Who are Functional Fiduciaries?

Appeals Court Decision Holds Service Provider Not a Plan Fiduciary

A recent decision from the U.S. Court of Appeals for the Third Circuit has provided a blueprint for when a retirement plan service provider is deemed a fiduciary and when it is not. The case grew out of a class action suit in which 401(k) plan participants charged John Hancock (“Hancock”) with violating its fiduciary duty to participants by charging them excessive fees.

The Case

The participants were enrolled in defined contribution 401(k) plans governed by ERISA. Each plan had a trustee, and the trustees entered into contracts with Hancock to provide group variable annuity contracts. Plan trustees selected particular investment options offered by Hancock to incorporate into their 401(k) plans. Investment options available to the trustees included funds managed by Hancock and other funds managed by other independent asset managers.

The trustees were given an incentive to choose Hancock funds for their plans. However, if they chose at least 19 funds managed by Hancock, they became eligible for a Fiduciary Standards Warranty (“FSW”) from Hancock. The FSW provided that the selected investment options satisfied ERISA’s prudence requirement. The FSW would reimburse the plan sponsors for any litigation costs for challenges to this prudence or selected investment options.

Hancock also retained the right to make changes to its menu of investment options available to plan trustees. In addition, Hancock agreed to review investment options daily, monthly and quarterly, and replace them if Hancock determined that the investment option no longer delivered its value proposition.

“Functional Fiduciary” Status

Hancock clearly stated in the agreements that it was not serving in a fiduciary capacity. However, by merely making that assertion, it didn’t preclude a determination that Hancock was a “functional fiduciary” by virtue of the role it performed. Under ERISA, a functional fiduciary is a person who exercises any discretionary authority or discretionary control managing the plan, or exercises any authority or control respecting management or disposition of plan assets. It also includes persons who have discretionary authority or discretionary responsibility administering the plan.

The Third Circuit Court concluded that Hancock was not a fiduciary. According to the court, when a plan trustee (the employer) exercises final authority in deciding whether to accept or reject the terms of a service agreement, the service provider does not owe a fiduciary duty to a plan with respect to the agreement’s terms.

The court also referenced an earlier ruling it had made in explaining why Hancock wasn’t a fiduciary. In that case, the court concluded that, because the service provider did not have contractual authority to control the mix and range of investment options offered, or to veto the sponsor’s selections, or to prevent the plan sponsor from offering any competing investment options, the service provider lacked the discretionary authority necessary to create a fiduciary responsibility as to these activities. The court applied this same reasoning to the Hancock case.

Finally, the plaintiffs argued that Hancock was a functional fiduciary because it had the authority to unilaterally delete and substitute investment options, even if it didn’t actually do so. The court rejected this argument, finding that ERISA’s reach is limited to circumstances where the individual actually exercises some authority.

The Bottom Line

If you, as a Trustee, have any expectation that a service provider can provide cover for a fiduciary lapse, you may be disappointed. There is no substitute for fulfilling the full burden of fiduciary responsibility when managing your retirement plan.

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