Barry’s Pickings: DOL’s Fiduciary Theory: Fundamentally Incoherent

Michael Barry, president of O3 Plan Advisory Services LLC, discusses the inconsistencies in the Department of Labor’s (DOL)’s theory of retirement plan sponsor fiduciary responsibility, especially with respect to participant choice, and the consequences of its failure to provide clear guidance.
Art by Joe Ciardiello

Art by Joe Ciardiello

Why exactly does the Department of Labor (DOL) believe the Employee Retirement Income Security Act (ERISA) prudence rule exists? The intuitive answer to this question, based on traditional fiduciary theory, would be that when a participant sets aside savings for retirement an “other people’s money” problem is created. Individuals (fiduciaries) are investing on behalf of others (participants). Which creates an agency problem. And the law solves that problem by imposing a high standard of care on the investment manager/fiduciary.

That policy concern may be extended to a participant-directed account plan where, unlike an individual, non-plan investor, the participant only has access to a limited menu of funds to choose from, “curated” by plan fiduciaries. It would, however, not be implicated where the participant has (e.g., via a brokerage window) access to—may invest her savings in—something approximating the entire market—that is, where the participant can direct her investment more or less as she would if she were saving outside the employer plan system (and outside DOL’s jurisdiction).

In its famous (and ultimately vacated) fiduciary rule, as grounds for its (unprecedented) assertion of jurisdiction over IRAs, DOL articulated a different, novel and, as the head of DOL’s Employee Benefits Security Administration (EBSA) described it, “creative” theory:

The specific duties imposed on fiduciaries by ERISA and the Code stem from legislative judgments on the best way to protect the public interest in tax-preferred benefit arrangements that are critical to workers’ financial and physical health. [Emphasis added.]

So, the fiduciary rules don’t (or at least don’t just) protect the participant. They protect “the public interest,” for which DOL speaks. And, quite aside from the traditional fiduciary concern about agency, our tax policy gives DOL the right to insert itself into investment decisions of the participant.

In addition to providing a pretext for its application of ERISA’s general fiduciary rules to IRAs—the investment of which is generally entirely under the control of the IRA owner—this theory also provides a rationale for DOL’s prohibition (in FAB 2018-01) of investment in “bad” ESG (environmental, social and governance) funds, that is, ESG funds that cannot be justified on strictly economic grounds. Even where the participant, after full disclosure, wants to make the investment.

This theory begins to fray at the edges when we consider DOL’s position on brokerage windows. It’s fair to say that most practitioners believe that, where, e.g., an investment “platform” (e.g., a brokerage window) offers (literally) thousands of different mutual funds, the fiduciary prudence obligations that apply to a plan’s “core” investment funds don’t apply to the funds in the brokerage window. For one thing, plan fiduciaries generally have no control over which funds are/are not offered in the window. For another, there are so many funds offered, the idea that an ERISA fiduciary could select and monitor each one for performance or reasonableness of fees, in a way that conforms to ERISA’s prudence standard, is kind of ludicrous. And who, exactly would that fiduciary be? Certainly not the window provider.

DOL, however, can’t stand the idea of an employer/sponsor somehow getting off the fiduciary-responsibility hook by simply offering participants the opportunity to invest in the market (via a brokerage window) the way any other investor could. And so, in the revised version of FAB 2012-02 Q&A 39 DOL stated:

[I]n the case of a 401(k) or other individual account plan covered under the [participant disclosure] regulation, a plan fiduciary’s failure to designate investment alternatives, for example, to avoid investment disclosures under the regulation, raises questions under ERISA section 404(a)’s general statutory fiduciary duties of prudence and loyalty.

So, in DOL’s view, you can’t have a “window only” plan. ERISA’s prudence obligation requires that the “plan fiduciary” designate (in effect, curate) a core fund menu. Why? The only possible theory is the one that we just discussed—“protecting the public interest in a tax-preferred benefit.” Is there anything in ERISA that actually says that?

In this regard, DOL was very upset by the following language in the 2009 decision by the 7th U.S. Circuit Court of Appeals in Hecker v. Deere (one of the first round of 401(k) fee cases):

We turn next to plaintiffs’ contention that Deere violated its fiduciary duty by selecting investment options with excessive fees. In our view, the undisputed facts leave no room for doubt that the Deere Plans offered a sufficient mix of investments for their participants. Thus, even if, as plaintiffs urge, there is a fiduciary duty on the part of a company offering a plan to furnish an acceptable array of investment vehicles, no rational trier of fact could find, on the basis of the facts alleged in this Complaint, that Deere failed to satisfy that duty. As the district court pointed out, there was a wide range of expense ratios among the twenty Fidelity mutual funds and the 2,500 other funds available through [Fidelity’s] BrokerageLink. At the low end, the expense ratio was .07%; at the high end, it was just over 1%. Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition.

This language—which seems to say that if you give participants enough choice you are off the hook if they pick funds with high fees—so disturbed DOL that it filed an amicus curiae brief for rehearing en banc. In denying that petition, the 7th Circuit’s Hecker v. Deere three-judge panel disavowed such a reading, stating:

The Secretary also fears that our opinion could be read as a sweeping statement that any Plan fiduciary can insulate itself from liability by the simple expedient of including a very large number of investment alternatives in its portfolio and then shifting to the participants the responsibility for choosing among them. She is right to criticize such a strategy. It could result in the inclusion of many investment alternatives that a responsible fiduciary should exclude. It also would place an unreasonable burden on unsophisticated plan participants who do not have the resources to pre-screen investment alternatives. The panel’s opinion, however, was not intended to give a green light to such “obvious, even reckless, imprudence in the selection of investments” (as the Secretary puts it in her brief).

That reads like an endorsement of DOL’s position, that ERISA plan fiduciaries have a duty (to me at least the source of this duty remains obscure) to curate a fund menu. In fact that language reads like, even if the plan fiduciary has curated a blue-chip best practices totally prudent fund menu, if there is an over-priced, “unsound” or “reckless” fund in the brokerage window, the plan fiduciary is also responsible for that.

I could be wrong here, but I don’t think that any practitioner out there believes that plan fiduciaries have an obligation to scrutinize for prudence the funds in a brokerage window. How could they? It’s my understanding that in some plans, brokerage windows sometimes include a higher fee version of a fund available at a lower fee in the plan’s core fund menu. Investment in that higher fee fund—say, by an “unsophisticated plan participant”—doesn’t seem prudent.

More pertinent to the sorts of issues that providers and sponsors are currently grappling with, most believe that including an ESG fund—even a “bad”one, under FAB 2018-01’s “good vs. bad” criteria—in brokerage windows is “OK”—or at least that it presents significantly less risk than putting that fund in the core fund menu.

But how does that result “protect the public interest in a tax-preferred benefit”—when you can’t invest in a “bad” ESG fund in the core fund menu but you can in the brokerage window?

If the point here isn’t clear, these issues would not be a problem under the alternative (and less creative) theory that ERISA’s prudence requirement is simply solving a (relatively ancient) agency problem. If a participant—after full disclosure and assuming no self-dealing (between the plan and the participant)—wants to invest in a “bad” ESG fund, or in a fund with irrationally high fees, that is not an ERISA problem. Because it’s his money.

That is in fact—despite what DOL claims—what ERISA section 404(c) says in so many words:

In the case of a pension plan which provides for individual accounts and permits a participant or beneficiary to exercise control over the assets in his account, if a participant or beneficiary exercises control over the assets in his account … (i) such participant or beneficiary shall not be deemed to be a fiduciary by reason of such exercise, and (ii) no person who is otherwise a fiduciary shall be liable under this part for any loss, or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control ….

Why does any of this matter? It sounds pretty theoretical. In my experience, however, bad (that is, incoherent) theory is going to produce really bad results. Here—with respect to this one problem I’ve been discussing—is my list of the problems that this theory has created:

  • Making small plan sponsors function as fiduciaries when they are totally incapable of doing so and don’t have the capacity/money/time to learn how to. And that problem is a big chunk of why small employers don’t have plans. We should just let them have a “window only” plan—and treat them as mere consumers, which is what they are.
  • Creating the 401(k) fee fiduciary lawsuit industry, which is based (in large part) on seizing on marginal differences in fees, based on cherry picked surveys of the entire fund universe. This industry feeds on the uncertainty around what exactly the standards for a plan fiduciary are. For all I know, DOL thinks all these lawsuits are a good idea (it’s mostly lawyers at DOL, after all). Which is both naïve and sad.
  • Sending all of us—providers, sponsors, policymakers—on the wild goose chase that was the fiduciary rule, and specifically the attempt by DOL to assert jurisdiction over IRAs. As almost everyone on the other side of this exercise pointed out, in many cases there’s not a lot of difference between a client’s money in an ordinary (and unprotected by ERISA) brokerage account and an IRA.

None of this has been good for the U.S. retirement system. IMHO.

I’m not, in fact, suggesting that DOL abandon its theory. If there are virtues to it I am somehow missing, then go for it. But, then, apply it consistently. Or come up with a version that can be applied consistently.

To repeat what I’ve said in the past, DOL’s conduct here—in not giving clear and coherent guidance on these issues—is an example of what Jeremy Bentham called “dog law”—“When your dog does anything you want to break him of, you wait till he does it, and then beat him for it.”

So—in the absence of clear direction—plan sponsors do their best. And then are judged on DOL’s secret notion of what they should have done, or on what some judge can be talked into believing by the plaintiffs lawyer industry. Then, having been beaten like dogs, plan fiduciaries—who were and are generally only trying to do the right thing—conform to whatever sense they can make out of the new (generally obscure and incoherent) rule that has been explained to them via a money judgment.


Michael Barry is president of O3 Plan Advisory Services LLC, and author of the new book, “Retirement Savings Policy: Past, Present, and Future.” He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly about retirement plan and policy issues.


This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services (ISS) or its affiliates.