The document discusses two approaches to retirement plan governance - Fiduciary #1 and Fiduciary #2. Fiduciary #1 focuses on meeting minimum ERISA requirements while Fiduciary #2 adheres more closely to trust law principles. A recent study found 44% of investment losses in 401k plans were due to fiduciary decisions, and plans following Fiduciary #2 principles saw 91% lower losses. While most plan sponsors follow Fiduciary #1 due to support from service providers, the author argues Fiduciary #2 should be seriously considered as it often significantly reduces fees.

1. A Tale of Two Fiduciaries
A Worthy Approach to Retirement Plan Governance
By: Daniel M. Connelly, CFP®
Founder & President of Pilleum Consulting, Inc.
Employers that sponsor retirement plans know how important it is to follow and document a process for making
plan-related decisions. The common objective of the process is for the plan to be in compliance with the Employee
Retirement Income Security Act (ERISA) and the associated Department of Labor (DOL) regulations so that it
qualifies for a “safe harbor” from liability for investment losses that result from a participant’s investment decisions.
Plan sponsors generally rely upon their plan’s record-keeper or investment advisor to implement the process for
them, but few question whether the process is focused on the proper objective. This article is intended to raise
awareness amongst plan sponsors that there is an alternative approach to governing a retirement plan that utilizes
a similar process to achieve a greater objective which often results in a significant reduction in plan fees and
stronger protections for the plan sponsor from fiduciary liability.
Ironically, the alternative approach has been in existence prior to ERISA and is considered by many industry experts
to be the better one for plan sponsors to follow. The problem, however, is that the alternative approach conflicts
with the interests of the majority of retirement plan service providers, and this is why so many plan sponsors are not
aware that an alternative approach even exists.
The central difference between the two approaches is based on the answer to a very important question: What is
the most prudent process that a plan sponsor can follow in order to create and monitor an investment menu that
will be offered to their plan’s participants?
For most, the answer is summarized below as “Fiduciary #1”. The
alternative answer is summarized as “Fiduciary #2”.
a)
Fiduciary #1: The process for creating an investment menu is guided by interpretations of ERISA Section
404 (c) and the related Department of Labor regulations.
Section 404(c) spells out the minimum
requirements that must be met so that a plan sponsor can be exempted from being held liable for
investment losses incurred by a plan participant’s investment decisions. Therefore, if the plan meets these
minimum requirements, and the plan sponsor follows a prudent and well-documented process, then this is
the best way to create and monitor an investment menu. This answer provides a great amount of flexibility
in terms of which investments to include on the menu once the minimum requirements are met.
b)
Fiduciary #2: The process for creating an investment menu is guided by the principles found within trust
investment law and the Restatement (Third) of Trusts, Sections 90-92 (the Prudent Investor Rule). Since ERISA
is based upon trust law, this approach looks to satisfy not only Section 404(c), but also the spirit of ERISA.
This rationale is best expressed by James Kwak, a renowned author and Associate Professor at the
University of Connecticut School of Law, in his recently published paper, Improving Retirement Savings
Options for Employees. Mr. Quak notes: “ERISA expressly incorporates key concepts of the common law
of trusts … [and the] The current section 404 (c) regulations are too broad because they encompass
pension plans that contravene the principles of trust investing and therefore violate ERISA’s fiduciary duties.”
Broadly speaking, an adherence to the basic principles upon which ERISA is based places a high emphasis
on avoiding unnecessary costs and prudent delegation of investment authority. Thus an investment menu
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2. that results from this approach is often quite different (and less expensive) than a menu produced by the
more common approach described above.
There is a fair measure of uncertainty these days with regard to retirement plan fees and whether ERISA Section 404
(c) adequately protects plan fiduciaries of plans that have high fees. A recent study published by Quinn Curtis
(University of Virginia School of Law) & Ian Ayres (Yale Law School) entitled Measuring Fiduciary and Investor Losses
in 401(k) Plans, may add more uncertainty as plan sponsors assess their exposure to liability due to investment losses
incurred by plan participants. This study is the first to examine investor losses within retirement plans and to attribute
the losses to specific causes. The specific causes were broken down into two main categories: a) losses due to
investor decisions, and b) losses due to fiduciary decisions. After studying more than 3,500 401(k) plans, the study
determined that, of the total investment losses incurred by participants, 44% of the losses were due to fiduciary
decisions, or “fiduciary losses”, while the remaining 56% were due to investor decisions. Also noteworthy was the
finding that fiduciary losses of plans that featured investment menus congruent with the principles of the Prudent
Investor Rule were 91% lower than those that weren’t. The results of this study may help plaintiffs prevail against
their employers for losses due to high fees as the study provides a methodology for calculating fiduciary losses.
The most common process that plan sponsors follow to govern their plan is one that is advocated by the majority
of retirement plan service providers. The process has their support because it represents a “win-win” proposition,
such that the plan is compliant with ERISA and the plan’s service providers are able to offer a broad array of
investment products to plan participants. The alternative process is a “Win-lose” proposition from the point of view
of most service providers. While the plan sponsor still wins, the service provider loses because the process will likely
result in lower fees and lower profits.
Conclusion
The purpose of this article is not to advocate for one process over another, or to criticize how plan sponsors have
designed their plans. The point is to raise awareness that when it comes to governing retirement plans, there is a
well-established and proven approach that is worthy of serious consideration, but often remains hidden because
it conflicts with the interests of most retirement plan service providers. While each plan is different, the contrast
between plans that follow one approach over another is significant. In my own experience, from a cost standpoint
alone, the secondary approach described above has consistently resulted in total plan fees being reduced by 7090%. Given the magnitude of the potential value that an alternative process may yield, it is worthy of serious
consideration by plan sponsors.
About the Author
Daniel M. Connelly is the founder and President of Pilleum Consulting, Inc. a 17-year veteran of the financial services
industry and subject matter expert in the areas of pension plan design, investments and risk management strategies.
He has consulted for hundreds of Fortune 500 Companies on various aspects of their retirement plans while serving
as Head of Portfolio Solutions for Fidelity Investments; Managing Director at Bear Stearns and Vice President at State
Street Corporation. Dan is a graduate of Boston College and a Certified Financial Planner professional.
Pilleum Consulting is an independent consulting firm specializing in helping employers improve their retirement plans.
Pilleum offers objective and expert guidance. It is not affiliated with any financial services companies, does not sell
financial products, does not manage money, and does not accept any compensation from third parties.
Pilleum Consulting Inc.
20 Park Plaza, Suite 400
Boston, MA 02116
(617) 307-6731
www.freedomfromwallstreet.com
©2014 Pilleum, Inc.