When a company establishes a 401(k) plan it is necessary to name a trustee of the plan. This is a very important decision that is not always given the careful deliberation that it deserves. This post covers why it is such a crucial decision and outlines some of the options for naming a plan trustee.
Why it Matters
The trustee is responsible for the plan assets. Every 401(k) plan involves a tax-qualified trust established under Section 401(a) of the Internal Revenue Code and all plan assets are nominally held in that trust, so the trustee of that trust is in charge of all plan assets. That includes collection of contributions, their investment while held by the trust, and their ultimate disbursement to plan participants and beneficiaries. In most 401(k) plans, even though participants take on responsibility for choosing among plan investment options under Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA), the plan trustee is responsible for selecting the menu of options from which participants choose. If problems are identified with plan investment performance, or with the amounts paid to plan service providers, the plan trustee may be called to answer in court.
The standard of care is one of the most stringent known under law. A plan trustee is a fiduciary under ERISA. The fiduciary standard of care, often referred to as the “prudent expert” standard, is set forth under ERISA § 404(a)(1). It requires that plan trustees consistently do all of the following:
- Act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
- Carry out their duties prudently;
- Follow the terms of the plan documents (unless doing so is inconsistent with ERISA);
- Diversify plan investments; and
- Pay only reasonable plan expenses to service providers, with “reasonableness” being measured in light of the services provided to the plan.
More information about fiduciary duties under ERISA is set forth in a booklet titled “Meeting Your Fiduciary Responsibilities” that is published by the Department of Labor, Employee Benefits Security Administration. Every person who is serving as an ERISA plan fiduciary or who is in a position to appoint a plan fiduciary should familiarize themselves with the contents of the booklet and should seek out qualified ERISA counsel to assist in applying the concepts in the booklet to their particular factual situation.
At this juncture it is appropriate to discuss specialized types of ERISA fiduciaries who can be engaged to assist plan trustees in various ways. Perhaps the most prevalent is the ERISA 3(21) fiduciary, a paid investment advisor that assists the plan trustee in selecting plan investments, reviewing investment performance, and providing recommendations about investments to the plan fiduciary. They bear fiduciary liability, but the plan trustee carries ultimate liability for acting, or not acting, on the 3(21) fiduciary’s recommendations. An ERISA 3(38) investment manager, rather than merely making recommendations, directly selects and monitors the plan’s investment option menu, changing out funds and providers as it finds appropriate. The plan trustee is regularly advised about the investment manager’s decisions and retains fiduciary liability over the selection and monitoring of the 3(38) investment manager. An ERISA 3(16) fiduciary primarily has an administrative role, rather than having to do with plan investments. They can take over responsibility for signing and filing Form 5500 return/reports and other tasks that plan trustees would otherwise have to fulfill. (This is just a very brief overview of these various roles; there is more information about these three types of fiduciaries here and here.) Each of these types of fiduciary will charge fees for their services; selection of any of them is itself a fiduciary act and their fees must be reasonable in light of the services provided.
401(k) litigation continues apace. Litigation against 401(k) plan trustees and other fiduciaries have been trending for almost 20 years. The lawsuits, most of which have been brought in class action format and have settled out of court, generally allege that plan fiduciaries have selected overly expensive investments or and/or are overpaying service providers such as investment managers, record keepers and third-party administrators. A recent Supreme Court opinion did not, as had been hoped, articulate a pleading standard that would have made it easier to eliminate an excessive fee lawsuit at the pleading stage. Although generally the lawsuits are directed at 401(k) plans with hundreds of millions of dollars in assets, there is nothing preventing class action counsel from targeting smaller plans.
Who to Name as Plan Trustee
Against that background, exercising extreme care in choosing a plan trustee is essential. There are two main options, and the sub-options within those two main categories.
The first consideration is whether or not to choose an institutional or third-party trustee such as a bank or trust company. An institutional or “corporate” trustee will have fiduciary liability for plan assets under investment, but they often serve as “directed” trustees who take investment direction from the plan sponsor or from an ERISA 3(38) investment manager, rather than as discretionary trustees who call the investment shots themselves. It is also possible to name a discretionary corporate trustee. Corporate trustees of either variety charge fees, usually in the form of a small percentage of plan assets, with a minimum fee for start-up plans. The fees must be reasonable in light of the services performed, and as with the choice of a fiduciary advisor or manger, selection of a corporate trustee is itself a fiduciary act.
Start-up and smaller plans often select an individual who is an executive or owner of the company sponsoring the plan to serve as plan trustee. That individual will potentially be personally liable for plan losses that are the result of their negligence or malfeasance. It is important that the individual named as a plan trustee be aware of this fact. It is also not uncommon for the company that sponsors the plan, to be named as the plan trustee. In this instance the company can only act by and through its board of directors, managers or partners (if an LLC or partnership), so if the company is named it is recommended that the board (or managers, or partners) form a plan committee to fulfill plan trustee duties. The committee should be comprised of individuals who have experience with investments and financial matters and who would be equipped to interview, select among, and monitor the performance of plan service providers such as ERISA 3(21) fiduciaries, 3(38) investment managers, record keepers, and third party administrators. Any individual serving as a plan trustee should also be comfortable performing those duties.
Whether an individual or board committee carries out plan trustee functions, the individual(s) serving in this role should commit to introductory and ongoing fiduciary training. This would include information about the standard of care applicable to, and duties of, an ERISA fiduciary and would break down how those duties translate into tasks such as regular meetings to review plan investment performance, protocol for documenting decisions made during such meetings (e.g., minutes and resolutions), selection and monitoring of plan service providers, and the like. In addition to undergoing training, individual fiduciary(ies) will need to be diligent in fulfilling their appointed tasks.
One further consideration is the purchase of fiduciary liability insurance. This is specialized liability coverage that is separate and different from the fiduciary bond required under ERISA Section 412(a). Fiduciary liability coverage acts like errors and omissions coverage, but with respect to a company or individual’s role as a fiduciary under an ERISA plan. 401(k) plan fee litigation has impacted the fiduciary liability insurance market, but coverage remains affordable and should be evaluated by individuals and board committees serving as plan trustees.
The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.
Photo credit: Joshua Hoehne, Unsplash