The Courts, the Restatement of Trusts, ERISA and Fiduciary Liability

Yesterday, I posted an article written by a fellow attorney, Ary Rosenbaum. The article, “Simple Advice to Retirement Plan Sponsors,” provided sound advice on a number of key topics for pension plan fiduciaries.

As an ERISA and fiduciary attorney, it has always amazed me how many people that serve in a fiduciary capacity, whether in an ERISA or non-ERISA capacity, have never taken the time to actually read the Act and the related regulations, the Restatement (Third) Trusts (“Restatement”), or the key fiduciary legal decisions regarding same.  These materials are key in determining the applicable standards for legal liability for fiduciaries.

Given the fact that fiduciaries may face unlimited personal liability for violations of their fiduciary duties, one would think that they would want to know the applicable rules so that they can avoid unnecessary and unwanted such potentially life-changing liability. Yet, my experience is that very few non-professional fiduciaries understand the applicable fiduciary standards and very few have made any effort to educate themselves on such standards.

As the Supreme Court pointed out in the recent Tibble decision1, the courts often look to the Restatement in determining applicable fiduciary law in ERISA cases, since ERISA is essentially a codification of the Restatement. The same is true for courts in non-ERISA fiduciary cases, as courts in non-ERISA fiduciary actions look to both the Restatement and the Restatement Agency.

In my consulting and litigation practices, I have several “go-to” provisions of the Restatement that describe key duties of a fiduciary. While these key provisions are not, and are not intended to be, a substitute for a complete reading of the previously mentioned materials, they are worth reviewing and remembering.

ERISA Fiduciaries
One of the arguments that I often hear from ERISA fiduciaries is that they are not legally required to choose the least expensive investment option available. While this is absolutely true, to suggest that cost is not a factor that must be seriously considered in selecting a plan’s investment options would be a dangerous misinterpretation of ERISA and it stated purpose.

Section 88 of the Restatement states that one of a fiduciary’ key duties is to be cost conscious.2 Section 90 of the Restatement references Section 7 of the Uniform Prudent Investor Act, which warns that “wasting beneficiaries money is imprudent,” and cites a fiduciary’s duty to minimize costs.

Most pension plans use mutual funds as the primary investment options within their plan. The Restatement states that fiduciaries should carefully compare the cost associated with a fund, especially when considering funds with similar objectives and performance.3 The Restatement advises plan fiduciaries that in deciding between funds that are similar except for their costs, the fiduciary should only choose the fund with the higher costs if

the course of action in question can reasonably be expected to compensate for its additional costs and risk,…4

Given the historical under-performance of many actively managed mutual funds, this can be a significant hurdle that pension plan fiduciaries too often fail to properly consider. A higher priced fund that fails to provide a tangible benefit to a plan participant, namely a higher positive incremental return, has no inherent value to a n investors and is therefore clearly imprudent.

Therefore, to simply say that a fiduciary is not legally bound to select the least expensive investment option can be misleading, as other factors must be considered. TIAA-CREF properly summed up a plan sponsor’s fiduciary obligations with regard to factoring in an investment’s costs, stating that

[p]lan sponsors are required to look beyond fees and determine whether the plan is receiving value for the fees paid. This should include an evaluation of vital plan outcomes, such as retirement readiness, based on their organization’s values and priorities.5

One of the most annoying trends that I see in many ERISA-related court decisions is the concept of an acceptable range of fees for a plan’s investment options. As the TIAA-CREF quote correctly point out, given the stated purpose of ERISA, assessing the prudence of investments within a pension plan based purely on the costs associated with such investment options is itself imprudent.

Apparently some courts have lost sight of ERISA’s stated goal, that being to protect workers and to help them prepare for retirement. A prudent pension plan investment option is one that is cost efficient, one whose benefits are at least commensurate with the extra cost involved. Consequently, a fund with higher costs, but commensurable returns, would be more prudent than a less expensive fund with a consistent history of relative underperformance. The problem for many plan sponsors and other plan fiduciaries is the history of consistent underperformance by many actively managed mutual funds relative to passively managed index funds.

Another challenge for plan sponsors with regard to their fiduciary duty to be cost conscious has to do with so-called “closet index” mutual funds. A closet index fund, or “index hugger,” is an actively managed mutual fund that closely tracks a relevant index or index fund, yet charges significantly higher fees than an index fund. Fiduciaries  who chose to offer or to invest in closet index funds face the challenge of justifying the selection of such funds since they could receive the same or, in some cases, better returns from comparable, less expensive index funds. Remember, wasting beneficiaries’ money is always imprudent.

When plan sponsors and their plans are challenged on the prudence of their investment choices, they often try to justify their choices based on allegations of good faith/ignorance and/or the use of modern portfolio theory (MPT) in selecting the plan’s investment options. Plan sponsors and other plan fiduciaries quickly learn that the courts have consistently rejected such defenses. A well-known quote in ERISA breach of fiduciary duty cases is that “a pure heart and an empty head are no defense.”6 The courts have also stated that MPT alone is not a complete defense in fiduciary breach of duty cases involving a defined contribution plan, as prudence is determined as to each investment option in a plan, not with regard to the plan’s investment options as a whole7

Non-ERISA Fiduciaries
Most of what has already been discussed in the context of ERISA fiduciaries is equally applicable to non-ERISA fiduciaries. With non-ERISA fiduciaries, the threshold question is whether or not the stockbroker or financial adviser is even a fiduciary for liability purposes.

Most stockbrokers and financial advisers are not deemed to be fiduciaries for their customers unless they contractually agree to assume such responsibilities, such as managing an account on a discretionary basis, or they are deemed to have taken control of a customer’s account. The “taken control” requirement is generally met when it can be shown that a customer routinely acted in accordance with whatever their  stockbroker or financial adviser recommended. Investment advisers are held to a fiduciary standard by law, which requires them to always act in a client’s best interests.

One development that stockbrokers and financial advisers are often unaware of is that the courts have shown an increasing willingness to impose a fiduciary standard on such investment professionals, even in connection with non-discretionary accounts, when they feel such is necessary to protect naïve or inexperienced investors. The courts have stated that the applicable standard in deciding whether to impose a fiduciary standard on such investment professionals is

whether or not the customer has sufficient intelligence and understanding to evaluate the broker’s recommendations and to reject one when he thinks it unsuitable.8

[w]hether or not the customer, based on the information available to him and his ability to interpret it, can independently evaluate his broker’s suggestions and to reject one when he thinks it unsuitable.9

With the pending implementation of the DOL’s new fiduciary rule, stockbrokers and other financial advisers should take notice of these decisions and recognize situations that potentially create  a greater risk of being held to the fiduciary standard’s higher “best interests” standard, as opposed to their normal, less stringent suitability standard. Retirees, older customers, women and those suffering some sort of mental impairment are often mentioned as customers who courts would consider as meriting special fiduciary protection.

The courts are becoming more protective of employees and others involved in investing activities. The recent court decisions rejecting challenges to the Department of Labor’s new fiduciary rule are a perfect example of this fact. Given that fiduciaries may face unlimited personal liability for any breach of their fiduciary duties, the prudent fiduciary, in both ERISA and non-ERISA situations, will take the time to educate themselves on both existing and future applicable fiduciary standards and develop due diligence programs than ensure compliance with same.

1. Tibble v. Edison International, 135 S.Ct. 1823, 1828 (2015).
2. Restatement (Third) Trusts §88.
3. Restatement (Third ) Trusts §90 cmt m.
4. Restatement (Third) Trusts §90 cmt h(2).
5. TIAA-CREF, “Assessing the Reasonableness of 403(b) Fees,” available online at
6. Donovan v. Cunningham, 716 F.2d 1455, 1468 (5th 1983).
7. DiFelice v. U.S. Airways, 497 F.3d 410, 423-24 fn. 8 (4th 2007).
8. Carras v. Burns, 516 F.2d 251, 258-59 (4th 1975).
9. Follansbee v. Davis, Skaggs & Co,, Inc., 681 F.2d 673, 677 (9th Cir. 1982).

© 2017 The Watkins Law Firm. All rights reserved.

This article is neither designed nor 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 advisor should be sought.

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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