Posted By: CFP&WM On: May 24th, 2010 In: Money Matters

401(k) Common Mistakes in Selecting and Monitoring Investment Options

One of the primary responsibilities of operating a retirement plan is the selection and monitoring of the investment options. Unfortunately there is great diversity in how well these processes are executed.

Plan sponsor does not understand the fiduciary responsibilities of selecting and monitoring.

  • Result: If plan sponsors do not know their duties, they will most likely fail to carry them out, which would be a fiduciary breach. The fiduciary duty is very high. Donovan v. Bierwirth, 680 F.2d 263 (2nd Cir. 1982), cert denied, 459 U.S. 1069 (1982) (given that a fiduciary’s duties are the highest known to the law, a trustee is held to something stricter than the morals of the market place; fiduciaries are subject to three different, although overlapping, standards of ERISA section 404).

Plan sponsor has lack of experience or the time to carry out processes.

  • Result: The plan sponsor relies on the salesperson that sold the plan rather than acting as a “prudent person.” ERISA section 404(a)(1)(B) provides that a fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” Court cases have affirmed that it is a fiduciary failure to rely on insurance or investment companies to do these processes for the plan and the plan sponsor is liable for these processes.

Plan sponsor does not have the selection and monitoring process in writing or record of the results.

  • Result: This can be a breach of fiduciary duty since there are no documented processes in place stating the process or a written record that they were applied.

Plan sponsors utilize a plan vender that only offers funds sponsored by that plan vendor without looking at other options.

  • Result: This can be breach of fiduciary duty for several reasons:
    • Lack of prudent process. It would not be reasonable for the plan sponsor to purchase a piece of equipment without looking at competing manufacturers or from different dealers. The same is true with plan service providers.
    • Failure to identify a conflict of interest between what is best for the plan and what is best for the vendor when restricted to those limited higher fee investment options.
    • Not acting solely in the interest of plan participants and their beneficiaries and “with the exclusive purpose of providing benefits to them.”

Plan sponsor relies on the insurance company or investment company to run the plan.

  • Result: Based on case law, this is a fiduciary breach. “The fact that all administrative functions of the Plan were delegated to the Plan administrator did not and does not absolve the trustees of their duty to review and insure that the administrator was acting in the best interests of the participants.”

Plan sponsors reliance on recent past performance to select and monitor.

  • Result: The SEC requires all prospectuses or advertisements to plainly state, “Past Performance Is Not an Indication of Future Results.” The sole or primary use of “recent past performance” would be violating SEC guidelines and would thus fail to meet the ERISA responsibility of being “prudent.” Once poor performance is identified, the damage has been done to the plan participants.

The next blog will cover the suggested best practices for selecting and monitoring investment options.

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