The 401(k) decision in the 9th U.S. Circuit Court of Appeals on March 21 in Glenn Tibble et al. vs. Edison International et al. found the company breached its fiduciary responsibilities in selecting retail-class shares in an investment fund by failing to investigate the availability of cheaper, institutional-class shares in the same fund. The case raised other issues of significance to plan sponsors that deserve airing as well.
Among other findings, the court established that allegations of fiduciary breach in the selection of funds are subject to a six-year statute of limitations that runs from the date when the funds were selected. In addition, the court found that Section 404(c) of the Employee Retirement Income Security Act did not relieve fiduciaries from liability for fund selection because that relief is available only when losses result directly from a decision made by a participant. Finally, the court found that selecting mutual funds, short-term investment funds and a unitized company stock fund was not inherently imprudent.
In an appellate decision, one does not necessarily see a discussion of all of the evidence and arguments presented to the lower court. However, there are a couple of curiosities in this decision of which plan executives need to beware.
First, in establishing when the clock starts ticking under the statute of limitations, the court rejected the idea that there is a continuing breach where fiduciaries fail to correct an imprudent decision, unless there is evidence of the commission of a second breach.
Think about that in the context of the separate fiduciary responsibilities applicable to: (i) fund selection; and (ii) fund monitoring. The court found that the initial selection of retail-class shares was imprudent. But there is no discussion of what subsequent monitoring, if any, was performed by the plan fiduciaries, even though the use of retail-class shares seems to have persisted for a number of years. This is important, because a fiduciary's failure to monitor funds on a periodic basis, including their investment performance and cost, gives rise to a second, separate breach, one that might not let the clock run out on the limitations period.
What plan executives and their investment advisers should investigate, this decision notwithstanding, is what share classes are available for the funds selected and how share class selection affects the cost of running the plan. The Edison decision suggests sponsors would always pick institutional-class shares when available. But sometimes a more expensive class is prudent and justified, for example when revenue sharing is involved and the use of a retail-share class would offset record-keeping fees charged to the plan. Even if retail-class shares were prudent at the point of selection, plan sponsors can't ignore the cost of funds as circumstances change. As plan assets grow over time, a switch to a lower-cost share class might be available without increasing administration costs and it would be imprudent then not to make the change.
Another curiosity of the Edison decision is the role played by the plan's consultant. The court found that while the plan's consultant provided plan fiduciaries with recommendations that led to the selection of retail-class as opposed to institutional-class shares, the consultant was not acting as a fiduciary. Therefore, the court further found plan fiduciaries had an independent obligation to investigate and make certain that reliance on the consultant's advice was reasonably justified under the circumstances.
The Securities and Exchange Commission investigated the role of consultants in relation to pension plans back in 2005 and reported that many consultants did not consider themselves to be fiduciaries to their pension clients. The SEC reported that consultants believed they had taken appropriate actions to insulate themselves from being considered a fiduciary under ERISA, ignoring their fiduciary status under the Investment Advisers Act of 1940.
Now we are some eight years later and Edison, a major power supply company, hires a consultant, registered with the SEC as an investment adviser under the "40 Act, to provide what on the record consists of investment advisory services. Apparently the consultant was not considered to be a fiduciary. Had the consultant been found by the court to be a fiduciary, the outcome of the Edison case might well have been different: the court might well have found that reliance on the advice of the consultant acting in a fiduciary capacity discharged the other fiduciaries' duty of independent investigation and thus was prudent.
The takeaway for plan sponsors is to make sure the consultant is acting as a fiduciary. Disclosures now required under ERISA Section 408b-2 should expose this issue and plan sponsors with non-fiduciary consultants need to change their arrangement or hire a different firm if the incumbent declines to accept fiduciary status.
Fiduciary litigation respecting 401(k) plans is unlikely to abate. More claims are getting to trial and a more robust fiduciary code should emerge.
However, one should beware propaganda, even in the guise of judicial pronouncements, and apply a critical eye to court decisions, because not all members of the judiciary qualify as prudent investment experts.
Roger L. Levy is CEO of Cambridge Fiduciary Services LLC, Scottsdale, Ariz.