THE LOST ART OF PLAN DESIGN: Origins of Fiduciary Liability | February 2014
By Philip J. Koehler, Esq.
The plaintiff’s attorney cracked open the rings of the large black binder he had pulled from a long row of identical binders neatly arranged in the middle of the conference room’s granite table and thumbed rapidly through the crisp white pages behind tab #1400. While he did this, the court reporter dropped her hands in her lap and flexed her fingers at the knuckle joint one by one. Then she leaned back in her chair and massaged the nape of her neck for a moment. A haggard-looking man in a dark suit and tie sat nervously at the head of the table clutching his reading glasses in his balled up fist. A video camera mounted on a tripod a few feet away seemed to stare back at him with its flashing red light. Taking advantage of the pause, he swiveled his chair to the right and tried to stop his brain’s incessant replay of the answers he’d been giving for the last four hours: (“What should I have said?” “Did this SOB trap me into saying something I hadn’t meant to say?” “How will this read in the transcript?”) After all that, plus three bathroom breaks, two offline conferences with his attorney and a ridiculous four cups of increasingly tasteless, industrial grade coffee, he sat with his thoughts sucked up into a dense word cloud of legalese (fiduciary, ERISA, revenue sharing, prudence).
The oncoming headache firmly gripped the base of his skull. It had been building since the lunch break that would have happened had he agreed to take one. The resentment and distrust that had burned so brightly at the outset was dissolving into a pool of low blood sugar. Now, he gazed through the partially open vertical blinds that covered the room’s floor-to-ceiling windows and felt nothing but the throb at his temples and the rise and fall of his own breath. Assuring himself that this can’t go on much longer, he let his eyelids close momentarily and when he reopened them he noticed a large brown speckled bird taking flight from a narrow ledge half way up an adjacent building. It could have been a continent away. In serene defiance of the hard bound world of gravity, it soared into the jagged backdrop of grey sky that lay behind the enveloping towers of glass and steel.
“Back on the record,” the attorney snapped.
PLAINTIFF’S ATTORNEY: “I am handing the witness a copy of what I represent to be the ABC Company’s 401(k) plan document currently in effect, marked Exhibit 1407. Sir, have you ever seen this document before?”
DEPONENT: “I’m not sure. It’s possible.”
PLAINTIFF’S ATTORNEY: “Is it your testimony that you might not have seen this document before?”
DEPONENT: “I don’t recall whether or not I’ve ever seen this document before, so yeah, I guess it’s possible that I have never seen it before.”
PLAINTIFF’S ATTORNEY: “Sir, I am not asking you to guess. We simply want your answers based on your best recollection. Now, this document appears to be slightly over eighty plus pages in length. Is it safe to say that you’ve never read this document in whole or in part?”
DEPONENT: “Since I don’t recall seeing it before, I’d have to say that I have no recollection of reading any part of it.”
PLAINTIFF’S ATTORNEY: “Is it your testimony then that, even if you had read this document in whole or in part, as you sit here today you are not familiar with the contents of this document?”
DEPONENT: “I probably would have remembered reading an eighty-plus page legal document, so, yes, since I just told you I don’t remember reading it, I certainly am not familiar with its contents.”
PLAINTIFF’S ATTORNEY: “OK. I am now handing the witness a copy of what I represent to be a written consent resolution signed by the witness, marked Exhibit 1410, which bears the title: Unanimous Written Consent of the Board of Directors of ABC Corporation in Lieu of a Meeting Approving Adoption of the 401(k) Savings Plan. Sir, have you seen this document before?”
PLAINTIFF’S ATTORNEY: “And, if you can recall, what were the circumstances in which you last saw this document?”
DEPONENT: “The first and only time I saw this document was as part of a board package I received that the company sent to each director to approve the adoption of the 401(k) plan four years ago. My recollection is that we, I mean the board, had a telephonic meeting in executive session and we all agreed that, based on management’s recommendation, we should approve adoption of the plan and each one of us would sign this form of unanimous written consent that was in the package. I signed off on this consent resolution like all the other board members and sent my copy to the corporate secretary. That’s my signature.”
PLAINTIFF’S ATTORNEY: “And directing your attention to the document attached to the written consent resolution that you signed, I represent that there is an attachment, designated Exhibit A, which is entitled….”
DEPONENT: “The 401(k) Savings Plan for the Employees of ABC Company. Yeah, OK I see that. Well, I guess it must have been part of the board package I received, so I must have seen that other document that you were asking me about, the 401(k) plan document, at the same time.”
PLAINTIFF’S ATTORNEY: “Thank you for that. Now, sir, directing your attention again to the written consent resolution that you signed, I represent that there is another attachment designated Exhibit B, which is entitled The Investment Policy Statement for the 401(k) Savings Plan for the Employees of ABC Company. My question is: Do you recall seeing this document before?”
DEPONENT: “My answer is the same as before. I don’t have a recollection of seeing this document, but I agree that I must have since it was evidently part of the package I received as a board member. And let’s cut to the chase here counselor, I don’t recall reading it and as I sit here today I have zero familiarity with its contents.”
PLAINTIFF’S ATTORNEY: “Thank you for that. Now, sir directing your attention specifically to the language of Exhibit 1410, which is the written consent resolution that you signed, do you see the series of individual resolutions under the heading RECITALS on that page and specifically the third and fourth resolutions?”
DEPONENT: “Yeah, OK. I see it.”
PLAINTIFF’S ATTORNEY: “Please read the third and fourth resolutions out loud.”
DEPONENT: “OK. Let’s see. Hum. The third ones says…Whereas, I have read and reviewed all attachments hereto and the fourth one says…Whereas, the board having thoroughly discussed the merits of adopting the Plan.”
PLAINTIFF’S ATTORNEY: “Does this refresh your memory regarding my previous question to you about whether or not you read either of the two attachments to the written consent resolution you signed and by that I mean either the 401(k) plan document or the Investment Policy Statement?”
DEPONENT: “Not really. We are a very busy board and, frankly, something as routine as this doesn’t get a lot of detailed attention at the board level. Everything in that board package had been thoroughly vetted by senior executives at the company, so, as far as I was concerned, our approval was more ceremony than anything else. We really didn’t need to discuss it in any detail. There was nothing in that document that related to my duties as a director. It was my understanding the company had hired outside professionals, you know, a third party administrator and an investment advisor, who would work with our HR staff. They were the ones who had to understand the ins and outs of this eighty-page plan document, which I believe is pretty much all standard off-the-shelf language. They were the experts, not me.”
PLAINTIFF’S ATTORNEY: “Thank you for that. Now, sir, directing your attention back to the plan document, Exhibit 1407 for a moment. Please turn to page 8. When you’re there would you please read the definition of the term Named Fiduciary as it appears there out loud?”
DEPONENT: “OK. Let’s see. Hum. Named Fiduciary, named fiduciary, named fiduciary….yes, here it is. It says Named Fiduciary shall mean the Corporation.”
PLAINTIFF’S ATTORNEY: “Thank you for that. Now, sir, please turn to page 2 of Exhibit 1407. When you’re there would you please read the definition of the term Administrator as it appears there out loud?”
DEPONENT: “OK. Let’s see. It says Administrator shall mean the Corporation.”
PLAINTIFF’S ATTORNEY: “Sir, I believe you testified that you signed this written consent resolution and….”
* * * * *
Once upon a time the preparation of plan documents was considered the practice of law. Legal counsel drafted them after first determining the plan sponsor’s specifications for every material term of the plan and with a thorough knowledge of the plan sponsor’s corporate structure and business plans, as well as its HR policies and practices. While you can argue about the low cost and convenience of standard form plan documents, at least the former approach didn’t get the cart in front of the horse and the attorney’s work product was subject to professional standards enforced under the applicable State Bar’s Code of Conduct and the State’s Business and Professions Code.
In this excerpt from a fictional transcript of the deposition of a corporate board member (a designated fiduciary of the company’s 401(k) plan), taken in a garden variety ERISA fiduciary breach lawsuit, we get a glimpse into a very common and very flawed plan establishment process, one that ignores the most fundamental issues of plan design. The witness testified that he doesn’t believe he has any responsibility for the management of the plan, even though he (along with the other directors) voted to approve the plan with provisions that, in effect, designate the board as both the plan’s “Administrator” and “Named Fiduciary.” He further testified that he didn’t read the plan document or IPS or discuss them with his fellow board members, despite having signed off on the board’s unanimous written consent that contains contrary recitals, and is not familiar with their contents. As a matter of litigation strategy, such damaging testimony assures that the defendants’ inevitable motion for summary judgment will be denied, which, barring a last minute settlement, means the parties get to do this all over again at trial, the defendants’ attorney fees continue to accumulate and the court will ultimately render a decision on the merits, including a potential damage award and even attorneys’ fees. So much for the ”low cost” of standard form documents.
Most discussions of fiduciary responsibility begin by referencing the definition of the term “fiduciary” in Section 3(21) of ERISA. If you read the brief language of Section
3(21), it seems one can only be a fiduciary if he: (1) is expressly granted discretionary authority and control over the plan (“designated fiduciaries”), (2) exercises discretionary authority and control, though not designated (“functional fiduciaries”), or (3) renders investment advice to the plan for a fee (“investment advice fiduciaries”). While the witness in this case, along with his fellow board members, is clearly a designated fiduciary, this sort of classification clouds one of the statute’s underlying presumptions, i.e. that the fiduciary is aware of said designation. Although not mentioned in Section 3(21), as a practical matter, this board member falls into the single largest category of fiduciaries, those who are unaware that they are designated fiduciaries in the first place. For lack of a better term, we can call them “clueless fiduciaries.”
How is it possible that a party can be a designated, yet “clueless,” fiduciary? Afterall, senior executives and board members got to where they are because they are detail oriented, highly intelligent and business savvy. The explanation lies in a chain of faulty assumptions that starts with undue reliance on the appropriateness of standard form plan documents prepared and presented by a service provider for whom the plan document is merely a means to an engagement. While the plan sponsor’s design of the plan is not itself a fiduciary act, critical decision points in the plan design process that affect fiduciary liability exposure are usually obscured by the default plan provisions contained in standard form plan documents. Vital areas of concern, viz. the selection of fiduciaries and their internal rules of governance, as well as the design of investment and participant fee payment policies, are simply omitted or defaulted to serve the service provider’s agenda.
Default provisions include any language in the plan document that does not serve to satisfy either mandatory tax qualification rules or the requirements of ERISA Title I and, which were predetermined by the service provider to conform to the constraints of its administrative systems or secure for it advantages in marketing its (or its affiliate’s) services or products to the plan. A plan sponsor’s failure to critically examine a standard form plan document’s numerous default provisions creates fertile ground for fiduciary breaches later on.
Every plan sponsor should consider its individual objectives in determining the optimal plan design. If the standard form documents proposed by a service provider cannot fully accommodate this optimal design, then that disconnect with the plan sponsor’s objectives should be identified so that the plan sponsor can properly compare and contrast the proposals of alternative service providers. For obvious reasons, the service provider is uniquely conflicted, if not completely unqualified, to assist the plan sponsor in this undertaking.
Standard form plan documents generally identify their optional plan terms, e.g. eligibility, vesting, availability of participants loans, etc., as virtual boxes to be checked or blanks to be filled in. Default provisions, on the other hand, use a predetermined plan term created by the drafter of the document. Designating the plan sponsor’s corporation as the “Administrator” and “Named Fiduciary” are default plan provisions that appear in the vast majority of standard form plan documents. Accordingly, the service provider rarely identifies them as optional plan terms that require the plan sponsor’s attention, leaving them lost in the sauce of the many pages of boilerplate language. In this manner, the plan sponsors unwittingly ignore the following fundamental plan design issues:
- Who are the qualified candidates to fill fiduciary roles, e.g. “Administrator” and “Named Fiduciary?”
- How should fiduciary duties be allocated?
- What rules of internal governance apply to fiduciary actions?
- How will the fiduciaries performance be evaluated?
- What protections should be available in the form of corporate indemnifications and fiduciary liability insurance coverage?
Another fundamental plan design issue is whether, and the extent to which, plan participants should pay the administrative expenses of the plan. Yet, since most standard form documents either don’t include an IPS, or include one that is strictly boilerplate, this fundamental issue, which goes to the heart of the appropriateness of including retail vs. institutional class shares in the fund line up, is almost never reviewed with the plan sponsor prior to plan establishment.
Representations by the service provider that its plan document, in some manner, has been “pre-approved” by the IRS cannot substitute for a rational plan design process. Such “pre-approval” has no bearing on the fiduciary responsibility issues discussed above.
The commoditization of plan documents has become so engrained in the industry that rarely does the plan sponsor’s management or its board have the draft plan reviewed by independent legal counsel before approving it, accepting on faith the bulk of a complex standard form document on the advice of a service provider who is acting neither as an attorney nor a fiduciary and who possesses little, if any, institutional knowledge about the plan sponsor. Besides ending up with a sub-optimal plan design, such a process places fiduciaries (“clueless” or otherwise) in untenable positions. To prevent this, plan sponsors must once again put the horse in front of the cart by having independent counsel review the draft document and take the appropriate time to walk through all the essential plan design steps to establish its fit (or lack thereof) with the plan sponsor’s optimal plan design. These steps include the selection of the appropriate parties to act as fiduciaries, the allocation of their specific responsibilities and the establishment of internal rules of fiduciary governance, as well as creation of policies regarding investment of plan assets and the participants payment of administrative fees.