OVERVIEW

OF

FIDUCIARY DUTIES UNDER ERISA

March 20, 2007

Barbara E. Schlaff

VENABLE LLP

(410) 244-7494

TABLE OF CONTENTS

Introduction...... 1

Identification of Plan Fiduciaries...... 2

Fiduciary Duty Rules...... 5

Prohibited Transaction Rules...... 8

Penalties...... 11

Limitations on Fiduciary Duties and Liability...... 14

Indemnification and Bonding...... 15

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INTRODUCTION

The Employee Retirement Income Security Act ("ERISA") is the principal federal law governing employee benefit plans.

  • It covers both pension plans (e.g., retirement and § 401(k) savings plans) and welfare plans (e.g., health, life insurance, and long-term disability ("LTD") plans).
  • It imposes substantive rules governing the content of pension plans, reporting and disclosure rules applicable to all plans, and fiduciary rules governing the conduct of those with discretionary authority or control over the management or administration of a plan.

The Internal Revenue Code of 1986, as amended (the "Code"), also governs various aspects of employee benefit plans, including fiduciary conduct.

This outlineprovides a general introduction to ERISA's fiduciary rules.

IDENTIFICATION OF PLAN FIDUCIARIES

GENERAL RULE

Under ERISA, fiduciaries are defined functionally. Individuals or entities that meet any of the following criteria will be considered fiduciaries and held to fiduciary standards of behavior:

  • individuals or entities that exercise any discretionary authority or control with respect to the management of the plan or its assets,
  • individuals or entities that render investment advice to a plan for a fee, or who have any authority or responsibility to render such advice, or
  • individuals or entities that have any discretionary authority or responsibility for administering a plan. ERISA § 3(21)(A)

Individuals and entities providing services to a plan or rendering professional advice are not fiduciaries unless they have discretionary authority or responsibility with respect to a plan or its assets. 29 C.F.R. § 2509.75-5, Q&A D-1.

  • Generally, actuaries, attorneys, accountants and consultants (other than investment advisers) are not plan fiduciaries in the absence of the necessary discretionary authority.
  • Note, however, that in certain circumstances, non-fiduciaries can face liability for participation in conduct that is a breach of a fiduciary's duties or a prohibited transaction. See Penalties, below.

Individuals and entities responsible for selecting and reviewing the performances of plan fiduciaries and plan service providers are themselves fiduciaries with respect to their duties of selection and retention. 29 C.F.R. § 2509.75-8, Q&A D-4, Q&A FR-11. See, e.g., Dep't of Labor Interpretive Bulletin 96-1, 29 C.F.R. § 2509.96-1 (Participant Investment Education), paragraph (e).

Convicted criminals are prohibited from serving as plan fiduciaries or holding any other responsible position with respect to a plan for a specified period of time. ERISA § 411.

"SETTLOR" FUNCTIONS

Certain categories of plan activities, while discretionary, are deemed non-fiduciary.

"Settlor" activities are not treated as fiduciary activities.

  • Settlor activities include the decisions to establish, amend, or terminate a plan, and decisions pertaining to plan funding.
  • Individuals or entities engaging in settlor activities are not held to fiduciary standards of behavior (e.g., they need not act in the exclusive interest of plan participants). Dep't of Labor Information Letter issued to Kirk Maldonado (Mar. 2, 1987) ("Maldonado Letter").

An individual or entity can perform both fiduciary and non-fiduciary functions. For example, the same committee can be responsible for both plan administration and amending the plan.

  • However, if an individual or entity has both fiduciary and non-fiduciary responsibilities, the two roles should be clearly identified. This helps to reduce the risk that the plan sponsor will be deemed to have chosen to subject non-fiduciary activities to fiduciary standards.

NAMED FIDUCIARIES

ERISA requires each plan to have at least one "named fiduciary."

The named fiduciary has authority to control and manage the operation and administration of the plan. ERISA § 402(a); 29 C.F.R. § 2509.75-8, Q&A FR-12.

Special rules apply to named fiduciaries:

  • Named fiduciaries or their delegates may employ persons to provide advice with respect to any of their responsibilities if the plan so provides. ERISA § 402(c)(2).
  • Named fiduciaries with respect to the investment of plan assets may appoint investment managers, if the plan so provides. ERISA § 402(c)(3).
  • Named fiduciaries may appoint trustees. ERISA § 403(a).
  • Named fiduciaries may direct trustees, if the plan so provides. ERISA §403(a)(1).

  • Named fiduciaries may delegate certain of their fiduciary responsibilities if the plan so provides. ERISA §405(c).
  • Note however: trustee responsibilities of named fiduciaries cannot be delegated. ERISA § 405(c).

INVESTMENT FIDUCIARIES

Generally, ERISA requires all plan assets except insurance contracts or policies to be held in trust by a trustee. ERISA §403(a).

The trustee has exclusive investment authority unless:

  • the plan expressly provides that the trustee is subject to the direction of a named fiduciary who is not the trustee, or
  • the plan provides that a named fiduciary with respect to investments may appoint one or more investment managers. ERISA § 403(a)(1), (2).

The following individuals and entities will generally be plan fiduciaries with investment authority:

  • the trustee,
  • any named fiduciaries with investment authority, and
  • any investment manager appointed by a named fiduciary.

FIDUCIARY DUTY RULES

FOUR RULES

ERISA fiduciaries are subject to four affirmative rules of behavior:

  • the loyalty rule (solely-in-the-interest and for the exclusive purpose),
  • the prudent man rule,
  • the diversification rule, and
  • the plan document rule.

ERISA § 404(a)(1).

THE LOYALTY (SOLELY-IN-THE-INTEREST AND EXCLUSIVE PURPOSE)RULE

The Rule

The loyalty rule has two components:

  • A fiduciary must discharge its duties with respect to a plan "solely in the interest" of the participants and beneficiaries.
  • A fiduciary must act for the "exclusive purpose" of (i) providing benefits to participants and their beneficiaries and (ii) defraying the reasonable expenses of administering the plan. ERISA § 404(a)(1)(A).

Key Points

A breach of the loyalty rule occurs when a fiduciary acts to benefit his own personal interests, or to favour someone other than a plan participant.

An action that provides incidental benefit to the sponsor or the fiduciary does not violate the solely-in-the-interest and exclusive purpose rules, provided that the fiduciary's decision was made in accordance with these rules. SeeDonovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir.1982), cert. denied 459 U.S. 1069 (1982).

THE PRUDENT MAN RULE

The Rule

A fiduciary must "act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims." ERISA § 404(a)(1)(B); 29 C.F.R. §2550.404a-1(a).

Key Points

This is an objective standard; subjective good faith is not a defense to a charge of imprudence. Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983).

The prudent man rule is principally a procedural requirement: a fiduciary is judged principally not by the results of his decisions, but by the process he follows in making decisions.

  • Courts generally do not measure the actual success of a decision; rather, the focus is on the diligence of the process used to reach the decision, and whether the fiduciaries exercised due diligence and undertook a careful investigation of the course of action. SeeDonovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir.1982), cert. denied 459 U.S. 1069 (1982).

A fiduciary must undertake a thorough and independent analysis of the alternatives, and should document the procedures followed.

If a fiduciary lacks the necessary knowledge or expertise, the fiduciary must obtain expert help.

With regard to an investment or an investment course of action pursuant to a fiduciary's investment duties, the prudent man rule is satisfied if the fiduciary

  • gives appropriate consideration to those facts and circumstances that, given the scope of the fiduciary's investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved (including the role the investment or investment course of action plays in that portion of the plan's investment portfolio with respect to which the fiduciary has investment duties), and
  • acts accordingly. 29 C.F.R. § 2550.404a-1(b)(1).

The prudent man rule applies not only to the selection of investments, but to allofthe fiduciary'sactivities including, if applicable, the selection of other fiduciaries.

Implicit in the prudent man rule is an on-going duty to review, at appropriate intervals, the consequences of the fiduciary's decision (for example, an investment that has been made or the performance of an investment manager who has been appointed). 29 C.F.R. § 2509.75-8, Q&A FR-17.

THE DIVERSIFICATIONRULE

The Rule

A fiduciary must "diversify the investments of the plan to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so." ERISA§ 404(a)(1)(C).

Key Points

The duty to diversify is evaluated on the basis of all fact and circumstances, including the type of investments utilized and the percentage of plan assets involved; it "is not measured by hard and fast rules or formulas." In re Unysis Savings Plan Litigation, 74 F.3d 420 (3d Cir. 1996).

Diversification is determined by "looking through" certain collective investment funds such as mutual funds, bank collective trust funds, and insurance company pooled separate accounts to the ultimate investment of the plan's assets. Conference Report at 304-05.

Limited protection is available under participant directed plans. See Participant-directed Individual Account Plans, below.

THE PLAN DOCUMENTRULE

The Rule

A fiduciary must act in accordance with the plan documents, but only to the extent those documents are consistent with ERISA. ERISA §404(a)(1)(D).

Key Points

The provisions of a plan document cannot override a fiduciary's duties under ERISA. If there is a conflict between a fiduciary's duties under the plan and its duties under ERISA, ERISA prevails.

PROHIBITED TRANSACTION RULES

PROHIBITED TRANSACTIONS

Certain transactions between a plan and a "party in interest" with respect to the plan are prohibited regardless of the intent of the parties and regardless of the benefits of the transaction to the plan. These prohibitions are set out in both ERISA and the Code. ERISA § 406, Code § 4975.

A fiduciary is prohibited from causing a plan to engage in a transaction if he knows, orshouldhaveknown, that the transaction was a direct or indirect:

  • purchase, sale, exchange or leasing of property, between the plan and a party in interest,
  • lending of money or extension credit, between the plan and a party in interest,
  • furnishing goods, services or facilities, between the plan and a party in interest,
  • transfer to, or use by or for the benefit of, a party in interest of any income or plan assets of the plan, or
  • acquisition of employer securities or employer real property, unless in accordance with specified requirements (see below).

ERISA § 406(a)(1).

Plan fiduciaries also are prohibited from engaging in self-dealing or conflicts in interest:

  • A fiduciary may not deal with plan assets in his own interest.
  • A fiduciary may not act in a transaction involving the plan if he is acting on behalf of a person with interests adverse to the plan or its participants.
  • A fiduciary may not receive consideration for his personal account from any person in connection with a transaction involving plan assets.

ERISA § 406(b).

PARTIES IN INTEREST

Parties in interest (or disqualified persons) are individuals or entities with specified relationships to the plan. Examples include:

  • any plan fiduciary,
  • any service provider to the plan,
  • any contributing employer; any affiliate of the employer,
  • any employee, officer or director of the employer,
  • any employee organization whose members are covered by the plan, and
  • any relative of any of these people.

ERISA § 3(14); Code § 4975(e)(2).

EMPLOYER SECURITIES

It is a prohibited transaction for a fiduciary to cause a plan to acquire or hold employer securities that are not "qualifying employer securities" as defined in ERISA, or that are in excess of the limits established by ERISA. ERISA § 406 (a)(1)(E), (a)(2).

ERISA imposes a general prohibition on acquiring or holding "employer securities." ERISA §§ 406(a)(1)(E), 406(a)(2); 29 C.F.R. § 2550.407a-1.

There is an exception for "qualifying employer securities". ERISA § 407(a)(1).

  • A qualifying employer security is a security that is stock, a marketable obligation, or an interest in a publicly traded partnership. ERISA § 407(d)(5); 29 C.F.R. §2550.407d-5.

A plan that is an "eligible individual account plan" is not subject to any limitation on the percentage of its assets that may be held in qualifying employer securities. ERISA §407(b)(1).

An eligible individual account plan's investment in qualifying employer securities is exempt from the diversification requirement. ERISA § 404(a)(2).

An eligible individual account plan's acquisitions or sales of qualifying employer securities are exempt from the prohibited transaction rules if:

  • the acquisition or sale is for adequate consideration, and
  • no commission is charged directly or indirectly to the plan. ERISA §408(e); Code § 4975(d)(13); 29 C.F.R. §2550.408e.

A plan that is not an eligible individual account plan is limited in the amount of qualifying employer securities it may acquire, is not exempt from the diversification requirements of ERISA, is not exempt from the prohibited transaction rules with respect to the acquisition or sale of qualifying employer securities unless certain requirements are satisfied. ERISA §§ 407(a)(2), 404(a)(1)(C)408(e); Code §4975(d)(13); 29 C.F.R. §2550.408e.

EXEMPTIONS

Certain common transactions that otherwise would be prohibited are exempted by statute. ERISA §408(b), Code § 4975(d.

Examples include:

  • loans from the plan to plan participants,
  • contracts with plan service providers,
  • transactions between plans and common or collective trust funds maintained by a party in interest that is a bank or trust company, and
  • reimbursement of a fiduciary's direct expenses.

See 29 C.F.R. §§ 2550.408b-1 (loans to plan participants), 2550.408b-2 (services or office space), 2550.408c-2 (reasonable compensation); Treas. Reg. § 54.4975-6 (office space or services).

The Department of Labor is authorized to issue (and has issued) administrative exemptions from the prohibited transaction rules. Some of these exemptions (class exemptions) apply to all transactions described in the exemption, while others (individual exemptions) apply only to the person(s) applying for the exemption.

PENALTIES

PENALTIES FOR VIOLATION OF FIDUCIARY DUTIES

Personal Liability for Losses or Profits

ERISA §409(a) imposes personal liability on a fiduciary for losses created by a breach of fiduciary duty or profits made from the use of plan assets in connection with the breach. SeeLeigh v. Engle, 727 F.2d 113 (7th Cir. 1984).

Although ERISA §410(a) voids any provision of a plan that attempts to relieve a fiduciary from any responsibility or liability for his fiduciary duties, a fiduciary of aplan can protect himself or herself from this liability by ensuring that the plan sponsormaintains fiduciary liability insurance coverage for the plan and all of the fiduciaries, and by amending the plan document to specify that plan fiduciaries (other than independent trustees) are indemnified by the plan sponsor for any liability that they incur as a result of their service as a fiduciary to the plan. Such indemnification must be made by the plan sponsor, not by the planitself, and cannot be made for a fiduciary's gross negligence or willful misconduct. 29 C.F.R. §2509.75-4.

Equitable Relief

ERISA §409(a) also contemplates equitable relief for breaches of fiduciary duty, which can include:

  • removal of the fiduciary,
  • rescission of the transaction, or
  • injunctive relief.

Co-Fiduciary Responsibility

A fiduciary is liable for a breach committed by a co-fiduciary if the first fiduciary:

  • participated in or concealed the breach,
  • permitted the breach to occur because of the fiduciary’s failure to comply with his own fiduciary responsibility, such as monitoring the conduct of other fiduciaries (SeeFreund v. Marshall & Ilsley Bank, 485 F.Supp. 629, 640 (W.D. Wis. 1979), or

  • has actual knowledge of the breach and does not make reasonable efforts to remedy the breach.

ERISA § 405(a); 29 C.F.R. § 2509.75-5, Q&A FR-10.

There must be some causal connection between the co-fiduciary and the fiduciary breach. Pension Fund - Mid-Jersey Trucking Industry - Local 701 v. Omni Funding Group, 687 F.Supp. 962 (D. N.J. 1990).

20% Civil Penalties

Under ERISA §502(l), the DOL is required to impose a 20% penalty against a plan fiduciary or any other person who knowingly participates in a breach of fiduciary responsibility. The 20% penalty is based upon the amount which is recovered from the fiduciary pursuant to a settlement agreement or court-ordered restitution.

The penalty may be waived or reduced by the DOL if it determines that the fiduciary or other person acted reasonably and in good faith, or if the person liable for the penalty will not be able to make full restitution to the plan “without severe financial hardship” unless a waiver or reduction is granted. ERISA §502(l)(3).

Liability of Non-Fiduciaries

Generally, non-fiduciaries who are not partiesininterest will not have any liability under ERISA other than the potential 20% civil penalty under ERISA §502(l), even if the non-fiduciary knowingly participates in a breach of fiduciary duty (although the non-fiduciaries may have liability under other causes of action). SeeMertens v. Hewitt Associates, 508 U.S. 248 (1993); Reich v. Continental Casualty Co., 33 F.3d 754 (7th Cir. 1994); Reich v. Rowe, 20 F.3d 25 (1st Cir. 1994).

However, Mertens does not bar equitable relief against parties in interest that engage in prohibited transactions. SeeSalomon Bros. v. Harris Trust & Savings Bank, 530 U.S.238 (2000).

PENALTIES FOR ENGAGING IN PROHIBITED TRANSACTIONS

For Fiduciaries

A fiduciary that has engaged in a prohibited transaction must: 1) make restitution to the plan of the losses resulting from the prohibited transaction; 2) disgorge any profits obtained by the fiduciary from the prohibited transaction; and 3) be subject to other equitable relief or remedial relief deemed appropriate by the court, including removal of the fiduciary. ERISA §409(a).

A 15% excise tax will be assessed under the Internal Revenue Code, on the "amount involved" in a prohibited transaction involving a tax-qualified plan. IRC §4975(a). If the prohibited transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved in the prohibited transaction is imposed on any disqualified person who participated in the prohibited transaction. IRC §4975(b).

  • A fiduciary will not be liable for the excise tax unless his participation in the prohibited transaction was in a capacity other than as a fiduciary of the plan. Code § 4975(a), (b).

ForNon-Fiduciaries

A non-fiduciary party in interest can be sued under ERISA §502(a)(3) by a plan fiduciary for participating in a prohibited transaction under ERISA §406, and "appropriate equitable relief can be imposed." Salomon Bros. v. Harris Trust & Savings Bank, 530 U.S.238 (2000).