by Fred Reish
The U.S. Supreme Court recently decided the Northwestern University case. In that decision, the Court interpreted the fiduciary rules for retirement plans to require that plan fiduciaries prudently monitor plan investments. The Court’s decision was unanimous.
The Court further decided that, when fiduciaries determine that a plan investment no longer can be prudently offered to the participants, they must remove the investment within a reasonable time.
As a result, the “law of the land” is that plan sponsors, acting as fiduciaries for their plans, must monitor the plan investments at appropriate intervals and, when an investment no longer is prudent to offer to the participants, that investment must be removed from the plan.
What Does Monitoring Require
But, plan sponsors—and their officers and committee members who make plan decisions—may not know how to fulfill the fiduciary responsibility to regularly monitor plan investments. That is, what are the steps necessarily to prudently monitor investments? In essence, the process for monitoring plan investments is similar to the process for selecting investments. Fiduciaries, with the help of their advisors, need to gather and assess the information necessary to make informed decisions about the quality of the investment managers. Past performance is part of that information, but there is more than that. A critical question is, does the manager have a good track record, and can it reasonably be expected to continue in the future? The purpose of monitoring is not to look backwards. While past performance may support a determination that the manager has been doing a good job, the fiduciary responsibility is to look forward . . . will the investment manager generate superior results in the future, in light of the risk and return profile of the investment? It’s difficult to do that kind of qualitative evaluation without the help on an experienced and knowledgeable advisor.
Another critical issue for the selection and monitoring of plan investments is whether the investment’s expenses are reasonable, compared to the range of investments available to a plan of that size? For example, a $5 million plan may only have access to retail mutual funds, with their higher cost structure. However, a $100 million plan can probably obtain virtually identical investments with lower costs. These cost differentials are often described as “share classes,” where investors with more money can get less expensive share classes. If a plan sponsor doesn’t know how to get information about the share classes that are available to plans of different sizes, it should seek professional advice. The share class issue may be the single most common issue raised in fiduciary litigation.
The Monitoring Process
The selection and monitoring process involves several steps:
- The first is to obtain the information necessary to make an “informed” decision. In other words, a plan fiduciary has to have the information about the investments that a person who is knowledgeable about investments would want to review. The first part of this article discusses some of the most important information that a fiduciary should have . . . past performance of the investment, a qualitative assessment of the investment manager, and the available share classes.
- The second step is to make a thoughtful evaluation of that information. However, the evaluation standard is not that of a lay person, but instead it is that of a knowledgeable investor. Where the fiduciaries—the company officers or committee members—are not investment “experts,” they should seek the advice of an independent, experienced investment consultant. Courts often point to the used of experienced advisors as being evidence of a prudent process.
- The third step is to reach an informed and reasoned decision. “Informed” means that the fiduciaries obtained and reviewed the needed information. To the extent that some of that information requires skills that the fiduciaries do not have, the courts expect fiduciaries to turn to knowledgeable advisors. “Reasoned” means that the decision has a thoughtful, reasonable connection to the information reviewed and the advice received.
- The final step is to implement the decision. For example, this step means that, if the monitoring process revealed that an investment was not prudent to retain, the investment would have to be removed from the plan (and possibly be replaced by a better qualified investment).
The steps are, in combination, a “prudent process.” That is what the law requires. In the Northwestern University case, the Supreme Court recognized that fiduciaries have a hard job and may have to make difficult decisions. As result, courts will defer to plan fiduciaries if they engage in a prudent process to make their decisions.
One more comment . . . the Supreme Court specifically said that imprudent funds had to be removed from the plan. In the past, some plans have “frozen” popular investments when the fiduciaries lost confidence in them and added a new investment of that type to the plan. (A “freeze” is where no new money can be added to a plan, but the “old” money can stay in the investment.) The Supreme Court decision said that imprudent investments had to be removed and did not say that those investments could stay in the plan if they were frozen. As a result, a conservative practice would be to remove all investments that are no longer thought to be superior alternatives for the participants. There is now some risk to keeping frozen investments in a plan.
Concluding Thoughts
The Supreme Court’s decision is clear . . . plan fiduciaries must regularly monitor all of the investments that a plan offers to participants. If the fiduciaries determine that an investment cannot be prudently retained—because, for example, of a loss of confidence that it will provide superior results in the future or because the investment is too expensive for a plan of that size—the investment must be removed from the plan in a reasonable time. While the Court didn’t define a “reasonable” time, the safe answer is that it should be removed as soon as administratively feasible (considering, among other things, the need to communicate with participants). Practically that could mean that the investment should be removed within a few months of the determination that it was no longer prudent to be in the plan.
This content was authored by Fred Reish. Fred Reish is a partner with the law firm of Faegre Drinker who specializes in retirement law, focusing on fiduciary and best interest standards of care, prohibited transactions, conflicts of interest, and retirement plans.
The views expressed in this article are those of Fred Reish, and not necessarily of Faegre Drinker or HUB International. The article is for general information only and is not intended to provide investment, tax or legal advice, or recommendations for any particular situation. Please consult with a financial, tax or legal advisor on your circumstances.
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