Fiduciary Issues
Understanding who qualifies as an Employee Retirement Income Security Act (ERISA) fiduciary, what duties they owe, and how plan sponsors can limit liability through safe harbor provisions are core Series 65 topics.
ERISA Overview and Coverage
ERISA (Employee Retirement Income Security Act of 1974) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry. It is enforced by the Department of Labor (DOL), not the SEC, and protects participants and beneficiaries of employer-sponsored retirement plans.
Plans covered by ERISA:
- Private employer-sponsored retirement plans (401(k), 403(b), pension plans)
- Defined benefit plans (traditional pensions)
- Defined contribution plans (401(k), profit-sharing)
- SEP IRAs and SIMPLE IRAs (when employer-sponsored)
Plans NOT covered by ERISA:
| Excluded Plan Type | Reason |
|---|---|
| Government plans (federal, state, local) | Statutory exemption |
| Church plans (unless they elect coverage) | Statutory exemption |
| IRAs (individual, Roth, rollover) | Set up by individuals, not employers |
| Plans maintained outside the U.S. | For nonresident aliens only |
Exam Tip: Gotchas
- A 401(k) rolled into an IRA is no longer covered by ERISA. The rollover IRA loses ERISA's creditor protection in most states. ERISA plans have unlimited federal creditor protection, while IRAs rely on state law and the federal bankruptcy exemption of roughly $1.5 million.
Who Qualifies as an ERISA Fiduciary
ERISA uses a functional definition of fiduciary: a person is a fiduciary based on what they do, not their title. Anyone who exercises discretionary authority or control over plan management, plan assets, or renders investment advice for compensation is a fiduciary.
Who qualifies as an ERISA fiduciary:
- Plan administrator
- Plan trustee
- Investment committee members
- Anyone with discretionary authority or control over plan assets
- Anyone who provides investment advice for compensation
The Four Core ERISA Fiduciary Duties
1. Loyalty (Exclusive Benefit Rule)
- Act solely in the interest of plan participants and beneficiaries
- Use plan assets exclusively for providing benefits or defraying reasonable plan expenses
2. Prudence (Prudent Expert Rule)
- Act with the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use
- This is the prudent expert rule, not the ordinary prudent person standard
Exam Tip: Gotchas
- ERISA's standard is the prudent expert rule ("familiar with such matters"), which is a higher standard than the common law prudent man rule because it assumes specialized knowledge.
- Do not confuse ERISA's prudent expert rule with the Uniform Prudent Investor Act (UPIA), which governs trustees of personal trusts, not ERISA plans.
3. Diversification
- Diversify plan investments to minimize the risk of large losses, unless clearly prudent not to do so
4. Follow Plan Documents
- Act in accordance with plan documents, as long as those documents comply with ERISA
- A fiduciary cannot follow plan provisions that violate ERISA itself
3(21) vs. 3(38) Fiduciary Roles
| Role | Section | Authority | Liability |
|---|---|---|---|
| Investment Adviser | 3(21) | Recommends investments; plan sponsor retains final decision | Shared with plan sponsor |
| Investment Manager | 3(38) | Full discretion to select, monitor, and replace investments | Manager assumes fiduciary liability for investment decisions |
- A 3(38) investment manager must be a registered investment adviser, bank, or insurance company
- Hiring a 3(38) manager transfers investment fiduciary liability from the plan sponsor to the manager (for those delegated decisions)
Section 404(c) Safe Harbor: Participant-Directed Plans
ERISA Section 404(c) provides a safe harbor that relieves plan fiduciaries from liability for losses resulting from participants' own investment decisions. It applies only when participants exercise independent control over their account assets.
404(c) safe harbor requirements:
- Offer at least 3 diversified investment alternatives with materially different risk/return characteristics
- Allow transfers among options at least once per quarter (every 3 months)
- Provide sufficient information for participants to make informed decisions (fund descriptions, fees, performance)
- Notify participants that the plan intends to comply with 404(c) and that fiduciaries may be relieved of liability
Exam Tip: Gotchas
- Even under 404(c), fiduciaries are NOT relieved of the duty to prudently select and monitor the investment options offered. The safe harbor only protects against losses from the participant's choice among those options.
Qualified Default Investment Alternative (QDIA)
Under ERISA Section 404(c)(5), a Qualified Default Investment Alternative (QDIA) is the default investment for participants who do not make an active election. Authorized by the Pension Protection Act of 2006 (PPA) to encourage automatic enrollment, plan fiduciaries receive safe harbor protection for defaulting contributions into a QDIA.
Four Types of QDIAs
| QDIA Type | Description |
|---|---|
| Target-date fund (lifecycle fund) | Asset mix shifts based on participant's expected retirement date (most common) |
| Balanced fund | Diversified mix based on group characteristics of plan participants as a whole |
| Managed account | Professional management service that allocates among plan options based on individual age/retirement date |
| Capital preservation product | Stable value or money market; permitted only for the first 120 days of participation |
QDIA Conditions for Safe Harbor
- Participant must have had the opportunity to direct investments but failed to do so
- Written notice must be provided at least 30 days before the first QDIA investment and annually thereafter
- Participant must be able to transfer out of the QDIA at least quarterly, without financial penalty
- No restrictions, fees, or expenses on transfers during the first 90 days of investment in the QDIA
Exam Tip: Gotchas
- A money market fund or stable value fund can only serve as a QDIA for the first 120 days of participation. After that, contributions must go into one of the other three QDIA types (target-date, balanced, or managed account).