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Investment Advice: The Liability Issue

The question is simple. If online advice services do not accurately model stable value funds in defined contribution plans, could plan sponsors or plan providers be found liable for providing plan participants with bad advice?

The answer isn't so simple. For starters, advice providers such as mPower and Financial Engines contend they do a good job of modeling stable value products, suggesting that this isn't an issue at all. Some plan sponsors buy into that argument. Others do not. (See "The Great Debate: Do Advice Providers 'Get' Stable Value?")

For another perspective, Stable Times contacted ERISA attorney Donald Myers, a partner in the Washington, D.C. office of Reed Smith. Myers analysis: selecting a service provider for a retirement plan is a fiduciary decision, and so must be done prudently. If it were demonstrated that such a decision were made imprudently, plan participants would have a basis for trying to hold a plan sponsor liable for that decision.

Leslie Kramerich, acting assistant secretary for the Pension and Welfare Benefits Administration, spoke at Stable Value Investment Association's 2000 National Forum in October, noted that employers whose plans comply with ERISA Section 404(c) are not liable for losses that are directly the result of a plan participant's exercise of control. As with any selection of a service provider, Kramerich added, the plan fiduciary is still responsible for the prudent selection and periodic monitoring of the designated adviser. Prudent selection, she said, limits the employer's liability.

"With regard to the selection of a service provider under ERISA, the (Labor) Department has indicated that the responsible plan fiduciary must engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of the services offered, and the reasonableness of the fees charged in light of the service provided," Kramerich said. "In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence."

In applying these standards to the selection of investment advisors, Kramerich said, the DOL "would anticipate that the responsible fiduciary would take into account the experience and qualifications of an investment advisor, including registration with applicable federal and/or state securities laws; the extent to which the advisor acknowledges its fiduciary status and responsibility under ERISA to participants; and the extent to which the advisor can provide informed, unbiased, and appropriate investment advice to the plan's participants."

In monitoring the investment advisor after selection, Kramerich said, "it is anticipated that the responsible fiduciary would periodically review the performance of the investment advisor, whether the investment advisor continues to meet applicable state and federal securities law requirements, compliance with contractual provisions of the engagement, utilization of investment advice services by participants in relation to the cost of the services to the plan, and comments and complaints about the services."

As a practical matter, Myers noted, the liability issue has not been tested in court, nor is it clear how well a liability claim would fare.

"If a plan fiduciary does not have expertise in an area, it is reasonable to expect that the fiduciary will hire people who have that expertise," Myers observed. "The law says that if a fiduciary hires an expert, it does not have to second-guess the expert, but the fiduciary does have to make a reasonable and diligent inquiry as to the quality of the service the expert is providing. Therefore, an employer would have some responsibility to be familiar with the various advice providers and to be able to defend why it chose one provider over another, and to make some assessment of the service being provided."

"It is not clear," Myers continued, "whether that (requirement) would extend to looking at particular portfolios of plan participants and determining whether they are constructed consistent with generally accepted investment principles. I don't know how far the courts will go in requiring an employer to inquire as to the different components of those portfolios and how the advisor made its determinations. It is difficult to speculate on the employer's liability where the allocation model is flawed. But it is an issue that employers should be thinking about."

With growing numbers of plan sponsors making investment advice available to participants in their defined contribution plans, it's clear that many believe offering no advice is worse than offering potentially flawed advice. Comments by Kramerich seem to support that view.

"The selection of providers that offer informed, unbiased and appropriate investment education or investment advice will, in our view, not only serve to increase the likelihood of employees achieving retirement security, but also significantly reduce the potential for employee dissatisfaction and possible litigation," Kramerich said in September.

Concluded Michael Melcher, investment manager for Hallmark Cards retirement plans, at the SVIA National Forum: "In the end, you still must select somebody, even though you may have some disagreement on some issues."

Read Next: How Adding Advice to a 401(k) Plan Can Impact Stable Value Contracts