The Importance of Retirement Plan Oversight

John E. Rich, Jr.
Director & Chair of the Tax Department
Published: New Hampshire Business Review
May 23, 2022
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On April 26th Fidelity Investments announced that it was expanding its retirement plan investment offerings to enable employers to offer digital assets, specifically bitcoin, as an investment option in 401(k) Plan investment lineups.  It is expected that many employers will face pressure from employees to add this investment option. Employers have also been considering the addition of environmental, social, and governance (“ESG”) funds to their investment menus as an option that better aligns with corporate values. The addition of any new investment option, especially one that is a new vehicle, brings into focus the significant legal responsibilities associated with the oversight of retirement plan investment options.

Fiduciary Oversight over Plan Investments

The Employee Retirement Income Security Act of 1974 (“ERISA”) requires employers and other fiduciaries to act solely in the interests of plan participants and beneficiaries.  Fiduciaries must act with the care, skill, prudence, and diligence under the circumstances that a prudent person acting as a fiduciary and familiar with retirement plan matters would use to manage a retirement plan. As a result, fiduciaries must make a careful inquiry into the merits of any investment offered by the retirement plan.  If the fiduciaries do not have sufficient knowledge to evaluate investments, the fiduciaries must obtain expert advice in making the decision. ERISA provides that fiduciaries are responsible for reimbursing a retirement plan for losses that are incurred if the fiduciaries have not complied with their responsibilities. Even if oversight of plan investments has been properly delegated to a financial professional, the employer still has exposure for losses due to indemnification obligations owed the financial professional.

The importance of proper oversight has never been more important as hundreds of class action lawsuits have been filed in recent years against employers and individual fiduciaries challenging the use of allegedly imprudent investments in 401(k) and other plans. These cases including a case filed against Dartmouth-Hitchcock Clinic in April of this year, involve numerous claims including that funds are underperforming versus alternatives, have excess fees, and were overinvested in “alternative investments” such as hedge funds and private equity.

Prior Guidance on Digital and ESG Investments

On March 10, 2022, the U.S. Department of Labor (the “Department”) published Compliance Assistance Release No. 2022-01, in which it warned retirement plan fiduciaries to exercise extreme care before adding cryptocurrencies to a 401(k) plan investment lineup.  The informal guidance covers a wide range of digital assets. The Department stated that it had serious concerns about exposing plan participants to direct investments in cryptocurrencies and such investments presented significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft, and loss. The Department noted that when plan fiduciaries, charged with the duties of prudence and loyalty, choose to include a cryptocurrency option on a 401(k) plan’s menu, they effectively tell participants that knowledgeable investment experts have approved the cryptocurrency option as a prudent option for plan participants. The Department announced that it expected to investigate plans that permitted cryptocurrencies investments and take appropriate action to protect participants.  The Department’s warning even extended to plans that offered cryptocurrencies investments through brokerage windows that surprised experts in light of limited prior guidance on oversight responsibilities of brokerage windows.

Unlike the new guidance on cryptocurrencies, there is a long history of Department guidance relating to the use of ESG considerations in retirement plan investment options. In November of 2020, the Department published a final regulation addressing “Financial Factors in Selecting Plan Investments.”  The final regulation imposed a high bar for fiduciaries to justify the use of ESG factors by generally requiring fiduciaries to select investments based solely on consideration of “pecuniary factors.”  If strictly interpreted, the regulation would limit the use of ESG considerations in selecting retirement plan funds and investments. However, on March 10, 2021, the Department reversed course and announced it would not enforce either the final regulation or otherwise pursue enforcement actions against any fiduciary based on a failure to comply with the final rules. The Department’s reason for the action only 5 months after issuing final regulations was that it had heard from a number of stakeholders who questioned whether the regulation adequately considered and addressed the evidence that the use of ESG considerations can improve investment value and long-term investment returns.

What Should Fiduciaries Do?

Employers and plan fiduciaries should carefully consider the addition of any new investment option especially one involving new investment vehicles, or investments without a long-term track record. There should be a written investment policy statement that establishes procedures for adding new plan investments and describes the periodic monitoring of all plan investments.  In order to prove that a sound process was followed, a written record of all activities should be created and retained indefinitely in case of a claim or Department audit. The Department’s new cryptocurrency Release effectively puts the burden of proof on fiduciaries to demonstrate that adding such an investment is prudent.  Expert advice will be needed to meet this burden. In the case of an ESG investment, fiduciaries should obtain expert advice on the merits of the investment, and carefully establish a written record of the reasons why it meets the established criteria for inclusion in the investment menu. Lastly, fiduciaries need to keep abreast of Department guidance as history shows that the Department may modify its requirements or change its views.

In summary, the Department’s recent digital asset guidance serves as a good reminder that retirement plan fiduciaries must carefully select the investments offered in retirement plans and then continually monitor the investments chosen. When special circumstances arise, such as with cryptocurrency or ESG investments, fiduciaries must make additional inquires in order to comply with their fiduciary duties.