The scope and substance of a fiduciary’s duty to monitor those persons it appoints to carry out plan-related functions is becoming an issue in several contexts. The fiduciary’s ongoing duty to monitor the prudence of investment decisions was the issue the Supreme Court sent back to the lower court in the recently decided Tibble case . Monitoring the cost of record-keeping services was a key element in the Tussey decision . And it is one of the major issues in outsourcing – after a sponsor outsources plan-related functions, what is its ongoing, ‘residual’ review obligation?
The law on the duty to monitor is, currently, abstract – we know some basic principles, but how they apply to specific issues (relevant to, e.g., fees or outsourcing) is, as yet, not very well articulated. In this article we review those basics, identify some key duty-to-monitor issues for sponsors and some monitoring strategies that sponsors may consider. In follow-on articles we will discuss how the application of those principles may play out in some typical contexts – plan investments, revenue sharing arrangements, and outsourcing.
Our focus will be primarily on DC plans. That’s because, in DC plans, losses – e.g., due to imprudent investments or excessive fees – reduce participant account balances, and participant losses create plaintiffs. In DB plans, losses are typically (although not always) made up by the sponsor and, for that reason, less likely to result in litigation. The principles, however, in both cases are the same.
And, as always, our focus will be on sponsor fiduciaries.
What is prudence (generally)?
The duty to monitor is an instance of the fiduciary’s more general duty under ERISA to ‘be prudent’ – to make prudent decisions on behalf of the plan. Here, in full, is ERISA’s prudence standard:
Obviously, this standard is abstract, but it is not empty. You might boil it down to the following questions:
If this were my money, would I, taking into account the relevant facts and circumstances, consider this decision prudent?
Compared to what?
Prudent evaluation of a fiduciary decision is, always, relative. That is, in effect, the importance of the clause “under the circumstances then prevailing” in ERISA’s prudence standard.
Performance is tested relative to a benchmark. Cost is not simply a matter of, e.g., choosing the ‘cheapest’ fund; cost is always relative to what other consumers are paying for the same product/service (the ‘market price’). Competence is generally determined by the standards of the relevant community (e.g., the investment or service provider community).
What is ‘monitoring?’
According to the Supreme Court, the duty to monitor “exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset. The Bogert treatise states that ‘[t]he trustee cannot assume that if investments are legal and proper for retention at the beginning of the trust, or when purchased, they will remain so indefinitely.'”
In a sense, the monitoring/review process is an extension of the selection process; the same issues considered in the selection process will be relevant in the review process. Nevertheless, it’s probably fair to say that, absent special circumstances, the monitoring process need not be as thorough as the selection process. For instance, while initial selection of a record keeper may involve a full RFP process, ongoing review would typically require at most an RFI. (Of course, the point will at some point be reached when another RFP must be undertaken.)
Finally, facts and context will matter a lot.
What to monitor
Under ERISA, any exercise of discretion by a fiduciary must be prudent. If that discretionary decision has an ongoing effect on plan performance, then the fiduciary has a duty to ‘monitor’ (i.e., review) it. Thus, fiduciaries have a duty to monitor investment decisions because they affect the ongoing performance of the plan. In a DC plan, key ‘things to monitor’ include:
Selection of plan investments and investment managers . This was, for instance, the issue in Tibble : “Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones.” [Emphasis added.] Under ERISA, the decision to invest plan assets in a mutual fund is generally understood to be a selection of a plan investment in the shares of the mutual fund, rather than as the selection of the mutual fund manager. Some ‘plan investments’ (e.g., selection of a collective trust and separate account) are more properly characterized as a selection of an investment manager.
Selection of plan service providers . The duty to prudently select and monitor is not limited to fiduciary functions. As DOL said in the investment education interpretive bulletin (IB 96-1):
The Tussey fiduciaries were found to have failed to monitor the cost of (non-fiduciary) plan record keeping services.
What to monitor for
Stated abstractly: plan fiduciaries should focus on all factors that will affect the participant’s ability to achieve her retirement savings goals. With respect to the selection of any particular fund/manager/service provider, those factors certainly include: performance, cost, competence and suitability.
The initial selection decision should, ideally provide a roadmap for the monitoring process. A particular fund/manager/service provider was selected for a set of reasons: performance history, relative cost, the competence of the manager and its role in the plan’s portfolio/service suite. The review process should establish, with some reasonable and practical degree of certainty, that the fund/manager/service provider continues to meet those criteria.
Assuming that the initial selection decision was prudent, subsequent ‘monitoring’ is generally about the evaluation of changes in the relevant circumstances. If nothing had changed since the original selection, there generally would be no need for a review. So a good question to begin the monitoring process with is: what has (or may have) changed since the original decision was made? There are three areas where change will obviously matter:
Has the investment fund/manager/service provider or its performance changed? Is the manager sticking to the stated investment style? Have managers left? Are quality targets being met? Are performance targets within an acceptable range?
Has the market changed? As we said, prudence decisions are always made ‘compared to what?’ If, for instance, the cost of record keeping services in the market have gone down, then a review of what the plan is paying for those services (compared to the new market conditions) may be in order.
Where the initial selection is imprudent
We note, however, that even where there is no ‘significant’ change in any circumstances there is still an ongoing obligation to review the prudence of prior selection decisions. (As a practical matter, this question generally only comes up where ERISA’s six-year statute of limitations would otherwise bar claims with respect to the initial decision.)
The extent of the required review in ‘unchanged circumstances’ is, more or less, the question the Supreme Court remanded to the lower court in the Tibble case. We should get some guidance on that question when the lower court makes its decision.
Frequency of review
One very obvious question is, how often should prior decisions be reviewed? The standard answer is ‘regularly.’ Practically, the frequency of review should reflect the dynamics of the conditions affecting the review decision: plan needs, performance and relevant market. If those conditions are relatively stable, there may be circumstances in which an annual review would be prudent. If, e.g., the market is rapidly changing, more frequent (quarterly or even monthly) review would be required.
Prudence as process – and documentation
As the courts have said time and again, prudence is about having the right process. Thus, with respect to the duty to monitor, the most important thing is to have a process for monitoring the ongoing prudence of prior decisions. But the second most important thing is to be able to document that process: to be able to prove (e.g., via committee minutes) that the relevant fiduciary (e.g., the plan’s investment committee) reviewed, on an adequately regular basis, plan-related decisions, considering the relevant issues, e.g., performance, cost, competence and suitability, and the relevant circumstances, e.g., changes in plan needs, changes in the provider or provider performance and changes in the market.