Fiduciary Liability and Mutual Fund Scandals

[Guest smscottish]

Is there any Fiduciary Liability to Plan Trustees when a Mutual Fund they have selected for their plan is involved in unethical procedures such as the market timing and mutual fund scandal currently going on?

[MoJo]

Of course there is - but only for a breach of a duty that the fiduciary has. Fiduciaries do not have "strict liability" for their mutual fund choices - that is, they aren't responsible for what happens to the fund PROVIDED their selection and retention of the fund was done consistent with their fiduciary obligations. The key is the "prudent expert standard," as defined in ERISA. That standard provides that a fiduciary must conduct the plan's affairs consistent with what a prudent person, experienced in such matters (and "expert") would do, in similar cirsumstances. So, if the selection was made prudently, and the fiduciary monitors the fund as a prudent expert would, then there probably isn't any liability, IF a prudent expert would have done nothing different. Hindsight is always 20/20, but foresight is what counts for fiduciaries.

In the current situation, it is interesting to note that well over 100 mutual fund families have been the subject of inquiry, and a handful have made settlements (but only one - Putnam, has admitted to any wrongdoing). The question a fiduciary has to answer is 1) whether the mere allegation of impropriety is a salient factor to consider in being a prudent expert; and 2) whether the process each fund company is or has implemented for dealing with the potential abuses is appropriate. Further, even in the case of those alleged (or admitted) to have allowed abuses, is that even salient to the plan or its participants?

[Demosthenes]

Glad you used the word "unethical" rather than illegal. Certain fund companies have avoided entaglement with the SEC because their prospectus specifically discloses the existence of "special" arrangements that permit timing. Kind of Orwellian "Some shareholders are more equal than other shareholders".

For those companies shouldn't the fiduciary avoid the funds because of the expense impact on thier particiapnts, the less equal shareholders?

[mbozek]

There is no fiduciary liability under ERISA to plan trustees for the improper actions taken by mutual funds or their employees because the fund assets are not assets under ERISA. The mere selection of a fund by trustees prior to disclosure of improper activites is not imprudent action as long as the selection was made in accordance with the procedures for selecting investments under the plan. The difficult question is whether a plan should continue to allow investment in a fund that is the subject of investigation for improper trading activities or has admitted to have engaged in such activities. There are good reasons to continue investing in such a fund after disclosure, such as the risk that a replacement fund may be accused of a similar violation at a future date, cost and disruption in replacing the fund, etc. Market timing is only impermissible if the trading violated the funds internal rules for market timing. Many funds do not restrict market timing or do not disclose the precise paramaters of the restictions and instead deal with market timers on a case by case basis. Late trading and insider trading by principals is always illegal.

[MoJo]

I disagree mbozek, that there is no liability for the actions of the mutual funds, while agreeing that the underlying assets are not assets of the plan. But, in the selection process, an inquiry should be made as to the "behavior" of the fund company, managers. distributors, and others connected with the fund(s). Maybe in the past it wasn't a breach of a fiduciary duty to not inquire as to such matters, but now that the news is widespread, I would suggest that the prudent thing to do is to make appropriate inquiry. and base the decision to include, or keep, the fund, based on what the fiduciaries believe the impact is, or would be, to the plan, of such (continued) behavior. Check out the State of Maryland's 15 questions fiduciaries should ask mutual fund providers....

[Guest planman]

I agree with MoJo that appropriate inquiry is needed. Now that it is common knowlegde a mutual fund may have questionalble activity, fiduciaries need to do more than before. ERISA is focussed on process not outcome. Asking the additional questions will not insure against the same issues. But if there are issues and you didn't ask the questions, then you've got a fiduciary problem.