive fees and conflicts of interest resulting from revenue sharing – Active vs. passive – More recently claims relating to “float” income received by plan recordkeepers © Morgan, Lewis & Bockius LLP 43
Fee and Expense Litigation • Supreme Court heard a fee and expense case—Tibble v. Edison— on February 24. • Like many fee and expense cases, Tibble involved a claim that plan fiduciaries had breached their duty of prudence by offering retail class mutual funds, among other claims. • The issue at the Supreme Court, however, focused more on whether the breach occurred only at the time the investment options were initially chosen or whether the breach was ongoing. – If only at the time investment options were chosen, claim may have been barred by the statute of limitations. • Questioning at oral argument not limited to the statute of limitations point – Many questions trying to identify the nature of the ongoing duty to monitor fees © Morgan, Lewis & Bockius LLP 44
Agenda Questions? © Morgan, Lewis & Bockius LLP 45
Marla J. Kreindler Chicago tel: 312. 324. 1114 email: mkreindler@morganlewis. com © Morgan, Lewis & Bockius LLP • Marla J. Kreindler is a partner in Morgan Lewis's Employee Benefits and Executive Compensation Practice. Ms. Kreindler concentrates her practice on the management and investment of employee benefit plan assets and tax-qualified retirement plans and on the establishment of, and investment in, private funds. • Ms. Kreindler is well versed in the application of ERISA's fiduciary standards and prohibited transaction rules and related banking, securities, and state insurance law requirements. She also regularly counsels clients on their qualified retirement plans, including 401(k) and defined benefit plans. • Ms. Kreindler represents a wide range of publicly traded and privately held corporations and nonprofit entities, as well as major banks, investment advisory and financial services firms, insurance companies, broker-dealers, and private and government pension funds. 46
Julie K. Stapel Chicago tel: 312. 324. 1113 email: jstapel@morganlewis. com © Morgan, Lewis & Bockius LLP • Julie K. Stapel is a partner in Morgan Lewis's Employee Benefits and Executive Compensation Practice. Ms. Stapel focuses her practice on the investment and management of employee benefit plan assets. She advises and counsels a wide variety of clients on ERISA's fiduciary and prohibited transaction rules, with a focus on the application of these rules to investment products and services. Ms. Stapel represents both plans and financial service providers in complying with ERISA's fiduciary and prohibited transaction rules. She also negotiates investment management agreements, trust agreements, securities lending agreements, transition management agreements, ISDA agreements, and other investment-related agreements and documentation on behalf of both plans and financial service providers. • In addition, Ms. Stapel counsels clients on plan fiduciary governance structures, including the formation and operation of plan fiduciary committees. She counsels clients on best practices to help fiduciaries comply with ERISA and effectively manage risk. She also advises clients on ERISA's ever-changing reporting and disclosure obligations. 47
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