Brian M. Pinheiro, Esq.

DMEAST #9309628 v1

Fiduciary Issues for 2006 and Beyond

Brian M. Pinheiro, Esq.

PEBA Presentation

November 10, 2005

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Fiduciary Topics

• Who is a fiduciary?• What are the fiduciary duties?• What are the consequences of a breach

of fiduciary duties?• Can fiduciary responsibility be delegated?• What is ERISA 404(c)?• Can I fix a fiduciary breach?• Specific fiduciary issues

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In 2005, did your company . . .

• Ignore investment options in a 401(k) plan– Especially employer stock investments

• Tell little white lies to “avoid confusion”• Pay plan expenses out of plan assets• Assume that your third-party administrator is

the responsible fiduciary• Have regular investment / benefits

administration committee meetings• Review your fiduciary insurance policy

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Who is a fiduciary?

• Any person who –

– Exercises discretionary management or control over plan administration.

– Exercises any authority or control over plan assets.

– Renders investment advice with respect to plan assets for a fee.

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Who is a fiduciary?

• Individual• Committee• Committee Members / Corporate

Officers– Confer v. Custom Engineering Co.

• Plan Sponsor/Company• Third-Party Administrator• Investment Manager/Investment Advisor• Trustee

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Who is a fiduciary?

• Vice President of Human Resources• Vice President of Compensation and

Benefits• Benefits Manager• 401(k) Administrative Committee• Compensation Committee of the Board

of Directors

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What are the ERISA Fiduciary Duties?

A fiduciary must exercise his duties with respect to a Plan

• Solely in the interest of Plan beneficiaries;• For the exclusive purpose of paying benefits

and reasonable administrative expenses;• In a prudent manner;• By diversifying Plan investments; and• In accordance with Plan documents (to the

extent consistent with ERISA).

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Consequences of a Breach of Fiduciary Duty

• A fiduciary is personally liable to restore losses to the Plan and to restore to the Plan any profits he earns by subjecting Plan assets to non-Plan use.

• Prohibited transactions must be reversed; subject to an excise tax.

• Civil and criminal penalties may apply.

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Consequences of a Breach of Fiduciary Duty

• Fiduciaries may be sued by the DOL, Plan participants, and other fiduciaries to:

– Enforce the provisions of the Plan and ERISA;

– Enjoin any act or practice that violates ERISA or the terms of the Plan; or

– Obtain other appropriate equitable relief.

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Voluntary Fiduciary Correction Program

• DOL voluntary program to encourage fiduciaries to self-correct certain fiduciary violations.– Relief from certain penalties and DOL enforcement

• New DOL guidance on the VFC Program published in 2005.– Expands covered transactions list– Clarifies relief from excise taxes– Reduces documentation required to be submitted to

DOL

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Voluntary Fiduciary Correction Program

• Common fiduciary breach transactions that are covered under the VFCP –– Delinquent participant contributions– Improper use of Plan assets to pay expenses– Correction of participant loan failures– Prohibited purchases, sales and exchanges of Plan

assets

• VFCP correction does not bar other enforcement actions (e.g., participant lawsuits).

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Consequences of a Breach of Fiduciary Duty

• Related Issues –

– Corporate indemnification of fiduciaries– Fiduciary insurance– Bonding– Covenants in credit agreements and sale &

purchase agreements

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Delegating Fiduciary Responsibility

• Fiduciaries can delegate certain fiduciary functions to other parties.

– Investment Committee can delegate investment responsibility to a professional investment manager.

– Benefits Administration Committee can delegate claims administration to a third-party administrator.

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Delegating Fiduciary Responsibility

• Delegating fiduciary retains the duty to –

– Prudently select the responsible fiduciary

– Monitor the fiduciary’s conduct and take action to replace the fiduciary if necessary

• Co-fiduciary liability

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ERISA 404(c)

• When a participant directs the investment of his 401(k)/403(b) account, a Plan fiduciary is not liable for losses resulting from the participant’s investment decision.

– But only if the requirements of Section 404(c) of ERISA are satisfied.

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ERISA 404(c)

• Requirements relating to the types of investments available under a Plan.

– Plan must provide a broad range of investment alternatives, including at least 3 diversified alternatives.

– Participant should be able to reach any point on a normal risk/return curve.

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ERISA 404(c)

• Requirements relating to the participant’s control over his or her account.

– Participants must have a reasonable opportunity to give instructions that will be followed, and must be able to change investments at least quarterly.

– Default investments not protected.

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ERISA 404(c)

• Information that must be provided to all participants.

– Statement that the plan is intended to be an ERISA Section 404(c) plan, and fiduciaries may be relieved from losses resulting from participant investment instructions.

– General description of investment alternatives (objectives, risk and return characteristics, types of assets).

– Names of any investment managers.

– Explanation of procedures regarding investment instructions.

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ERISA 404(c)

– Description of transaction fees and expenses.

– Prospectus

– Information on pass-through voting rights.

– “Sufficient information to make informed investment decisions.”

•Role of investment education

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Investing in Employer Stock

• Heavily litigated area in the past 5 years.

• Employers face tough decisions when stock declines in value.

– When do you shut off new investments?– When do you eliminate the stock fund as an

investment?– When do you disclose material, non-public

information about the employer stock?– How do you objectively evaluate the prudence of an

employer stock fund?

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Investing in Employer Stock

• Employers are taking action to limit employer stock investments; reduce exposure to class action litigation.

– No longer a mandatory investment.– Percentage limits on investments.– Offering employer stock only through brokerage

windows.– Independent fiduciaries handle decisions on the

employer stock fund.

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Fiduciary Misrepresentations

• Duty not to lie to participants

– Accounting irregularities– Varity case– Misrepresentations in communications

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Payment of Plan Expenses

• Plan assets may be used to pay “reasonable” plan administrative expenses.– Using Plan assets to pay other expenses is a breach

of fiduciary duty.• Plan administrative expenses are those that

relate to the management or administration of the plan.– E.g., Form 5500 preparation, nondiscrimination

testing, actuarial valuations, investment fees.• Expenses must be reasonable

– Determined by a Plan fiduciary.

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Payment of Plan Expenses

• May allocate plan expenses among plan participants in a defined contribution plan.– Pro Rata vs. Per Capita.– Allocating expenses to individual participants.

•Hardship withdrawals•Calculation of benefits under different distribution

options•Distribution costs (e.g., check writing fees)•Terminated vested account administration•QDROs

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2006 New Years’ Resolutions

• Identify the fiduciaries• Draft charters for your plan investment

committee and your benefits administration committee– Outline responsibilities, how actions are taken, etc.

• Draft an investment policy statement– Creates boundaries and benchmarks for plan

investment decisions

• Fiduciary training

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2006 New Years’ Resolutions

• Review your Plan investment options quarterly

• If you pay expenses out of Plan assets, consider how expenses are approved

• Review your fiduciary insurance policies

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2006 New Years’ Resolutions

• THINK– Good fiduciary practice is based on sound

preliminary investigation and procedure– Don’t have to be able to tell the future