The 401(k)/404(c) Plan Sponsor’s Achilles Heels – Redux

With the effective date for the DOL’s new fiduciary standard getting closer, I have been receiving questions and calls from plans and fellow attorneys regarding the various obligations under the new standard. For that reason, I am re-posting an updated version of an article I posted earlier this year.

401(k)/404(c) plan sponsors need to realize that the primary reason that plans are being successfully sued involves a plan sponsor’s fiduciary duty that will not be changed due to the DOL’s announcement, a duty that plan sponsors need to address to “bulletproof” their plans. In far too many cases, liability is based primarily on a plan sponsor’s failure to properly perform the personal investigation and evaluation of a plan’s investment options.

ERISA requires that a plan sponsor make an independent investigation and evaluation of the merits of both the investment (1) and any and all service providers(2) chosen by a plan. In determining whether a plan sponsor properly fulfilled their fiduciary duty to investigate and evaluate,

[T]he determination of whether an investment was objectively imprudent is made on the basis of what the [fiduciary] knew or should have known; and the latter necessarily involves consideration of what facts would have come to his attention if he had fully complied with his duty to investigate and evaluate.(3) (emphasis added)

This fiduciary duty to conduct an independent investigation and evaluation of a plan’s investment options is a plan sponsor’s first “Achilles heel.” In applying the “objectively prudence” standard, the court have held that

a decision is “objectively prudent” if “a hypothetical prudent fiduciary would have made the same decision anyway.” (4) (emphasis added)

Plan sponsors and plan service providers often try to justify questionable investment choices by relying on modern portfolio theory (MPT), the idea that investments in an investment portfolio should be evaluated individually, but in the context of the portfolio as a while. While that argument may be applicable with regard to defined benefit plans, where the employer is essentially selecting one investment portfolio which will applicable to all plan participants, the courts have rejected the MPT argument when defined contribution plans are involved.(5) As the DiFelice court pointed out with regard to defined contribution plans

Here the relevant ‘portfolio’ that must be considered is each available fund considered on its own…not the full menu of Plan funds. This is so because a fiduciary cannot free himself from his duty to act as a prudent man simply by arguing that other funds, which individuals may or may not elect to combine [with another investment option], could have theoretically, in combination, create a prudent portfolio.

The case cited by the district court in support of its heavy reliance on modern portfolio theory involves a plaintiff challenging the prudence of one investment, contained in a monolithic, fiduciary-selected portfolio. [In that case], …the fiduciary himself  consciously coupled risk y securities with safer ones to construct one ready-made portfolio for participants….Here, in contrast, modern portfolio theory alone cannot protect [the plan sponsor]…just because it also offered other investment choices that made a diversified portfolio theoretically possible.(6)

While many plan sponsors are experts at the services their company provides, many lack the knowledge, expertise and experience needed to properly evaluate and select investment options. In such cases, the plan sponsor’s fiduciary obligations require them to hire independent professional advisers.(7)

What many plan sponsors do not realize, their second “Achilles heel,” is that they cannot blindly rely on any advice provided by a third party such as a service provider or any other professional adviser.(8) The plan sponsor still has a fiduciary duty to independently “review, evaluate and understand” the third-party advice.

The plan sponsor’s Achilles heel is made more vulnerable by the fact that a plan sponsor is not legally entitled to rely on the advice of a third-party unless the third-party is “independent and impartial.”(9) As the court pointed out in the Gregg decision, parties who do, or can, receive compensation from or produce compensation for other related third parties, such as stockbrokers and insurance agents, do not meet the impartiality requirements. This simple requirement has ensnared more than one plan sponsor and will undoubtedly ensnare others since very few plan sponsors or service providers are aware of the “independent and impartial requirement.

So, a plan sponsor’s duty to investigate, evaluate and select a plan’s investment options applies whether a plan sponsor attempts to do so independently or on the basis of advice provided by a truly “independent and impartial” third-party. And as the Supreme Court recently pointed out,

[A plan sponsor’s] duties apply not only in making investments but also in monitoring and reviewing investments, which is to be done in a manner that is reasonable and appropriate to the particular investments, courses of action, and strategies involved…. In short, under trust law, a [plan sponsor] has a continuing duty of some kind to monitor investments and remove imprudent ones.(10)

The takeaway from these decisions is that plan sponsors need to be able to properly investigate and evaluate a plan’s investment options. And the numerous successful cases that have been filed, and will be filed, against 401(k) and 404(c) plans strongly suggests that many plan sponsors lack the ability to perform this vital fiduciary duty.

It has been argued that requiring a plan sponsor to perform a service that it is not suited for is inequitable and not in the best interests of the plan participants and beneficiaries. Proponents of that position argue that plan sponsors should be able to retain and completely rely on the advice of third-party experts on such duties.

Yet, experience has clearly shown that competing, and conflicting, best interests of such third-parties does not necessarily ensure that the best interests of a plan’s participants and beneficiaries are not served by reliance on a plan’s third-party advisers. Plan sponsors are often unaware that their contracts with third-party providers include “escape” clauses that effectively negate any fiduciary duties and/or liabilities that the third-party would otherwise have to a plan and its participants, leaving the plan sponsor potentially exposed to complete and personal liability for any issues that arise under the plan.

People often ask me why I publicly released my metric, the Active Management Value Ratio™ 2.0 (AMVR). This is exactly why I did so, to provide a simple means for plan sponsors to perform a simple initial evaluation of actively managed mutual funds, as they are the type of funds commonly found in most plans. While there are other aspects of a plan’s prospective or current investment options that will always need to be investigated and evaluated, the AMVR is a simple cost/benefit analysis that is based on sound, proven principles and is an appropriate due diligence technique with regard to an investment’s cost efficiency relative to a fund’s return.

I believe that most plan sponsors truly want to do the right thing, but simply lack the knowledge, expertise, and experience to do so. History has clearly shown that third-party advisers have actual or potential conflicts of interest that prevent them from providing truly independent impartial advice to a plan or its participants. That is the very reason the DOL is revising ERISA’s current provisions to hopefully better protect plans and plan participants and beneficiaries.

But plan sponsors need to understand that the new DOL fiduciary standards will not relieve them of their personal ongoing fiduciary duty to independently investigate, evaluate and monitor a plan’s investments options, even when a third-party expert, such as a 3(21) or 3(38) fiduciary, is retained. The importance of understanding how to properly evaluate a fund’s prospective and actual investment options cannot be overstated. As one court stated

 [I]f fiduciaries imprudently evaluate, select, and monitor a plan’s investment options, or do so for any purpose other than the best interest of the plan, they breach their fiduciary duties. (11)

The new fiduciary standard that the DOL will introduce provides an opportunity for truly independent and impartial third-party advisers to demonstrate their value-added proposition to plan sponsors. Plan sponsors that retain the services of third-party experts should select only those experts that are willing to assume a fiduciary status and both advise and educate both the plan and the plan’s participants on the appropriate evaluation of investment options, thereby promoting a true win-win situation for both the plan, its participants and the third-party adviser.


1. U.S. v. Mason Tenders Dist. Council of Greater New York, 909 F.Supp. 882. 887 (S.D.N.Y. 1995); Liss v. Smith, 991 F. Supp. 278, 298 (S.D.N.Y. 1998); Fink v. National Sav. and Trust Co., 772 F.2d 951, 957 (D.C.C. 1984).
2. Liss, at 300.
3. Fink, at 962.
4. Tatum v. RJR Pension Investment Committee, 761 F.3d 346 (4th Cir. 2014)
5. DiFelice v. U.S. Airways, 497 F.3d 410, 423 and fn. 8.
6. DiFelice, at 423
7. Mason Tenders, at 886; Liss, at 296.
8. Howard v. Shay, 100 F.3d 1484, 1488 (9th Cir. 1996); Donovan v. Mazzola, 716 F.2d 1226, 1234 (9th Cir. 1983 ); Donovan v. Bierwirth, 680 F.2d 263, 272-73 (2d Cir. 1982).
9. Gregg v. Transportation Workers of America Intern., 343 F.3d 833, 841 (6th Cir. 2003).
10. Tibble v. Edison International, 135 S.Ct. 1823, 1828-29 (2015).
11. In re Regions Morgan Keegan ERISA Litigation, 692 F.Supp.2d 944, 957 (W.D. Tenn. 2010).

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This article is for informational purposes only, and is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional adviser should be sought

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ 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 and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
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