Fiduciary Responsibility for Investments a Serious Matter

August 8, 2014 ( – 403(b) plan sponsors subject to the Employee Retirement Income Security Act (ERISA) should be concerned about the fiduciary responsibilities imposed by ERISA.

For governmental employers and churches, the question of fiduciary responsibility for sponsors is not as easily answered. State statutes are the source of fiduciary responsibilities, but these statues can vary greatly. In some states, fiduciary obligations are not extended to 403(b) plan sponsors. 

Whether they are sensitive to their role as a fiduciary or not, plan sponsors are required to take their responsibility seriously and to put their plan participants’ interests first when considering the management of assets in retirement plans. Registered investment advisers (RIAs) are held to this standard while other advisers, such as brokers and insurance agents, may not be. In fact, efforts by regulators to require that such entities be held to this standard have been vigorously resisted time and time again.

For example, a financial institution may recommend investment in a mutual fund that is managed by that institution, even though the selected fund did not live up to the standards or characteristics of other funds that could have been recommended to the client. If the distinction is only the amount of the investment management fee, the plan sponsor should be ready to provide employees with a viable explanation as to why it chose the higher-cost fund. This is especially true over a lifetime of investing for retirement because studies demonstrate low-cost funds can add significant value to a portfolio.

When plan sponsors take on the responsibility of choosing among providers of investment alternatives, they must take care not to put themselves in a conflict of interest that would impinge upon their fiduciary duties.

For example, a few years ago, I was involved in competing for the portfolio management contract for a charitable institution. During the interview we were asked whether we would be willing to make contributions to the institution. We indicated that we were not in a position to make such contributions. Ultimately, we were informed that we did not get the contract. We later learned that a larger financial institution won the contract and had committed to making financial contributions to the charitable institution.

Another term for this situation is “pay to play,” where plan sponsors encourage potential providers to contribute to the institution in one form or another. The Department of Labor (DOL) looks into such situations from time to time, and a plan sponsor could become liable if the DOL determines that the plan participants suffered as a result of such a decision.

Plan sponsors also must be sensitive to the risks involved in selecting actively managed funds versus passively managed or index funds. Since index funds are designed to replicate an index, such as the S&P 500 or the Russell 2000, portfolio managers should not be making decisions other than balancing the minimization of tracking error with rebalancing costs. In the case of an actively managed fund, however, there is the risk that a deviation from the fund’s basic objectives may result in a disaster.

While such a situation is unlikely, it can happen. In 2008, a fund manager made a decision to deviate from the stated basic fund objectives and engage in the use of derivatives to bolster the fund’s performance. During the financial meltdown of 2008, this fund experienced disastrous performance results. By the end of 2008, the fund had declined roughly 80% in value.

The mutual fund company was sued by many shareholders and had to pay out large sums to investors who had experienced losses. Knowing beforehand about this potential time bomb would have been almost impossible. For plan participants who held this fund, due in part to the decision of the plan sponsor, the upset caused by the losses and subsequent time requirements to recover the losses created a situation that all plan sponsors would prefer to avoid.

Plan sponsors can also minimize or avoid litigation instituted by plan participants by designing simple investment policies and strategies that are easily understood by plan participants. Plan sponsors should familiarize themselves with the basic tenets of modern portfolio theory and recognize there is a logical approach to minimizing the risks of portfolio management. By sticking with the basics and avoiding the latest and greatest fads in portfolio construction, plan sponsors can keep their policies transparent.

When plan participants can access all the relevant information about a particular investment, they are less likely to claim they were misled about the investments in the plan and file a lawsuit. The use of secretive hedge funds or alternative investments can make it hard for participants to understand the risks associated with their investments.

Imagine a plan sponsor who became enthralled with gold investments based on radio and television ads extolling the perceived attributes of gold as an investment. Some of these ads, by unregulated pitchmen, advocated that individuals put their entire retirement plan in a gold investment. Since early 2013, the divergence in performance between the S&P 500 and gold has been enormous, with stocks dramatically gaining value and gold losing value.

Plan sponsors should carefully consider who they choose as a portfolio manager and consider using a registered investment adviser or an entity that has investment fiduciary responsibility. Such a decision will act as a first line of defense against the risks faced by plan sponsors who also serve as plan fiduciaries.


Tom Nugent is executive vice president and chief investment officer for PlanMember Securities Corp. Nugent, who has worked in investment and portfolio management since 1968, provides investment framework and market strategy for all PlanMember Services investment programs.  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.     

Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.