The Easiest Way to Reduce Personal Fiduciary Liability for Plan Sponsors and Other Non-Professional Trustees

(The following is the first in a five-part series of articles devoted to helping fiduciaries, especially individual trustees and ERISA plan sponsors, best align investment goals with beneficiaries’ needs.)

Congratulations again. You are among the few to be chosen to serve as an individual trustee, director, officer or, more generally, fiduciary. We have discussed the importance of the role (see “The Role and Responsibilities of the Individual Trustee,” FiduciaryNews.com, August 7, 2012). Certainly, we do not need to talk about the prestige of the position. Before we get too consumed with the good news, we need to bluntly reveal the bad news.

If you, as an individual fiduciary, fail to meet the needs of the beneficiaries in any manner, you may be held personally liable for such failure. Remember, as an individual trustee, the most you may be able to do is to share that liability. You may never be able to fully remove your personal liability. In practical terms, your investment adviser may choose to make inappropriate investments and render the trust unable to provide for the beneficiaries as intended. You may think, “Well, that’s the investment adviser’s problem.” Wrong. Sure, the investment adviser may be sued, but nothing prevents the beneficiaries from suing the trustees. After all, the trustees have responsibility for selecting the investment adviser in the first place.

There may be some heartening news. However, beginning in the 1990’s with the advent of the new Prudent Investor Laws as well as certain pronouncements of government regulators (namely, the Department of Labor), individual trustees can greatly reduce or even remove personal liability as it pertains to investment management. In fact, it’s incredibly easy. Given the anxiety caused by selecting investments, it’s clear individual trustees, like, for example, the average 401k plan sponsor, still haven’t grasped just how stress-free they can make their job.

To reduce fiduciary liability in this area, the individual trustee will need to hire a professional investment adviser. After all, you can’t remove fiduciary liability for a particular function if you continue to perform the function. No, that function needs to first be outsourced to a qualified professional. In the case of the Uniform Prudent Investor Act, this generally means hiring a registered investment adviser (RIA). In the case of ERISA plans, the plan sponsor will need to hire a fiduciary, which, given the confusion caused by dual registration, may or may not be a RIA. (One potential way plan sponsors can insure this is not a problem is to only hire RIAs who are not dual registered, but there are plenty of dual registrants who can also act as a fiduciary.)

But the mere hiring of the professional investment adviser does not alone insure a reduction in fiduciary liability. No, the individual trustee must also produce sufficient documentation to provide evidence of proper and comprehensive due diligence in both the initial selection and the ongoing monitoring process. No regulatory body has ever defined the selection and monitoring process. It’s generally understood such documentation must be thoroughly understood by the individual trustee, faithfully executed by the individual trustee and consistently applied by the individual trustee. Certainly, having a structured selection and monitoring process, such as outlined in Due Diligence: The Individual Trustee’s Guide to Selecting and Monitoring a Professional Investment Adviser, may prove helpful to the individual trustee. If you work in the non-ERISA world, you may be subject to additional state laws regarding trust. In such cases, it’s always wise to consult a trust attorney familiar with the trust laws in that specific state.

It might seem the job is done once the selection and monitoring process of the RIA has been implemented, but it is not. Whether subject to state trust law or ERISA trust law, the primary duty of a trustee remains to provide for the beneficiaries as defined by the trust document (yes, ERISA plans are trust documents). The (perhaps most important) task for the individual trustee, then, is to best align the appropriate investment goals with the trust’s beneficiaries. In fact, you’d want to have this done either prior to or in conjunction with hiring the RIA.

You may think all you have to do is to follow the instructions of the trust document. Again, this is a naïve notion. Today’s trust lawyers have a greater understanding of the need for flexibility when it comes to investments. More significantly, today’s government legislators understand that very same need. In the past, state governments (state law governs most personal trusts) restricted the types of investments a trust might purchase. For a long time, trusts were not permitted to buy common stocks. This has changed. State and federal laws (federal law governs most employee benefit plans) now permit a broad array of investments. Indeed, Section 404(c) requires all 401k plans to offer at least three options, each with their own “materially different risk and return characteristics.” While this generally refers to investment style – something very different than investment goal – it can also mean investment goal; therefore, a single 401k plan may include investment options support three different investment goals.

With little or no guidance from the law and the trend toward broadly written trust documents, the individual trustee must consciously choose the appropriate investment goal (or goals, in the case of 401k plans). The trust document states the intention of the trust (e.g., to maintain the standard of living for a decedent’s spouse or to pay the ongoing expenses of a non-profit institution or to provide sufficient income in one’s retirement). The individual trustee must determine the investment goal(s) most suitable for meeting the trust’s intention. This documentation is essential for the individual trustee to reduce his personal fiduciary liability. This is the document that becomes the foundation of the trust’s Investment Policy Statement.

Before we begin our discussion of choosing the appropriate investment goal, we will need to explore some common investing mistakes. After all, “winning by not losing” stands out as one of the cornerstones of successful investing. By avoiding the obvious pitfalls faced by investors, the individual trustee will possess an investment portfolio more likely to meet the necessary investment goals.

Part I: The Easiest Way to Reduce Personal Fiduciary Liability for Plan Sponsors and Other Non-Professional Trustees
Part II: Experts: 3 Common Investor Mistakes All Retail and 401k Investors Should Avoid
Part III: A Better Way to Help 401k Investors Choose Among Options
Part IV: A How-To Guide: Investing Using the Total Return Method or the Assigned Asset Method
Part V: The Choice 401k Investors Must Make Before They Choose

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.