Articles | October 12, 2022
It’s everything you’ve ever wanted to know about plan governance but were afraid to ask.
Our discussion will focus on the importance of plan governance and the fiduciary standards required for plan sponsors of a defined contribution (DC) plan. We’ll share the four rules all plan fiduciaries must follow. Plus, we’ll cover how to know if you are a plan fiduciary, what your personal liability may be in the event of a fiduciary breach and what you can do to implement the necessary framework to avoid costly penalties for you and your organization. Listen now.
This article and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor.
Rick Reed: Okay. Hi, my name is Rick Reed and I'm the Defined Contribution Practice Director at Segal. Today our topic of discussion is about the importance of plan governance in meeting the necessary fiduciary standards when sponsoring a defined contribution plan for your employees, such as a 401(k) or a 403(b) plan. Today, Jarred Wilson is joining me for this discussion. Jarred is the Vice President and a consulting actuary in Segal's New York office with over 24 years of consulting experience. He has specialized expertise in a wide range of employee benefit services for both defined benefit and defined contribution plans, including nondiscrimination testing, plan design, actuarial analysis, and funding and de-risking strategies. Hi Jarred, how are you doing today? Thanks for joining us.
Jarred Wilson: Hi, Rick. Thanks for inviting me to join today's discussion.
Rick Reed: Sure. I guess to kick things off, would you please share with us and the audience an overview of the general DC marketplace and why governance is so important for DC's plan sponsors?
Jarred Wilson: Sure. I think that really the biggest issue today is that we've seen so many lawsuits that have been brought by participants in recent years, and it's just really highlighted why for plan sponsors maintaining a well-run defined contribution plan can be a significant challenge, and it requires continuous oversight to avoid some of these costly mistakes that we've seen. And it's imperative for plan fiduciaries and trustees to regularly review fiduciary best practices and ensure that proper plan governance and oversight is in place.
Rick Reed: Okay. Also, can you give us an overview of maybe a sponsor's fiduciary responsibilities and why they're important? For example, what are some of the basic standards of conduct they must follow?
Jarred Wilson: So ERISA has several basic standards that are expected and in fact required of plan fiduciaries. And we tend to think of these in four separate categories. We have the prudent person rule, which states that a fiduciary must perform his or her duties with the care, skill, discretion, and diligence that a prudent person acting in a similar capacity would use. Think of the most practical, sensible, and cautious person that you know, and ask yourself what would they do in this situation?
Jarred Wilson: Then we have the exclusive benefit rule, which states that a fiduciary must perform his or her duties solely in the interest of the plan's participants and beneficiaries. This includes both the providing of benefits as well as the paying of any and all reasonable expenses necessary to administer the plan. In this specific capacity, you should essentially be telling yourself, "I work for the participant."
Jarred Wilson: The investment diversification rule is another rule that fiduciaries must follow. And this ensures that the plan's investment menu provides a variety of options to participants with the key goal of reducing the risk of significant investment losses. Each investment option under the plan must be considered prudent. And this was a large factor in the recent case of Hughes versus Northwestern. In this decision, the Supreme Court ruled that it is not acceptable to have underperforming investment options in the plan just because you also have well-performing funds. Having a prudent option does not mean you can continue to also have imprudent options.
Jarred Wilson: And finally, we have the plan document rule, which simply states that the plan must be administered in accordance with the terms of the plan. And it's very important, especially for new fiduciaries, to review all plan related documents and ensure that the terms of the plan are both clearly understood and that any gray areas are carefully reviewed with plan counsel. We've seen far too many examples of plan sponsors administering a plan in a way that does not exactly align with the provisions of the plan. Examples include using incorrect definitions of compensation or not properly administrating required minimum distribution payments. In many instances, these operational defects can be self-corrected with minimal fees, but for other higher end errors that could be filings with the Department of Labor and additional penalties and fees that would apply.
Rick Reed: Okay, well, that sure makes a lot of sense. So you've outlined the rules or the standards of conduct for a fiduciary. How does someone actually become a fiduciary?
Jarred Wilson: Well, that's the thing is that it can be a lot easier than people might think because we've seen situations over the years where an employee was considered a plan fiduciary and didn't even realize it. People tend to think of a fiduciary, common example of a fiduciary, I guess I would say, is somebody that provides investment advice for a fee. And that's certainly one example. But in reality, any person that has any type of discretionary authority, control or responsibility over the management and administration of a plan is considered a fiduciary. Basically, if you are acting like a fiduciary, you are a fiduciary. There does not necessarily need to be a formal resolution in place that names you as a fiduciary. If you act like a fiduciary, you are a fiduciary.
Rick Reed: So can a fiduciary actually be held personally liable in the event of a plan defect?
Jarred Wilson: Yes, they can. And there are several penalties that can be assessed to an individual, some of which may be covered by the employer, but that is not always the case. And these include both monetary penalties and for more serious infractions could also include imprisonment. We certainly don't see that very often, but I think the key takeaway is that yes, people can be held personally liable in the event of a plan defect.
Rick Reed: Well, are there some steps that an employer can do, such as with insurance protections, to cover their fiduciaries to give them a certain comfort level of their actions?
Jarred Wilson: Yes, there are. And certainly in most cases, any type of individual liability risk can be covered by the employer. Employers will typically protect individual fiduciaries with some sort of liability insurance. There'll be a fidelity bond in place that will protect the plan's assets while the fiduciary liability insurance really does protect the individual. And as an example, a fidelity bond will generally cover up to 10% of the plan's assets up to a cap, which may be a half a million dollars in some cases, or even $1 million in some other situations.
Rick Reed: So Jarred, one of the areas of your specialization that we've talked about in the past is risk consulting. Can you also share with us your views of risk consulting and how proper plan governance can help mitigate risk with defined contribution plans?
Jarred Wilson: Sure. There are several components of risk, both financial risk, operational risk. All these types of risks are in play when it comes to sponsoring a defined contribution plan. For this reason, it's vital for a plan sponsor to implement a sound fiduciary governance framework, which will help ensure that the plan maintains best practices and complies with required legislation and regulations and passes all required compliance testing.
Jarred Wilson: So the key is to balance the inherent risks that come with administering a plan while also meeting the company's goal of attracting and retaining talent with a meaningful retirement benefit. Too many times we see plan sponsors encounter unintended consequences from their decisions, but which could be avoided with a sound framework in place. For example, a plan may be amended for a specific business reason. Let's say, as an example, to remove a division of employees from receiving employer contributions. And while the business criteria for this decision may be sound, plan sponsors may not realize that such a change could put the plan at risk of failing certain compliance testing. And these tests are required to be satisfied in order to maintain your tax qualified status.
Rick Reed: So how can clients implement the necessary governance that you're talking about into their existing oversight responsibilities?
Jarred Wilson: So first and foremost, we recommend strongly establishing a plan committee and with such committee having regularly scheduled meetings throughout the year. We typically recommend quarterly, but at a minimum, we would say committees should meet at least twice a year. Each committee meeting should include a review of various fiduciary topics such as investment performance, plan administration performance, and current legislative and regulatory updates. These are staples that should be discussed at each meeting.
Jarred Wilson: And then also at each meeting, we would suggest a deeper review of a specific topic, let's say, at each meeting. So one example of a typical schedule of meetings that we see is that in the first quarter of the year, in addition to the staples that we just mentioned, you might conduct annual fiduciary training to make sure all fiduciaries are up to date on what their exact responsibilities are. And then in the second quarter, maybe we double-click on an annual review of the investment policy statement and ensure that the investment line is satisfying all the criteria that it should be.
Jarred Wilson: In the third quarter, we might look at the record keeper services and see how those are being performed and maybe do some benchmarking, et cetera. And then in Q4 we would look at, for example, the fees that are currently being paid by participants. And we could do some benchmarking there as well, look at the plan design and take a look at how the plan compares to one's peers.
Jarred Wilson: For all these meetings formal minutes should be recorded, and this not only documents a discussion, but in particular for important plan decisions that are being made it includes a record that those decisions have been made and it includes any backup materials that were presented during the meeting that supported the decision that was made by the committee. It's also very important to have a plan charter, which provides formal documentation of each committee member's responsibilities and outlines the procedures that must be followed to administer the plan. And last but certainly not least, it's important to maintain the appropriate level of insurance coverage. And we talked about that a little bit already, but that's extremely important to protect both the participants and fiduciaries. And this includes fidelity bond, fiduciary liability insurance and cyber liability insurance.
Rick Reed: So Jarred, when advising your clients, do you have a formula or a structure that you recommend they follow?
Jarred Wilson: So there's four key pillars of risk that all plan sponsors should address. Governance, investments, operations and compliance. The focus of today's discussion has been around plan governance. There's certainly a lot of overlap though amongst all of the pillars. Specifically related to plan governance, the key areas of focus are to, one, ensure that the fiduciary standards of conduct are being followed. Two, recognize who is a plan fiduciary and what their roles are. And just as importantly, recognize what the key non fiduciary roles are. Three, we should reinforce all of these responsibilities with proper training. And then four, ensure that all the above is properly documented. Documentation really cannot be overstated enough. And we would say in many situations, if an error is made but there's proper documentation in place about the process that was followed to make a certain decision, even if that decision results in an error the penalties are far less severe when that documentation is in place.
Jarred Wilson: The other pillars that we discussed, investments, operations, compliance, they'll be discussed in more detail on subsequent episodes of this podcast. But to touch on them briefly, investment oversight includes such things as reviewing your investment policy statement and making sure that the investment lineup is continuously monitored. Operations oversight includes implementation plan procedures and documentation around such things as choosing service providers and the ongoing monitoring of said providers. And then compliance oversight is ensuring that the plan document procedures are being followed properly, that you're conducting plan audits on a regular basis, and that any plan errors that do arise are corrected in a timely manner.
Rick Reed: So overall, I mean, there's a lot of information and expectations for fiduciary responsibilities and you've mentioned a lot of them here today. Are you able to maybe identify some particular focal points that you think sponsors should focus on now for the rest of this year and into 2023?
Jarred Wilson: So nowadays, financial wellness is an extremely hot topic today, and for many organizations, this new generation of workforce is constantly looking for items from their employer beyond simply receiving their base compensation, which of course is always a high priority. But the overall financial wellness is extremely important and defined contribution plans can be a good tool for many of the financial issues that today's workforce is currently facing. And so with that, in addition to monitoring your fiduciary responsibilities, we think it's also important that you look at your plan overall as part of the total reward package that you're providing to your employees and making sure you're satisfying the needs of your employees.
Jarred Wilson: And any plan decision that's being made that directly impacts the participants, we can't overstate enough how important the proper communication is to provide to employees, to document that decision and to make sure the message is delivered clearly, and also to drive engagement with the employee. We've seen more personalized communications go a long way in accomplishing this goal.
Rick Reed: Well, Jarred, thanks again for your time and expertise today. Today's discussion has been very helpful. And hopefully members of our audience have learned some key concepts for retirement plan oversight. You've shared some excellent viewpoints, examples, and suggestions to help plan sponsors implement a sound governance framework to mitigate plan risks and avoid potential lawsuits. So our next podcast in this DC series will be about designing the optimal investment menu for plan participants while, of course, still leveraging the information you shared with us today about following proper fiduciary conduct. Thanks again for joining me today, and I hope you have a great day.
Jarred Wilson: Thanks, Rick. Thanks for having me and same to you. Look forward to speaking with you soon.
This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.
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