ERISA, Fiduciary Duty and the Art of Skinnydipping

Only when the tide goes out do you discover who’s been swimming naked. – Warren Buffett

As followers of this blog know, I normally post once a month. However, I am making an exception due to the importance of the subject matter.

This morning I met with a prominent law firm and performed a forensic fiduciary liability audit on their firm 401(k) plan. When I reviewed my findings with the firm’s managing partner and the head of their 401(k) investment committee to review my findings, they were clearly shocked by my projections as to their current liability exposure. After I went over the key data, they were mad, very mad, but they realized I was right and are dedicated to correcting the problems.

If you are a registered investment adviser, you are overlooking one of the greatest potential work opportunities if you are not helping 401(k)/404(c) plans. Fred Reish, one of the nation’s top ERISA attorneys, identified the opportunity with his observation that

our experience is that very few plans actually comply with 404(c). It is probable that most (perhaps as high as 90%) 401(k) plans do not comply with 404(c) and, as a result, the fiduciaries of those plans are personally responsible for the prudence of the investment decisions made by participants.

Compare Reish’s 90 percent figure with a recent study that reported that 94.6 percent of the 401(k)/404(c) plan sponsors surveyed believed that they were compliant with applicable 401(k)/404(c) regulations.

And it’s not just plan sponsors who simply do not truly understand the investment obligations of ERISA fiduciaries and the proper way to evaluate investment options. The Supreme Court’s recent decision in Tibble v.Edison International  clearly established an ERISA fiduciary’s ongoing duty to monitor a plan’s investment options and remove any unsuitable investment options within a plan. But before the SCOTUS ruling, the Ninth Circuit clearly indicated its lack of understanding regarding the fiduciary duties under ERISA’s prudent man standard when it denied Tibble’s claims with regard to the plan’s imprudent selection of the plan’s investment option, stating that

Nor is the particular expense ratio range out of the ordinary enough to make the funds imprudent…and there were roughly forty mutual funds to choose from.(1)

To be fair, the Ninth Circuit is not the only court to take such an indefensible position. But you would think that courts would educate themselves on the appropriate method to evaluate the prudence, or lack thereof, of investment options.

Stockbrokers and financial advisers who rely on commissions often object when the issue of fees on actively managed mutual funds is brought up , responding that the relative performance of a fund should also be considered. And they are right. Unfortunately, the well-documented consistent under-performance of actively managed mutual funds completely undercuts their arguments.

ERISA states that plan sponsors and other plan fiduciaries cannot simply accept the advice provided by third-parties such as stockbrokers, as there are obvious potential conflict of interest issues which can, and often do, impact the quality of such advice. As the Ninth Circuit properly pointed out in dismissing Edison’s blind reliance on their investment consultant,

HFS is its consultant, not the fiduciary. [Plans are required to] make certain that reliance on the expert’s advice is reasonably justified under the circumstances….Just as fiduciaries cannot blindly rely on counsel, …a firm in Edison’s position cannot reflexively and uncritically adopt investment recommendations.(2)

In applying ERISA’s fiduciary’s duties, the courts have consistently held that plan sponsors and other plan fiduciaries must conduct their own thorough and objective analysis of potential investment options for a plan. The courts have emphasized the importance of a plan sponsor’s independent investigation, stating that

A fiduciary’s independent investigation of the merits of a particular investment is at the heart of the prudent person standard.(3)

The failure to make an independent investigation and evaluation of a potential plan investment is a breach of fiduciary duty.(4)

And there it is, the opportunity for registered investment advisers. The law imposes a duty on plan sponsors to conduct a thorough, objective and independent investigation of potential plan investment options.  The problem is that, to put it bluntly, most plan sponsors have absolutely no understanding as to how to properly conduct such an investigation and therefore, the evidence suggests that, in many cases, thtey do not do so, hoping that they will not get caught.

My father once told me that putting your head in the sand and trying to ignore a problem simply provides your opponents a bigger target. Once I do a fiduciary liability audit and discuss my findings with the plan’s fiduciaries, I often get a response along the lines that their employees are not going to sue the company because they fear losing their jobs.

What plan sponsors do not seem to understand is that those employees eventually become former employees. Most of the current 401(k) excessive fees and breach of fiduciary duty cases are being filed by former employees. Divorcing spouses and the heirs of former employees are increasingly filing actions against 401(k)/404(c) plans. After all, they have nothing to lose and most plans will either settle or lose the cases since, as Reish points out, the majority of such plans are non-compliant.

I often hear investment advisers complain that they simply cannot get a foot in the door to even talk with 401(k)/404(c) plans. I have never had that problem. I ask for fifteen minutes and then I simply tell them how many funds are imprudent and show them the plan’s, as well as their personal, projected current liability. After that, they are more than willing to talk. After all, “money talks.”

Plan fiduciaries hear adviser after adviser tell them they can provide better advice than the plan’s current adviser, so the fiduciaries dismiss such promotion. My suggestion – show the plan’s sponsor and other plan fiduciaries how the plan’s current configuration might hit them personally in their wallets, (remember, plan fiduciaries face unlimited personal liability, including punitive damages, for a breach of their fiduciary duties) and all of a sudden they have all the time in the world to listen to you since you can back up your numbers. Sometimes they’ll even order lunch for everyone.

No one knows for sure when another correction or bear market is going to occur. However, history has shown that the markets are cyclical and bear markets are going to occur, often when least expected. History has also shown that the markets often react to sudden world events. Given the current state of world affairs, a serious market downturn or even a bear market may occur much sooner than expected. And when such events occur, you can be sure that there will be those who look to their 404(k)/404(c) plan now that more people have heard about the multi-million dollar settlements involving such plans and the fact that so many plans and plan fiduciaries will not be able to successfully defend actions against them.

The opportunities are out there. The large multi-national corporations may not want to listen, but there are plenty of local law firms and medical firms that need your services…they just do not know it yet. Based upon my experience as a compliance director, doctors and lawyers are often bad investors. If you make the proper presentation (fiduciary duty to put their interests first, then the identification of imprudent investments and projected potential liability, then a reminder that a loss is not necessary to find one guilt of a breach of one’s fiduciary duties), you should be on your way to a new client.


  1. Tibble v. Edison International, 711 F.3d 1061, 1083 (9th Cir. 2013)
  2. Tibble, at 1083
  3. Fink v. Nat’l Savs. & Trust Co., 772 F.2d 951, 957 (D.C. Cir. 1985)
  4. U.S. v. Mason Tenders Dist Council of Greater NY, 909 F. Supp. 882, 887 (S.D.N.Y. 1995)



About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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