The Employee Retirement Income Security Act of 1974 (ERISA) establishes a comprehensive framework of fiduciary duties for many involved with employee benefit plans. Failure to comply with these strict fiduciary standards can expose fiduciaries to personal and professional liability and penalties. With ERISA litigation on the rise, a new administration, and recent news that the Department of Labor (DOL) is sharing data with ERISA-plaintiff firms, a refresher on fiduciary duty compliance is necessary.
What Plans Are Covered?
ERISA’s fiduciary requirements apply to all ERISA-covered employee benefit plans. This generally includes all employer-sponsored group benefit plans unless an exemption applies, such as governmental and church plans, as well as plans solely maintained to comply with workers’ compensation, unemployment compensation, or disability insurance laws.
Who Is A Fiduciary?
A fiduciary is any individual or entity that does any of the following:
- Exercises authority over the management of a plan or the disposition of assets.
- Provides investment advice regarding plan assets for a fee.
- Has any discretionary authority in the administration of the plan.
Note that fiduciary status is determined by function, what duties an individual performs or has the right to perform, rather than an individual’s title or how they are described in a service agreement. Fiduciaries include named fiduciaries. Those specified in the plan documents are plan trustees, plan administrators, investment committee members, investment managers, and other persons or entities that fall under the functional definition. When determining whether a third-party administrator is a fiduciary, it is important to identify whether their administrative functions are solely ministerial or directed or whether the administrator has discretionary authority.
What Rules Must Fiduciaries Follow?
Fiduciaries must understand and follow the four main fiduciary duties:
- Duty of Loyalty: Known as the exclusive benefit rule, fiduciaries are obligated to discharge their duties solely in the interest of plan participants and beneficiaries. Fiduciaries must act to provide benefits to participants and use plan assets only to pay for benefits and reasonable administrative costs.
- Duty of Prudence: A fiduciary must act with the same care, skill, prudence, and diligence that a prudent fiduciary would use in similar circumstances. Even when considering experts’ advice, hiring an investment manager, or working with a service provider, a fiduciary must exercise prudence in their selection, evaluation, and monitoring of those functions and providers. This duty extends to procedural policies and plan investment and asset allocation, including evaluation of risk and return.
- Duty of Diversification: Fiduciaries must diversify plan investments to minimize the risk of large losses, with limited exceptions for ESOPs.
- Duty to Follow Plan Documents and Applicable Law: Fiduciaries must act in accordance with plan documents and ERISA. Plans must be in writing, and a summary plan description of the key plan terms must be provided to participants.
Fiduciaries also have a duty to avoid causing the plan to engage in any prohibited transactions. Prohibited transactions include most transactions between the plan and individuals and entities with a relationship to the plan. Several exceptions exist, including one that permits ongoing provision of reasonable and necessary services.
Liabilities and Penalties
An individual or entity that breaches fiduciary duties and causes a plan to incur losses may be personally liable for undoing the transaction or making the plan whole. Additional penalties, often at a rate of 20% of the amount involved in the violation, may also apply. While criminal penalties are rare, are possible when violations of ERISA are intentional. Causing the plan to engage in prohibited transactions may also result in excise taxes established by the Internal Revenue Code.
To limit potential liability, plan sponsors and fiduciaries should ensure the appropriate allocation of fiduciary responsibilities, develop adequate plan governance policies, and participate in regular training. Plan sponsors may purchase fiduciary liability insurance to cover liability or losses arising under ERISA. In addition, the DOL has established the Voluntary Fiduciary Correction Program (VFCP), which can provide relief from civil liability and excise taxes if ERISA fiduciaries voluntarily report and correct certain transactions that breach their fiduciary duties. The VFCP program was recently updated with expanded provisions for self-correction of errors, which are addressed in a previous advisory.