Fiduciary Checklists for Monitoring Major Risks to 401(k) and Other Plan Investments

For nearly a decade, there has been an escalation in the fiduciary demands
— and personal liability risks — associated with the monitoring of
401(k) and other retirement plan investments.  Corporate officers and directors should consequently establish practical systems for tracking both the investment performance of plan assets, and
new developments in governmental regulation and ERISA litigation. The
best approaches that we see tend to center on quarterly meetings that
include reports from plan administrators, investment professionals, and
legal counsel.

Employer representatives nevertheless need to stay on guard; to not settle for
superficial assurances of sound operations. With that in mind, presented
below are two checklists focused on the monitoring of plan investments.
The first takes a macro view, itemizing common issues that warrant a
deeper dive for fiduciary understanding. The second relates solely to
target date funds, in order to assure attention to eight items that the
Department of Labor identified in a notice issued earlier this year.

Checklist #1: Plan Investment Issues to Consider

?   1.  Section 404(c) Compliance. Fiduciaries
of 401(k) and other defined contribution plans that have
participant-directed investments should verify that the plan satisfies
the requirements of Section 404(c) of ERISA.  If these requirements are
met, the plan’s fiduciaries will not be personally liable for . . . continued at ERISA 404(c) Safe Harbor.

? 2.  Excessive Fees, and Cost-saving Alternatives. Over
the past several years, there has been a proliferation of ERISA cases
alleging that plan fiduciaries paid unreasonably high fees for
investment funds that they offered for participant-directed investments.
See Excessive Fee Litigation. As
a result, plan fiduciaries should beware of and regularly review the
fees and expenses that the plan pays for its investments. See Fee Disclosure Rules. For one cost-saving alternative, see Separately-managed Accounts under Investments.

?   3.  Target Date Funds. The
Department of Labor has provided detailed “tips” that place plan
fiduciaries on notice about issues to address for any target date funds
within their 401(k) and other retirement plans. See “Checklist #2 below
for a link. Further discussion of diligence requirements, and relevant
litigation, at Target Date Funds.

?   4.  Stable Value Funds. Although
these funds are often described as “safe” investment choices for
participants, they typically consist of one or more fixed income
portfolios that a bank or insurance company provides through a “wrapped”
contract.  A stable value fund’s suitability as a “safe” investment
may, however, be undermined by (i) investments in mortgage-backed
securities and other toxic investments, (ii) securities lending by the
fund, with the consequent risks noted above, and (iii) any financial
distress that the current economic crisis causes for the insurance
company or bank that provides the wrap contract. More information at Fixed Income Investments.

?   5.  Money Market Funds. A
critical operational feature of money market funds involves maintaining
a share value of one dollar.  The 2008 financial crisis caused some
share values to risk falling below one dollar (so called “breaking the
buck”), with desperate measures resulting in the form of calls on the
plan sponsor for added plan contributions, and for the money market fund
manager to impose unexpected moratoriums on customer withdrawals (in
order to buy time for the dollar value to be re-established). More information at Fixed Income Investments.

?   6.  Employer Stock. Ever
since the Enron collapse over a decade ago, downturns in the value of
employer stock funds have been stirring “employer stock drop” litigation
against 401(k) and other defined contribution plan fiduciaries. Those
who serve as corporate executives and as plan administrators or trustees
face the greatest risks, because the information they receive as
executives opens the door for second-guessing about whether they
breached their ERISA loyalty and prudence rules. The litigation risks
are even greater for Employee Stock Ownership Plans, because executives
are often plan trustees and significant stockholders — with the power
to steer executive compensation in ways that can lead to conflicts of
interest. For further information, see Employer Stock Funds.

? 7.  Mortgage-Backed Securities.
Some fund managers became overexposed in collateralized debt
obligations or CDOs and other non-agency rated mortgage-backed
securities that are now illiquid and difficult to value.  Some of these
funds have fixed income or other investment objectives that could be
viewed by participants as inconsistent with this approach. More information at Investments.

  • 2013.Apr.03 Mere Investment Losses Insufficient for ERISA Claim. The decision in PBGC v. Morgan Stanley
    begins by explaining that “the complaint relies on the decline in the
    market price of mortgage-backed securities . . . to suggest a reasonable
    investor would have viewed those securities as imprudent investments.”
    The 2nd Circuit dismissed that ERISA claim. Further discussed at Investment Monitoring.

?   8.  Securities Lending.
Many mutual funds, collective trusts and investment managers of
separately managed accounts engage in securities lending.  Securities
lending involves he short-term loan of securities from a retirement plan
to short sellers and other borrowers in exchange for cash collateral.
The cash collateral is then invested in “safe” investments such as
Treasury bills and money market funds, with the goal of achieving a rate
of return that is split among the investment fund, the lending agent,
and the borrower.  However, losses can occur from this, and . . . continued at Investments.

? 9.  Fraud or Misconduct by Fund or Advisor.
The Bernard Madoff scandal showed that Ponzi Schemes and other
investment fraud may fool financially sophisticated individuals and
their professional investment advisors.  Plan fiduciaries should review
their plan investments to make sure that due diligence has been
performed that would detect fraud.  For example, custody of assets and
purported investment holdings should be independently verified.

? 10.  Mistakes and Misconduct by Employer’s Fiduciaries. See generally Failure to Monitor / Diversion of Assets / Misleading Communications (with plan participants).