This Month’s Compliance Corner: ERISA Fiduciary Duties (Part 1)
ERISA imposes strict standards of conduct (i.e., fiduciary duties) on entities and individuals who fall within the definition of a fiduciary with respect to an employee benefit plan. The purpose of ERISA’s fiduciary duty rules is to ensure that plans are operated in the best interests of plan participants and beneficiaries. A fiduciary’s failure to comply with these rules may result in harsh consequences, including personal liability and enforcement actions by the Department of Labor (“DOL”).
The fiduciary rules generally apply to retirement plans, health plans, and other welfare plans alike, provided those plans are subject to ERISA. Some health and welfare plans could be exempt from ERISA under the church or governmental plan exemptions or the regulatory safe harbors for “voluntary” plans or plans that constitute “payroll practices.” Others may be exempt from ERISA because they are maintained outside of the United States or maintained solely for the purpose of complying with state workers’ compensation, unemployment compensation, or disability insurance laws. However, unless a company’s health and welfare plans fall under one of these exceptions, ERISA’s fiduciary rules will broadly apply to any entity or individual deemed to be a fiduciary with respect to those plans. Accordingly, the first question to ask is who is a fiduciary with respect to the company’s plans?
Who is a Fiduciary?
There are certain entities or individuals who, by virtue of their designated roles, will be “automatic” fiduciaries with respect to an ERISA plan. For example, every ERISA plan is required to have one or more “named fiduciaries” who jointly and severally “have authority to control and manage the operation and administration of the plan.” In addition to the named fiduciary, every plan will have a “plan administrator” (though many times the named fiduciary and plan administrator will be the same person or entity). In the case of employer-sponsored plans, the employer will typically serve as both the named fiduciary and plan administrator by default. Qualified retirement plans and “funded” health and welfare plans (i.e., health and welfare plans that are not exempt from ERISA’s trust requirement) will also have one or more trustees. The trustees, named fiduciaries, plan administrators are all automatic fiduciaries with respect to ERISA plans due to the nature of their positions.
In addition to these automatic fiduciaries, there may be other entities or individuals who are deemed to be fiduciaries with respect to an ERISA plan because of the plan functions they perform. Under ERISA § 3(21), an entity or individual is a “fiduciary” with respect to a plan to the extent the entity or individual does any of the following:
- Exercises any discretionary authority or control with respect to the management of the plan or exercises any authority or control with respect to the management or disposition of plan assets;
- Renders investment advice for a fee or for any other compensation, direct or indirect, or has any authority or any responsibility to do so; or
- Has discretionary authority or responsibility in the administration of the plan.
There are two important distinctions to keep in mind when analyzing whether a person’s decisions or actions with respect to an ERISA plan are fiduciary in nature. The first relates to when a person’s decisions or actions are deemed to be administrative functions (i.e., fiduciary) versus when they are deemed to be “settlor” functions (i.e., non-fiduciary). Settlor functions generally are decisions or actions that relate to the formation, design, or termination of ERISA plans. For example, the following kinds of decisions or actions are likely to fall within the category of settlor functions: deciding whether to sponsor one type of plan (or option within a plan) versus another; changing required levels of employee contributions or eligibility rules; amending a plan, including changing plan options; and terminating a plan or portion of a plan. Entities or individuals performing settlor functions will not be deemed to be fiduciaries, at least not with respect to those particular decisions or actions that are settlor functions. This distinction becomes particularly important when ensuring that the Exclusive Benefit Rule is being met (as discussed below under the section entitled “What are ERISA’s Fiduciary Duties?”).
The second distinction relates to when a person is performing administrative functions that are truly fiduciary in nature versus when a person is performing administrative functions that are purely ministerial (i.e., clerical functions that, arguably, do not require the exercise of discretion) within a framework of established policies and procedures. In situations involving the latter, the entity or individual will not be a fiduciary with respect to the plan. The following are examples of ministerial functions that have been cited by the DOL or courts as falling outside of the fiduciary definition (when performed within a framework of established plan policies and procedures): applying rules to determine eligibility for participation or benefits; processing claims; calculating benefits; orienting new participants and advising participants of their rights and options under the plan; preparing employee notices and government filings; and making recommendations to others for decisions about plan administration.
In many cases, third party administrators (“TPAs”) of ERISA plans (as well as individuals who are directors, officers, or employees of the plan sponsor) may escape fiduciary status by only performing ministerial functions within an established framework of policies and procedures. However, if an administrative function involves final authority to approve or deny benefits in cases where coverage is disputed over the interpretation of plan provisions, then a person performing that function will not be performing purely ministerial functions. Thus, a TPA that provides claims processing services will be a fiduciary if it has final discretionary authority over administering claims. Many TPAs attempt to avoid fiduciary status with respect to claims processing by including language in their service agreements stating that, although the TPA has the power to make claims decisions, final authority to approve or deny disputed claims remains with the plan sponsor.
What are ERISA’s Fiduciary Duties?
For those entities and individuals who are deemed to be fiduciaries with respect to an ERISA plan, it is important to understand the fiduciary duties that ERISA imposes, particularly since fiduciaries may be held personally liable for any breach of those duties, even if the breach was unintentional. The following are the main fiduciary duties imposed under ERISA:
- The duty to act solely in the interests of plan participants and beneficiaries (aka, the “Duty of Loyalty”), and to use plan assets for the exclusive purpose of providing plan benefits, or for defraying the reasonable expenses of plan administration (aka, the “Exclusive Benefit Rule”);
- The duty to act with the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims (aka, the “Prudent Expert Rule”);
- The duty to diversify the investments of the plan; and
- The duty to administer the plan in accordance with the plan documents.
Duty of Loyalty / Exclusive Benefit Rule. A fiduciary must act solely in the interests of plan participants and beneficiaries, which includes ensuring that plan assets are used solely for the benefit of those participants and beneficiaries, and/or solely to pay for the reasonable costs of plan administration. When plan assets are used to pay for administrative expenses, it is vital that the plan’s fiduciaries ensure that those administrative expenses are reasonable, which entails exercising regular oversight over a plan’s service providers, including the service agreements under which they operate, and over the plan’s operations in general. This may include ensuring that vendors provide any required fee disclosures and that the fiduciaries (either themselves or by retaining separate advisors to do so) regularly benchmark those fees against a cross-section of comparable fees charged by other vendors in the same market.
It is also vital that fiduciaries be able to recognize when funds represent plan assets versus non-plan assets and when decisions/actions they take represent administrative functions versus settlor functions. This is because, among other things, plan assets cannot be used to pay for expenses related to settlor functions. For example, legal or other advisory fees incurred in connection with establishing a plan or making discretionary plan design changes are expenses related to settlor functions, for which should not be paid for with plan assets.
Prudent Expert Rule. A fiduciary also must act with the care, skill, prudence, and diligence of a prudent person acting in a similar situation and in a like capacity. For purposes of the Prudent Expert Rule, prudence is measured according to an objective standard, and a fiduciary’s subjective intent or good faith do not matter, except to the extent such intent or good faith may be relevant to the comparison of the fiduciary’s actions with what a hypothetical prudent expert would have done in a similar situation. In assessing a plan fiduciary's prudence in a particular situation, the DOL, court, or other reviewing entity will adjudge the prudence of how a fiduciary went about reaching a decision, as opposed to the result of the decision.
One of the key points to consider is whether fiduciaries are being prudent in their selection and monitoring of a plan’s service providers. In many instances, selecting a plan’s service providers is a fiduciary function. In addition, plan fiduciaries have an ongoing fiduciary duty to monitor the performance of the service providers that are selected. Given all of the new transparency reporting and disclosure requirements that have been implemented over the past few years, the duty to monitor service providers has become increasingly important, as newly available public information has led to a rise in fiduciary breach lawsuits. Although such lawsuits are typically based on the actions of TPAs, they often include claims against the plan sponsor as the primary named fiduciary and plan administrator (and potentially against other individuals who may have been acting as fiduciaries) with respect to the plan.
Fiduciaries who breach their fiduciary duties may be liable for legal and equitable remedies to participants and beneficiaries as well as civil penalties in lawsuits or enforcement actions brought by the DOL. Among the legal remedies, fiduciaries may be held personally liable for restoring any losses to the plan resulting from the breach and disgorging any profits made from a transaction resulting in a breach. A civil penalty may be assessed on fiduciaries for breaches of their fiduciary duties, which is equal to 20% of the amount that the plan recovers from the fiduciary as the result of a court order or settlement with the DOL.
It is generally recommended that plan sponsors obtain sufficient fiduciary liability insurance to help mitigate the impacts of the aforementioned liabilities with respect to any potential fiduciary breach actions and, as necessary, that plan sponsors ensure the appropriate individuals are added to such policies (or portions of such policies) as covered persons thereunder. Additionally, plan sponsors (and individual directors, officers, and employees who may be fiduciaries with respect to a plan) should carefully review plan documents and contracts to confirm how responsibilities may be allocated among fiduciaries and to determine whether any indemnification or limitation of liability provisions are present that may be legally enforceable. Beyond purchasing insurance and reviewing plan documents and contracts, however, it is important that plan sponsors put in place appropriate policies and procedures establishing how fiduciary functions are to be allocated and what protocols are to be followed by fiduciaries on a regular basis. Fiduciaries are also advised to engage in periodic, formal fiduciary training.
For the second part of this fiduciary series, which will be published in January 2024, we will discuss ERISA’s prohibited transaction rules, the permissible and impermissible uses of plan assets, and other compliance issues that may arise in connection with the management of plan assets.
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