401(k) advisers should heed the legal aspects of outsourcing

The outsourcing of retirement plan functions — administrative, investment and others — is a practice that predates the Employee Retirement Income Security Act of 1974. But its prevalence has increased in recent years as a result of increased concerns about potential fiduciary liability, caused in part by some very large lawsuit settlements.

Various types of investment services would be included in this list, such as investment strategy, asset allocation, underlying investment management, manager selection and monitoring, and proxy voting. Vendors can provide varying levels of protection under ERISA, depending upon whether they provide nondiscretionary or discretionary fiduciary services.

There are a variety of reasons that a plan sponsor will seek to outsource functions related to a plan, in addition to attempting to limit its fiduciary liability. Outsourcing allows employers — particularly smaller employers — to focus their attention on their core business. It also may cost less than performing the services in-house, and provide access to technology needed to support complex plan transactions and to legal and compliance expertise.

(More: What a court decision teaches 401(k) advisers about choosing stable-value funds)

It’s clear under ERISA’s “prudence” requirements that if a plan sponsor lacks the knowledge to administer an employee benefit plan, it is obligated to seek providers that can assist in that process. However, it may not be clear to a plan sponsor the extent to which it can fully eliminate its fiduciary responsibilities under ERISA. Or, if it engages an investment adviser or investment manager, it may not know what its co-fiduciary obligations and potential liabilities are.

The extent to which fiduciary liability can be completely removed through outsourcing is an unresolved issue under ERISA. Investment advisers and consultants need to be cautious in describing the legal implications of outsourcing under various circumstances.

The law requires that every plan have a “named fiduciary,” who has the authority to control and manage the operation and administration of the plan. The named fiduciary is typically the employer or one or more committees appointed by the plan sponsor; ERISA does not limit the parties who can be named fiduciaries, so any entity could assume that role.

The employer can designate a named fiduciary, or the named fiduciary can be named in the retirement plan document. This is a potentially significant difference, in light of a distinction drawn in a series of Supreme Court cases between fiduciary functions and “settlor” functions. The latter are regarded as business activities and are treated as non-fiduciary in nature. The argument can be made that if the designation of a named fiduciary in a plan document is a non-fiduciary activity, there is also no ongoing fiduciary duty to monitor that fiduciary.

(More: Why 401(k) advisers should be aware of contractual language limitations)

It is not likely that the Department of Labor would agree with this analysis, although it has not issued any advisory opinions addressing the issue. It would likely take the position that the selection of a plan service provider as the named fiduciary by the employer would be a fiduciary act. That’s because the employer would be exercising control with respect to plan management, and the designation of the plan service provider in the plan document would not change that.

An agreement with an investment adviser — in which the investment adviser acknowledges that it has co-fiduciary liability with the plan sponsor — is of benefit to a plan sponsor, but the extent of that benefit is open to interpretation.

For example, a plan sponsor that delegates its fiduciary functions to an investment adviser will have co-fiduciary liability if it has knowledge of a breach of duty by another fiduciary, unless it makes reasonable efforts under the circumstances to remedy the breach. The fiduciary that appointed the investment adviser has a duty to monitor the investment adviser’s performance, but the relationship between the duty-to-monitor provisions and the co-fiduciary liability provisions is not clear. In its 2014 report to the Department of Labor, the ERISA Advisory Council recommended to the DOL that it provide additional guidance on this issue.

In addition to the allocation or delegation of fiduciary responsibility, ERISA also provides that a named fiduciary may employ one or more people to render advice with respect to any responsibility that the fiduciary has under the plan. So if a plan committee wants to retain the fiduciary responsibility for making investment decisions under the plan but hires an adviser to provide recommendations to the committee, nothing in ERISA provides that the plan sponsor is not liable if it acts upon that advice — even if that adviser is a fiduciary — and its actions result in a breach of fiduciary duty.

There is a counterargument, however — if the appointing fiduciary was prudent in its hiring and monitoring of the service provider, then it should not be liable to the plan for any losses that are incurred by reason of the service provider’s actions.

Marcia S. Wagner is managing and founding partner of The Wagner Law Group.