Regulators are soon expected to unveil a new fiduciary standard that will dramatically change how financial professionals do business.
Broker-dealers and those who work with Individual Retirement Accounts would be held to the same fiduciary standards as their 401(k) plan brethren, which would overturn 40 years of business practices that allowed these individuals to recommend investments in which they receive a commission.
Amid all of the teeth-gnashing, here’s a look at eight questions that are central to the debate:
1. Is a fiduciary liable for losses to a plan for failing to investigate and evaluate a proposed investment?
Not necessarily. A fiduciary’s failure to investigate and evaluate an investment decision alone is not sufficient to make him liable for losses to a plan. Instead, efforts to hold the fiduciary liable for a loss attributable to an inadequate investment decision must demonstrate a causal link between the failure to investigate and evaluate and the harm suffered by the plan.
The cases that hold a trustee liable for losses for failing to investigate and evaluate the merits of an investment have based the trustee’s liability on findings of fact that clearly established the unsoundness of the investment decision at the time it was made. If a court determines that a trustee failed to investigate a particular investment adequately, it will examine whether, considering the facts that an adequate and thorough investigation would have revealed, the investment was objectively imprudent.
“[T]he determination of an objectively prudent investment is made on the basis of what the trustee knew or should have known; and the latter necessarily involves consideration of what facts would have come to his attention if he had fully complied with his duty to investigate and evaluate.” It is the imprudent investment, rather than the failure to investigate and evaluate, that is the basis of liability.
2. Is the prudent person rule subject to the business judgment rules?
No. It is not a business judgment rule that applies to the question of prudence in the management of an ERISA plan, but rather a prudent person standard.
3. Is a fiduciary an insurer of plan investments?
No. “[T]he prudence rule does not make the fiduciary an insurer of the plan’s assets or of the success of its investments. ERISA does not require that a pension fund take no risk with its investments. Virtually every investment entails some degree of risk, and even the most carefully evaluated investments can fail while unpromising investments may succeed.
“The application of ERISA’s prudence standard does not depend upon the ultimate outcome of an investment, but upon the prudence of the fiduciaries under the circumstances prevailing when they make their decision and in light of the alternatives available to them.” The fiduciary duty of care requires prudence, not prescience.
In addition, the mere fact that a plan’s investment portfolio declines in value or suffers a diminution of income does not by itself establish imprudence. Market values are untrustworthy indicia of value especially in times of economic decline. In that respect, whether a trustee is liable for losses to the plan depends upon the circumstances at the time when the investment is selected and not upon subsequent events. Thus, if at the time an investment is made, it is an investment a prudent person would make, there is no liability if the investment later depreciates in value absent a failure to monitor its performance.
4. Can a successor fiduciary be liable for the investment acts of its predecessor?
Yes. If the selection of plan investments by a predecessor fiduciary constitutes a breach of duty or a prohibited transaction, a successor fiduciary has a duty to dispose of these investments upon assuming her responsibilities as fiduciary. A fiduciary has a continuing duty to advise the plan to divest of unlawful or imprudent investments, and its failure to do so gives rise to a new cause of action each time the fund was injured.
5. Is a fiduciary’s subjective good faith a defense to a breach of fiduciary duty?
No. The fact that a fiduciary may have acted in good faith is not a defense to a breach of fiduciary duties, because the sincerity of a fiduciary’s belief that his actions are in the best interests of the plan is essentially irrelevant to a determination of the prudence of the fiduciary’s conduct. Thus, good faith alone is not recognized as a defense to a breach of fiduciary duties.
6. Does the prudence requirement obligate a fiduciary to seek the assistance of an expert?
It depends. Although ERISA does not require a fiduciary to seek professional assistance in making plan investments, 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. The failure to do so is imprudent and constitutes a violation of ERISA Section 404(a)(1)(B).
7. Can a fiduciary avoid liability by relying on the professional advice of others?
Although fiduciaries are not expected by the courts to duplicate their advisers’ investigative efforts, fiduciaries are required to “review the data a consultant gathers, to assess its significance and to supplement it where necessary.” In addition, “[a]n independent appraisal is not a magic wand that fiduciaries may simply wave over a transaction to ensure that their responsibilities are fulfilled. It is a tool and like all tools, is useful only if used properly.”
8. Do plan losses create a presumption of a breach of duty?
No. The test of prudence under the prudent man rule is one of conduct, and not a test of the result of performance of the investment. The focus of the inquiry is how the fiduciary acted in his selection of the investment, not whether his investments succeeded or failed.