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The threat of a lawsuit is scary. With a new class action filing making headlines daily, many plan fiduciaries think they could be next. Unfortunately, too many fiduciaries try to pacify litigation fears by focusing on allegedly poor plan decisions cited in the headlines. Often the result is reactive plan decisions that may not be in the best interest of the plan’s participants—which, ironically, is the ultimate mandate of fiduciaries. The key to prudent fiduciary decision-making is the process used to make a decision, not the decision itself.

Here are 5 common myths that may sound like simple directives to plan fiduciaries, but do not always tell the full story about a fiduciary’s requirement to use a prudent process in order to act in plan participants’ best interests.

Myth #1

Build a line-up of least expensive investment options

Almost all of the recent 401(k) class action suits allege that the defendants breached their fiduciary duties by offering investment options that were managed imprudently or that charged excessive fees. One natural response is to limit plan investment options to the least expensive funds, but that, too, was alleged a breach of fiduciary duty.1 Rather than looking at cost first, fiduciaries should instead look first to the needs of the plan’s participants.

A prudent process first selects the investment managers that are best for participants, and then considers the most reasonably priced vehicle and share class.

Myth #2

Go with the least expensive recordkeeper

Some interpret the common claim that defendants breached their fiduciary duties by causing the plan to pay unreasonable and greatly excessive fees for recordkeeping to mean that a fiduciary should select the least expensive service providers. Just as in the debunking of Myth #1, least expensive does not mean prudent. Prudence requires a well-defined, recurring, and documented process.

A prudent process assesses the education and service needs of plan participants, identifies providers that can effectively meet the participants’ needs, and uses the Plan’s bargaining power to ensure that the pricing is reasonable.

Myth #3

Replace money market funds with stable value funds

A more recent addition to the list of alleged fiduciary breaches is that an investment committee imprudently selected a money market option and failed to provide a stable value fund as the plan investment option. To date, courts have confirmed that money markets as well as stable value funds are appropriate investments on a plan’s menu—as long as the selection of the investment option is consistent with the Plan’s Investment Policy Statement (IPS).^3,4

A prudent process assesses the investment needs of plan participants, identifies managers that can effectively meet the participants’ needs in changing market environments and uses the Plan’s bargaining power to ensure that the pricing is reasonable.

Myth #4

Stay away from company stock, “alternative”, or non-core investments

A variety of complaints have alleged fiduciary breach when the plan decision-makers imprudently selected “high priced alternatives” (company stock, hedge funds and private equity) as an investment option on the menu or as an allocation of the plan's target-date retirement funds. At issue in these claims is not the appropriateness of the investment option, but whether the fiduciary appropriately used a prudent expert to assist with the investment selection and monitoring. ERISA requires that fiduciaries act ‘with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.' (ERISA section 404) If the fiduciary does not have the required expertise, then the fiduciary is responsible for hiring an independent expert who does.

A prudent process demands expertise, so many investment committees benefit from an independent advisor or consultant.

Myth #5

Avoid any revenue sharing arrangements

Some notable class action filings have alleged that fiduciaries breached their duties by “secretly” accepting revenue sharing payments that should have been used to benefit the plan’s participants. Ultimately, this claim has been rejected by at least one court finding that it’s the total fee, not the details of a revenue sharing arrangement that are material to a participant’s investment decision.⁶

A prudent process clearly communicates the total fees of the plan’s investment options so that participants and plan beneficiaries can easily understand cost and net value of an investment choice.

Everyone loves a simple, straightforward best practice, but when it comes to ERISA’s fiduciary mandate, the best practice is always a prudent process.

Source: U.S. Department of Labor.

¹Bell v. Anthem Inc. et al, U.S. District Court, Southern District of Indiana, 1:15-cv-02062-TWP-DML.

²Abbott et al v. Lockheed Martin Cor et al, U.S. District Court, Southern District of Illinois, No. 06-00701.

³Charles E. White et al v. Chevron Corporation et al, U.S. District Court, Northern District of California, 16-cv-0793-PJH.

⁴Brian Loomis et al v. Exelon Corporation et al, U.S. Court of Appeals, Seventh Circuit, Nos. 09-4081, 10-1755.

⁵Gary Spano et al v. The Boeing Company et al, U.S. District Court, Southern District of Illinois, 3:06-cv-746-NJR-DGW.

⁶Dennis Hecker et al v. Deere & Company et al, U.S. Court of Appeals, Seventh Circuit, Nos. 07-3605, 081224.