Reading the Ninth Circuit’s recent decision in Tibble v. Edison International, I could not help but notice three issues that I believe will significantly impact ERISA plan sponsors and other plan fiduciaries going forward.

First, the Court correctly pointed out that “HFS is [the plan’s] consultant, not the fiduciary.” (page 48) Too many plans make this same mistake and are therefore unknowingly exposed to unnecessary liability. Too many plan sponsors do not take the time to educate themselves on the difference between the various types of ERISA “fiduciaries” and the potential liability implications of each type, both for plans and plan sponsors.

I have written before about the ERISA 3(21) “fiduciary” ruse. Plan sponsors should have all plan documents reviewed by counsel experienced in such matters to avoid becoming yet another victim to this ruse, which involves holding oneself out as a “fiduciary,” then drafting the fiduciary agreement in such a way to basically avoid any fiduciary obligations or liability. By adopting a proactive approach to risk management and properly utilizing available legal resources, plans and plan sponsors can properly protect themselves and avoid costly “lessons.”

Second, the Court stated that “a firm in Edison’s [fiduciary] position cannot reflexively and uncritically adopt investment recommendations.” (page 49) The Court also pointed out that when a retirement plan relies on consultants and experts to help them administer a plan, the plan has an obligation to ensure that such reliance is “reasonably justified under the circumstances.”

In construing whether a plan’s reliance on an expert’s advice is reasonably justified, the courts have stated various requirements, such as “independent,” “impartial,” “unbiased,” “objective,” and “thorough.” As an attorney, I can state that in far too many cases plans and plan sponsors blindly rely on whatever information and advice the service providers provide.

The Court goes on to properly point out that “ERISA’s duty to investigate requires fiduciaries to review the data a consultant gathers, to assess its significance and to supplement it where necessary.” (page 49).  My experience has been that plan sponsors are totally unaware that plans and plan sponsors have a fiduciary duty to conduct an independent and thorough investigation of each investment option being considered by a plan, and that such independent investigation is “at the very heart of [ERISA’s] prudent person standard.”

The courts have consistently held that a fiduciary’s “failure to do [such an] independent investigation and evaluation is a breach of [their] fiduciary standard.” Again, based on my experience as both an ERISA attorney and plan consultant, many plan sponsors either do not conduct the required independent investigation and evaluation at all, or do so improperly.

The final point in the decision that struck me was the ongoing failure of the courts to recognize the true issue with regard to mutual fund fees. Since the primary investment options offered in most retirement plans are mutual funds, the issue of excessive fund fees is, and will continue to be, a hotly contested issue.

In Tibble, the Court stated that “[nor] is the particular expense ratio out of ordinary enough to make the funds imprudent,” with the Court noting that fees ranged from .03 to 2 percent. (pages 42-43) Given the DOL study that stated that each 1 percent in fees reduces a participant’s end return by approximately 17 percent over a twenty year period, a 2 percent fee would cost a participant over 33 percent, or two-thirds, of their end return!

Rather than focus on mutual fund fees in terms of absolute numbers, courts should focus on fees in terms of the costs to plan participants and their beneficiaries relative to the benefit received for said fees.  The Tibble court intimated as much by refusing to require that plans only use institutional funds, stating that “[t]here are simply too many relevant considerations for a fiduciary, for that type of bright-line approach to prudence to be tenable.”

The Tibble court’s statement works the other way as well. The relevant, and proper, considerations should include some form of a cost-benefit analysis to determine how cost-effective, how prudent,  the plan’s investment options really are.  Most courts and regulators use ERISA’s “prudent person” standard in assessing a fiduciary’s compliance with their duty of loyalty.

I was introduced to the idea of evaluating mutual fund fees by using a cost-benefit analysis in Charles Ellis’ seminal work, “Winning the Loser’s Game.” By evaluating mutual fund fees in terms of the cost-benefit to plan participants, plan sponsors and the courts would actually be furthering the expressed purpose of ERISA, to protect the interests of plan participants and their beneficiaries.  Viewing mutual fund fees only in terms of absolute numbers does not provide the same level of protection for plan participants.

I have previously written about the proprietary metrics that I use in auditing and analyzing pension plans. I even disclosed the method of calculating one such metric, the Active Management Value Ratio (AMVR), which allows investors and fiduciaries to evaluate the cost effectiveness of actively managed mutual funds.  Anyone who can perform basic subtraction and division can calculate a fund’s AMVR.

My experience has been that very few plan sponsors or other fiduciaries perform any type of cost-benefit analysis in choosing investment options for their retirement plans.  Perhaps the reason for not performing some sort of cost-benefit analysis is due to the information such an analysis would reveal.

However, as Aldous Huxley pointed out, “facts do not cease to exist just because they are ignored.” Experience with the AMVR has shown that many actively managed mutual funds fail to provide plan participants with any benefit at all, based upon their failure to outperform less expensive low-load or no-load mutual funds.  Even when an actively managed fund does provide a benefit to an investor by outperforming a comparable low-load or no-load mutual fund, the fund’s fees often exceed the benefit received by 300-400 percent or more.

One would be hard-pressed to justify such an investment as “prudent” or with an “eye single” to the interests of the plan participants and their beneficiaries. Plan sponsors and other fiduciaries who choose to ignore such issues do so at their own risk, as the law clearly imposes personal liability on them for imprudent decisions and actions in connection with the administration of their plan.

It took years before an enlightened court in LaRue finally recognized the different issues involved in defined benefit and defined contribution plans, and the need to protect participants by recognizing different rights in connection with defined contribution pension plans.  Hopefully, an enlightened court will soon realize that defining prudence in terms of absolute mutual fund fees does not properly protect plan participants or further ERISA’s stated goals or purposes.

The Tibble and the Hecker v. Deere decisions provides valuable advice for plan sponsors. Both courts have established that ERISA Section 404(c) does not provide a “safe harbor” from potential liability for plan sponsors in selecting a plan’s investment options.  Plan sponsors must conduct an independent and impartial of each investment options considered by and chosen for their plan.  And in conducting such investigations, prudent plan sponsors will act proactively to protect themselves by evaluating a plan’s investment options in terms of the cost effectiveness of such investments  rather than in terms of absolute fees in order the promote the best interests of plan participants and the expressed purpose of ERISA.

The courts, regulators and plan fiduciaries need to understand that with regard to a plan’s investment options, it is the quality of the investment options, in terms of the benefits provided to plan participants, not the quantity of the plan’s investment options or their absolute fees, that truly matter under ERISA.