With the New York Attorney General, the SEC, and a number of other regulatory agencies investigating mutual funds for improper trading practices, many executives, human resource professionals, and other individuals who serve on retirement plan committees and/or who are involved in communicating benefits to employees have concerns about their obligations under ERISA. Fresh on everyone’s mind are the Enron and WorldCom decisions in which executives and HR professionals were alleged to have violated ERISA through their inaction and lethargy in the face of corporate scandals. In addition, as the news brings more and more evidence of improper mutual fund practices to light, the mere job of keeping track of the different funds implicated is challenging in itself and has been likened to “trying to stop a dam from bursting by using your fingers to fill the holes.”
The selection of a mutual fund as an option for investment in a 401(k) plan subjects those who are responsible for making the selection to ERISA’s fiduciary standards. Those who serve as ERISA fiduciaries must monitor the mutual funds offered to participants on a continuing basis and determine whether or not they remain suitable investment options for participants. In connection with these fiduciary standards, the Department of Labor (which is in charge of ERISA enforcement) recently made the following comments about the mutual fund scandals:
What should plan fiduciaries do in light of the allegations? ERISA requires that plan investment decisions, including the selection of mutual funds, must be prudent and solely in the interest of the plan’s participants and beneficiaries. Allegations of improper mutual fund practices where a plan is invested must be factored into the fiduciary’s determination of the continuing appropriateness of that investment. . . .We expect that fiduciaries will be attentive to activities that materially affect the plan’s investment in the mutual fund or expose the plan to additional risk. . .[We] hope that the issues raised by Enron and similar cases have focused corporate officials on the important role fiduciaries play in protecting plan participants and has provided a necessary wake up call for people to take their fiduciary responsibilities seriously.
In light of recent events, those individuals who serve on retirement plan committees involved in monitoring investments of retirement plans (401(k) and the like) should consider taking the following steps:
Plan fiduciaries should obtain information and stay on top of what is happening with respect to the mutual fund companies in their 401(k) plan line-up. While the New York Attorney General and the SEC have been investigating mutual fund practices, plan fiduciaries should be proceeding with their own independent investigation as well. In order to take appropriate action such as removing funds from a plan’s line-up, fiduciaries should gather accurate information about a mutual fund’s involvement in the current investigation. This would include seeking and keeping track of information from various news sources, from consultants who advise the plan, and most importantly from the fund managers themselves. Many plan fiduciaries have already sent letters to all of their investment providers (even those not implicated) asking that a checklist of information be completed by them in order for the fiduciaries to be able to prudently monitor the provider’s status and involvement in the mutual fund scrutiny. Included in this checklist would be such questions as to whether or not the mutual fund complex represented in the plan has been implicated in market timing or late trading as well as what procedures the mutual fund has in place to prevent such practices.
Plan fiduciaries should analyze information and evaluate alternatives. It is apparent that, of the mutual funds under scrutiny, not all are engaged in the same level of activity as others and that different levels of involvement would require that different actions be taken with respect to the various mutual funds implicated. Here are a few of the questions that plan fiduciaries may want to consider in evaluating their mutual fund providers who have been involved in market timing or late trading:
- Does it appear that only a few individuals were involved in the improper behavior without the knowledge or consent of management?
- Does it appear that the improper conduct occurred at the management level of the company or was it condoned by management?
- Have or will criminal allegations be brought?
In addition, plan fiduciaries should weigh the risks of different alternatives. For instance, are asset values of the plan or participant accounts at risk? Could enough investors begin to withdraw their money so that returns could be affected?
The investment policy statement can also be very helpful in evaluating the information collected and determining whether or not fund offerings continue to meet the standards set forth in the investment policy statement.
Plan fiduciaries should act prudently based on available information and in accordance with applicable laws. Plan fiduciaries should not “act in a vacuum” without considering the following legal constraints:
- Plan fiduciaries must act “solely in the interest of plan participants and beneficiaries.” (ERISA section 404(a)(1))
- Plan fiduciaries must act in accordance with provisions of the plan documents. (ERISA section 404(a)(1)(D))
- Plan fiduciaries should act in accordance with the plan’s investment policy statement.
- Plan fiduciaries must act in accordance with any applicable laws, i.e. ERISA, Sarbanes-Oxley, state law (with respect to public plans), etc.
Plan fiduciaries should also consider the following courses of action with respect to an implicated mutual fund offering, depending on the information gathered and the results of the analysis performed:
- Plan fiduciaries may decide to continue to provide the same mutual fund investment offerings with ongoing monitoring.
- Plan fiduciaries may decide to place funds on a special “watch” status and wait for further developments.
- Plan fiduciaries may decide to remove certain mutual fund investment options and replace them with other options.
Plan fiduciaries should communicate with participants and beneficiaries where necessary and appropriate. Recent developments in the law have further emphasized the principle that participants and beneficiaries need to be informed on an ongoing basis of any material information which would affect participants’ and beneficiaries’ interests in the plan. In the wake of mutual fund scandals, plan fiduciaries including HR professionals who communicate benefits to participants will be faced with difficult decisions regarding their disclosure obligations to plan participants, particularly if the plan is a 401(k) plan where participants direct their own investments. These individuals must determine whether or not prudence requires them to disclose to participants that a fund’s manager is under investigation and what steps the fiduciaries are taking in response to the allegations. They must also decide whether or not prudence requires them to issue a communication to all participants or to simply respond to individual inquiries. Many of these questions should be answered with the help of legal counsel who has been apprised of all of the pertinent facts and circumstances. Certainly if funds are removed and new ones offered, section 404(c) of ERISA would require participants to receive reasonable advance notice of such changes. However, the replacement of a fund would not constitute a “blackout period” requiring a Sarbanes-Oxley type advance notice, according to language in the preamble to regulations finalized by the DOL this year, unless the replacement constituted a “temporary” replacement, or unless in connection with implementing a permanent replacement, some rights would be temporarily suspended, limited or restricted.
Additional Note to Fiduciaries:
Document, document, document! It is important that all aspects of the prudent processes described above be fully and carefully documented. Plan fiduciaries should keep communication logs, recording relevant information that has been considered, and should document the decisions made and the decision-making process through preparation of minutes of their plan fiduciary meetings.
Plan Committees should meet frequently as needed. In addition, while retirement plan committees may normally meet on a quarterly basis, the current mutual fund scrutiny will likely require more frequent meetings otherwise known as “special meetings” to be called and attended by plan fiduciaries. In the recent Enron decision, the judge mentioned the lack of frequent meetings by plan committee members as one indication that fiduciaries may not have met their fiduciary standards under ERISA.