Guest Article

(From the December 27, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

DOL Issues Guidance on Directed Trustees' Responsibilities

The Department of Labor has issued general guidance to Employee Benefits Security Administration (EBSA) regional offices regarding the responsibilities of directed trustees under ERISA, particularly with respect to directions involving employer securities. Field Assistance Bulletin (FAB) 2004-03 (December 17, 2004). The FAB provides much needed clarification of the DOL's position on the obligation of directed trustees to question, and even refuse to carry out, directions in certain situations.

Background

All trustees with respect to ERISA plans are subject to ERISA's fiduciary requirements. This means that trustees for ERISA plans must conform to the "prudent man" and diversification requirements, among other things, when investing plan assets. See ERISA section 404(a). (Note, however, that trustees of individual account plans can purchase or hold employer stock without violating the diversification requirement, or the prudence requirement to the extent it requires diversification. ERISA section 404(a)(2).)

A plan can designate a named fiduciary, who is not a trustee, to provide "proper" directions to a trustee. See ERISA section 403(a)(1). These so-called "directed trustees" are still fiduciaries under ERISA, but their duties are "significantly narrower than the duties generally ascribed to a discretionary trustee." The true extent of these fiduciary duties and responsibilities are at issue in several ongoing cases involving directed trustees following directions to purchase and hold the plan sponsor's stock. One of the questions in these cases is whether the directed trustee has a fiduciary duty to question or challenge such directions in certain circumstances.

Duty to Determine if Directions Are "Proper"

According to FAB 2004-03, a directed trustee may not follow a direction that is not "proper." A direction is proper only if "made in accordance with the terms of the plan" and "not contrary to [ERISA]." Thus, "when a directed trustee knows or should know that a direction from a named fiduciary is not made in accordance with the terms of the plan or is contrary to ERISA, the directed trustee may not, consistent with its fiduciary responsibilities, follow the direction."

For purposes of determining whether a direction is consistent with the plan's terms, the FAB advises, "directed trustees necessarily have a duty to request and review all the documents and instruments governing the plan that are relevant to its duties as directed trustee." If the directed trustee fails to request these documents, or fails to review the documents provided, the directed trustee may be liable for following a direction contrary to the plan's terms. For example, if a directed trustee follows an instruction to purchase a particular stock in violation of the plan's investment policy, "the directed trustee may be liable for a breach of its fiduciary duty to follow only proper directions."

According to the FAB, "a direction is consistent with the terms of a plan if the documents pursuant to which the plan is established and operated do not prohibit the direction." If the directed trustee cannot determine from the plan documents if a direction is proper because the documents are ambiguous, the directed trustee should seek clarification of the plan's terms from the fiduciary responsible for interpreting those terms. The directed trustee can rely on this fiduciary's interpretation.

The FAB does not discuss what a directed trustee should do if the request for documents is ignored or denied. Presumably, the directed trustee in these circumstances would have little choice but to refuse to carry out any directions until the documents are provided, or resign.

Determining if Directions Are Contrary to ERISA

Of course, even directions that are consistent with the plan's terms are not proper if contrary to ERISA. For example, a directed trustee cannot follow a direction that it knows or should know would require the trustee to engage in a prohibited transaction. Therefore, a directed trustee must follow processes designed to avoid prohibited transactions. This obligation can be satisfied "by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions and, if prohibited, identifying the individual or class exemption applicable to the transaction." The directed trustee can rely on these representations unless it knows the representations are false.

Also, a directed trustee cannot follow directions that would require the trustee to violate ERISA's prudence requirement. Significantly, the FAB confirms that the named fiduciary, and not the directed trustee, has primary responsibility for determining the prudence of a particular transaction. Furthermore, the directed trustee does not have an independent obligation to determine the prudence of every transaction.

Nonetheless, the FAB indicates there may be circumstances when a directed trustee has an obligation to question the prudence of a transaction. The FAB describes this obligation as "quite limited" in situations where the trustee has been directed to buy publicly traded stock. But the directed trustee's obligation might be implicated if the directed trustee has "material non-public information" with respect to a security that is the subject of the direction, or in certain "extraordinary circumstances" where public information calls into "serious" question a "company's viability as a going concern."

Material Non-Public Information

According to the FAB, a directed trustee in possession of material non-public information is obligated to act if such information is necessary for a prudent decision regarding a security. The example cited by the FAB is a directed trustee with non-public information indicating a company's public financial statements contain material misrepresentations that significantly inflate the company's earnings. In this situation, the FAB indicates the directed trustee must inquire about the named fiduciary's knowledge and consideration of such information before following a direction to buy the company's stock at an artificially inflated price.

But what does it mean for a directed trustee to "possess" material non-public information about a company? Specifically, if one part of an organization provides directed trustee services to an ERISA plan, is the directed trustee deemed to possess material non-public information that a separate part of the same organization may be privy to? The FAB indicates the answer is "no," so long as "the organization maintains procedures designed to prevent the illegal disclosure of such information under securities, banking or other laws." Thus, in most cases the directed trustee will have to have actual knowledge of the information before a duty to act is implicated.

A directed trustee also possesses material non-public information if it "performs an internal analysis in which it concludes that the company's current financial statements are materially inaccurate." However, the directed trustee does not have to disclose reports and analyses that are available to the public.

Public Information

As noted, a directed trustee in very limited circumstances may have an obligation to question the prudence of a direction to purchase publicly traded securities at the market price solely on the basis of publicly available information. According to the FAB, this obligation may arise if there are "clear and compelling indicators, as evidenced by an 8-K filing with the Securities and Exchange Commission (SEC), a bankruptcy filing or similar public indicator, that call into serious question a company's viability as a going concern." Significantly, a footnote to the FAB clarifies that, "A directed trustee's actual knowledge of media or other public reports or analyses that merely speculate on the continued viability of a company does not, in and of itself, constitute knowledge of clear and compelling evidence concerning the company sufficient to give rise to a directed trustee's duty to act."

Finally, the FAB indicates the directed trustee may have to act if the named fiduciary is an employee of the plan sponsor and directs the trustee to buy or hold the plan sponsor's stock after federal or state regulators have formally charged the company, its officers or directors, with financial irregularities. In this situation, the directed trustee may need to refuse to follow the direction or to conduct an independent assessment of the transaction to determine if it would be consistent with ERISA. But a directed trustee could accept a direction to buy or hold from an independent fiduciary in these circumstances without having to conduct its own assessment.

What Happens if Directed Trustee Questions A Transaction?

If a directed trustee raises questions about a transaction, is there any effect on the nature and scope of the directed trustee's fiduciary responsibilities? The FAB indicates there is not. So, for example, if a named fiduciary changes a direction in response to questions raised or information provided by a directed trustee, the directed trustee does not become primarily responsible for the prudence of the direction.

Directed Trustees and Co-Fiduciary Liability

As fiduciaries, directed trustees are subject to liability as co-fiduciaries under ERISA. If a directed trustee has knowledge of a fiduciary breach, it may be liable as a co-fiduciary unless it takes reasonable steps to remedy the breach. Efforts to remedy a breach may include reporting the breach to other plan fiduciaries or the DOL.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Mike Haberman 202.879.4963, Stephen LaGarde 202.879.5608, J. D. Lutz 202.879.5366, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, or Deborah Walker 202.879.4955. Copyright 2004, Deloitte.