Outsourcing Does Not Make a Fiduciary Bullet Proof
Named planned fiduciaries are still liable for fiduciary responsibilities even if they hire a third party to monitor some aspects of the plan.
By Ian Kopelman
It has come in vogue in certain circles to advocate hiring an “independent” third-party fiduciary to take responsibility for a plan’s investments and other fiduciary functions in order to relieve the plan’s sponsor, in-house, or named fiduciaries of liability under ERISA. Some proponents of this approach argue that formally delegating fiduciary responsibility to an outside third party will completely insulate the plan’s named fiduciaries from all liability for damages suffered by the plan and its participants due to a fiduciary breach. However, the fact is that a named fiduciary is never completely free from fiduciary responsibility for the plan.
Naming a Third-Party Fiduciary
The fact that a third party formally assumes responsibility for fiduciary functions under a plan and acknowledges that it is a plan fiduciary means that it will be liable for its acts or omissions in carrying out its fiduciary responsibilities. It does not mean that the named fiduciary is relieved of liability in connection with the third party’s acts or omissions. A named fiduciary’s responsibility for the acts or omissions of another party is governed by Section 405(c) of ERISA, which provides that a plan may include procedures for the named fiduciary to delegate its fiduciary responsibility to another party by designating it to carry out the named fiduciary’s responsibilities under the plan. If the delegation of fiduciary responsibility to a third party meets certain requirements, the named fiduciary will not be liable for its delegatee’s acts or omissions. However, this relief is subject to three significant limitations.
Limitations of Fiduciary Relief for Named Fiduciaries
First and foremost, the delegating fiduciary must ensure that the plan provides for the delegation, and the delegation cannot be broader than the plan permits. Second, the named fiduciary will be liable for the third party delegatee’s acts or omissions to the extent the named fiduciary violated ERISA’s prudent man standard of care with respect to: (1) delegating fiduciary responsibility, (2) establishing or implementing the plan’s delegation procedure, or (3) continuing an existing delegation. Thus, a named fiduciary is liable for the acts or omissions of its third-party delegatee unless its actions in connection with the delegation are (a) solely in the interest of the plan’s participants and beneficiaries, (b) for the exclusive purpose of providing benefits under the plan, and (c) prudent under ERISA.
Third, Section 405(c) relief will not be available to the named fiduciary to the extent that it would otherwise be liable for the acts or omissions of its third party delegatee as a co-fiduciary. Section 405(a) governs a fiduciary’s liability for the actions of the plan’s other fiduciaries. It provides that a plan fiduciary can be held liable for a co-fiduciary’s breach of fiduciary responsibility if (i) it knowingly participated in or concealed the breach, (ii) its failure to satisfy the prudent man standard of care enabled the breach, or (iii) it knew or should have known of the co-fiduciary’s breach and did not make reasonable efforts to remedy the breach.
These exceptions to the relief from liability for the acts or omissions of other plan fiduciaries available to a named fiduciary that delegates its fiduciary responsibilities reflect the fact that, like selecting plan investments or service providers, establishing and implementing a plan’s procedure for delegating fiduciary responsibility and selecting the delegatee are actions subject to ERISA’s prudent man standard of care and potential co-fiduciary liability. Further, the act of delegating fiduciary responsibility to a third party does not terminate the named fiduciary’s responsibility for the delegation. Like an initial delegation of fiduciary responsibility, determining whether to continue an existing delegation is subject to both the prudent man standard of care and co-fiduciary liability. Responsibility for these actions cannot be delegated.
The truth is that a plan’s in-house or named fiduciaries cannot avoid fiduciary responsibility and potential liability under ERISA simply by retaining a third party to manage plan investments or other fiduciary functions, regardless of the terms of its agreement with the third party. Delegating fiduciary responsibility and deciding whether to continue an existing delegation are themselves fiduciary functions subject to ERISA. Not only does this mean that a named fiduciary must satisfy ERISA’s prudence and exclusive benefit requirements when it delegates its fiduciary responsibilities to third parties — it also means that the named fiduciary is responsible for oversight of the third party delegatee’s performance. A named fiduciary’s failure to monitor a third party delegatee’s performance and, if appropriate, terminate the delegation, is a breach of its fiduciary responsibilities and could result in co-fiduciary liability for enabling a fiduciary breach or for failing to try to remedy such a breach when the named fiduciary knew or should have known that a breach had occurred.
There may be various reasons why a named fiduciary might delegate some or all of its fiduciary functions with respect to a plan to a third party. Among them is a belief that a third party may be more experienced in a particular area than the named fiduciary and thus provide participants and beneficiaries with larger benefits or smoother plan performance. In addition, it is not unreasonable for a named fiduciary to delegate some or all of its fiduciary responsibilities with respect to a plan to a third party in an attempt to reduce its own exposure under the fiduciary responsibility provisions of ERISA. However, it is not reasonable, nor is it legally correct, for a named fiduciary to delegate some or all of its functions to a third party with the expectation that that delegation will completely insulate him or her from exposure under ERISA or the responsibility to monitor the delegatee’s performance. In short, under ERISA, such an attempt for a named fiduciary to completely insulate him or her self from such exposure will simply not be effective.
Ian Kopelman is a partner at DLA Piper LLP (US). Ian is also PSCA’s legal counsel.