Selecting Financial and other Service Providers for an Employee Benefits Plan

We have grown accustomed to corporate executives lining their own pockets when making virtually any business decision, whether it benefits the corporation or not. When it comes to managing a employee benefit plan, however, acting under such self-interest can be a very costly violation of the decision maker's legal duties to the employees.

In many contexts, "management" and "labor" have conflicting interests. Management wants to maximize profits, and will sometimes attempt to do so by minimizing labor costs. Labor, by contrast, will want to maximize wages and benefits. Recognizing this conflict of interests, the law generally does not require an employer to act in the interest of its employees. The law generally allows employer discretion in setting levels of employee compensation, as long as applicable minimum wage, overtime and collective bargaining obligations are met. Thus, the same corporate decision makers who slash wages and benefits then sometimes get an immediate seven or eight figure bonus, based on projected profits stemming from the lower labor costs, and without regard to the eventual actual profits, after decreased commitment, skill and morale of employees set in. It's not illegal; it's just bad, short-sighted business.

The law also doesn't require an employer to establish an employee benefit plan. But once a private-sector employer establishes an employee benefit plan, in exchange for the tax benefits of doing so, the law imposes stringent "fiduciary" requirements regarding plan administration. The assets of the plan are held "in trust" and the employees who participate in the plan are "beneficiaries" of the trust. The law requires that decisions regarding hiring, firing and monitoring service providers of an employee benefit plan must be made for the "exclusive benefit" of the employees participating in the plan.

The most fundamental duty of a fiduciary is the "duty of loyalty." That duty requires a fiduciary to affirmatively and steadfastly avoid conflicts of interest between himself/herself and trust beneficiaries. For example, a fiduciary is generally prohibited from receiving anything "on the back end" of a deal the fiduciary makes on behalf of an employee benefit plan. Such "self-dealing" violates the fiduciary's duty of loyalty. Thus, corporate decision makers who generally are free to make corporate decisions that benefit themselves (and some of them indulgently do so) violate ERISA, the federal statute governing employee benefit plans, if they follow that modus operandi in selecting service providers for an employee benefit plan. For example, a corporate officer in charge of selecting an investment manager for a retirement plan is generally prohibited from receiving a gift, a "commission" or anything else of value for selecting a specific investment manager. Such a corporate officer would also be prohibited from having an ownership or other financial stake in the company selected to provide such services to the plan. The types of such unlawful conflicts of interest are as unlimited as the greed of corporate officers who have grown accustomed to operating pursuant to such brazen self-interest.

ERISA provides for various remedies for such fiduciary breaches. Any employee participating in the plan whose interests were affected by the breach can sue the fiduciary on behalf of the entire plan. At a minimum, the fiduciary will be required to disgorge to the plan all ill-gotten gains. Often, the fiduciary's tainted decision will also prove to be a poor one for the plan. For example, selecting a second-rate investment manager often results in a retirement plan's investments underperforming. Even if the plan experiences investment gains in nominal terms, if such gains were substantially below the "benchmark" of investment returns over the relevant period, the plan suffered losses in the form or lower than expected investment returns. If a fiduciary had a conflict of interest in selecting the investment manager, the law will not tolerate the fiduciary claiming that such plan losses were unrelated to the tainted selection of the investment manager. Thus, the fiduciary better wish for luck regarding the tainted decision, otherwise it could be a very costly one for the fiduciary. On the other hand, in addition to fiduciary liability insurance and indemnification by the corporation, the fiduciary will probably be good for a big chuck of those losses personally, after pocketing several million dollars for cutting employees' wages and benefits. How ironic.

Categories: ERISA