The Prudent Investment Fiduciary Rules

Closing Argument: Humble Arithmetic, Common Sense, and Fiduciary Responsibility vs. In-Plan Annuities

Posted on October 13, 2025 by jwatkins

“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.” – John Adams

He fell at last a victim of the relentless ruless of humble arithmetic. Remember, O stranger: ‘Arithmetic is the first of the sciences and the mother of safety’- Justice Louis Brandeis

Mathematics is the light that reveals the nature of things.”- Justice Louis Brandeis

Closing Argument: Humble Arithmetic, Common Sense, and Fiduciary Prudence vs. In-Plan Annuities

“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.” – John Adams

He fell at last a victim of the relentless ruthless of humble arithmetic. Remember, O stranger: ‘Arithmetic is the first of the sciences and the mother of safety’- Justice Louis Brandeis

Mathematics is the light that reveals the nature of things.”- Justice Louis Brandeis

“May it please the court. At issue in this case is whether the plan sponsor breached their fiduciary duties of prudence and loyalty by including annuities within the company’s 401(k) plan.

The plan argues that its decision to include such annuities was done solely in the best interest of both the plan participants and their beneficiaries, as required under Section 404(a) of ERISA. The plan sponsor claims that the selection and inclusion of the in-plan annuity was done solely to provide plan participants with additional retirement income and added financial security for participants and their beneficiaries. However, the evidence clearly suggests otherwise

During this trial, we have introduced testimony and numerous exhibits that clearly establish that annuities are typically structured to benefit the annuity issuer, not the annuity owner. This is exactly why annuity issuers pay such a high commission to those who can convince a plan to offer annuities within their plan.

The evidence and the mathematics that we have introduced in this case clearly establish that the annuity offered within the plan not only was not in the best interest of the plans’ participants or their beneficiaries, but also that had the plan sponsor performed the legally required independent and objective investigation and evaluation required by ERISA, the resulting harm was easily foreseeable using basic mathematical skills, i.e., humble arithmetic.

Reviewing Exhibit A, a basic Microsoft Excel breakeven analysis on an immediate $50,000 annuity, based solely on present value, paying 3% ($1,500) annually, for a 65 year old woman, with a normal lifetime expectancy (20.7 year). The data indicates that the odds of her reaching the age of 86, are 63%. Should that occur, at age 86, our Excel present value calculation predicts that the annuity owner would have only recovered approximately $18,076.80 , or 36% of her original value. If we assume that the annuity owner chose a “life only” option in order to receive a higher annual distribution payment, that would result in a potential windfall of $31,923.20 for the annuity issuer. Multiply that by the potential number of owners of that particular annuity in the plan and you understand why the annuity industry is trying to make inroads into 401(k) plans and other ERISA pension plans.

The second part of the fiduciary breach equation in this case involves determining whether and when the annuity owner would actually break even by recovering the full amount of her $50,000 original investment. In this case, lets examine the situation if the 65 year old female participant lives to age 100. According to the Social Security Administration (SSA) Period Life Table:

A 65-year-old woman has about a 3.6% to 4% chance of living to age 100.

Assuming our annuity owner lives to age 100, our present value calculations project that at 100 she would only have recovered $19,000-$20,000 or 3.8-4% of her original investment, resulting in a windfall of $30,000- $31,000 for the annuity issuer.

In this case, our clients have stated that the plan sponsor never disclosed such information, even though ERISA 404(c) requires that a plan sponsor provide plan participants with “sufficient information to make an informed decision.

Annuity advocates point out that plan sponsors are not required to meet the “sufficient information” requirement unless they wish to qualify for the special protections offered under 404(c). However, since plan sponsors are legally fiduciaries, they are required to disclose “all material information” to plan participants.

The courts have consistent defined “material information” as any information which an investor would deem helpful in deciding whether to invest in a product.# I believe that a reasonable investor would consider the foregoing information, the heavy odds against simply breaking even, resulting in the annuity owner subsidizing the annuity issuer rather then the annuity owner’s heirs, “material.”

Exhibit B
As bleak as that breakeven analysis is, a more accurate, and troubling, breakeven analysis is provided by factoring in both present value and mortality rate, the odds that the annuity owner will even be around to receive the annual distribution at a certain age. Going back to Exhibit A, we see that at age 86, the annuity owner would have recovered approximately $15,307, or 30% of her original investment. If we project out to age 100 (odds of 3.6-4%), the annuity owner would have recovered $17,218, or 34% of her original investment, leaving a nice windfall of $34,693 for the annuity issuer. Just as in Las Vegas, annuities are typically structured to ensure that the odds favor the “house.”

During your deliberations, ask yourself, would you consider such information “material” in making a decision as to whether to invest in the annuity. Then ask yourself whether the plan sponsor’s failure to ascertain these facts (a) as part of their legally required thorough and objective investigation and evaluation, and (b) the failure to disclose such information was “in the best interest of both the plan participants and their beneficiaries, or, rather, the third party annuity issuer.

The plan sponsor has admitted that they were not aware of such information and did not perform the necessary calculations themselves, that they blindly trusted the annuity broker’s advice and “expertise.” The courts have consistently warned plan sponsors or the dangers in such situations, especially when the reliance is on a commissioned salesperson:

Defendants relied on FPA, however, and FPA served as a broker, not an impartial analyst. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative. FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of “can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.#

As the judge will advise you, “a pure heart and an empty head are no defense in a case involving allegations of a breach of fiduciary duties.”# In layman’s terms, there are no mulligans, no do-overs in fiduciary law, If a plan sponsor is unable to perform their legally required fiduciary duties, they have a duty to find someone who is qualified to do so objectively.

Experience shows that too often plan sponsors simply choose to blindly follow the recommendations of product vendors and rely on the pure heart/empty head defense. The dangers involved in adopting this practice were previously addressed in the Gregg decision, in which the court warned plan sponsors of the issues of relying on annuity brokers and other commissioned salespeople

Fortunately, plan sponsors can now use AI to perform a preliminary evaluation of an annuity recommendation. Note: An AI generated breakeven analysis should never be used as a replacement for the legally required investigation and evaluation, but rather as a “red flag’ for the need to obtain the services of a trained, experienced professional who is willing to serve in a fiduciary capacity and provide a written documentation of his breakeven analysis.

Using ChatGPT and the previously discussed data, I generated a breakeven analysis using the following prompt:

Prepare a fiduciary breakeven analysis, in annual intervals, on a $50,000 immediate annuity paying $1,500 a year, factoring in both present value and mortality risk, for a 65 year old woman, assuming normal life expectancy

ChatGPT concluded that:

📌 Breakeven Points

1. Nominal Breakeven (Total Cash = $50,000)

Reached in: Year 34 (age 99)
This is when she would have received $50,000 in total cash payments (50,000 ÷ 1,500 = 33.3 years)

This “nominal” breakeven analysis is the typical misrepresentation that the annuity advocates argue and the typical deliberately flawed analysis used by online annuity breakeven calculators and their providers. Just divide the amount of the investment by the interest rate, willfully ignoring the concept of the time value of money.

However, as ChatGPT points out, the legally proper way of constructing a breakeven analysis on an annuity requires that both present value and mortality risk be factored in order to account for both the time value of money and the likelihood of the annuity owner actually being alive to receive the annual annuity payment.

2. Present Value Breakeven

Total PV of future payments equals $50,000 around year 25–26 (age ~90–91), without mortality, well beyond the annuity owner’s life expectancy.
But adjusting for mortality, the expected value (EV) of all future payments peaks below $50,000, around $14,600–15,000.

This suggests the “actuarial expected value” of the annuity for a typical 65-year-old woman is around $14,000–15,000, despite the upfront $50,000 cost. This also assumes that the annuity owner chose the “single life” distribution option to maximize the annuity’s distributions.

🎯 Key Takeaways

Metric	Value
Total nominal breakeven (no time discounting)	Age 99 (Year 34)
PV breakeven (no mortality)	Age 90–91
EV of annuity (with 3% discount & mortality)	~$14,600
Life expectancy (female, age 65)	~20 years

🧠 Interpretation

If she lives to 90+, the annuity becomes a good deal in real-dollar terms.
If she dies earlier, the insurer “wins” (keeps remainder of capital).
This is the trade-off of longevity insurance—it’s not about individual return maximization, but hedging the risk of outliving assets

So, the odds favor the “house” ultimately receiving the majority of the initial investment at the expense of the annuity owner and their beneficiaries, in blatant violation of ERISA 404(a)’s requirement that plan sponsors act in the best interest of both plan participants and their beneficiaries.

This type of estate asset erosion, loss of estate assets (here, approximately $35,400, or 72%, of the of the original investment, is exactly why estate planning attorneys often refer to annuities as estate planning “saboteurs,” depleting an estate of the assets needed to carry out the decedent’s last wishes. Remember, as fiduciaries, plan sponsors have a duty to disclose all material facts, or, as ERISA section 404(c) states “sufficient information to make an informed decision.” You heard the plaintiffs state that the plan sponsor never met either of these standards.

ERISA requires a plan sponsor to acts as a prudent person would handle their own affairs. Ask yourself, does a prudent person invest $50,000 knowing that the odds are stacked against them, that the likelihood is that they are going to lose $72% of their investment in favor of the annuity company, to essentially subsidize the annuity issuer at the expense of one’s intended heirs.

Equally egregious is the fact that the plan sponsor claims to have included the annuity in the plan to help plan participants receive retirement income, yet admitted that it did not take the time to determine whether the annuity was actually in the best interests of said parties by performing these simple calculations despite the ready availability of such tools. The plan sponsor’s indifference and failure to properly perform the required investigation and evaluation is a blatant breach of their fiduciary duty of loyalty, which requires a plan sponsor to always put the best interests of both the plan participant and their beneficiaries first and foremost, ahead of the best interests of both the plan sponsor and any third parties.

In our example, the plan sponsor stand to receive 76% of the original investment compared to the plan participant’s 24%. I submit to you that such an inequitable result was both clearly foreseeable had the plan sponsor taken the time to properly perform the required investigation and evaluation of the annuity. The law clearly states that in determining whether a fiduciary breach occurred, the plan sponsor will be held liable for what they knew, or should have known, had they simply conducted the proper investigation and evaluation of the investment product.#

Ladies and gentleman, you will have the opportunity to review both the testimony offered in this case, and the charts of our forensic calculations in the jury room during your deliberations. We ask that unlike the plan sponsor, you understand the importance of this case and its consequences upon the financial security of the plaintiffs.

Today, you have more power than you will probably have at any other time in your life. This is the only chance that the plaintiffs have of receiving justice.

The late General Norman Schwartzkop once said

“The truth is that we always know the right thing to do. The hard part is doing it.”

Ladies and gentlemen, that is all the plaintiff is asking of you today. Objectively review and consider the testimony and the evidence in this case, and do the right thing.”

I am frequently asked about the most common fiduciary risk management mistake that i see investment fiduciaries make. By far, the most common mistake I see is the failure to understand what is and is not legally required. As a result, investment fiduciaries constantly expose themselves to unnecessary fiduciary liability.

Often, that is a result of misplaced trust, blindly following the recommendations and advice of parties that do not owe any fiduciary duty to the investment fiduciary. As I have previously posted, NAIC Rule 275, the applicable insurance rule covering fiduciary duties not only does not expressly cover annuities, it expressly exempts ERISA pension plans from requirements of the Rule. As a result an annuity broker can claim to be in compliance with Rule 275, even though the advice and product recommendations provided may actually result in a fiduciary breach for the plan sponsor. This reinforces the need for plan sponsors to heed the warning set out in the Gregg decision.

I believe that the situation that many plan sponsors unknowingly may find themselves in is accurately summarized in this snippet from the famous cartoon, “Pogo.”

There is nothing in ERISA or any other law or regulation that expressly requires a plan sponsor to address retirement income or to include annuities providing within a 401(k) or other type of ERISA plan. Furthermore, prudent plan sponsors will realize that such products are available outside the plan, without potentially exposing the plan to fiduciary liability.

As noted fiduciary attorney, Fred Reish, likes to say – “Forewarned is forearmed.” And as I advise InvestSense’s fiduciary risk management clients, “do the math!”

Selah

Posted in fiduciary compliance | Tagged finance, investing, money, travel | Leave a comment

DOL Advisory Opinion 2025-04A: Don’t Be Stupid!

Posted on September 29, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

As a fiduciary risk management counsel, I read the DOL’s recent Advisory Opinion 2025-04A (Opinion) with great interest. As I read the opinion, I kept remembering my father’s advice – “The good Lord gave you a brain for a reason. Use it! Don’t be stupid.” In other words, always strive to make well-reasoned decisions.

Along those same lines, one of my main messages to our clients is to avoid unnecessary fiduciary risk exposure. To that end, InvestSense recommends that plan sponsors always use a simple two question analysis as a first step in evaluating potential investment options for their plan.

1. Does ERISA require a plan to offer the investment product or strategy in a plan? Hint: ERISA does not specifically require that any specific investment product or strategy be offered within a plan, only that each product offered within a plan be legally prudent.

2. If the product or strategy is not legally required to be offered within a plan, would/could offering the product or strategy expose the plan to unnecessary fiduciary risk? If so, why go there? Don’t go there! Don’t be stupid! Smart people do not valuntarily assume unnecessary risk. Thus, our directive for fiduciaries to Keep It Simple & Smart, or KISS.

Upon reading the Opinion, one particular sentence immediately stood out to me:

For participants who do not make a [SIP] allocation selection, the plan sponsor selects a default allocation percentage.” SIP refes to the annuity component in the investment at issue in the Opinion. Selecting investments for a plan is one thing. Any language calling for plan sponsors to become actively involving in making allocation decisions is a definite red flag, especially when the product itself is suspect as to fiduciary prudence.

While the Opinion seems to indicate that a plan participant can subsequently revise the percentage chosen by a plan sponsor, the complexity of the product itself and the likelihood of confusion of a plan participant raises numerous fiduciary litigation red flags as to potential litigation . The product fails the two question test.

With no legal obligation to offer the product, the prudent choice for a plan sponsor is not to do so at all, as plan participants interested in said product can do so outside of the plan, without exposing the plan to unnecessary and unwanted fiduciary liability.

Another reason for my position is the inconsistency between the standards set out in NAIC Rule 275 and ERISA 404(a). As I discussed the in an earlier post.¹ The inconsistency clearly allows for the possibility that a broker’s recommendation may be compliant with Rule 275, while non-compliant with ERISA 404(a). As a result, the broker’s recommendation may actually result in a fiduciary breach by, and resulting liability for, the plan sponsor.

In managing fiduciary risk, InvestSense stresses the importance of two court decisions, one in connection with actively managed mutual funds, the other in connection with annuities. Both decisions are widely cited by courts across the country, The annuity case is Gregg v. International Transportation Workers of America, in which the court explained the need for pension plans to proceed in caution when considering recommendations involving annuity brokers:

Insurance brokers [like FPA] do not work for a pension plan; rather, insurance companies like Transamerica pay individual insurance broker a salary. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative. FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.”²

Because of the obvious conflict of interest issues created whenever commissions are involved, I would suggest that all investment fiduciaries heed the Gregg court’s warning. For investment fiduciaries, it is always best to avoid even the appearance of impropriety. As Judge Cardozo pointed out in the legendary fiduciary decision of Meinhard v. Salmon:

Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion” of particular exceptions). Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd.³ (citation omitted)

In other words, avoid even the appearance of impropriety.

This DOL Opinion has no impact on anyone other than the parties involved and does not compel any action on the part of other plan sponsors. As a result of the issues identified herein, we have advised our clients to ignore both this Opinon and the product involved.

Why go there? Don’t go there! Don’t be stupid!

Notes
1. https://fiduciaryinvestsense.com/2025/09/15/erisa-404a-vs-naic-rule-275-wake-up-call-or-ticking-fiduciary-litigation-liability-time-bomb-for-plan-sponsors/
2. Gregg v. Transportation Workers of Am. Intern, 343 F.3d 833, 841 (6th Cir. 2003).
3. Meinhard v. Salmon, 249 N.Y. 458, 464 (1928).

This article is for informational purposes only and 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.

Posted in fiduciary compliance | Leave a comment

ERISA 404(a) vs. NAIC Rule 275 -Wake-Up Call or Ticking Fiduciary Litigation/Liability Time Bomb for Plan Sponsors?

Posted on September 15, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

As a fiduciary risk management counsel, I’m often asked about my opinion as to the biggest risk management mistake plan sponsors make. To me, the answer is simple. The biggest and most common fiduciary risk management mistake that I see investment fiduciaries make, including plan sponsors, is not knowing and understanding what the law does, and does not, require of them in their fiduciary capacity.

I recently gave a presentation on the “next big thing” in ERISA fiduciary litigation. Overall, I expect healthcare fiduciary litigation to continue to increase. I believe there is going to be an increase in fiduciary litigation involving in-plan annuities and annuities, in any form, in plans in general, including TDFs with an embedded annuity element.

The litigation liability area that I think is most promising for ERISA plaintiff attorneys is the inconsistency in standards between ERISA 404(a)¹ and NAIC Rule 275.² There is simply no middle ground.i I have heard some annuity advocates claim that NAIC Rule 275 provides a safe harbor for plan sponsors who choose to include annuities in their plans, despite the fact that there is no evidence to support such claims. Furthermore, Rule 275 explicitly exempts ERISA plans from Rule 275 coverage…³

Other annuity advocates point to the SECURE Acts as providing safe harbor protection for plan sponsors choosing to include annuities in their plans. The SECURE Acts provide a safe harbor in connection with the selection of an annuity provider, not the selection ofan annuity product. The prudence of an annuity itself is still subject to ERISA’s prudence and loyalty requirements.

I think the Achilles’ heel that ERISA plaintiff attorneys should focus on is the obvious inconsistency of the standards between ERISA 404(a) and NAIC rule 275 and the potential fiduciary liability that exists, liability which is going to completely blindslide many plan sponsors, as there has been little discussion on the issue. The issue is that annuity salespeople can be in compliance with Rule 275 while leaving plan sponsors unknowingly in violation of ERISA 404(a) due to the inconsistencies in the two standards.

§ 2550.404a-1 Investment duties.

In general. Sections 404(a)(1)(A) and 404(a)(1)(B) of the Employee Retirement Income Security Act of 1974, as amended (ERISA or the Act) provide, in part, that a fiduciary shall discharge that person’s duties with respect to the plan solely in the interests of the participants and beneficiaries; for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan; and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

Compare that language to the NAIC’s suitability requirements in connection with the sale of annuities:

Section 1. Purpose A. The purpose of this regulation is to require producers, as defined in this regulation, to act in the best interest of the consumer when making a recommendation of an annuity and to require insurers to establish and maintain a system to supervise recommendations so that the insurance needs and financial objectives of consumers at the time of the transaction are effectively addressed

Section 4. Exemptions Unless otherwise specifically included, this regulation shall not apply to transactions involving: A. Direct response solicitations where there is no recommendation based on information collected from the consumer pursuant to this regulation; B. Contracts used to fund: (1) An employee pension or welfare benefit plan that is covered by the Employee Retirement and Income Security Act (ERISA); (2) A plan described by Sections 401(a), 401(k), 403(b), 408(k) or 408(p) of the Internal Revenue Code (IRC), as amended, if established or maintained by an employer;

Section 6. Duties of Insurers and Producers A. Best Interest Obligations. A producer, when making a recommendation of an annuity, shall act in the best interest of the consumer under the circumstances known at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest. A producer has acted in the best interest of the consumer if they have satisfied the following obligations regarding care, disclosure, conflict of interest and
documentation:

Section 6 (1) (a) Care Obligation. The producer, in making a recommendation shall exercise reasonable diligence, care and skill to: (i) Know the consumer’s financial situation, insurance needs and financial objectives; (ii) Understand the available recommendation options after making a reasonable inquiry into options available to the producer; (iii) Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs and financial objectives over the life of the product, as evaluated in light of the consumer profile information;,

Not only does NAIC Rule 275 explicitly exempt ERISA plans from coverage under tthe Rule, it also does not require an annuity agent to factor in the best interests of the annuity owner’s beneficiaries when making recommendations involving annuities. It has been suggested to me that Rule 275 does not require consideration of the plan participant’s beneficiaries’ best interests because Rule 275 assumes that ERISA plans have access to experts who will ensure that the beneficiaries’ best interests have been considered. Experience has shown that such assumption is not supported by the evidence.

InvestSense, LLC, teaches our clients a simple two-step risk management process in analying potential investment options wihtina plan:

– Step One – Does ERISA or any other law/regulation expressly require that a plan offer the investment option be offered within a plan?

The answer is “no.” ERISA does not expressly require that any specific type of investment option be offered within a plan, only that all investment options offeredwithin a plan be legally prudent.

Step Two – Would/Could the investment option under consideration potentially expose the plan to unnecessary fiduciary liability?

If so, common sense should tell the plan to avoid the investment option. Plan participants interested in such products would still have the option of purchaing such investments outside of the plan, without potentially exposing the plan to unnecessary fiduciary risk.

With regard to annuities, we generally advise our clients to avoid them altogether, since plans have no legal obligation to provide such so-called “retirement income” products or strategies. Furthermore, most forensic techniques, such as breakeven analysis, prove that annuities are rarely in the best interests of either the plan participant or their benficiaries. As for annuity industry claims that plan participants “want’ such products, as a former securities compliance director, I always remember the annuity wholesalers stressing to our brokers that “annuities are sold, not bought.” As for self-serving annuity industry polls and surveys supporting such claims, plan sponsors have a legal obligation to comply with ERISA, not the alleged whims of some plan participants.

My experience has been that very few plan sponsors are aware of or have actually read ERISA 404(a) or NAIC Rule 275, choosing instead to blindly rely on the misrepresentations of annuity wholesalers and brokers, despite the warnings of the courts that such blind reliance on commissioned salespeople is not legally justified due to the obvious financial conflict of interest.

Defendants relied on FPA, however, and FPA served as a broker, not an impartial analyst. {Brokers} are not independent analysts. FPA does not work for the plan; rather, insurance companies like Transamerica pay [a broker’s salary.] As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative. FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.⁴

See also: Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 301(5th Cir. 2000) (fiduciaries may not “rely blindly” on advice); In re Unisys.,74 F.3d 420, 435-36 (3d. Cir. 1996).

Fortunately, plan sponsors can independently evaluate the prudence of an annuity by performing an annuity breakeven analysis using Microsoft Excel. While a properly prepared breakeven should factor in both present value and mortality risk, a simple present value breakeven analysis using Excel often indicates the legal imprudence of an annuity based on present value considerations alone.

Going Forward
The key point to consider is that an adviser recommending an in-plan or another form of an annuity as an investment option in a plan may be in compliance with NAIC Rule 275, but may nevertheless place a plan sponsor in violation of ERISA 404(a) due to the inconsistency in standards. The fact that annuities often require the annuity owner to annuitize the annuity, i.e., surrender the annuity contract and the amount of their investment, in order to receive the alleged benefit of the annuity, the stream of retirement, with absolutely no guarantee of a commensurate rerturn means that the annuity issuer stands to receive a windall at the annuity owner’s expense. Courts dislike such inequitable situations, citing that equity law, a basic component of fiduciary law, abhors a windfall. Upon annuitization, the annuity issuer becomes the legal owner of the value within the annuity. So, there is typically nothing available for the annuity owner’s beneficiaries, a result that the plan sponsor “knew or should have known”, a foreseeable result that is an obvious violation of ERISA 404(a)’s requirement to act in the beneficiaries’ best interests and should have factored in deciding whether toan annuity within the plan..

Annuity advocates will typically mention the availability of various “rider”s to address these issues. Unless they offer such riders for free (they don’t), there is the issue of the additional cost and the findings of both the General Accountability Office (GAO) and the Department of Labor (DOL) on the impact of cumulative fees and the compounding of same. Both the DOL and GAO determined that over a twenty-year period, each additional 1% in fees reduces an investor’s end-return by approximately 17%.

Therfore, plan sponsors considering annuities need to keep “3%” in mind, since 3 times 17 would result in plan participants and their beneficiaries losing 51 percent of their end-return. So, while annuity advocates may mention various riders, they often “forget” to mention the cumulative/compounding cost issue of the basic cost and fees of annuities. Adding the cost of riders would be expected to easily exceed the “3%” cumulative fees threshold, benefitting the annuity issuer at the annuity owner’s expense, a clear breach of the fiduciary duty of loyalty..

One last piece of advice. Investment fiduciaries who receive a recommendation to include an annuity, any type of annuity, should always require the annuity salesperson to provide a written, properly prepared breakeven analysis on the annuity being recommended. A written analysis can be introduced into evidence, if necessary. Trial attorneys will tell you that you never want a case to become a “he said,” she said” situation. If the annuity salesperson refuses request to provide a written breakeven analysis showing the process they used (they will, they know the truth about their product. They just hope you don’t.) The the prudent plan sponsor will simply walk away.Fiduciary risk management often requires proactive strategies and measures by an investment fiduciary.

One last reminder for plan sponsors considering annuities, there is no such thing as “mulligans’ in fiduciary law! Heed the sound advice of former CEO Jack Welch – “Don’t make the process harder than it is.”

Notes
1. 29 U.S.C.A. Section 1104(a).
2. NAIC Rule 275 – Suitability in Annuity Transactions Model Regulation (Rule 275)
3. Rule 275, Section 4, “Exemptions,” B(2).
4. Gregg v. Transportation Workers of Am. Intern, 343 F.3d 833, 841 (6th Cir. 2003).
5. Pension and Welfare Benefits Administration, “Study of 401(k) Plan Fees and Expenses,” (DOL Study) http://www.DepartmentofLabor.gov/ebsa/pdf; “Private Pensions: Changes needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (GAO Study).

Posted in 401k, 401k compliance, 401k investments, 401k litigation, 401k plan design, 401k plans, 401k risk management, 401klitigation, 404(a), Annuities, best interest, DOL, ERISA, ERISA litigation, ERISA litigation, fiduciary liability, ERISA litigation, ERISA, ERISA litigation, fiduciary responsibility, fiduciary prudence, fiduciary duties, fiduciary litigation, 401k, 401k plans, plan sponsor, plan sponsors, fiduciary law, fiduciary, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary litigation, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary risk management, fiduciary standard, fiduciarylitigation, pension plans, plan sponsors, risk management | Tagged 401k compliance, 401k fiduciary, 401kplans, Annuities, ERISA, fiduciary, fiduciary risk management, investing, plan sponsor | Leave a comment

3 Things Prudent Plan Sponsors Must Understand About President’s Trump’s Executive Order and Fiduciary Risk Management

Posted on August 11, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

President recently released an excutive order requesting that the DOL and other relevant regulatory bodies create guidelines and other measures, including safe harbors, that would allow plans to offer unnecessarily risk investments, such as private equity and crypto, inside 401k plans.

1. As a fiduciary risk management counsel, one of the most noticeable aspects is that ERISA does not mandate that any specific types of investment be offered within an ERISA plan.

The key requirements of Section 404 of ERISA are:

a fiduciary shall discharge that person’s duties with respect to the plan solely in the interests of the participants and beneficiaries; for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan;
with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.
With regard to the consideration of an investment or investment course of action taken by a fiduciary of an employee benefit plan pursuant to the fiduciary’s investment duties, the requirements of section 404(a)(1)(B) of the Act set forth in paragraph (a) of this section are satisfied if the fiduciary:
(i) Has given appropriate consideration to those facts and circumstances that, given the scope of such fiduciary’s investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the plan’s investment portfolio or menu with respect to which the fiduciary has investment duties; and

(ii) Has acted accordingly.

For purposes of paragraph (b)(1) of this section, “appropriate consideration” shall include, but is not necessarily limited to:(i) A determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties) or menu, to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks;

The arguments can be, and have been, made that the alternative investments set out in the executive order are not only unnecessary, but are too risky and inconsistent with both the spirit and letter of ERISA’s provisions with the prudence process described under ERISA.

Prudent plan sponsors would be best served by totally ignoring the Presient’s executive order and just continue to monitor their plan’s existing internal process to ensure that their plan is ERISA compliant.
2. “”it is by now black-letter ERISA law that “the most basic of ERISA’s investment duties [is] the duty to conduct an independent an independent investigation into the merits of a particular investment….’The failure to make any independent invstigation and evaluation of a potential plan investment” has repeatedly been held to constitute a breach of fiduciary olgigations.” Liss v. Smith, 991 F. Supp. 278. 297 (S.D.N.Y. 1989), citing In re Unisys Savings Plan Litigation, 74 F.3d 420, 435 (3d Cir 1996), and Whitfield v. Cohen, 682 F. Supp. 188, 195 (S.D.N.Y 1988).

In In re Citigroup ERISA Litigation, 112 F. Supp 3d 156 (S.D.N.Y. 2015) (2017), the federal court for the Southern District of New York emphasized that a plan sponsor acting as a fiduciary under ERISA has a duty to independently and thoroughly investigate and evaluate each investment option offered within a 401(k) plan.

The court stated that fiduciaries cannot simply rely on the mere presence of an investment option or general market reputation but must conduct a careful, ongoing review to ensure the option is prudent and aligns with the plan participants’ best interests. This includes analyzing fees, risks, performance, and any other relevant factors that affect the value and suitability of the investments.

The ruling underscored that fiduciaries must:

Perform an independent due diligence process rather than blindly following advice or defaulting to common offerings.
Continuously monitor the investments, removing imprudent ones if necessary.
Ensure investment decisions are thorough, deliberate, and documented to meet ERISA’s standard of prudence.

Failure to meet these fiduciary duties can lead to liability for losses to plan participants.

Given the lack of transparency associated with the alternate investments set out in the executive order, is it even possible for a plan sponsor to comply with the independent investigation and evaluation requirement? The lack of transparency typically associated with alternative inevsments would clearly require a plan sponsor to rely on the information and value estimations of these conflicted and legally unreliable vendors. Gregg v. Intern’l Trasportation Workers of America, (reliance on commissioned salespeople is never legally justifiable}.

Since neither ERISA not any any laws/regulations require a plan to offer such potentially liability ridden investments, the obvious question from a fiduciary risk management standpoint – “Why go there?

3. We teach our fiduciary risk management clients that the best risk management strategy is to avoid risk altogether whenever possible. The Executive Order suggested that the DOL and other agencies create safe harbors for plan sponsors recommending alternative investments.

Why is it that whenever Congress or the President support unecessarily risky investments that could undermine the financial wellness and retirement security of American workers, they always seek to include a safe harbor to protect plan sponsors, but totally frustrate the very focus of ERISA, protecting the American workers? The financial services industry needs a helping hand, so we’re going to recommend these risky investments…and to Hell with American workers.

Think that’s unduly harsh? Ask an annuity peddler to provide a properly prepared written breakeven analysis, factoring in both present value and mortality risk. I am often asked to sit in on a plan’s investment committee meeting where an annuity peddler is scheduled to make a presentation. Ask the annuity wholesaler to provide a written breakeven analysis. Typicall response is that they are not legally required to do so. I quickly offer to provide such a breakeven analysis after the meeting.

In my opinion, a refusal to provide such a properly prepared, written breakeven is the equivalent to what the legal profession refers to as an admission against interest and/or an example of the what the law refers to as res ipsa loquitor (the facts speak for themselves). That should be the red flag to end the meeting.

The written breakeven analysis is also prudent in that it demonstrates due diligence on the part of the plan sponsor. Fiduciaries have a duty to disclose all “material facts” to plan participants.

Quite often a properly prepared breakeven will indicate that the odds of benefitting from an annuity heavily favor the annuty issuer rather than the plan participants. With regard to investments, the law described a “material information” as any fact or information that an investor would find beneficial in making an investment decision. I’m guessing that most investors would consider information suggesting that they are unlikelly to break even on a certain annuity, that the odds favor the annuity issuer at the investor’s expense, would influence the investor’s investment decision.

I’m also guessing that few plan sponsors have the skill or knowlege to properly create their own annuity breakeven analysis. I’m also guessing that few plan sponors have the experience or skill to properly investigate and/or evaluate alternative investments.

Going Forward
Fortunately, there is no obligation under ERISA or any other law to offer any specific type of investments in an ERISA plan. Nothing about the Executive Order changes that fact.

President Trump suggested safe harbors for plan sponsors who decide to offer alternative investments within a plan. I have read the executive order several times and still cannot find a provision addressing the best interests and financial wellness of the plan participants. Until such such concerns are properly addressed, prudent plan sponsors and their plan participants would be well advised to ignore the Excutive Order and follow the sage advice of jack Welch – “Don’t make the process harder than it is.”

Posted in ERISA litigation, fiduciary liability, ERISA litigation, fiduciary duty, fiduciary liability, Fiduciary litigation, fiduciary prudence | Tagged 401k, defined contribution, ERISA, ERISA litigation, Executive Order, fiduciary liability, Fiduciary litigation, fiduciary loyalty, fiduciary responsibility, finance, investing, personal-finance, retirement, retirement planning | 2 Comments

“And Their Beneficiaries”: Annuities, Commensurate Returns, and Fiduciary Liability

Posted on August 4, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

ERISA Section 404a-1 provides as follows:

2550.404a-1 Investment duties.

(a) In general. Sections 404(a)(1)(A) and 404(a)(1)(B) of the Employee Retirement Income Security Act of 1974, as amended (ERISA or the Act) provide, in part, that a fiduciary shall discharge that person’s duties with respect to the plan solely in the interests of the participants and beneficiaries; for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan; and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

Based on my experience, too many plan sponsors who are considering or have included in-plan annuities as an investment option within their plan have either overlooked or have not properly assessed the potential fiduciary liability risks presented by the inclusion of the “and their beneficiaries” language.

The most obvious concern for a plan sponsor should be with the possibility of an in-plan annuity resulting in an erosion of estate assets. Annuity advocates frequently point to available options such as annuity riders to protect against estate asset protection. Unless the annuity issuer iss providing such riders for free (they don’t), then the additional costs further reduce returns and estate assets. As SCOTUS pointed out in Hughes v. Northwestern University#, each investment option within a plan must be individually prudent, must stand on its own.

That would presumably rule out the added costs of the “bells and whistles suggested by the annuity industry. After all, as both the DOL and GAO studies# pointed out, over a twenty year period, each additional 1 percent in fees and costs reduces an investor’s end-return by approximately 17 percent. It does not take much for cumulative costs on annuities to exceed 3 percent annually, at which point the annuity becomes a better investment for the annuity issuer than the plan participant, and a fiduciary breach for the plan sponsor.

The annuity industry loves to use head games to sell their product. They used the “squandering plaintiff” ruse in an attempt to convince courts to require structured settlements in cases involving significant damage payments. Attorney Jeremy Babener exposed that ruse by pointing out that there was no verifiable evidence of the evidence cited by the industry, with the general counsel essentially admitting that the “evidence” cited by the industry were simply made up to help promote the industry.#

Currently we have some annuity advocates attempting to manipulate plan sponsors and other investment fiduciaries by reportedly suggesting that they have a legal obligation to offer annuities within a plan. Other questionable annuity marketing strategies involving plan sposnors include recommending annuities for decumulation purposes. Let’s set the record straight:

There is no legal foundation for the suggestion that ERISA or any other law requires a plan to offer annuities within plan.
There is no legal foundation for the suggestion that ERISA or any other law requires a plan to offer any specific type of investment. ERISA simply requires that each investment offered within a plan be legally prudent.
There is no legal foundation for the suggestion that plan sponsors have any legal obligation with regard to assisting in the decumulation of a plan account, whether by providing products or advice. In fact, providing advice and/or assistance can be grounds for holding that an otherwise non-fiduciary has crossed the line and is legally recognized as a fiduciary.

Annuity advocates claim that my positions are cruel and insensitive. My response – my advice is legally prudent and reflects prudent fiduciary risk management strategies. Furthermore, the alleged “humanitarian” argument coming from the annuity industry is extremely ironic coming from an industry marketing a product that is intentionally designed to produce a windfall for the annuity issuer at the expense of both the plan participant and their beneficiaries.

Ironic coming from an industry that consistently opposes any type of a meaningful fiduciary standard that would simply require that the industry always act in the best interests of the public. Ironic coming from an industry that, as Judge Barbara Lynn pointed out, markets products that reserve the right for the annuity issuer to unilaterally change key terms of the annuity, after the fact, so as to shift the risk of the investment from the annuity issuer to the annuity owner.

Plan sponsors, plan participants and their beneficiaries would be better served by heeding the advice of Jack Welch, former CEO of GE – “Don’t make the process harder than it is.” Yet, far too many plan sponsors do just that, resulting in unnecessary fiduciary liability exposure.

Another marketing strategy currently being used by the annuity industry is to suggest that plan sponsors have a duty to offer annuities within a plan because plan participants supposedly “want” to buy them. As soon as I hear the “participants want them” argument, I immediately think “tell me that you know nothing about fiduciary law without telling me that you know nothing about fiduciary law.” I even had a well-known annuity advocate tell me that someone cannot be a fiduciary without offering annuities. That simply is not true.

I sometimes receive requests to sit in on plan investment committee meeting to offer fiduciary risk management advice. Whenever an annuity wholesaler is going to make a presentation, I “woodshed” plan’s investment committee so they know how to evaluate the wholesaler and their sales pitch. In following Steve Job’s advice to always include a “Holy S**t” moment, I always tell the committee to ask the wholesaler if they are willing to submit a written breakeven analysis of any recommended annuities.

The wholesaler will immediately object, “that’s not required by law,” or offer to provide a verbal breakeven analysis. Always insist on a written breakeven analysis, as it should be admissible in court, if necessary. Amazing how facts often change under stress.

To summarize, plan sponsors should always remember Jack Welch’s advice. I have a saying for my clients – KISS – Keep It Simple and Smart. Simple refers to the fact that the more investment option a plan offers, the greater the likelihood of a breach. ERISA only mentions a required number of investment options once, as in a minimum of three broadly diversified investment options are required for plans looking for the protection offered under 404(c). For a long time, the federal government’s highly successful Federal Thrift Plan (FTP) only offered five, diversified index-type investment options. As a result, they offered federal employees an easily understandable and effective plan, while protecting against “paralysis by analysis.” Today, the FTP boasts a number of millionaires.

As for the “smart” part of the equation, I recommend evaluating investment options with simple cost-benefit analysis {CBA}. Obviously, I prefer the Active Management Value Ratio (AMVR) metric I created for my fiduciary risk management consulting firm, InvestSense, LLC. The AMVR is essentially a cost-benefit analysis using incremental risk-adjusted returns and incremental correlation-adjusted costs as the input data. Based on the investment concepts investment icons such as Nobel laureate Dr. William F. Sharpe and Charles D. Ellis, the metric is fundamentally sound and simple to use. Further information on the AMVR and sample analyses can be found at fiduciaryinvestsense.com.

In concluding, lets return to the “and their beneficiaries” language of ERISA Section 404a. I submitted the following query on ChatGPT:

Using cost-benefit analysis, prepare a fiduciary prudence analysis of a $50,000 immediate annuity, paying 5% annually, on a 65 year old woman, assuming normal life expectancy, factoring in commensurate return, breakeven analysis, estate asset erosion, present value and mortality risk concerns, as well the best interest of the plan participants and their beneficiaries.

I am not going to post the chat GPT generated report here due to its length. However, with one notable exception, the report’s findings, conclusions, and recommendations agreed with mine. The exception involved the report’s use of a “nomina”l breakeven point, which is nothing more than diving the cost of the annuity by its interest rate. Here, the reported reported a nominal breakeven point of 10 years, Most courts would not such a deliberatively misleading analysis into evidence.

A properly prepared annuity breakeven analysis should always factor in present value and mortality risk .In legal actions involving significant damages, the defendant will generally seek a structed settlement in which the majority of such damages be covered by an annuity. A plaintiff’s attorney needs to understand how to properly evaluate any proposed settlement involving an annuity to ensure that the proposed settlement is actually in the plaintiff’s best interest. An attorney who recommends that a plaintiff accept a structured settlement at a certain price, needs to be sure the represented settlement price is accurate. In our “and their beneficiaries” scenario, I personally ran a breakeven analysis using the previously mentioned facts. The results of that analysis are shown below.

Assuming a normal life expectancy of 86 years, the accumulated present value of the annuity would only be $25,512, resulting in an estate asset loss of $24,487, or 48.97 percent less than the original investment in the annuity. .

Posted in fiduciary compliance | Tagged finance, investing, travel, writing | Leave a comment

“And Their Beneficiaries”: Annuities, Commensurate Return, and Fiduciary Liability

Posted on August 4, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

ERISA Section 404a-1 provides as follows:

2550.404a-1 Investment duties.

The most obvious concern for a plan sponsor should be with the possibility of an in-plan annuity resulting in an erosion of estate assets. Annuity advocates frequently point to available options such as annuity riders to protect against estate asset protection. Unless the annuity issuer iss providing such riders for free (they don’t), then the additional costs further reduce returns and estate assets. As SCOTUS pointed out in Hughes v. Northwestern University¹, each investment option within a plan must be individually prudent, must stand on its own.

That would presumably rule out the added costs of the “bells and whistles suggested by the annuity industry. After all, as both the DOL and GAO studies² pointed out, over a twenty year period, each additional 1 percent in fees and costs reduces an investor’s end-return by approximately 17 percent. It does not take much for cumulative costs on annuities to exceed 3 percent annually, at which point the annuity becomes a better investment for the annuity issuer than the plan participant, and grounds for a fiduciary breach action against a plan sponsor.

There is no legal foundation for the suggestion that ERISA or any other law requires a plan to offer annuities within plan.
There is no legal foundation for the suggestion that ERISA or any other law requires a plan to offer any specific type of investment. ERISA simply requires that each investment offered within a plan be legally prudent.
There is no legal foundation for the suggestion that plan sponsors have any legal obligation with regard to assisting in the decumulation of a plan account, whether by providing products or advice. In fact, providing advice and/or assistance can be grounds for holding that an otherwise non-fiduciary party has crossed the line and is legally a fiduciary.

Annuity advocates claim that my positions are cruel and insensitive. My response – my advice is legally prudent and consistent with both prudent fiduciary risk management strategies. Furthermore, the alleged “humanitarian” argument currently being advanced by the annuity industry is extremely ironic coming from an industry marketing a product that is intentionally designed to produce a windfall for the annuity issuer at the expense of both the plan participant and their beneficiaries.

Ironic coming from an industry that consistently opposes any type of a meaningful fiduciary standard that would simply require that the industry always act in the best interests of the public. Ironic coming from an industry that, as Judge Barbara Lynn pointed out, markets annuity products that reserve the right of the annuity issuer to unilaterally change key terms of the annuity, after the fact, so as to shift the risk of the investment from the annuity issuer to the annuity owner.⁴

Plan sponsors, plan participants and their beneficiaries would be better served by ignoring the annuity industry’s questionable marketing startegies and heeding the advice of Jack Welch, former CEO of GE – “Don’t make the process harder than it is.” Yet, far too many plan sponsors do just that, resulting in unnecessary fiduciary liability exposure.

Another marketing strategy currently being used by the annuity industry is to suggest that plan sponsors have a moral duty to offer annuities within a plan because plan participants supposedly “want” to buy them. As soon as I hear the “participants want them” argument, my immediate reaction is “tell me that you know nothing about fiduciary law without telling me that you know nothing about fiduciary law.” I even had a well-known annuity advocate tell me that someone cannot be a fiduciary without offering annuities. That simply is not true.

The wholesaler will usually decline and immediately object, “that’s not required by law,” or offer to provide a verbal breakeven analysis. Plan sponsors should always insist on a written breakeven analysis, as it should be admissible in court, if necessary. Amazing how facts often change under stress.

Going Forward
Based on my conversation with fellow ERISA plaintiff’s counsel, I expect to see an increase in litigation based on the “and their beneficiaries” language of ERISA Section 404a. It would appear to be the proverbial “low hanging fruit” in litigating fiducairy breach actions. To that end ,I submitted the following query to ChatGPT:

I am not going to post the chat ChatGPT generated report here due to its length. The reader can submit the same query and presumably receive the same analaysis. However, with one notable exception, the report’s findings, conclusions, and recommendations agree with my findings and analysis. The exception involved the report’s use of a “nominal”breakeven point, which is nothing more than dividing the face value of the annuity by its interest rate. Here, the ChatGPT reported a nominal breakeven point of 10 years, Most courts would not such a deliberatively misleading analysis into evidence.

The chart shown is for informational and teaching purposes only and the data and analysis does not represent a specific person or situation and is not intended to be used, and should not be used, in any specific situation, as each client situation involves a unique set of facts and circumstances. Investors needing presonal advice should consult with an experienced professional such as an attorney and/or actuary.

Assuming a normal life expectancy of 86 years (65+20.7), the accumulated present value of the annuity would only be $25,512, resulting in an estate asset loss of $24,487, constituing an estate asset erosion of 48.97 percent. So much for any alleged fiduciary prudence of the annuity option and compliance with the “and their beneficiaries ” requirement of ERISA 404(a). Given the fact that offering an annuity option, in any form, is not legally required, the obvious fiduciary risk management question is – “Why go there?”

Plan participants interested in annuities can always pursue their interest outside of the plan, without exposing the plan to unnecessary liability. After all, the best startegy for managing fiduciary risk is to avoid such risk altogether whenever possible. Where do I go to reommend a new regulation that requires that any and all recommendations involving an annuity to plan sponsors, as well any investment fiduciary, must be accompanied with a properly prepared written breakeven analyses, one that factors in both present value and mortality risk considerations? Even better, how many annuity advocates would be willing to support such an equitable measure?

Notes
1. Hughes v. Northwestern University, 595 U.S. ___, (2022)/
2. Pension and Welfare Benefits Administration, “Study of 401(k) Plan Fees and Expenses,” (DOL Study) http://www.DepartmentofLabor.gov/ebsa/pdf; “Private Pensions: Changes needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (GAO Study).
3. Jeremy Babener, “Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlement Monies,” NYU Journal of Law and Business Vol 6 (Fall 2009), 129. (Babener)
4. Chamber of Commerce of the United States of America v. United States Department of Labor, 231 F. Supp.3d 152 (N.D. Tex 2017). (District Court).

Posted in 401k, 401k compliance, 401k investments, 401k litigation, 401k plans, 401k risk management, 401klitigation, 404(a), Active Management Value Ratio, AMVR, Annuities, consumer protection, cost-efficiency, defined contribution, DOL, elderly investment fraud, ERISA, ERISA litigation, ERISA, ERISA litigation, fiduciary responsibility, fiduciary prudence, fiduciary duties, fiduciary litigation, 401k, 401k plans, plan sponsor, plan sponsors, fiduciary law, fiduciary, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary standard, Mutual funds, pension plans, plan sponsors, prudence, retirement planning, retirement plans, risk management, wealth preservation | Tagged 401k 401k plans, Annuities, ERISA, ERISA litigation, fiduciary, fiduciary investing, fiduciary law, fiduciary liability, fiduciary responsibility, fiduciary riskmanagement, investing, investor protection, litigation, personal-finance, plansponsor, plansponsors, retirement, retirement planning | Leave a comment

May It Please the Court: Closing Argument on Palsgraf, Annuities, Commensurate Return and the Future of Fiduciary Litigation

Posted on July 20, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

May It Please the Court:

In the landmark case of Palsgraf v. Long Island R.R.¹, Judge Benjamin Cardozo held that “the risk reasonably to be perceived defines the duty to be obeyed.”² While Palsgraf arose in a tort context, its foundational principle — that liability follows from harms that are reasonably foreseeable to a person in a position of duty — is broadly applicable in fiduciary law. In the context of ERISA fiduciary obligations, this foreseeability principle operates to inform the scope of the fiduciary’s duties of prudence and loyalty.

Just as the court in Palsgraf found no liability where the harm was unforeseeable, the inverse must also apply: where harm is foreseeable, liability should attach.

A. ERISA § 404(a)(1): Duty of Loyalty and Prudence

ERISA § 404(a)(1)(A)-(B)⁵ requires fiduciaries to:

Act “solely in the interest of the participants and beneficiaries” and
Act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity… would use.”

Inclusion of a Structurally Deficient Annuity was a Foreseeable Harm

The plan sponsor, acting in a fiduciary capacity, could — and should — have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to most participants.

The foreseeability of loss, a core principle of Palsgraf, is relevant and probative in fiduciary litigation. The plan sponsor’s decision to offer an annuity product that actuarially cannot provide a commensurate return — and predictably results in a participant financial loss absent exceptional longevity — is a breach of both the duty of prudence and loyalty. The financial harm to the participant was not a remote or unexpected event, but rather an inherent, foreseeable outcome of the annuity’s structure.

HOW FORESEEABILITY ESTABLISHES FIDUCIARY BREACH

A. Imprudence in Design and Selection

In the same way the defendant in Palsgraf should have anticipated a zone of risk caused by negligent conduct, the plan sponsor here should have anticipated that plan participants who selected the annuity would — based on actuarial and present value analysis — be unlikely to even recover their principal. This also violated the plan sponsor’s duty to always act in the beat interests of the plan participant and their beneficiaries. Depletion of estate assets is obviously not in the best interests of a plan participant and their beneficiaries. This renders the product categorically imprudent.

B. Loyalty Breach: Favoring the Issuer over the Investor

The foreseeable erosion of participant value and simultaneous financial benefit to annuity providers constitutes a breach of the loyalty duty. The plan sponsor knew or should have known that the annuity option conferred substantial benefit to the issuer (via fees and retained capital) while imposing foreseeable harm to participants.

C. Failure to Investigate or Disclose Material Facts

Under Tibble v. Edison International⁶, fiduciaries must continuously monitor investments. A product with a known, predictable failure to breakeven violates this duty. The failure to disclose this foreseeable non-breakeven point — especially in relation to participant mortality — strengthens the breach claim.

B. Inclusion of a Structurally Deficient Annuity was a Foreseeable Harm

As mentioned previously, the plan sponsor, acting in a fiduciary capacity, could – and should – have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to plan participants, based upon the consideration of such factors as:

Publicly Available Mortality Tables (e.g., Society of Actuaries, IRS 2022 Applicable Mortality Tables);
Breakeven Analysis clearly demonstrating that the annuity requires survival to an age well beyond the plan participant’s normal life expectancy or just to recover the initial principal;
High Cumulative Costs including income rider fees, administrative expenses, and embedded commissions exceeding 300 basis points annually in some cases;
No Estate Value Transfer, making the product inappropriate for participants with legacy or liquidity priorities;
Availability of Superior Alternatives, including low-cost bond ladders, TIPS, or deferred income strategies.

HOW FORESEEABILITY ESTABLISHES FIDUCIARY BREACH

A. Imprudence in Design and Selection

B. Loyalty Breach: Favoring the Issuer over the Investor

The foreseeable erosion of a plan participant’s account value and the simultaneous financial benefit to annuity providers constitutes a breach of the loyalty duty. The plan sponsor knew or should have known that the annuity option conferred substantial benefit to the issuer (via fees and retained capital) while imposing foreseeable harm to participants.

Equity law is a major component of fiduciary law. A basic tenet of equity law is that “equity abhors a windfall.”⁷

C. Failure to Investigate or Disclose Material Facts

Under Tibble, fiduciaries must continuously monitor investments. A product with a known, predictable failure to breakeven violates this duty. The failure to disclose this foreseeable non-breakeven point — especially in relation to participant mortality — strengthens the breach claim.

The plan sponsor, acting in a fiduciary capacity, could — and should — have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to most participants, resulting in an reduction of estate assets, which would constitute yet another fiduciary, breach, in thjs case the duty to always act in the best interest of the plan participants and their beneficiaries.

The long-term underperformance of such annuities was not speculative — it was actuarially predictable and financially foreseeable, as in Palsgraf’s classic formulation.

Just as the court in Palsgraf found no liability where the harm was unforeseeable, the inverse must also apply: where harm is foreseeable, liability should attach. In the case of 401k annuities lacking guaranteed or inflations-adjusted returns, it is eminently foreseeable that participants and the their beneficiaries may suffer erosion of principal and estate asset value. While the annuity industry may point to the availability of riders to address such concerns, such riders add additional costs, which often only serve to exacerbate the costs and financial loss for the annuity owner and their participants. As the Supreme Court pointed out in Hughes v. Northwestern University⁸, the fiduciary prudence of each investment option in a plan must stand alone. The availability of costly add-ons should, therefore, not be considered, especially given their impact on commensurate return. Fiduciaries who approve such offerings without rigorous due diligence fail to meet ERISA’s prudence standard and may be analogized to the negligent actors in Palsgraf – except here, the zone of foreseeable harm includes each plan participant and their beneficiaries.

The foreseeability of loss, a core principle of Palsgraf, is relevant and probative in fiduciary litigation. The plan sponsor’s decision to offer an annuity product that actuarially cannot provide a commensurate return — and predictably results in a financial loss for a plan participant absent exceptional longevity — is a breach of both the duty of prudence and loyalty. The financial harm to the participant was not a remote or unexpected event, but rather an inherent, foreseeable outcome of the annuity’s structure.

Accordingly, the court should apply foreseeability as a lens in evaluating the sponsor’s fiduciary conduct and hold that offering such an annuity was a fiduciary breach under ERISA § 404.

Notes
1. Palsgraf v. Long Island R.R., 248 N.Y. 339. 162 N.E. 99 (1928) (Palsgraf)
2. Palsgraf
3. Palsgraf
4. Palsgraf.
5. 29 U.S.C.A. Section 1104.
6. Tibble v. Edison Int’l, 575 U.S. 523 (2015).
7. U. S. Airways v. McCutchen, 663 F.3d 671(3d. Cir. 2011)
8. Hughes v. Northwestern University, 135 S. Ct. 1823 (2022).

Posted in 401k, fiduciary compliance, fiduciary duty, fiduciary liability, fiduciary prudence | Tagged 401k, 401k compliance, 401k plans, Annuities, ERISA, fiduciary, fiduciary investing, fiduciary law, Fiduciary litigation, pension plans, plan sponsors | Leave a comment

Pizarro v. Home Depot and the Future of ERISA Litigation

Posted on May 18, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

Right on the heels of its historical decision in Cunningham v. Cornell University¹, SCOTUS is facing yet another crucial decision involving ERISA in Pizarro v. Home Depot, Inc². Just as in Cunningham, the key issue in Pizarro involves the question of which party has the burden of proof on the issue causation in an ERISA action once the plaintiff plausibly pleads its case and establishes a resulting loss.

Unlike Cunningham, the Court’s decision in Pizarro will not involve prohibited transactions and/or prohibited transaction exemptions. Therefore,it can be argued that the Court’s decision in Pizarro will have a broader, and greater, impact on future ERISA litigation.

The Supreme Court invited the Solicitor General (SG) of the United States to file an amicus brief in Pizarro. This is noteworthty, because the Court often shows great respect for the Solicitor General’s opinions, as they are generallywell-reasoned and accurately reflect the applicable law.

This is potentially more noteworthy due to the fact that the Solicitor General’s office submitted an amicus brief on the issue of shifting the burden of proof on causation to the plan sponsor in Putnam Investments v. Brotherston³. The SG’s arguments in its Brotherston amicus brief⁴ may provide an indication of the SG’s positions in the forthcoming Pizarro amicus brief, as the SG relied heavily on the Restatement of Trusts in its amicus brief. While the SG has changed, the Restatement has not.

The Court, the Restatement, and Fiduciary Law
In Tibble v. Edison International⁵, SCOTUS recognized the value of the Restatement of Trusts as a resource in cases involving fiduciary law.

An ERISA fiduciary must discharge his responsibility “with the care, skill, prudence, and diligence” that a prudent person “acting in a like capacity and familiar with such matters” would use. §1104(a)(1); We have often noted that an ERISA fiduciary’s duty is “derived from the common law of trusts.” In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.

Which is exactly what the SG did in its amicus brief.¹

The “default rule” in ordinary civil litigation when a statute is silent is that “plaintiffs bear the burden of persuasion regarding the essential aspects of their claims.” Schaffer v. Weast, 546 U.S. 49, 57 (2005). But “[t]he ordinary default rule, of course, admits of exceptions.”⁶ Ibid.

One such exception applies under the law of trusts. This Court has repeatedly made clear that ERISA’s fiduciary duties are “derived from the common law of trusts.” Tibble v. Edison Int’l, 135 S. Ct. 1823, 1828 (2015) Accordingly,“[i]n determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.” Tibble, 135 S. Ct. at 1828; see Varity, 516 U.S. at 497 (explaining that trust law offers “a starting point, after which courts must go on to ask whether, or to what extent, the language of the statute, its structure, or its purposes require departing from commonlaw trust requirements”⁷

Put another way, when a trustee has breached his duties and a related loss to the plan has occurred, “he has a defense to the extent that a loss would have occurred even though he had complied with the terms of the trust.” Restatement (Second) of Trusts § 212(4) (1959) (Second Restatement)^.9

b. Applying trust law’s burden-shifting framework to ERISA fiduciary-breach claims also furthers ERISA’s purposes. In trust law, burden shifting rests on the view that “as between innocent beneficiaries and a defaulting fiduciary, the latter should bear the risk of uncertainty as to the consequences of its breach of duty.”¹⁰

ERISA likewise seeks to “protect * * * the interests of participants in employee benefit plans” by imposing high standards of conduct on plan fiduciaries. 29 U.S.C. 1001(b). Indeed, in some circumstances, ERISA reflects congressional intent to provide more protections than trust law. Applying trust law’s burden-shifting framework,which can serve to deter ERISA fiduciaries from engaging in wrongful conduct, thus advances ERISA’s protective purposes.¹¹

By contrast, declining to apply trust-law’s burdenshifting framework could create significant barriers to recovery for conceded fiduciary breaches. That is especially true if the question of causation focuses on what the particular fiduciary would have done if it had not committed the breach (as distinguished from the substantive standard of prudence, which turns on what a reasonable person in like circumstances would do, see 29 U.S.C. 1104(a)). See Third Restatement § 100 cmt. e.1/ ¹²

The fiduciary is in the best position to provide information about how it would have made investment decisions in light of the objectives of the particular plan and the characteristics of plan participants. Indeed, this Court recognized in Schaffer that it is appropriate in some circumstances to shift the burden to establish “facts peculiarly within the knowledge of” one party.¹³

Going Forward
All signs suggest that Pizarro v. Home Depot should be an easy decision for SCOTUS:

Tibble > Restatement of Trusts > Section 100, comment f

Interestingly, the Second Circuit of Appeals followed the same logic in deciding Sacerdote v. NYU¹⁴, ruling that once the plaintiff/plan participant plausibly pleads a fiduciary beach and resulting loss, the burden of proof on the issue of causation shifts to the plan spsonsor, adding that once plaintiff meets its pleading requirements, there really is no issue of causation to transfer. I agree with the Second Circuit’s logic. Yet, for legal reasons, SCOTUS needs to officially establish that the burden of proof in ERISA cases shifts to the plan spsonsor once the plaintiff plausibily pleads both a fiduciary breach and a resulting loss.

Why? Because, in the majority of cases, based on forensic analysis, I believe that in the overwhelming majority ERISA cases, plan spsosors will not be able to carry that burden. From a forensics standpoint, a simple cost-benefit analysis, such as the Active Management Value Ratio (AMVR), establishes that most actively managed mutual funds are cost-inefficient, and, thus, imprudent under the fiduciary standards set out in the Restatement.

As for annuities, a simple breakeven analysis will generally establish the imprudence of most annuities. For other annuities, a simple comparison of relative costs, including spreads, will disqualify most annuities from being prudent under both the fiduciary duty of prudence and loyalty.

The fiduciary duty of loyalty is breached when a fiduciary acts in a manner that benefits the plan sonsor personally, or a third party, at the expense of the annuity owner. The failure of an annuity to provide a commensurate return for the additional costs and risks associated with an annuity, necessarily results in a windfall for the annuity issuer or a third party, resulting in a fiduciary breach.

I expect SCOTUS to hear the Pizarro case early duing the next term that begins next October. In the interim, prudent plan sponsors will carefully review their plans to determine which proactive fiduciary risk management strategies are appropriate going forward.

Notes
1. Cunningham v. Cornell University, United States Supreme Court, Case No. 23-1007 (2025).
2.Pizarro v. Home Depot, Inc, United States Supreme Court, Case No. 24-620 (2026).
3.Solicitor General’s Amicus Brief in Brotherston v. Putnam Investments, LLC, https://www.justice.gov/usdoj-media/osg/media/1035476/dl?inline. (Brotherston amicus brief)
4. Brotherston amicus brief, 8.
5. Tibble v. Edison International, Inc, 135 S. Ct. 1823, 1828 (2015) (Tibble)/
6. Brotherston amicus brief, 8.
7. Brotherston amicus brief, 8.
8. Brotherston amicus brief, 9.
9. Brotherston amicus brief, 9.
10. Brotherston amicus brief,10.
11. Brotherston amicus brief, 11.
12. Brotherston amicus brief, 11.
13. Brotherston amicus brief, 11.
14. Sacerdote v. New York University, 9 F.4th 95 (2d Cir. 2019).

Posted in fiduciary compliance | Tagged fiduciary, fiduciary duty | Leave a comment

Fiduciary Risk Management 101: Mutual Funds

Posted on April 27, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

With all the recent SCOTUS decision in Cunningham v. Cornell University¹, there has been a lot of discussion about Prohibited Transactions and Prohibited Transaction Exemptions (PTEs). That is understandable; however, it is important for plan sponsors not to overlook the traditional fiduciary duties of fiduciary prudence and loyalty.

As a fiduciary risk management counsel, I offer fiduciary audits and plan reviews. Unfortunately, I often find that plans are unknowingly exposed to unnecessary fiduciary liability due to legally insufficient fiduciary processes. The problems are typically due to a lack of understanding as to what fiduciary status requires and/or a lack of experience and/or knowledge about certain investments.

With our clients, we stress the importance of selecting cost-efficient investment options. To help them accomplish this goal, we teach them about the simplicity and benefits of cost-benefit analysis.

Companies around the world routinely use cost-benefit to evaluate proposed projects. However, my experience has been that the financial services industry and its agents typically do not use cost-benefit analysis in evaluating investment options. Why? Because, more often than not, cost-benefit analysis will reveal that actively managed mutual fund investments are not cost-efficient when compared to comparable passivley managed index funds.

For over twenty years, I served as a compliance professional for broker-dealers and insurance companies. As I got a better understanding of those businesses, I gained a greater understanding of their “tricks of the trade,” ” and how to properly deal with them.

Several years ago, I created a simple metric, the Active Management Value Ratio™ (AMVR). The AMVR is based on the research and concepts of investment icons such as Nobel laureate Dr. William F. Sharpe, Charles D. Ellis, and Burton G. Malkiel.
/quote

The best way to measure a manager’s performanceis to compare his or her return with that of a comparable passive investment.²

So, the incremental fees for an actively managed fund relative to its incremental returns shoud always be compared to the fees for a comaprable index fund relative to its returns. When you do this, you’ll quickly see that the incremental fees for active management are really, really high – on average, over 100 of incremental returns^.3

Past performance is not helpful in predicting future returns. The two variables that do the best job in pedicting future performance [of mutual funds] are expense ratios and turnover.⁴

So, the incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fees for a comparable index fund relative to its returns. When you do this, you’ll quickly see that the incremental fees for active management are really, really high – on average, over 100% of incremental returns.

The AMVR is essentially a cost-benefit analysis using incremental cost and incremental returns, or versions thereof, in performing the analysis. Shown below are sample slides showing the basic AMVR analysis process.

Using purely nominal numbers, FCNKX’s incremental benefit does exceed its incremental costs. But a good ERISA plaintiff’s attorney will argue that a more accurate analysis of fiduciary prudence is provided by using the incremental return numbers obtained by applying Ross Miller’s Active Expense Ratio (AER), which factors in the correlation of returns between two mutual funds. Miller explains the value of his AER metric as follows:

Mutual funds appear to provide investment servicws for relatively low fees because they bundle passive and active funds together in a way that understates the true cost of active management. In particular, funds engaging in ‘closet’ or ‘shadow’ indexing charge their investors for active maangement while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have 90% of the variance in its returns explained by its benchmark index.⁵

So, essentially, the higher the correlation between an actively managed fund and a comparable index fund, the less likely the value of active management, if any, being provided by the actively managed fund.

Using the AER, an argument can be made that FSPGX is the much better choice in terms of fulfilling a plan sponsor’s fiduciary duties. The fact that FSPGX and FCNKX are offered by the same mutual fund company, Fidelity, and belong to the fund category, large cap growth, makes that analysis even more compelling. At the very least, an argument should be made that a plan sponsor should inquire into the availability of FSPGX for the plan rather than Fidelity Contrafund fund, which ironically is one of the most common mutual funds found in 401(k) plans. When I review plans, one of the first things I look for is whether Fidelity Contrafund is offered within the plan. Humble Arithmetic, as John Bogle was fond of saying.

So, if Fidelity refuses to offer FSPGX to a plan, what should the plan sponsor’s response be? A simple fiduciary risk management principle we teach our clients is that a fiduciary can never “settle.” “Settling” is the antithesis of a fiduciary’s “best interest” duty under the fiduciary duty of loyalty.

A prudent plan sponsor looking for cost-efficient options for a plan should always do an AMVR analysis using a comparable Vanguard index fund. I know various courts and judges dismiss Vanguard funds, some claiming you cannot compare “apples and oranges.”

That is absurd, simply a ruse to protect the cost-inefficient actively managed mutual fund industry. In fact, one of the primary benefits of using cost-benefit analysis in fiduciary prudence analysis is that it allows fiduciaries to compare investments based purely on an objective basis, cost-efficiency. Furthermore, Section 100 of the Restatement (Third) of Trusts recognizess the validity of comparing actively managed funds with comparable index funds.⁶ Judge Kayatta cited Section 100 of the Restatement in his opinion in Brotherton v. Putnam Investments LLC.⁷ As for Vanguard index funds specifically, Judge Sidney Stein, the well-respected district court judge for the Southern District of New Yor,k aka the Wall Street federal Court, has recognized the validity of using Vanguard index funds as comparators in forensic analysis.⁸

In the AMVR analysis shown for FCNKX and VIGAX (Vanguard Large Cap Growth Index Fund), based purely on the nominal, or publicly reported, numbers, VIGAX, is the more prudent option due to anpositive incremental risk-adjusted return (0.07) that is also less than the incremental cost between the two funds (0.51). If we base the comparison on the AER correlation-adjusted costs, the prudence of the VIGAX is even clearer (3.26 v 0.07).

In both of the comparisons shown, the correlation of returns between the two funds was 97. Surprisingly, such a high correlation of returns is not unusual today, as claims of “closet index” funds is a much-debated issue, not only in the U.S., but internationally as well. Canada and Australia have been the leaders in studying the existence and impact of closet index funds.

The AMVR itself, both the calculation and interpretation process, are very simple. Just divide the incremental cost between the funds by the incremental return between the funds. Since cost-efficiency is the goal, an AMVR score greater than 1.00 indicates that the actively managed fund is cost-inefficient relative to the comparator index fund. Actively managed funds that do not provide a positive incremental return should be automatically disqualified from consideration, since they will automatically be cost-inefficient and imprudent.

One of the “secret” benefits of using the AMVR metric is that it automatically reveals the unrewarded premium that a plan participant would be paying. That premium is common used by plaintiff’s attorneys in ERISA actions in calculating damages in a trial. An AMVR score of 1.25 would indicate a premium of 25% per share. Multiply the shares in the plan by the premium to determine the damages due to the inclusion of a particular fund within a plan.

The good news is that a plan sponsor can limit any potential fiduciary liability in connection with mutual funds and similar investment, e.g., TDFs, by using the AMVR to evaluate competing investment options for a pension plan. I used the AMVR in a case to compare the index-based version of Fidelity’s TDFs with the actively managed versions of the same TDFs.

ERISA plaintiff’s attorneys are well aware of the AMVR. Hopefully, your plan will never be involved in fiduciary litigation. However, if so, do not be surprised to see the familiar AMVR slide format at trial.

That is an absurd assertion and a ruse to protect the cost-efficient actively managed mutual fund industry. In fact, one of the primary benefits of using cost-benefit analysis in fiduciary prudence analysis is that it allows fiduciaries to compare different kinds of investments with each other based purely on cost-efficiency. Furthermore, Section 100 of the Restatement (Third) of Trusts authorizes the validity of comparing actively managed funds with comparable index funds.⁹ Judge Kayatta cited Section 100 of the Restatement in his opinion in Brotherton v. Putnam Investments LLC.

So to determine whether there was a loss, it is reasonable to compare the actual returns on that portfolio to the returns that would have been generated by a portfolio of benchmark funds or indexes comparable but for the fact that they do not claim to be able to pick winners and losers, or charge for doing so. Restatement (Third) of Trusts, § 100 cmt. b(1) (loss determinations can be based on returns of suitable index mutual funds or market indexes).¹⁰

As for Vanguard index funds specifically, Judge Sidney Stein, the well-respected district court judge for the Southern District of New York aka the Wall Street Court, has supported the use of Vanguard index funds.¹¹

In the AMVR analysis shown for FCNKX and VIGAX (Vanguard Large Cap Growth Index Fund), based purely on the nominal, or publicly reported numbers, VIGAX, is the more prudent option due to an incremental risk-adjusted return (0.07) that is less than the incremental cost between the two funds (0.51). If we base the comparison on the AER correlation adjusted costs, the prudency of the VIGAX is even clearer (3.26 v 0.07).

In both of the comparisons shown, the correlation of returns between the two funds was 97. Surprisingly, such a high correlation of returns is not unusual today, as claims of “closet index funds” is a much-debated issue, not only in the U.S., but internationally as well. Canada and Australia have been the leaders in studying the existence and impact of closet index funds.

The AMVR itself, both the calculation and interpretation are very simple. Just divide the incremental cost between the funds by the incremental return between the funds. Since cost-efficiency is the goal, an AMVR score greater than 1.00 indicates that the actively managed fund is cost-inefficient relative to the comparator index fund. Actively managed funds that do not provide a positive incremental return should be automatically disqualified from consideration, since they will automatically be cost-inefficient.

One of the “secret” benefits of using the AMVR metric is that it automatically indicates the unrewarded premium that a plan participant would be paying. That premium is a plaintiff’s attorney would use in calculating damages in a trial. An AMVR score of 1.25 would indicate a premium of 25%, or 25 basis points on each share. Multiply the shares in the plan by the premium to determine the damage due to a particular fund.

The good news is that a plan sponsor can limit any potential fiduciary liability in connection with mutual funds and similar investments by using the AMVR to evaluate competing investment options for a pension plan. The AMVR can even be used to evaluate the prudence of individual elements of TDF funds.

ERISA plaintiff’s attorneys are well aware of the AMVR. Hopefully, your plan will never be involved in fiduciary litigation. However, if so,, do not be surprised to see the familiar AMVR slide format at trial.

Going Forward
A basic understanding of the core principles set out in the Restatement (Third) of Trusts is an absolute necessity for prudent plan sponsors and other investment fiduciaries. In my opinion, three key comments in Section 90 of the Restatement, aka The Prudent Investor Rule, are shown in the box below.

We tell our clients that if they simply remember and apply these three concepts in their practices, they will greatly reduce the risk of unwanted fiduciary liability exposure. Time has proven that advice to be true.

When I think of fiduciary risk management, I think of a quote by the late General Norman Schwarzkopf. I always used this quote in my closing argument to the jury.

The truth of the matter is that you always know the right thing to do. The hard part is doing it.

Notes
1. Cunnigham v. Cornell University, Supreme Court Case No. 23-1007 (2024).
2. William F. Sharpe, “The Arithmetic of Active Investing,” available online t https://web.stanford.edu/~wfsharpe/art/active/active.htm.
3. Charles D. Ellis, “Letter to the Grandkids: 12 Essential Investing Guidelines,” https://www.forbes.com/sites/investor/2014/03/13/letter-to-the-grandkids-12-essential-investing-guidelines/#cd420613736c
4. Burton G. Malkiel, “A Random Walk Down Wall Street,” 11th Ed., (W.W. Norton & Co., 2016), 460.
5. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-49 (2007). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=746926.
6. Restatement (Third) of Trusts, Section 100, American Law Institute. All rights reserved.
7. Brotherston v. Putnam Investments, LLC, 907 F.3d 17, 31, 39 (2018). (Brotherston)
8. Leber v. Citigroup 401k Plan Investment Committee, 2014 WL 4851816.
9. Restatement (Third) of Trusts, Section 100, American Law Institute. All rights reserved.
10. Brotherston, 31, 39
11. Leber v. Citigroup 401k Plan Investment Committee, 2014 WL 4851816.

Posted in 401k compliance, 401k investments, 401k risk management, Active Management Value Ratio, AMVR, closet index funds, compliance, cost consciousness, cost-efficiency, DOL fiduciary standard, ERISA, fiduciary liability, fiduciary prudence, wealth preservation | Tagged 401k, 401k compliance, compliance, ERISA, fiduciary, fiduciary investing, fiduciary law, fiduciary risk management, Mutual funds, risk management | Leave a comment

Plan Sponsor and RIA Alert: Navigating the 78(3) Fiduciary Liability “Gotcha”

Posted on March 31, 2025 by jwatkins

James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

During a recent deposition I asked the plan sponsor if he understood the requirement under the fiduciary duties of prudence and loyalty. His answers were your basic ERISA 404(a) language. When he finished describing the duty of loyalty, I clearly surprised him when I asked, “Anything else?”

I have recently posted a number of posts about my expectation of the coming increase in fiduciary litigation involving RIAs and annuities based on their breach of their fiduciary duty of loyalty. When I inform plan sponsors, RIAs, and other investment fiduciaries that the duty of loyalty includes a duty to disclose all material facts that they knew or should have known.¹ The same “should have known” language shown in ERISA 404(a).

“Of course, the thoroughness of a fiduciary’s investigation is measured not only by the actions it took in performing it, but by the facts that an adequate evaluation would have uncovered.²(Scalia, J., concurring in part and dissenting in part)

[T]he determination of whether an investment was objectively prudent is made on the basis of what the trustee 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.” (emphasis in original))^.3

blind reliance on a broker whose livelihood was derived from the commissions he was able to garner — is the antithesis of such independent investigation. ⁴

If a plan sponsor RIA, or other investment fiduciary is not even aware of the duty of disclosure required under ERISA the duty of loyalty, as set out in section 78(3), it is reasonable to assume that the required investigation and evaluation, as well as the required disclosure of material facts, was not performed as well. Given the annuity industry’s known opposition to transparency and disclosure, that assumption is more reasonable since it was unlikely that the annuity issuer did or would provide material information such as applicable spreads and other costs. or the risks involved with a particaular type of annuity.

So, what constitutes “material information” that must be disclosed under the fiduciary duty of loyalty, as set out in Section 78(3)?

Information is ‘material’ if there is a substantial likelihood that, the disclosue of the omitted fact would have been viewed by the reasoanble investor as having significantly altered the ‘total mix’ of information made available.⁵

I am a big fan of Stanford University’s new AI platform, STORM (storm.genie,stanford.edu. I especially like the fact that STORM includes extensive footnotes, which helps in further researching, as well as a BrainSTORMing section, which provides focused answers from various experts on issues relevant to the original topic

I submitted a “material information” query to STORM. I cannot improve on the answer it provided:
/quote

“Under ERISA, the term “material” refers to any information that could affect a participant’s decision-making regarding their investments. This inlcudes details about the investment options available , the associated risks an returns, and any fees that might be incurred. The requirement emphasizes that participants mu be able to understand the risk and benefits of each option, allowing them to make choicds that align with their financial goals and risk tolerance^.6

The Department of Labor (DOL) has issued guidelines specifying the type of information that must be disclosed, which encompasses investment performance data, fee structures, and the nature of the risks associated with each investment option. Effective communication of the information is crucial for ensuring that participants can exercise informed control over their accounts and make prudent investment choices.⁷

Fiduciaries must carefully navigate the complexities of compliance with the sufficient information requirement. Failure to adequately disclose material information can expose them to legal challenges from participants, as it undermines the intended protective mechanisms of ERISA^.8

[Restatement Section 78(3) and ERISA Section (404(a) emphasize] the fiduciary duty of plan administrators to provide necessary disclosures oin a manner that allows participants to make informed investment decisions.^“9

The annuity indusry has been engaged in a campaign to convince RIAs and plan sponsors to increase their use of annuities. My concern is that in the annuity industry’s marketing materials on so-called “advisory annuities,” they have tended to focus on the compensation issue, suggesting that fiduciaries can use “advisory annuities” to increase income while avoiding legal hassles, since advisory annuities do not pay a commission. Fiduciaries cannot receive commissions or other financial compensation from third parties, as it would create conflict of interest issues. However, the compensation is far from being the only liability issues investment fiduciaries have to consider in connection with annuities.

For example, most of the annuity industry annuity marketing material to RIAs that I have seen seems to suggest that RIAs can recommend annuities to their clients, even if the client does not understand annuities, and then turn around and offer to manage the annuity for them, using management fees to make up for the loss of commissions. In the retail securities industry, this is known as “double dipping” and is prohibited. While I understand the managing variable annuities concept, no annuity advocate has explained the concept of managing FIAs, given the structure of the product and the fact that the FIA issuer typically reserves the right to unilaterally change key terms within the FIA annually to protect the issuer’s best interests

In a famous study by annuity expert, Moshe Milevsky, Milevsky determined that variable annuities were charging five to ten times the industry’s median M&E risk fee of 115 basis points (1.15%) a year, a fee five to ten the most optimistic estimate of the economic benefit of the death benefit guarantee.This raises obvious fiduciary breach issues.¹⁰In my opinion, inverse pricing is a blatant breach of an investment fiduciary’s fiduciary duties.

Insurance/annuity executive John D. Johns wrote an article in which he suggested it was time for change, as inverse pricing was counterintuitive.

Another issue is that the cost of these protection features is generally not based on the protection provided by the feature at any given time, but rather linked to the VA’s account value. This means the cost of the feature will increase along with the account value. So over time, as equities appreciate, these asset-based benefit charges may offer declining protection at an increasing cost. This inverse pricing phenomenon seems illogical, and arguably, benefit features structured in this fashion aren’t the most efficient way to provide desired protection to long-term VA holders. When measured in basis points, such fees may not seem to matter much. But over the long term, these charges may have a meaningful impact on an annuity’s performance.¹¹

As mentioned earlier, my concern is that the annuity industry’s marketing materials to RIAs on advisory annuities that I have seen could be deemed misleading and could expose RIAs to fiduciary liability unless they consider the other potential fiduciary liability issues, e.g., cost of death benefit, inverse pricing, and cost inefficiency of the subaccount offered by a variable annuity. Trying to discuss these issues with annuity advocates has proven to be extremely difficult in most cases, with such irresponsible statements such as “you cannot be a fiduciary unless you offer annuities.” Tell me you know nothing about fiduciary law without telling me that you know nothing about fiduciary law.

An example of inverse pricing would be where the annuity contract limits the death benefit to the annuity owner’s actual capital contribution. So, if the variable annuity (VA) owner’s actual contribution was only $100,000, his death benefit would be limited to $100,000. With inverse pricing, the annuity issuer typically uses the accumulated value of the VA instead of the contract’s terms. As a result, if the VA has grown to $200,000, under inverse pricing, the annuity issuer charges an annual fee based on the $200.000 accumulated value instread of the actual amount under the terms of the annuity contract. Counterintuitive indeed. Pay more to get less.

My experience has been that annuity brokers do not disclose if inverse pricing will be used in connection with the VA or explain the risdks and equitable issues involved with inverse pricing. This would appear to be a clear fiduciary breach under Restatement Section 78(3).

As for cost-efficiency of a VA’s subaccounts, I have never seen a case where the plan sponsor, RIA, or other investment fiduciary says that each subaccount was compared to a comparable index fund to determine the cost-efficiency of the VA subaccounts. I believe a case can be made that such information would consitute “material information” under 78(3) and the fiduciary duty to perform an independent investigation and evaluation of each investment option, as well as offering cost-inefficient subaccounts is clearly not in the best interests of a plan participant or RIA client.

During my time as a compliance director, first as an RIA compliance director, then as a general securities compliance director, the brokers all wanted to be approved to exercise discretion so they could offer to manage annuities for a fee, providing for a steady sourve of annual income rather than look for new customer s each year.

FIAs Why Go There At All
In a recent opinion involving the Retirement Security Rule , Chief Judge Barbara M.G. Lynn summed up the fiduciary issues with FIAs, stating that
/quote

The DOL described the complexity of FIAs (fixed indexed annuities) in its Regulatory Impact Analysis (“RIA”). The RIA explained that FIAs generally provide “crediting for interest based on changes in a market index,” but noted there are hundreds of indexed annuity products, thousands of index annuity strategies, and that “the selection of the crediting index or indices is an important and often complex decision.” Further, there are several methods for determining changes in the index, with different methods resulting in varying rates of return. Rates of return are also affected by “participation rates, cap rates, and the rules regarding interest compounding.” Because “insurers generally reserve rights to change participation rates, interest caps, and fees,” FIAs can “effectively transfer investment risks from insurers to investors.” The DOL found that FIAs may offer guaranteed living benefits, but such benefits “may come at an extra cost and, because of their variability and complexity, may not be fully understood by the consumer.” The DOL also cited the SEC, which recently stated, “[y]ou can lose money buying an indexed annuity … even with a specified minimum value from the insurance company, it can take several years for an investment in an indexed annuity to break even.¹ (emphasis added)¹²

Purchasing an annuity, or any investment for that matter, that allows the issuer to annually change the interest rate to be credited and/or other key terms of the investment unilaterally, to effectively shift all investment risk to an investor, makes absolutely no sense. Talk about being counterintuitive.

As Judge Lynn pointed out, FIAs allow the FIA issuer to shift the total risk of loss to the annuity owner.This, on top of the fact that it is unlikely that the annuity issuer has disclosed the spreads that will be used to further reduce the annuity owner’s realized return, is a fiduciary breach action waiting to happen. Any argument suggesting that FIAs are in the best interest of the FIA owner is simply disingenuous and an attempt to justify a fiduciary breach. This is clearly information that would qualify as “material information, as it would definitely impact an investor’s decision in deciding on whether to invest in an FIA.

When it comes to FIAs, the question is why go there at all. Neither ERISA nor any other law requires plans to offer annuities of any type. Academic studies claim plan participants want the income that annuities provide. From a fiduciary risk managment perspective, the plan sponsor’s response should be “so what. ” An investment fiduciary in under no obligation to expose themselves to unnecessary fiduciary risk. Furthermore, plan participants interested in annuities can always purchase annuities outside of the plan, without exposing the plan sponsor to fiduciary risk.

The most obvious and effective risk management strategy is to totally avoid risk whenever possible. Toward that goal, I teach my fiduciary risk management clients a simple two-question process.

(1) Does ERISA or any other law explicitly require you to offer the investment option? ERISA does not explicitly reuuie a plan to offer specific type of investment. Therfore, under current law, the answer to question will always be “no.”

(2) If the answer to question number (1) is “no,” could offering the investment in question possibly expose the plan to unnecessary fiduciary liability?

Since we already know that the answer to the first question is “no,” we can focus purely on the fiduciary risk management issues presented by the second question, what I refer to a the “why go there” issues. Academic studies often argue the interest in annuities from plan participants and the alleged benefits of increased retirement income. From a fiduciary risk mangement perspective, since there is no legal requirement that fiduciaries expose themselves to unnecessary fiduciary risk, a decison to do so would clearly be imprudent. What the academics conveniently refuse to to addess is that a plan participant can easily purchase an annuity outside of the plan, without exposing the plan to unnecessary risk exposure. Why do academics and annuity advocates fail to address the annuity options out of the plan? My theory is that they do not discuss the availability of annuities outside of a plan for the same reason that the annuity industry has targeteted in-plan annuties.

The annuity industry desperately wants greater access to the significant sums in 401(k) plans and other retirement accounts. However, the fact is that annuities, especially guaranteed lifetime income annuities, in their presenrt form, are the antithesis of both fiduciary prudence and fiduciary loyalty. Unless and until the annuity industry acknowledges and properly addesses the legitimate fiduciary liability issues with annuities, in their current form, investment fiduciaries should ignore annuities altogether, especially guaranteed lifetime income annuities.

As for FIAs, simple common sense indicates that FIAs are not a prudent fidiciary investment choice for a number of reasons. First, explain the prudence of investing in a product where the issuer reserves the right to unilaterally change the annuity interest rate and other key terms annually, to effectively shift the entire burden of risk from the insurer to the investor. This simply ensures that the annuity issuer can protect their best interest instead of the annuity owners, a clear breach of fiduciary duties. Secondly, as Judge Lynn pointed out, it allows the annuity issuer to shift all of the risk from the insurer to to the FIA owner. But I’m sure the annuity issuer disclosed all of those risk consideration when they made the required disclosures pursuant to their fiduciary duty of loyalty under 78(3).

An even more basic question is whether FIAs are an inherent breach of a plan’s fiduciary duty of prudence. There is ample evidence that suggests that the structure of FIAs prevents FIAs from being a prudent investment choice. William Reichenstein, a chaired finance professor at Baylor University, has done extensive research on the fiduciary issues associated with FIAs..His conclusion

Because of their design, managers of indexed annuities cannot add value through security selection, they buy Treasury securities and index options, but do not engage in in indovidual security selection….By design, the IA wil produce returns that trail benchmark portfolio by the average spread.¹³

For the indexed annuities, the question is whether they offer competitive risk-adjusted returns. On average, their returns must trail those of the risk-appropriate benchmark portfolio of Treasurys and index funds[s} by their annual expense. Since by design, indexed annuities cannot add value through security selection, all indexed annuities must produce risk-adjusted returns that trail those avaialble on the risk-appropriate portfolio. Their structure ensures this outcome.¹⁴

Further support for this conclusion is provided by a Mass Mutual study when EIAs, nka FIAs, were first introduced. Mass Mutual’s findings –

“over a 30 year period ending December 2003. the equity-indexed annuity would have delivered just 5.8 percent a year, far below the 8.5 perent for the S&P 500 without dividends and 12.2 percent for the S&P 500 with dividends, reinvested. Indeed, annuity investors would have been better of in super-safe Treasury bills,which delivered 6.4 percent a year.¹⁵

When one considers the various costs and return restrictions imposed by FIAs, a common sentiment among objective observers seems to be expressed by an article entitled “Equity Indexed Annuities: Downside Protection, But at What Cost?”

Each EIA (equity-indexed annuity) has so many moving parts that are under the discretion of the issuing insurer that it is difficult to determine whether company A’s EIA strucure is better or worse than company B’s.¹⁶

As a plaintiff’s attorney, my concern is that such issues and risks will not be disclosed to plan participants, as required by the fiduciary duty of disclosure and loyalty. Disclosure and transparency are the annuity industry’s kryptonite, as it would expose the serious fiduciary issues such as arbitrary and excessive costs and the true impact of caps and other articial and self-serving restrictions on an investor’s end returns. Collectively, these issues are why I constantly remind my fiduciary clients to pause and ask themselves – “Why go there?”, which, in the case of annuities, especially guaranteed life income annuities, ultimately leads to a decision of “Don’t go there!”_

My advice on navigating the 78(3) disclosure requirements and the inherent breach of fiduciary duty of loyalty traps – Don’t even try. Without the spread information for an annuity, plan sponsors and other investment fiduciaries set themselves up for a per se fiduciary breach since they cannot properly perform the required independent investigation and evaluation or the disclosure of material information required by ERISA and 78(3). Better to just avoid annuities and FIAs altogether, since not legally required. To quote Jack Welch, “Don’t make the process harder than it is.” If something is neither required by ERISA or some other law or regulation – “Don’t go there!” As I tell my clients, Keep it simple and smart”

Update: After I published this post, I had numerous responses asking me where to find the Restatement, Third, Trusts and/or to publish the exact languauge from Section 78(3). The American Law Institute (ALI) is the publisher of the Restatement, which is protected by copyright law. I had submitted a request to publish the exact language and the ALI has graciously granted permission for me to do so. Section78 (3) states as follows:
/quote

(3) Whether acting in a fiduciary or personal capacity, a trustee has a duty in dealing with a beneficiary to deal fairly and to communiacte to the beneficiary all material facts the trustee knows or should know in connection with the matter. (emphasis added)

Restatement of the Law, Third, Trusts, copyright © 2003-2012 by The American Law Institute. Reproduced with permission. All rights reserved.

Pretty powerful little provision in terms of fiduciary risk management. And yet, based on my experience, very few investment fiduciaries have ever read Sections 77, 78, 90 (aka The Prudent Investor Rule), or 100 of the Restatement. So, further support for following my three-prong annuity investigation/evaluation approach before considering or adding any annuity to a plan.

The courts have consistently stated that costs qualify as “material information.” As mentioned in the post, per the DOL and GAO, over a twenty year period, each additional 1 percent in fees, cost or anything thst reduces an investor’s end return, e.g., spreads, reduces an investor’s end return by approximately 17 percent. A common 2 percent spread would project to a 34 percent loss, more than one-third , of the value of the investor’s account. Still think it’s not important to make the annuity salesman provide written information on spreads and cumulative costs?

Plan sponsors, share this post with your plan’s investment commitee. As leading ERISA attorney, Fred Reish, likes to say, “forewarned is forearmed.”

Notes
1. Restatement Third, Trusts Section 78(3).
2. Fink v. Nat’l Bank and Trust, 772 F.2d 962
3. In re Unisys Sav. Plan Litigation, 74 F.3d 420, 436 (3d. Cir. 1996)
4. Liss v. Smith, 991 F. Supp. 278, 299 (S.D.N.Y. 1998). (Liss), In re Enron Corp. Securities, Derivatives, and ERISA Litigation, 284 F. Supp. 2d 511, 546 (N.D. Tex 2003)
2. Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983
5. Basic v. Levinson, 108 S. Ct. 978, 983 (1988)
6. STORM IA analysis (STORM)
8. STORM
9. STORM
10. Moshe Milevsky and Steven E. Posner, “The Titanic Option: Valuation of the Guaranteed Death Benefit in Variable Annuities and Mutual Fund,” Journal of Risk Management and Inssurancce, Vol. 68, No. 1, (2009), 91-126, 92.
11.John D. Johns,”The Case for Change,” Financial Planning, 158-168, 158 (September 2004) (Johns)
12. Chamber of Commerce of the United States, et. al. v Hugler, 231 F. Supp. 3d 152 (N.D. Tex. 2017) (Lynn decision), 187
13. Reichenstein, W. (2009), “Financial Analysis of Equity Indexed Annuities,” Financial Services Review, 18, 291-311, 303 (Reichenstein)
14. Reichenstein, 303
15. Jonathan Clements, “Big Insurers Avoid Equity-Indexed Annuities, Wall Street Journal, (as published in Pittsburgh Post Gazette), January 14, 2006.
16. Collins, P.J., Lam, H., & Stampfi, J. (2009) “Equity indexed annuities: Downside protection, But at What Cost? Journal of Financial Planning,” 22, 48-57.

Posted in 401k, 401k compliance, 401k investments, 401k litigation, 401k plan design, 401k plans, 401k risk management, 401klitigation, 404(a), Annuities, compliance, ERISA, ERISA litigation, fiduciary, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary risk management, fiduciarylitigation, pension plans, plan advisers, plan sponsors, prudence, retirement plans, RIA, RIA Compliance, RIA marketing, risk management | Tagged 401k, 401k compliance, 401k fiduciary, 401k litigation, 401k plans, Annuities, compliance, ERISA, fiduciary, fiduciary law, investment advisers, plan sponsors, RIA compliance, RIA marketing, RIA risk management | 1 Comment

The Prudent Investment Fiduciary Rules

Closing Argument: Humble Arithmetic, Common Sense, and Fiduciary Responsibility vs. In-Plan Annuities

DOL Advisory Opinion 2025-04A: Don’t Be Stupid!

3 Things Prudent Plan Sponsors Must Understand About President’s Trump’s Executive Order and Fiduciary Risk Management

“And Their Beneficiaries”: Annuities, Commensurate Returns, and Fiduciary Liability

May It Please the Court: Closing Argument on Palsgraf, Annuities, Commensurate Return and the Future of Fiduciary Litigation

Pizarro v. Home Depot and the Future of ERISA Litigation

Fiduciary Risk Management 101: Mutual Funds

Plan Sponsor and RIA Alert: Navigating the 78(3) Fiduciary Liability “Gotcha”

Email Subscription

Meta

Recent Posts

The Prudent Investment Adviser Rules

Follow Blog via Email