A recent federal court decision has critical implications for broker dealers and others who are wrestling with what new fiduciary status may mean for platform design and ongoing monitoring of retirement investment options.
Case History—Tibble v. Edison International
In 2007, 401(k) plan beneficiaries brought a breach of fiduciary duty claim under the Employee Retirement Income Security Act of 1974 (ERISA) against Edison International and others (the plan fiduciaries). The plan beneficiaries alleged that plan fiduciaries acted imprudently by offering higher priced retail-class mutual funds as plan investments, when lower priced institutional-class funds were available. The United States District Court Central District of California and the Ninth Circuit Court of Appeals dismissed the plan beneficiaries’ claim, holding that it was barred by six year statute of limitations. However, in 2015, the Supreme Court reversed the Ninth Circuit’s finding, ruling that the plan beneficiaries’ claim was not barred by the statute of limitations because the fiduciaries had an ongoing to duty to monitor plan investments, which effectively prevented the time period under the statute of limitations from commencing.
After recognizing the effect that the duty of ongoing monitoring had on the matter, the Supreme Court remanded the case to the lower court to determine whether the plan fiduciaries had breached their fiduciary duty of prudence. On remand, on August 16, 2017, the District Court found that fiduciaries had indeed breached their duty of prudence under ERISA by investing plan assets in higher priced retail-class shares instead of identical lower priced institutional–class shares of the same fund.
Duty of Ongoing Monitoring
In Tibble, the Supreme Court held that under ERISA, a fiduciary has an ongoing duty to monitor investments and remove imprudent investments from a menu of options. This duty exists independently from a fiduciary’s duty to make prudent initial investments and requires fiduciaries to monitor and review investments in a reasonable and appropriate manner given the type of investment and strategy involved.
While the Supreme Court established the duty to monitor, neither the Supreme Court nor the District Court (on remand) established a level of review that is required for fiduciaries to satisfy that duty. During a presentation sponsored by the American Law Institute & West LegalEdCenter titled Living with Tibble: a Practical Guide for Plan Sponsors and Fiduciaries, dated December 14, 2016, Jerry Schlichter, counsel for beneficiaries, stated that its possible that the fiduciary duty for ongoing monitoring would not be as onerous as the fiduciary responsibility exercised in the initial selection of investment options (although there is no case law directly on point). Further, Mr. Schlichter, recommended a quarterly framework for ongoing monitoring of the following:
- Continuity of management
- Changes in market conditions
Monitoring at Regular Intervals
The Supreme Court noted that the duty of ongoing monitoring requires that a fiduciary systematically consider all investments at regular intervals to determine if each is still appropriate for offering to beneficiaries. However, neither the Supreme Court nor the District Court established how often monitoring must occur. The District Court found that a fiduciary breach does not necessarily occur on the day an investment becomes imprudent, specifically noting that reasonable fiduciaries are not expected to conduct daily monitoring of all investments and that reasonable discovery of an imprudent investment may not occur until the systematic consideration of investments at regular intervals. During the Living with Tibble presentation, Mr. Schlichter stated that many fiduciaries would argue that quarterly monitoring is reasonable, although no law requires it. Mr. Schlichter also noted that significant occurrences, such as market changes, could require more frequent monitoring or a more complete due diligence review to determine whether investments are prudent.
Removing Imprudent Investments
What is a fiduciary required to do if it finds an investment to be imprudent? This question had a relatively straight forward answer in Tibble, where the District Court found that the reasonable action of a prudent fiduciary who knew that institutional-class shares provided identical investment at a lower cost would be to switch the retail-class shares to institutional-class shares immediately after they became available. However, identifying and disposing of imprudent investments is not always so simple. The District Court found that in some instances a reasonable fiduciary may believe that an investment is imprudent, but it may still wait for a regularly scheduled review to confirm that belief and dispose of that investment. In Living with Tibble, Mr. Schlichter stated that an interim step to show that a fiduciary is taking reasonable steps, short of disposing of the investment immediately, may be to put a suspect investment on a watch list, for which the fiduciary would apply a higher level of scrutiny.
Navigating the DOL Fiduciary World in Light of Tibble
In light of the DOL Fiduciary Rule and the findings in Tibble, broker dealers need to be particularly cautious with the investment platform decisions they make for retirement investors, including through their ongoing monitoring process. While case law provides minimal guidance on the level or regularity of ongoing monitoring that is required, quarterly (or semi-annual) monitoring of publicly registered investment programs seems reasonable, given the rhythm of required financial disclosure. (Note that currently, FactRight provides ongoing quarterly or semi-annual coverage on 24 investment programs. To access FactRight’s current due diligence on these investment programs, click here for the FactRight Report Center.) In any event, broker dealers have reason to become more vigilant about curating a platform of investment options at all times.