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Fiduciary Update

Fiduciary Update | February 2017

In this quarter’s Fiduciary Update, CAPTRUST’s Drew McCorkle provides an update on the uncertainty around implementation of the DOL’s conflict of interest rule, addresses recent fee and related plan litigation, and reports on topics including cybersecurity and lifetime income.

Fiduciary Expansion: Uncertain Future and Possible Next Steps

While the Department of Labor’s expansion of activities covered by ERISA’s Conflict of Interest Rule is scheduled to become applicable beginning April 10, President Trump issued a memo on February 3 directing the acting Secretary of Labor to reevaluate the impacts of the new rule. The memo did not mandate a delay to the applicability date. Instead, it directed the DOL to reevaluate the rule and prepare an updated economic and legal analysis. Immediately following the memo’s issuance, the DOL issued a statement that it is evaluating its legal options to delay the applicability date of the rule. On February 9, the Office of Management and Budget (OMB) acknowledged receipt of proposed rulemaking from the DOL which delays the applicability date for 180 days past April 10.

As of this writing, the OMB has not finalized its review of the proposed rulemaking and released it to the DOL when presumably some shortened public comment period will be opened—after which the DOL will review these comments and promulgate the updated rule ahead of April 10. In short, a six-month delay seems likely. However, beyond that, likely regulatory scenarios are difficult to handicap, but possibilities include:

  • Portions of the rule will be modified or amended and
  • Replacement or repeal of the rule.

In the courts, several of the lawsuits filed last year challenging the new rule have been resolved in favor of the Department of Labor—with no change to the rule.

In spite of the likely delay, most retirement plan providers are waiting until such a delay is final and are working toward the April 10 initial applicability date as they were before the President’s memo. Delivery of participant services is the area most likely to be affected, with providers taking different positions on whether they will assume a fiduciary role. As a result, plan fiduciaries should understand the roles their providers will assume under the new rule, along with any limitations, and expect any contract changes set to go into effect as scheduled.

Some vendors have issued contracts to reflect their updated service models that would seem to take effect regardless of any delay in the rule. In an interesting twist, these new vendor service models (and documents, where applicable) likely depend on prohibited transaction exemptions related to the new rule. A significant question in these situations is what services clients who do not agree to a vendor’s new fiduciary services will receive in the event the new rule do not go into effect.

In reaction to the rule, some investment managers will offer new investment share classes with consistent or level revenue, including options with zero revenue for broker compensation. These share classes may be worthy of consideration by retirement plans, depending on fiduciaries’ preferred method for allocating and paying plan-related fees.

Cybersecurity Issues in the Retirement Plan World

In recent months, two retirement plan cybersecurity breaches have been reported. In one, a municipality’s deferred compensation plan suffered losses of $2.6 million from fraudulent participant loans. The firm administering the program is believed to have restored the losses. In the other, hackers encrypted a union pension plan’s server and demanded a ransom payment to restore the server. Backup data permitted the demand to be ignored.

These events highlight the importance of retirement plan fiduciaries considering the controls their recordkeepers and asset custodians have to guard against data breaches.

Lifetime Income in QDIAs? No…But There’s More

In a recent information letter, the DOL addressed the question of whether a qualified default investment alternative (QDIA) could include a particular annuity feature and keep its QDIA status. To qualify as a QDIA, an investment must allow participants to transfer assets out no less often than quarterly. The lifetime income feature reviewed by the DOL included liquidity restrictions longer than the required three-month limit. As a result, the investment with the annuity feature presented could not receive QDIA protection.

The DOL noted that fiduciaries are not obligated to use a QDIA as a plan’s default investment. It suggested that plan fiduciaries “may be able to conclude” that lifetime income features are appropriate for their plans based upon relevant facts and circumstances. The DOL did not mention the issues of participant and plan portability for this type of plan investment, which can be significant. (DOL Information Letter, 12-22-2016)

In a related development, the DOL has included a project to consider the inclusion of lifetime income options in QDIAs in its regulatory agenda. It will begin the project with a request for information as soon as this spring.

Fee and Related Plan Litigation Developments

Fee and related plan litigation developments continue. The cases that follow may help plan fiduciaries in carrying out their responsibilities:

  • Participants in Deutsche Bank’s 401(k) plan alleged that plan fiduciaries improperly used Deutsche Bank’s index funds rather than less expensive Vanguard index funds. Although the complaint did not allege specific facts of a fiduciary failure, the court allowed the case to continue, saying that such a failure could be inferred from the facts if “a superior alternative investment was readily apparent such that an adequate investigation would have uncovered that alternative.” This issue was exacerbated by Deutsche Bank’s gain from using its own funds. Moreno v. Deutsche Bank Americas Holding Corp. (S.D.N.Y. 2016)
  • A plan sponsor with several plans did not consolidate recordkeeping to a single firm, which allegedly could have reduced plan fees. Plan fiduciaries also allegedly failed to monitor and manage the fees paid to the two recordkeepers. The case is pending. Morin v. Essentia Health (D. Minn, filed 12-29-16)
  • Plan participants sued American Airlines and its 401(k) plan fiduciary committee for utilizing a fund managed by the AA Credit Union as the plan’s cash equivalent fund. During a 12-month period ending in early 2016, the Credit Union fund returned 0.24 percent, while an example stable value fund returned 2.27 percent. The parties proposed a settlement that would pay $8.8 million (less attorney fees) to plan participants and use a stable value fund going forward. The filings noted that, by adding a stable value fund, plan participants would gain between $30 million and $48 million over three years. Based on the disparity between the settlement amount and future participant gain and other concerns, the judge declined to approve the settlement and requested justification. Ortiz v. American Airlines, Inc. (N.D. Tex. 2016)
  • Tibble v. Edison has been through another round of litigation. Following a landmark decision at the Supreme Court, the 9th U.S. Circuit Court of Appeals has held that plan participants may pursue their claims for damages resulting from plan fiduciaries’ failure to monitor investment share classes offered in the plan. An earlier decision by this same appeals court held that a technicality precluded further action on these claims by plan participants. Tibble v. Edison International (9th Cir 2016)
  • The Walt Disney Company’s fiduciary committee was sued for including—and continuing to include—the Sequoia Fund in the company’s 401(k) plan. The fund suffered considerable underperformance largely attributable to a single security. Dismissing the claims, the court noted that (a) underperformance of an investment alone—even a precipitous decline that, in hindsight, reflects a bad investment—does not support a claim for breach of fiduciary duty, (b) there was no allegation that the fiduciaries lacked a sufficient review process, and (c) plan fiduciaries have no duty to monitor the underlying investments in a mutual fund. In Re Disney ERISA Litigation (C.D. Cal. 2016)


DOL Interpretation: Proxies, Shareholder Activism, Proxy Voting, and Investment Policy Statements. In the waning days of the Obama administration, the DOL issued an interpretive bulletin (IB) on plan fiduciaries’ responsibilities for shareholder activism, proxy voting, and investment policy statements. An IB sets out the DOL’s interpretation of the law and is an indication of its view in the event of an audit.

Here are a few highlights:

  • Plan fiduciaries may engage in shareholder activism if they expect it to increase shareholder value and it makes sense from a cost-benefit perspective.
  • DOL supports the use of economically targeted or socially responsible investing—so long as plan fiduciaries do not “increase expenses, sacrifice investment returns, or reduce the security of plan benefits in order to promote” goals beyond providing retirement benefits for plan participants.
  • Plan fiduciaries have a duty to exercise proxy voting rights, and they must do so in the best interests of plan participants and beneficiaries. When plan fiduciaries retain investment managers, the obligation to vote proxies rests with those managers, and plan fiduciaries have a duty to monitor their proxy voting. The IB stresses investment managers’ obligations to provide information to permit fiduciary monitoring.
  • Finally, the IB references inclusion of items on proxy voting and socially responsible investing in investment policy statements.

For plans holding mutual funds, this guidance will likely have little impact on day-to-day fiduciary activities.

Madoff Issues Linger (Whether They Should or Not). Over the years, a union pension fund invested in Bernard Madoff’s Ponzi scheme through Ivy Asset Management. The bankruptcy trustee of the Madoff firm determined that this union pension fund received nearly $33 million in “profits”—more than its investment. Because it withdrew these “profits” some time ago, the statute of limitations prevented a clawback of the $33 million, which would have helped compensate other investors who lost principal. The union’s account also had a face “value” of more than $50 million in 2008 when the Ponzi scheme collapsed.

Not satisfied with its gains, the union pension fund sued Ivy Asset Management for failing to identify the Madoff scheme by 1998. One argument, among others, was that in 1998 the “value” of the account was more than $36 million, and that the pension fund would have made more if the account had been withdrawn and otherwise invested at that time. After being rejected in a U.S. district court, the union appealed. The U.S. Court of Appeals for the Second Circuit noted that there could not be a “loss” to the union in not receiving money that belonged to someone else.

New Life for Employer Stock Claims? Fiduciaries of J.C. Penney’s ESOP sued the plan’s independent fiduciary, alleging that J.C. Penney stock should not have been retained during a period when the stock price fell dramatically. Like most other employer stock cases decided since the Supreme Court’s 2014 decision in Fifth Third Bancorp v. Dudenhoeffer, the case was dismissed. The complaint did not allege “special circumstances” that warranted looking beyond the share price set by the market. In district court, the plaintiffs made an alternate argument that Penney’s fiduciaries violated ERISA’s ongoing “duty to monitor” employer stock set out by the Supreme Court in the more recent case of Tibble v. Edison. This claim was also rejected.

On appeal to the U.S. Court of Appeals for the D.C. Circuit, the plaintiffs failed to challenge dismissal of the Tibble duty-to-monitor claim, so it was forfeited. Dismissal of the remaining claim for not meeting Dudenhoeffer’s strict pleading standard was affirmed. In an unusual step, two judges on the three-judge panel wrote separate opinions to make it clear that they were not affirming dismissal of the duty-to-monitor claim. One judge said, “Given the facts and allegations pled, it is hard to comprehend how [plaintiffs] complaint could not survive a motion to dismiss under Tibble.” This is an important reminder that the law on employer stock claims continues to develop and warrants ongoing attention. Coburn v. Evercore Trust Co. (D.C. Cir. 2016)