confero A quarterly publication of Westminster Consulting
ISSUE NO. 3
TIBBLE v. EDISON WHERE DO WE GO FROM HERE?
confero A quarterly publication by Westminster Consulting
A quarterly publication of fiduciary ideas by various contributors within the industry.
Publisher Westminster Consulting, LLC. Editor-In-Chief Gabriella Martinez Contributing Editors Sean Patton, AIF速 Thomas Zamiara, AIFA速 Creative Director Gabriella Martinez Contributors Erica Harper, ASA, EA, MAAA Eric Paley, Esq. Gabriel Potter, AIF速 Diana K. Powell, Esq. Thomas Zamiara, AIFA速 Gabriella Martinez Angel L. Garrett, Esq.
Questions or Comments? email us at email@example.com
The information contained in this on-line magazine is for general information purposes only. The information is provided by Westminster Consulting and while every effort is made to provide information which is both current and correct, Westminster Consulting makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the on-line magazine or the information, products, services, or related graphics contained within the on-line magazine for any purpose. Any reliance you place on such information is therefore strictly at your own risk. In no event will Westminster Consulting be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this on-line magazine.
Contents SUMMER 2013
2 PUBLISHERS LETTER 3 CONTRIBUTORS 4 UPCOMING EVENTS Cover Story 12
Tibble Vs. Edison What Does this Decision Mean For Plan Fiduciaries?
Issue no. 3
RES IPSA LOQUITUR
Fiduciary Governance: Trust Me
9 1/2 QUESTIONS
A Conversation with Sean Patton, Partner at Westminster Consulting
With Markets Going Up, Why Does My Funded Status Keep Going Down?
A Sea of Change in Fixed Income
The Trouble with Tibble: What if you don’t know what you don’t know
ON THE COVER
confero A quarterly publication of Westminster Consulting
ISSUE NO. 3
TIBBLE v. EDISON WHERE DO WE GO FROM HERE?
Tibble v. Edison Int’l, No. 10-56406 (9th Cir. 2013)
www.conferomag.com | 1
In our recurring interview feature 9½ Questions, we have a practical and real-world discussion with Sean Patton, one of the founding partners at Westminster Consulting about his approach on the Tibble v. Edison court case when discussing its impact on his clients. Sean discusses why it’s important for plan sponsors to be aware of this case and what they can do to stay away from finding themselves on the right side of the “v” in the event of a challenge. Our cover story by Angel L. Garret of Trucker Huss, APC, provides us with excellent context of the case and leaves the reader with practical and actionable lessons to be learned. In March of this year, the court case Tibble vs. Edison
The article, A Sea of Change in Fixed Income, talks about
International (Tibble v. Edison Int’l, No. 10-56406 (9th
how the exit strategy of accommodative monetary policy is
Cir. 2013) made headlines within our industry. Since the
scaring the fixed income market.
case dealt with a number of important topics plan sponsors should be aware of, we’ve dedicated this issue of confero to both the case and topics it addresses. Angel Garrett in our feature article says, “In its detailed decision, the court addressees a myriad of issues that are essential for plan fiduciaries in understanding how to limit and avoid liability under the Employee Retirement Income Security Act of 1974 (“ERISA”) going forward.”. We open this quarter’s edition with an article by Diana K. Powell, Esq. on the core tenets of fiduciary responsibility and governance. This is an excellent refresher and review of the responsibilities that fiduciaries shoulder under ERISA and a well-positioned preface to the viewpoints and considerations around Tibble v. Edison.
2 | SUMMER 2013
Finally, Eric Paley, with a clever reference to Star Trek’s 15th episode of its second season, “The Trouble with Tribbles”, provides his thoughts on the case with his The Trouble with Tibble article. “…to my mind, Tibble v. Edison International isn’t about willful ignorance. It’s about sheer ignorance.” We hope you enjoy this issue and we continue to appreciate your comments and support in our mission to provide timely and valuable information from a variety of sources to you our clients and friends.
Tom & Sean
Gabriella is a marketing professional with over seven years of experience. She currently holds a Bachelor of Science in Multidisciplinary Studies with concentrations in Marketing, Printing & Publishing, Photographic Arts & Sciences and Psychology from Rochester Institute of Technology. She has been a featured writer and editor in several publications including Rochester Woman Magazine and Pup Culture.
Gabriel is a Senior Investment Research Associate of Westminster Consulting where he designs strategic asset allocations and conducts proprietary market research. He earned a B.A. in Economics and a Certificate of Business Management from the University of Rochester and an M.B.A. with concentrations in Corporate Finance and Computers & Information Systems from the University of Rochester’s William E. Simon School of Business. He also holds an Accredited Investment Fiduciary Analyst (AIF®) designation and has been quoted in Human Resources Executive Magazine and his articles have been published through fi360 and AdvisorOne.
Diana K. Powell, Esq. is Senior Legal Advisor with over 20 years of experience. She was a sole practitioner who advised educational organizations, government bodies and private corporations. Diana was responsible for negotiating agreements for high-tech software corporations and contracts involving Intellectual Property issues. Diana is a graduate of the University of Rochester with a B.A. in Political Science and Albany Law School of Union University, J.D. She holds a Certificate of International Law from the University of Notre Dame, London Law Center and has studied negotiations, mediation and arbitration at the University of Cornell’s School of Industrial Labor Relations, as well as Statistics and International Studies, specializing in the Republic of China, and Educational Policy and Research Methods at the Warner School of Education at the University of Rochester.
Erica is one of the founding partners of Harper Danesh LLC. Prior to that, she was a Principal with Mercer, having worked in its Boston, New York and Rochester, NY offices. She has considerable experience consulting on both defined benefit and defined contribution plans to a wide range of clients, including healthcare, financial services, manufacturing and educational institutions. She also writes on a variety of topics focusing on retirement industry trends. Erica is a graduate of Mount Holyoke College with a Bachelor of Arts degree in Economics and French. She is an Associate of the Society of Actuaries, a Member of the American Academy of Actuaries, and an Enrolled Actuary.
Eric Paley is a member of Nixon Peabody’s Employee Benefits & Executive Compensation team. He focuses his practice on the law and regulations governing retirement plans, welfare plans, nonqualified deferred compensation plans, and equity compensation plans. A significant portion of Eric’s practice also involves counseling retirement plan committees on their fiduciary responsibilities under ERISA. The vast majority of Eric’s clients are tax-exempt institutions—hospitals and health systems; colleges and universities; internationally known arts/cultural icons; trade organizations; and social welfare agencies—although he also represents both privately held and public for-profit companies.
Angel L. Garrett is an associate of Trucker Huss, the largest employee benefits specialty law firm on the West Coast. She represents plan sponsors and service providers in ERISA employee benefit and fiduciary breach class action and single plaintiff lawsuits nationwide. Her cases have included those involving valuation of employee stock ownership plans, use of employer stock in retirement plans, and investment of plan assets. Additionally, she counsels clients on issues related to fiduciary responsibility, prohibited transactions, benefits claims, and Department of Labor investigations. Angel is admitted to practice in California and Michigan. She is also fluent in Mandarin and Taiwanese.
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confero A quarterly publication of Westminster Consulting
ISSUE NO. 3
TIBBLE v. EDISON WHERE DO WE GO FROM HERE?
Subscribe to Confero and receive the digital issue directly in your inbox. You can view the issue online or on your mobile device.
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RES IPSA LOQUITUR
“the thing itself speaks”
FIDUCIARY GOVERNANCE: TRUST ME By Diana K. Powell, Esq.
“The best way to find out if you can trust somebody is to trust them.” — Ernest Hemingway
he term fiduciary comes from the Latin term fiducia which means “trust.” According to the Department of Labor (DOL) a plan fiduciary is “a person or entity that uses discretion in administering and managing a plan or controlling a plan’s assets to the extent of that person or entity has discretion or control.” This operation of a plan is the exercise of fiduciary governance of plan fiduciaries. Under the Employee Retirement Income Security Act (ERISA) 404(a)(1) “… a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of: • Providing benefits to participants and their beneficiaries; and • Defraying reasonable expenses of administering the plan. ERISA 404(a)(1)(A) the Duty of Loyalty to plan participants and their beneficiaries requires that in discharging his fiduciary duties, the fiduciary’s decisions … “Must be made with an eye single to the interests of the participants and beneficiaries.” Further, ERISA 404(a)(1)(B) requires that in discharging his fiduciary duties, the fiduciary must act…“ with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” Experts clearly warn that “the role as fiduciary is based on function, not title.” Therefore it is important to pay close attention to the duties performed, not just the title one is assigned with regard to a plan, because it is the “actions involved in operating a plan that make the person or entity performing them a fiduciary” not the title.
6 | SUMMER 2013
Anyone who is a plan sponsor should have their duties clearly defined and the details of the plans distinctly stated. That is the main purpose of documentation such as Investment Policy Statement (IPS) and Summary Plan Descriptions (SPD), among others. Having plan documents in place protects both the plan sponsors and the participants. Reducing the plan to writing is in fact required by law. ERISA 402(a)(1) requires that plans be written: “Every employee benefit plan shall be established and maintained pursuant to a written instrument.” Armed with written documents and proper training, plan sponsors should be capable and able to perform their duties to the standards expected of them by the corporations they represent and the participants they serve. Standards are high but so are the stakes to the participants and beneficiaries. The risks are great. The duties and responsibilities are immense. “Fiduciary duties under ERISA ‘are the highest known to law.’” (Donovan v. Bierworth, 680 F.263, 271 (2d Cir.), cert. denied, 459 U. S. 1069 (1982) Participants trust that plan sponsors will fulfill their fiduciary duties. They literally trust them with their life savings. However, training and documentation may not be enough to prepare a plan sponsor to meet his fiduciary duties. It is at these times when the courts recognize that a plan sponsor has a duty to hire an outside expert advisor. “Where a trustee does not possess the education, experience and skill required to make a decision concerning the investment of a plan’s assets, he has an affirmative duty to seek independent counsel in making the decision.” (Katsaros v. Cody, 74 F.2d 279 (2nd Cir.), (1984) In cases where the plan sponsor lacks the knowledge to prudently carry out his fiduciary duties to implement the plan for the benefit of the participants and beneficiaries the court has found the plan sponsor liable for a breach of his fiduciary duty. “The failure to seek outside counsel when
RES IPSA LOQUITUR
“the thing itself speaks”
‘under the circumstances then prevailing … a prudent man acting in a like capacity and familiar with such matters’ would seek outside counsel, is imprudent and a violation of ERISA.” (Katsaros v. Cody) A word of caution with regard to plan sponsors seeking outside council – although failure to do so may be regarded as a breach of fiduciary duty by the courts, case law has held that “blind faith” in the advice of an independent expert does not necessarily relieve a plan sponsor of his liability. Courts have held that while plan sponsors should retain the services of third part consultants when circumstances necessitate it. Plan sponsors should use the advice appropriately, basing their decisions upon the particular facts and individual needs and requirements of their participants and beneficiaries, “… (the court) believes that ERISA’s duty to investigate requires fiduciaries to review the data a consultant gathers, to assess its significance and
to supplement it where necessary.” (Unisys Savings Plan Litigation, 74 F. 3d 420 (3rd Cir.), (1996) The timing of this is important because experts warn that in the past twelve months the Department of Labor has been “cracking down on retirement plan advisors for fiduciary negligence.” This is significant because it should serve as a “heads-up” to plan sponsors to bring their “A” game to the table. Understand what your duties and responsibilities are to the plan and the participants and beneficiaries. Make certain as a plan sponsor you are meeting your fiduciary responsibilities under ERISA. If you are uncertain or do not understand how to carry out your duties as a plan sponsor seek outside counsel – it is not only prudent, it is legally required! Be worthy of the trust that is placed upon you by the participants! Meet your fiduciary duties – it’s the law!
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he recent court case, Tibble v. Edison International, has the industry talking about how plan sponsors need to reevaluate how their plans are run and why having a process in place is essential. To help shed some more light on the subject, Confero was able to interview Sean Patton, one of the founding partners of Westminster Consulting. Sean discusses why Tibble v. Edison is an important case plan sponsors should make themselves aware of. Sean, we’re going to talk about the Tibble v. Edison case – some would say an important case that all plan sponsors should spend time with. Do you agree? Absolutely, there’s a lot to be learned from not only a fiduciary perspective, but also a practical perspective that can allow plan sponsors to improve the experience of the plan for their employees. Is it your experience that most plan sponsors are aware of the case and its significance? Most plan sponsors are not aware of Tibble v. Edison and what the importance is for them and their employees. I think most plan sponsors are buried with the day-to-day responsibilities of running a business and therefore anything associated with their Defined Contribution plan typically does not rise to the top of their priority list. 8 | SUMMER 2013
By Thomas Zamiara
A Conversation with Sean Patton, Partner at Westminster Consulting
How do you discuss Tibble w/ clients and not appear to either be judgmental of their current structure and decision making process or scold them about their behavior? Westminster’s role as a consultant is to be educational and informational with our clients to assist them in understanding what their different responsibilities are, and in this case the court cases that may apply to them. Then hopefully through that education, allow them to be better fiduciaries and stewards for their employees’ dollars. Practically speaking, clients have a lot on their plates and I would add that they are generally and genuinely well-intentioned with regards to the plan and participants. Doesn’t this count quite a bit? It may count, but the courts have been very clear that a good heart and an empty head defense does not ring true. So while what we said is true, they are very busy, at the end of the day they have a responsibility and a liability to make sure they are carrying out their duties under ERISA. What are your top 3 tips for clients who want to improve their behavior in light of the Tibble decision? I think the number one thing that plan sponsors should be doing right now— not only in light of Tibble, but in light of 408b(2)— is going through some
type of formal process to evaluate the reasonableness of the fees for any of their covered service providers, which obviously includes their recordkeeper. From that, I think when they understand how revenue sharing works, they are then able to take a look at the share classes they have – which was one of the biggest takeaway from Tibble—and make sure that they have the appropriate share classes for their plan. Most fiduciaries do not understand how revenue sharing works and the different share class structure. This is an area where an outside expert can bring value to an employer. We typically review clients’ exisiting share classes, what revenue sharing is being generated, and how much revenue sharing the plan needs. We can then make suggestions to the plan sponsor on how to optionally construct a fund lineup that places the appropriate share class in the plan. This can ultimately reduce the all in fees for the plan. What’s your prescription for ongoing vigilance to keep your clients away from finding themselves to the right of the “v.” in any action? Certainly ERISA is a process-driven law and so, on behalf of our clients, we want to make sure that we have prudent process in place that protects them in a number of different areas ... So process and the documentation of that process are critical.
Have you had a situation where you were advising a committee about an issue or taking a certain course of actions and they completely ignored your advice? W/O mentioning names can you walk the reader through it? I would say for our retainer clients, the answer would be no. I mean there is reason why they’ve hired us—they get their responsibilities, they understand the liability and the breadth of what’s expected of them. But for some of our project clients, we have seen where we’ve made a recommendation and they either have kind of pushed that recommendation aside or have not been timely in responding to that recommendation. So an example would be a recent benchmarking that we did for a client. There was an identified area of liability that came up in our review. It had to do with compensation received by an advisor out of the plan and the advice he was providing to employees. Our first area of concern was that his compensation seemed unreasonable. It was above what others were receiving for similar services. Secondly, his
agreement with the client disclosed that he was not a fiduciary, yet he was providing specific advice to employees. This very well could lead to liabiilty for the fiduciaries of the plan. We were very clear to the client that they needed to address this issue sooner rather than later. At this time, they have yet to examine this further. How did it turn out? Are they still clients? We are hoping to assist them in an ongoing relationship; I think it’s a committee that’s fractured in their appreciation for the risk that they have, as fiduciaries, to their defined contribution plan. I think a certain segment of that committee recognizes the need to get ongoing assistance and then other parts of that committee feel they don’t need the assistance—that the plan just kind of runs itself. So, stay tuned. Are you conscious of “absent” behavior when talking with prospects or new clients and your exposure? I think it’s very difficult again to do what we’ll phrase as “turning the light
switch on” for committees if they don’t want to hear it. Again, for most of them, this is not their full time job. They have a lot on their plate and it’s almost like this is a nuisance for them to have to carry out this responsibility. So the goal of the Westminster consultant is to be a consultant to “turn the light on for them,” kind of lead them to what best practices are, and hope they recognize the benefit of behaving as the appropriate fiduciary should. So what’s better: an empty head or a good heart? I think a good heart is certainly better, but at the end of the day the courts have been very clear—a good heart and an empty head is still not a reasonable defense. Committees need to be more engaged with regards to their defined contribution plans. They need to make sure they have a prudent process in place and where applicable, use outside experts to assist them in meeting those responsibilities and in mitigating their liability.
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With Markets Going Up,
Why Why Does Does My My Funded Funded Status Status Keep Keep Going Going Down? Down? By Erica Harper, Harper Danesh, LLC.
t seems so long ago, but it was just March of 2000. Technology stocks were peaking, valuations were stretched and investors started to sell, bursting the dotcom bubble. With interest rates plummeting as well, defined benefit (DB) plan sponsors watched their funded status flip from surplus to deficit almost overnight. Over the course of the next eight years, the market recovered, again reaching all-time highs, interest rates stabilized and plan sponsors were once again blissfully ignorant about the future. Investment returns masked the requirement for contributions and plan sponsors were back on the holiday they enjoyed before the crash of 2000. Then Lehman Brothers became front page news, causing another plunge in pension plans’ funded status. Now, just four years later, the market is back. Here we go again… 10 | SUMMER 2013
As the saying goes, “Fool me once, shame on you; fool me twice, shame on me.” But a third time? Yet it is impossible not to get caught up in the run up, but is it worth the risk? As the market continues to go gangbusters, many pension plan sponsors are scratching their heads. If the market is going up, why is my funded status going down? The answer lies in the liabilities. Pension plan liabilities are typically measured based on high-quality corporate bond yields. Similar to bond prices, pension liabilities move in the opposite direction of interest rates and, as we’ve seen over the last few years, are highly sensitive to movements in these rates. Unfortunately, this interest rate risk is out of your control. But what about your investment risk?
Pension plan sponsors have traditionally directed money managers to invest their pension assets with the goal of maximizing returns within acceptable risk parameters. Success is measured by how the assets perform relative to certain benchmarks year over year. Seems like a reasonable objective to any investor. However, a pension plan is not any investor and its financial wellbeing is not driven by asset performance alone. Rather, the measure of financial success for a pension plan is its funded status – or the interplay between assets and liabilities. While asset risk – investing in equities over bonds – is a compensated risk (in other words, there is a payback for taking on the risk), interest rate fluctuations are considered uncompensated risks and should be avoided to the extent possible. This is what a liability-driven investing (LDI) approach strives to do: mitigate the volatility of funded status due to interest rate risk while also limiting market risk. The concept of LDI was first introduced in the UK over 50 years ago but did not start to really gain traction in the US until the early 2000s. Generally speaking, an LDI strategy looks at pension plan asset allocation from the perspective of total plan risk and return and includes the plan’s liability as a risk factor in setting the allocation. Regardless of how the assets perform, the liability can still fluctuate with changes in interest rates, directly affecting the funded status. In fact, the interest rate risk often outweighs the asset risk. Let’s take a look at what happened in 2012 to help illustrate this (fig. A):
83% funded status
Plan A was fully frozen on December 31, 2010. As of December 31, 2011, Plan A had assets of $100 million and liabilities of $120 million, resulting in a funded status of 83%. Plan A’s portfolio was invested 60% in stocks and 40% in fixed income and had a return of 11.5% during
2012. Separately, plan assets increased by $3 million due to a contribution and decreased by $4 million in benefit payments to retirees. In total, the plan assets increased by 10.5%. During the same time period, interest rates decreased 55 basis points, resulting in an 11.3% increase in liability. Including the interest cost on past service liability offset by benefit payments, the total plan liability increased by 12.1%. At the end of 2012, despite very positive market returns, the plan’s funded status actually decreased to 82%. Remember what this plan looked like in the perfect storm of 2008? This phenomenon generally occurs when plan assets are invested in an asset-only framework and the investments have a shorter duration than plan liabilities, creating a mismatch and increasing interest rate risk. By increasing the duration of the portfolio, the uncompensated risk can be diminished. As a starting point, this may simply mean lengthening the duration of your current fixed income portfolio. Given the current underfunding of most pension plans, the idea is not to jump into an LDI strategy tomorrow, but to formulate a plan that gradually moves assets from return-seeking to liability-hedging as funded status improves. This requires a thoughtful approach orchestrated by the plan sponsor integrating both the actuary and the investment manager. With the volatility in the markets, this analysis cannot occur once a year on a plan’s valuation
82% funded status
date. It requires close coordination and constant monitoring to capture market opportunities and movements in interest rates. When the market is going strong, it is so easy to forget. But as history has shown, anything can happen… and then it’s deja-vu all over again.
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| SUMMER 2013 14 12 | January-March 2012
EDISON INTERNATIONAL What Does This Decision Mean For Plan Fiduciaries? By Angel L. Garrett, Trucker Huss APC
“ In its detailed decision, the court addresses a myriad of issues that are essential for plan fiduciaries in understanding how to limit and avoid liability under the Employee Retirement Income Security Act of 1974 (“ERISA”) going forward.”
n March 21, 2013, the Ninth Circuit issued its opinion in Tibble v. Edison International, affirming the district court’s decision in a case where participants alleged that 401(k) plan fiduciaries breached their duties of loyalty and prudence by including certain investment options in the plan, such as retail-class mutual funds, and engaging in revenue sharing. This decision resulted from the plaintiffs’ appeal of the district court’s partial grant of summary judgment to the defendants, and the defendants’ cross-appeal of the posttrial decision. In its detailed decision, the court addresses a myriad of issues that are essential for plan fiduciaries in understanding how to limit and avoid liability under the Employee Retirement Income Security Act of 1974 (“ERISA”) going forward.
Fiduciary Duty When Selecting Retail-Class Mutual Funds The Ninth Circuit upheld the lower court’s post-trial decision that the defendants acted imprudently by including retail-class shares of three mutual funds in the Edison 401(k) Savings Plan’s (“Plan”) investment menu without www.conferomag.com | 13
“… The Tibble appellate decision contains an abundance of points for ERISA plan fiduciaries to consider.” first investigating the possibility of similar, institutionalclass alternatives. It rejected the defendants’ argument that they had reasonably relied on Hewitt Financial Services for advice because “independent expert advice is not a whitewash.” Moreover, it found that institutional-class shares for the three mutual funds at issue would have been more appropriate for the following reasons. First, all three mutual funds offered institutional shares that were 24 to 40 basis points cheaper. Second, there were no major differences in the investment quality or management for these two classes of funds. Third, even if the Plan could not meet these three funds’ investment minimum, it could have obtained a waiver because funds regularly waive such requirements for 401(k) plans with assets over a billion dollars, such as the Plan.
The Ninth Circuit, in joining the Third and Sixth Circuits, refused to limit the application of a deferential standard of review to only benefit claims. It held that the framework for reviewing disputes over plan terms — as set forth in key Supreme Court cases, Firestone Tire & Rubber Co. v. Bruch, Metropolitan Life Insurance Co. v. Glenn, and Conkright v. Frommert — also applies to all ERISA claims, including cases implicating fiduciary duties.
Statute of Limitations
The Ninth Circuit agreed with the district court that the six-year prong of the ERISA statute of limitations for the breach of fiduciary duty applied to the plaintiffs’ claims and started to run from when the initial decision was made to include the challenged investments as Plan options absent changes in conditions that prompted “a full due diligence review of the funds, equivalent to the diligence review Defendants conduct when adding new funds to the Plan.” With this decision, the court rejected the plaintiffs’ argument that their claims were timely so long as the challenged investments were in the Plan because there was a “continuing violation.” It also rejected the defendants’ argument that a three-year statute of limitations applied because the plaintiffs knew about the retail-class mutual funds through the Plan’s SPD and mutual fund prospectuses.
The Ninth Circuit held that the defendants did not violate the Plan document or ERISA section 406(b)(3) by using funds from revenue sharing to pay for some of the Plan’s administrative costs.
Safe Harbor Section 404(c) In agreeing with the Department of Labor (“DOL”), the Ninth Circuit held that ERISA section 404(c) does not apply to a fiduciary’s selection of investments funds as part of an investment menu. According to the DOL, ERISA section 404(c) could not protect the defendants from losses that resulted from their decision to include the challenged funds because “the selection of particular funds to include and retain as investment options in a retirement plan is the responsibility of the plan’s fiduciary, and logically precedes (and thus cannot result from) a participant’s decision to invest in any particular option.” The court found the DOL’s interpretation reasonable because the fiduciary is in
14 | SUMMER 2013
a better situation than the participant to prevent the losses that could arise from the inclusion of unsound investment options.
Standard of Review for Fiduciary Breach Claims
In applying the deferential standard of review because the Plan explicitly vested the Plan’s Benefits Committee with the “full discretion to construe and interpret [its] terms and provisions,” the court concluded that there was no abuse of discretion for several reasons. First, the revenue sharing practice did not explicitly conflict with the Plan’s plain language which stated that the “cost of the administration of the Plan will be paid by the Company” because a natural reading of “cost” meant the bills Hewitt Associates, the Plan’s service provider, sent to Edison. Also, there was nothing within the Plan prohibiting a third party from paying Hewitt Associates for its recordkeeping services. Second, the inclusion of these revenue sharing mutual funds increased the number of mutual fund options in the Plan. Third, the union discussed the use of these revenue sharing funds with Edison during union negotiations which amended the Plan to include mutual funds. Finally, the plaintiffs were made aware on at least seventeen occasions, such as through the Plan’s SPD, that Hewitt Associates used the funds from revenue sharing to pay for some of the Plan’s recordkeeping costs. The court also held that the defendants did not violate ERISA section 406(b) (3) because the DOL regulations under ERISA section 408(b)(2) exempt revenue sharing from the definition of consideration.
Inclusion of Mutual Funds, Short-Term Investment Fund and Unitized Stock Fund The Ninth Circuit also rejected the plaintiffs’ claims that the defendants violated their duty of prudence by including mutual funds, a short-term investment fund (similar to a money market fund) rather than a stable value fund, and a unitized fund for participants’ investment in Edison stock in the Plan’s investment menu. The Ninth Circuit joined the Seventh Circuit in refusing to accept a bright line rule that fiduciaries should only offer wholesale or institutional shares, instead of retail-class mutual funds, because there are several factors a fiduciary must consider in selecting a fund. Such factors included whether the lower cost alternative may have lower returns, higher financial risk, or offer fewer services. The court also found that the expense ratio range for the Plan’s
approximate forty mutual funds of 0.03 to 2% was not out of the ordinary. However, the court stated that its decision assumed that the cost of revenue sharing did not drive up the selected fund’s overall expense ratio and that the defendants were not motivated to select the mutual funds because of the financial benefit of revenue sharing. As for the short-term investment fund, the court held that the defendants were prudent because there was uncontroverted evidence, such as discussions on the pros and cons of a stable-value fund, showing that they had investigated the merits of this investment. Additionally, the inclusion of the unitized stock fund was not imprudent because the evidence showed that the defendants were vigilant in adjusting this fund when market conditions changed.
Lessons for Plan Fiduciaries to Take Away from the Ninth Circuit’s Decision The Tibble appellate decision contains an abundance of points for ERISA plan fiduciaries to consider. The following are lessons that we believe plan fiduciaries should take away from this decision: •
Before including any mutual fund investments in a plan, plan fiduciaries should ask about any alternative class shares and make reasoned determinations on what class share would be in the plan participants’ best interests. If the fiduciaries determine that there are no salient differences between the retail and institutional class shares, they should inquire whether the plan meets the minimum investment requirement for institutional shares. If the plan does not meet this requirement, the fiduciaries should request that this requirement be waived. Plan fiduciaries should not automatically exclude retail-class mutual funds from their plans’ investment options. Selection of retail-class mutual funds is not automatically deemed an imprudent decision in the Ninth and Seventh Circuits, but plan fiduciaries should
inquire about the availability of alternative class shares and make reasoned determinations as to which share classes should be included. •
Plan fiduciaries should monitor their service providers, including investment consultants, to ensure that they are analyzing all aspects of the current and recommended investment options. Plan fiduciaries should document the reasons for all decisions related to investments, especially if they decide to choose a more costly class share. Note that the Ninth Circuit stated that expense ratios for mutual funds ranging from 0.03 to 2% were considered ordinary. Plan fiduciaries should review the mutual funds in their plans and determine whether to include or remove certain funds.
This review should include determining which mutual funds have revenue sharing, the amount of the revenue sharing, and the costs associated with these funds. •
Plan documents should contain language granting the plan administrator, and perhaps other fiduciaries, full discretion to construe and interpret the terms of the plan. This is especially important for plans in the Third, Sixth, and Ninth Circuits, because courts in these appellate circuits have applied a deferential standard of review to fiduciary duty claims as well as to benefit claims.
Plan fiduciaries in the Sixth or Ninth Circuits should be aware that section 404(c) may not protect them from liability if a participant brings a claim alleging imprudent selection of investment funds.
If you have any questions on the Tibble decision or on fiduciary issues under ERISA, please contact Brad Huss or Angel L. Garrett at Trucker Huss. www.conferomag.com | 15
A Sea ofin Change Fixed Income By Gabriel Potter, AIF速
16 | SUMMER 2013
Bonds as a Safe Haven Relative to equities, the bond market has 3 essential advantages: diversification against equity market direction, lower volatility than equities, and a greater tendency to protect principal. For the first time in a long time, the bond markets are starting to lose material amounts of money. Not since the bear fixed income market of 1994 has the bond market had the opportunity to remind investors that bonds can, and do, lose value. In general terms, the fixed income categories have outperformed equities in the previous decade given the collapse of the technology driven exuberance of the early 2000s and the fiscal crisis of the late 2000s. Even more generally, over the past 30 years, bonds have demonstrated a tremendous ability to preserve principal. A key driver of bond market out performance regards interest rates; for the past 30 years, interest rates have taken a significant downward trend. In simple terms, when interest rates go down, bonds gain value.
What changed? The problem for fixed income that primarily relies on interest rate movements (like Treasuries or government backed Agencies) is that interest rates can’t really fall any further. The Federal Reserve is signaling a “tapering” down of their extraordinary measures (Quantitative Easing) which support the fixed income market, and they now project an end to the QE program by the middle of next year. This action is a necessary prelude to a potential increase in interest rates. Again, the simplification is when interest rates go up, bonds lose value. Several members of the Fed have dissented from the Chairman’s proposed timelines for interest rate increases and suggest a hawkish interest rate policy to contain inflation. To be clear, the Fed consensus for increasing interest rates is still more than a full year away (late 2014-2015), but the bond markets – sensing the shift in tone – have been punishing for investors.
First: acknowledge a potential tactical disadvantage We are afraid that many investors have simply forgotten that bonds can lose value and they are going to be surprised by the next month’s statements. More importantly, an increase of interest rates now seems inevitable and the reversal of this long term bias towards fixed income may disappoint investors. The reasons for investing in bonds are not completely absent now that there are signs of interest rate increases; for example, even an asset class with a long term return projection of zero might find its way into an optimized, efficient portfolio if it had sufficiently negative correlations to other return-seeking asset types. Still, it is important for investors to recognize the potential tactical disadvantages of classic core bond portfolios. Depending on the ability of an institution to conduct appropriate due diligence, the fixed income mandate for a portfolio may expand to include non-core elements such as multi-sector, unconstrained, total return, or global fixed income products which expand the risk and exposure beyond interest rate driven risk.
Second: revisit your strategic asset allocation Another other key consideration in the wake of these changes: asset allocation modeling. When determining an optimal asset allocation for a portfolio, consultants often rely on asset allocation software which uses historical data to figure out optimal portfolios based on the risk and return profiles of different asset classes. Asset allocation software works by comparing the risk, return and correlation of different asset classes over their longest concurrent timeline. Again - over the past 30 years, interest rates have trended down so bond market performance has enjoyed a structural advantage. In order to have a fair comparison of bonds and equities, asset allocation software should historical data beyond 30 years the downward interest rate trend, which otherwise would bias the results. The problem, however, is relatively new and significant asset classes – Emerging Markets, Hedge Funds and so forth – do not have historical returns greater than 30 years. Thus, asset allocation software has a built in structural bias because of the interest rate trend. Investors should be wary of this bias and check to see if their asset allocation decisions have incorporated this bias. Consultants using asset allocation software should disclose and, if appropriate, account for this bias.
www.conferomag.com | 17
The Trouble with
What If You Don’t Know What You Don’t Know? By Eric Paley, Nixon Peabody
18 | SUMMER 2013
e’ve all been guilty of willful ignorance at one time or another. “I don’t like brussel sprouts,” even though you’ve never come close to eating them. “That book is boring”, though you’ve never actually cracked the cover. “I don’t think the heavy stuff’s gonna come down for quite awhile,” even as a torrential downpour tears at your face. Willful ignorance is about burying your head in the sand – believing what you want to believe and refusing to open your mind to the alternative. When we engage in willful ignorance, we can’t expect much sympathy from others if the tide turns against us. Ignore reality at your own peril. But to my mind, Tibble v. Edison International isn’t about willful ignorance. It’s about sheer ignorance. Naḯveté. “What, me worry?” à la Alfred E. Neuman. (That’s a Mad magazine reference for you young’uns. Go Google it.) And that’s why I can’t help but feel a tad sorry for the members of the Edison Investment Committee. What if they truly didn’t know what they didn’t know? They certainly seemed to have the best of intentions. The Ninth Circuit’s decision tells us that Edison had long contracted with a reputable firm, Hewitt Financial Services, for investment consulting advice. HFS met frequently with the Committee to ensure Edison’s menu of 401(k) plan investment options continued to satisfy the Committee’s chosen criteria. And HFS even provided the Committee monthly, quarterly, and annual investment reports. Good stuff, right? Not good enough, apparently. The court chastised Edison “to illustrate a point, which, though it should be unmistakable, seems to have eluded” the company. HFS was merely a consultant, experts though they may have been in their field. A fiduciary, like the Committee, cannot unreasonably rely upon an expert’s advice. The law demands more. And there’s the rub. The brave men and women of the Edison Investment Committee never had a chance, and I want to believe they didn’t even see the coming storm. HFS recommended the inclusion of retail share classes for mutual funds on the Edison 401(k) plan investment menu, and the Committee blindly accepted HFS’s advice without considering whether cheaper institutional share classes might be available. Did the Committee members even appreciate what they were doing? Did they understand they were getting retail shares? Did they know what retail
shares were? Did they have even the foggiest notion there might be an animal called an institutional share? Did they know it was less expensive than a retail share? Having sat down with more than my fair share of retirement plan committee members over the years, I tend to doubt it. To be clear, I do not question the intelligence of these folks one iota. I’m sure they were every bit as smart and talented as anyone else at the company, and they approached their Committee charge with the utmost professionalism. But being smart and talented doesn’t make you an expert in everything. Remember, Einstein supposedly couldn’t tie his own shoes. The law demands more. It’s right there in black-andwhite. (Section 404(a)(1)(B) of ERISA, for those of you who care about such things.) A fiduciary must discharge its duties with respect to a plan “with the care, skill, prudence, and diligence under the circumstances 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.” That’s a pretty high standard – actually, the “highest known to law,” as a federal appeals court once said. And so, as badly as I feel for the members of the Edison Investment Committee, it won’t change the result. As the Ninth Circuit said, the Committee should have “reviewed all available share classes and the relative costs of each when selecting a mutual fund.” This is especially true, “considering that supposedly the ‘expense ratio’ was a core investment criterion.” And yet, despite having ample opportunity to do so, Edison presented no evidence the Committee ever did any of this. The law expected them to act as experts, and they failed to meet the challenge. I have given countless speeches on fiduciary responsibility over the years, and my parting advice to attendees is always the same: though nothing in ERISA requires a plan’s committee to engage an outside fiduciary adviser, it’s strongly recommended. Tibble vindicates me, for all those who dared to question the wisdom of my words. It matters not that your heart is full, if your mind is empty. Sheer ignorance can be downright costly and dangerous in the face of a legal standard that demands expertise. “What, me worry?” Oh Alfred, poor, poor Alfred …If you only knew.
www.conferomag.com | 19