“Litigation concerning retirement plans appears to be a growth industry.” John Ergastolo and Darin Hoffner outline three fundamental strategies to address fiduciary risk and strengthen the operation of retirement plans.
A key responsibility of CFOs is the oversight of their organization’s retirement programs. And typically, they have a seat on at least one investment committee for defined benefit (DB) plans, defined contribution (DC) plans or both. The financial stakes of this role have never been higher. Litigation concerning retirement plans appears to be a growth industry, with increases in both the frequency and magnitude of claims — including recent settlements for $50 million dollars or more. Every CFO should be concerned about this trend and take steps to address the associated risks.

OWTI ImageFor many employers, retirement plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA) — a federal law that establishes fiduciaries’ duty of care. Section 404 of ERISA defines four specific elements of fiduciary responsibility: 1) the duty of loyalty; 2) the duty of prudence; 3) the duty to diversify plan assets; and 4) the duty to comply with the plan’s governing documents.¹

The duty of loyalty is very clear. ERISA requires that a fiduciary “shall discharge his [or her] 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” (emphasis added).¹

The duty of loyalty can easily create a conflict for CFOs, who have the same duty to their organization and its owners or directors. As a consequence of this duality, avoiding potential conflicts of interest becomes a paramount concern. The duty of prudence can also present problems — for example, if the investment committee lacks the requisite knowledge or skills to make certain decisions.

CFOs have three fundamental strategies at hand for managing the risk of failing to meet their fiduciary responsibility to retirement plan participants and beneficiaries. They need to reduce exposure by addressing common sources of risk, insulate against risk by retaining an independent fiduciary and transfer risk through adequate insurance coverage. In the current environment, the more sensible approach for most CFOs is to pursue a combination of these strategies — usually all three of them.

Addressing common sources of risk
CFOs can reduce their exposure to some common risks with a focus on three areas. It’s important to pay attention to the reasonableness of fees and expenses, update and maintain investment policies, and use a competitive bidding process for all service providers.

Pay attention to the reasonableness of fees and expenses

The potential consequences of not managing this risk effectively are best illustrated by examples of recent lawsuits. In the cases of several high-profile companies and higher education institutions, the DC plan members’ complaints focused on excessive fees they paid to the plans’ investment managers. The claimants deemed the fees out of line with peer organizations, and accused employers of lacking prudent oversight in selecting these managers.

Also, revenue-sharing arrangements between the managers and employers were characterized as pay-to-play. To address this category of risk, it’s often helpful for plans to hire a consultant with extensive knowledge of fees and experience in evaluating investment managers.

Update and maintain investment policies

Investment decisions should not deviate from the investment policy, which is included under the duty to comply with plan documents. CFOs need to know the policy they are operating under, and take steps to review and update it as needed.

Use a competitive bidding process for all service providers

Running RFPs for retirement plan custodians, recordkeeping services and independent fiduciaries help to ensure a higher level of rigor in the selection process.

Hiring an independent fiduciary 

Independent fiduciaries take on the fiduciary role on behalf of the plan fiduciary. Just like a regular fiduciary, the independent fiduciary’s duty is solely to the plan participants and beneficiaries. The plan fiduciary still holds ultimate responsibility and should exercise care in selecting the independent fiduciary. Nevertheless, this decision can help insulate the plan fiduciary from liability.

The use of independent fiduciaries also extends other opportunities for the organization. They include providing independent expert advice to plan fiduciaries, permitting plans to take advantage of otherwise prohibited investment options, and helping relieve the plan fiduciaries of conflicts of interest.

Hiring an independent fiduciary is particularly important in some situations, including these examples:

  • The DB or DC plan includes employer stock. CFOs could have inside information about the stock’s value. For this reason, they may be caught between their fiduciary duty to the plan participants and beneficiaries, and their requirement not to violate securities or other federal laws.
  • The employer or union wants to contribute real property as a plan asset. An independent fiduciary can conduct a full due diligence review. Working with an independent appraiser, the fiduciary would determine the appropriate property valuation and whether contributing the property is a prudent decision.
  • A plan is subject to a class action lawsuit. An independent fiduciary is needed to evaluate the litigation settlement and determine whether the plan should grant a release of claims against the employer sponsoring the plan, as well as company officials.

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Obtaining adequate insurance coverage

Along with taking preventive steps to reduce potential liability, it’s also important for employers and plan sponsors to obtain adequate insurance coverage. The cases mentioned earlier highlight the potential scope of liability — with settlements of about $50-$60 million. As a result, a lot more thought is now going into determining the appropriate risk coverage limits.

Many employers are woefully underinsured, even if the likelihood of a loss is low. So it’s critical to quantify potential damages, which are largely a function of the amount of plan assets. Similar to other kinds of insurance, the underwriting process starts with base ratings for various plan types and adjusts them for the employer’s industry, claims history and actions taken to mitigate risk.

By deploying these three strategies — addressing common causes of risk, hiring an independent fiduciary and obtaining adequate insurance coverage — CFOs can strengthen the operation of retirement plans. They’re better prepared and positioned to reduce financial risk to the organization, and ensure they are fully meeting their fiduciary responsibility to the plans.

This article is an excerpt from our 2019 Organizational Wellbeing & Talent Insights Report – U.S. Edition.

John Ergastolo
Area Executive Vice President, Management Liability Practice

John focuses on public, private and nonprofit management liability exposure analysis and product placement. He is recognized as a national D&O specialist for Fortune 500 companies and other large accounts.

Darin Hoffner
Area Senior Vice President & Area Counsel, Investment & Fiduciary Consulting

Darin coordinates and manages an independent fiduciary decision-making group that focuses on providing independent, conflict-free, discretionary decisions about particular transactions or plan assets. He oversees the performance of client assignments on both a project and ongoing consulting basis.

¹The Employee Retirement Income Security Act of 1974, ERISA §404(a)(1)(A)(D), 29 U.S.C. §1104(a)(1)(A)(D)