Fiduciary Responsibility in the Case of Defined Contribution Plans

<p>It has long been
recognized that ERISA (Employee Retirement Security Act of 1974)
requires
fiduciaries such as plan trustees, plan administrators, chief
investment
officers, money managers and others to bear responsibility for
overseeing
retirement plans. However, with the well-publicized severe losses
borne by
employees in defined contribution pension plans such as those
associated with Enron, the responsibility of plan fiduciaries is now

receiving increased attention from both employees and the courts.
Cases in
which plan participants were not properly informed about changes in
the
risk/return profile of the company or where participants were
provided
information misrepresenting relevant facts about the company are now
being
litigated. Companies such as Enron that have encountered severe
financial
distress are but the tip of the iceberg. Others, through lack of
communication and misrepresentation, have caused plan participants
to also
suffer serious losses in their pension portfolios.

</p><p>Firms have been increasingly switching their
retirement plans offered to employees from defined benefit plans to
defined
contribution plans. A defined benefit plan promises to pay an
employee a
specific amount per period in retirement. The amount is generally
paid
throughout the participant's lifetime with the risk of payment borne

by the plan sponsor. A defined contribution plan is one in which
employers
and/or employees contribute a specified percentage of income or
dollar
amount to fund either a lump-sum payment from the company or an
annuity
upon retirement. In such plans the retiree bears the financial risk
that
she/he will outlive the funds available for retirement. The 401(k)
has
become the most popular of the different types of defined
contribution
plans. Of these plans, those that permit a participant or
beneficiary to
exercise control over the assets in the retirement account are
frequently
referred to as 404(c) plans.

</p><h4>Fiduciary Duty in 404(c) Plans</h4>

<p>Under ERISA, fiduciaries are liable for losses
suffered by the plan participants or beneficiaries that are caused
by a
breach of ERISA-imposed fiduciary duties and responsibilities. In
404(c)
plans, if the plan and its fiduciaries comply with a broad range of
requirements, liability is shifted to plan participants. These
requirements
assure that the fiduciaries provide sufficient information for the
plan
participants to make informed investment decisions. They also
require that
fiduciaries not misrepresent information or materially mislead the
employees and beneficiaries. Similarly, requirements such as
diversification, adherence to plan, etc. are also imposed. Should
these
conditions not be met, the burden of liability is not shifted to the
plan
participants. As a result, the fiduciaries have a choice. They can
make
full disclosure of relevant information to the plan participants and
be
absolved of liability resulting from poor investment performance, or
not
make complete disclosure and bear the risk of incurring any
resulting
liability from poor investment performance. To avoid liability,
ERISA
guides the fiduciaries to make full, complete disclosures about
company
performance to plan participants.

</p><p>More generally, fiduciaries are responsible for
exercising the duties of prudence, care and loyalty to plan
participants. A
fiduciary is said to act prudently if he/she acts with the care,
skill,
prudence and diligence that a "prudent man" would exercise
under similar circumstances. Fiduciaries for participant-directed
accounts
must consider the prudence of investment options made available to
plan
participants and maintain oversight over these options. The duty of
care
necessitates that fiduciaries should provide sufficient information
to plan
participants to enable them to make knowledgeable choices. They
should also
provide investment monitoring and assist employees in evaluating and

interpreting the measurement of performance. In addition,
participants
should be allowed to give investment instructions with appropriate
frequency to facilitate the rebalancing of the participant
portfolios over
time. The duty of loyalty requires that the fiduciaries resolve
conflicts
between the sponsoring organization and the plan in ways that are
not
disadvantageous to the plan or the plan participants. Moreover, it
becomes
the responsibility of the fiduciaries to be as faithful as possible
to the
pension plan participants and beneficiaries, not materially mislead
them or
make material misrepresentations to them.

</p><h4>Investment in CompanyStock</h4>

<p>One area of company pension plans where fiduciary
responsibility received significant attention recently is when an
option is
provided to employees to invest in company stock. While company
stock may
well be a legitimate investment choice, in several matters it has
been
argued that fiduciaries have lost sight of their responsibilities of

prudence, care and loyalty to the plan participants. Whether the
fiduciaries are pressured to encourage investment in company stock
or
simply do not communicate risk/return changes adequately to plan
participants, the plan participants are not provided the relevant
information to make informed investment decisions.

</p><p>Fiduciary responsibility relating to the issue of
company-matched contributions to an employee's 401(k) plan is an
area
of continuing concern. In a number of matters investigated by the
Department of Labor, the plan fiduciaries continued to maintain a
match in
company stock as the company deteriorated financially and in some
cases
became financially distressed. In numerous instances, the
participant is
unable to transfer funds from the company stock fund to another
option as
the firm's finances worsen. Even in those situations where the
company is making complete disclosures as to material events, but
not
enabling the individual to transfer funds in the case of
deteriorating
finances, the fiduciary is not exercising his/her duties of
prudence,
care and loyalty to the participants.

</p><p>In cases of employer match plans where complete
disclosures are being made to plan participants about the
company's deteriorating financial condition, fiduciaries may argue
that the purchase price was reasonable. They may argue that in an
efficient
market, pricing was fair and they should incur no liability.
However, the
overriding question is whether the firm's stock is now an
appropriate
investment in the employee's retirement plan. For many firms, the
speculative nature of the investment following the financial
deterioration
makes the company stock an inappropriate investment for a retirement
plan.
As a result, while the fiduciary might have a number of reasons for
wanting
to keep the investment in company stock, the prudence, care and
loyalty
obligations trump all other motivations on the part of the
fiduciaries.

</p><h4>Fiduciaries and Non-public Information</h4>

<p>In the typical 404(c)-defined contribution plan
where an employee has the opportunity to invest in company stock,
the
fiduciaries must exercise care to learn and transmit all relevant
public
information about the company. Moreover, if there is non-public
information available to the fiduciary, that fiduciary also has a
responsibility to act. Possible actions that are available to the
fiduciary
include removing the company stock from the set of possible
investment
choices, blocking further investment in the company's stock,
advising
employees against further investment in the stock or forcing the
disclosure
of the information publicly. While fiduciaries may well be reluctant
to
take some of these actions, the consequences for the fiduciary of
not
doing so are severe.

</p><h4>Access to Sufficient Information</h4>

<p>A plan fiduciary must not materially misrepresent a
participant's benefits to the participants or plan beneficiaries. In

fact, in <i>Bixler v. Central Pennsylvania
Teamsters Health and Welfare Fund,</i> it was
determined that fiduciaries have an affirmative duty to "inform when

the fiduciary knows that silence can be harmful."<small>^{<a href="#2" name="2a">2</a>}</small> Moreover, plan
participants and beneficiaries in 404(c) plans "must have access to
sufficient information to enable them to make informed investment
decisions."<small>^{<a href="#3" name="3a">3</a>}</small>
Any misrepresentation that materially misleads
investors in such a way that they are unable to make informed
investment
decisions has the effect of retaining the liability for poor
investment
choices with the plan fiduciaries.

</p><p>While the motivations on the part of plan fiduciaries
may vary significantly, there are certainly motivations to keep the
stock
price from plummeting as the firm faces financial difficulties and
possibly
financial distress. This is particularly true when plan fiduciaries
wear
multiple hats—namely, when they also act as corporate officers
or
play another role in senior management. In these situations it is
necessary
for the plan fiduciaries to remember their duties of prudence, care
and
loyalty to the plan participants and beneficiaries.

</p><p>In sum, the duties and responsibilities of plan
fiduciaries are paramount. Whether the company is performing well or
in
financial distress, the welfare of the plan participants and
beneficiaries
takes center stage. Much of the fiduciary-related litigation results
from
an investment in company stock by plan participants and
beneficiaries. The
litigation often arises as a result of an alleged breach of
prudence, care
and/or loyalty associated with periods of a significant downturn in
the
company's stock price. To avoid liability, the fiduciaries must meet

the carefully crafted ERISA requirements at all times—including
times
of severe financial distress.

</p><hr>
<h3>Footnotes</h3>

<p>^{<small><a name="1">1</a></small>} The authors
are professors at Boston University's School of Management and
managing directors of The Michel-Shaked Group, a Boston-based firm
providing financial consulting and expert witness services
nationwide. <a href="#1a">Return to article</a>

</p><p>^{<small><a name="2">2</a></small>} <i>Bixler v.
Central Pennsylvania Teamsters Health and Welfare Fund,</i> CA-3
(1993), 12 F.3d 1292. <a href="#2a">Return to article</a>

</p><p>^{<small><a name="3">3</a></small>} McInerney,
Kerry, Pope, Elizabeth, Sulzer, Glenn and Thompson, Carol E.,
<i>2004 U.S. Master Pension Guide,</i> Chicago: CCH Inc. (2004). <a href="#3a">Return to article</a>