Fiduciaries of Governmental Retirement Plans in Virginia

Marc Purintun Partner and Chair of Employee Benefits Practice Discussion Overview

> Who is a Fiduciary? > Sources and Standards of Fiduciary Duties > Overview of Litigation

22 Who is a Fiduciary?

3 Fiduciary Defined

> An entity or individual may be a fiduciary either by designation or by function: – An individual or entity specified in the plan as a fiduciary responsible for plan administration and/or management and control of plan assets. • Plan Sponsor • Plan Administrator • Investment Committee • Trustee – A person who exercises discretionary control over investment decisions or plan administration. • Claims administrators. • Anyone who chooses, evaluates, or monitors service providers. – An individual or entity who provided advice for a fee with respect to plan assets. - Internal Revenue Code § 4975(e)(3); ERISA § 3(21)

44 Who is Not a Fiduciary?

> The settlor establishes the terms of the plan, and amends or terminates the plan. – The settlor = The Commonwealth or the Municipality. – Settlor functions include establishing, amending, and terminating the plan. > Unless plan or statute provides otherwise, the settlor is not a fiduciary, but determines the scope of authority of the fiduciary. – The fiduciary must administer the trust and the plan for the benefit of the participants and their beneficiaries in accordance with the role assigned. – The fiduciary must implement decisions made by settlor in accordance with fiduciary duties.

55 Who is Not a Fiduciary?

> Entities or individuals that solely perform administrative functions: – Receives contributions and applies to accounts, – Distributes educational materials, – Implements rules, and/or – Processes forms.

66 Sources and Standards of Fiduciary Duties

7 Sources of Fiduciary Duties

Fiduciaries are held to extremely high standards of conduct under the law.

Plan and Plan- State and Local Federal Law Common Law Related Law Documents • Internal Revenue • State • Restatement • Municipal Code Code Constitution (Third) of Trusts • Administrative • ERISA (not • Statutory (collection of Code directly applicable • Municipal code common law) • Plan Documents to governmental • Policies and • Uniform • Trust plans, but regulations Management of Agreements excellent Public Employee resource) Retirement Systems Act (UMPERSA) (not adopted by Virginia, but an excellent resource)

88 ERISA

> Employee Retirement Income Security Act (ERISA) requires fiduciaries of private sector plans to discharge their duties with respect to a plan: – solely in the interest plan participants, – for the exclusive purpose of providing benefits to participants and defraying reasonable expenses of administering the plan, – with the care, skill, prudence, and diligence under the circumstances then prevailing, – that a prudent man acting in like capacity and familiar with such matters would use.

99 ERISA (cont’d)

> Adopts a "prudent expert" rule. > ERISA does not apply to governmental plans. – However, ERISA derives from the common law of trusts, which does apply to governmental entities, and imposes standards similar to those under ERISA. – Courts often look to ERISA to determine if non-ERISA plan sponsors satisfied their fiduciary duties. – Non-ERISA plan sponsors sometimes defend against breach of fiduciary claims on the grounds that their conduct satisfied ERISA standards.

1010 Code of Virginia

Title 51.1. Pensions, Benefits, and Retirement – Provides fiduciary standards of care and relief for certain plans. – Is a complex statute that provides for retirement and other benefits for employees of the Commonwealth, its agencies and authorities, as well as political subdivisions. – The key retirement benefits of the Commonwealth are maintained by the Virginia Retirement System (VRS) and the retirement systems of localities.

1111 Code of Virginia

Title 51.1 authorizes the VRS Board of Trustees and its committees and agents to establish and maintain the VRS, which includes: – The Pension Plan; – The Hybrid Retirement Program; – The Deferred Compensation Plan; – The Cash Match Plan; – The Optional Retirement Plans; and – A 415(m) excess benefit plan.

1212 Code of Virginia

Title 51.1 authorizes the counties, cities and towns to establish and maintain a local Retirement System, which can include: – A defined benefit pension plan; – A 403(b) plan for public school employees; – A 457(b) deferred compensation plan; – A cash match plan; and – A 415(m) excess benefit plan.

1313 Code of Virginia

Section 51.1-124.30 provides for funds of the Retirement System. > The VRS Board is the trustee of the Retirement System. – The Board shall discharge its duties with respect to the Retirement System solely in the interest of the beneficiaries thereof and shall invest the assets of the Retirement System with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. The Board shall also diversify such investments so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so.

1414 Code of Virginia

This standard of care is almost word-for-word the applicable standard for ERSIA fiduciaries, frequently called the prudent person standard. – Fiduciaries acting within the standard of care are relieved of liability for losses. – Such fiduciaries are also relieved of liability with respect to participant-directed investment, including default investments, and the selection of automatic rollover IRAs for mandatory cash-out distributions, provided the Board’s selection is made in accordance with guidelines similar to the DOL guidelines.

1515 Code of Virginia

Section 51.1-803.A provides a substantially similar standard of care for investments of the local retirement system. – The statute does not explicitly relieve fiduciaries acting within the standard of care of liability for losses to the local retirement system. – “The selection of services related to the management, purchase, or sale of investments authorized by this section, including but not limited to actuarial services, shall be governed by the standard of care set forth in this section and shall not be subject to the provisions of the Virginia Public Procurement Act.” – Such fiduciaries are, however, relieved of liability with respect to the selection of automatic rollover IRAs for mandatory cash-out distributions, provided the Board’s selection is made in accordance with guidelines similar to the DOL guidelines.

1616 Code of Virginia

Section 51.1-169 provides the terms of the Hybrid Retirement Program. > The Hybrid Program includes both a defined benefit component and a defined contribution component. > As the Hybrid Program is maintained by VRS, it is subject to the standard of care in section 51.1-124.30. Subparagraph G of this section applies to the defined contribution component for a political subdivision that has adopted a 403(b) plan. > Eligible employees may contribute the defined contribution portion of the Hybrid Program to the 403(b) Plan.

1717 Code of Virginia

This subsection provides the following relief from liability and the applicable standard of care: In the case of a 403(b) plan or local cash match plan administered by a political subdivision that provides individual accounts permitting an employee or beneficiary to exercise discretion over assets in his account, the political subdivision shall not be liable for any loss resulting from such employee's or beneficiary's (i) investment of voluntary contributions in the political subdivision's 403(b) plan or matching contributions in the political subdivision's 403(b) plan or local cash match plan, (ii) exercise of discretion over the assets in any of his accounts, or (iii) inaction with respect to the assets in any of his accounts that results in such assets being placed in a default investment option selected by the political subdivision, provided that the investment options for the affected individual account and the particular default investment option for such individual account are selected in accordance with subsection A of § 51.1-803, applied mutatis mutandis.

1818 Code of Virginia

Section 51.1-603 provides for local deferred compensation plans, i.e., 457(b) plans, of counties municipalities and other political subdivisions. – Rather than remit deferred compensation contributions to the VRS 457(b) plan, eligible entities can establish a local 457(b) plan. – The locality “may” adopt a trust for the assets of the 457(b) plan – federal tax rules require that governmental 457(b) plans hold the assets in trust. – The locality may adopt an automatic enrollment feature for the 457(b) plan. – The statute does not provide an explicit standard of care.

1919 Common Law of Trusts

The Fiduciary rules in ERISA, which are incorporated into Title 51.1, are based on the common law of trusts. >The Restatement (Third) of Trusts is essentially a collection and summary of the common law trust rules. >The Restatement is not binding authority, but is highly persuasive because it provides a compilation of how the law has developed through relevant case law and in many ways is considered a recitation of what the law is. >Adopts a “prudent investor” standard.

2020 Affirmative Fiduciary Duties

> Internal Revenue Code requires that the assets of 401(a) and governmental 457(b) plans be held in trust. > All powers held as a trustee – express and implied – are held in a fiduciary capacity. > Every power or duty given to a trustee under state law must be exercised in accordance with fiduciary principles.

- Internal Revenue Code § 401(a); UMPERSA § 4(a); Restatement (Third) Trusts § 85, comment b(2)

2121 Affirmative Fiduciary Duties (cont’d)

Duty to act solely in the interest of participants and beneficiaries. Duty to act for the exclusive purpose of providing benefits or paying reasonable plan expenses.

Duty to act independently and without conflicts of interest. Duty of Loyalty Duty to act impartially among differing interests. Duty to act with care, skill, prudence, and diligence of prudent person familiar with like matters.

Duty to be informed.

Duty to delegate responsibilities outside of expertise. Duty of Prudence Duty to diversify investments.

Duty to Follow Plan Document

2222 Duty of Loyalty

> Internal Revenue Code’s Exclusive Benefit Rule: – Fiduciaries must act for the exclusive benefit of the plan participants and their beneficiaries – This is a qualification requirement under the Internal Revenue Code. > VRS Board shall discharge its duties with respect to the Retirement System solely in the interest of the beneficiaries thereof – Avoid self-dealing that serve management, administrative, or personal interests – Section 51.1-124.30.C.

2323 Duty of Loyalty (cont’d)

>ERISA (private sector plans) similarly requires fiduciaries to discharge their duties with respect to a plan for the exclusive purpose of – providing benefits to members and their beneficiaries; and – defraying reasonable expenses of administering the plan. - ERISA § 404(a)(1); see also UMPERSA § 7(1); Restatement (Third) of Trusts § 78.

2424 Duty of Loyalty – Costs

> A fiduciary shall discharge duties with respect to a plan incurring only costs that are appropriate and reasonable to administer the plan. – Fee transparency. – Understand what and how fees are paid. > Only plan expenses can be paid from trusts. > Settlor expenses cannot be paid from trusts.

- Internal Revenue Code § 401(a)(2); ERISA § 404(a)(1)(A);UMPERSA § 7(5)

2525 Duty of Loyalty – Practical Impact

> A fiduciary has a duty to act in the interest of the trust as if it had no other competing interests to protect. – Cannot act for fiduciary's own interest. – Cannot be influenced by the interest of any third person. – Must set aside the interests of the party that appoints the fiduciary, e.g., is not an agent for such party.

2626 Duty of Prudence

> If a fiduciary does not have the skills, the fiduciary must retain an expert pursuant to a prudent process. – State statutes may require certain types of expertise, e.g., investment expertise. • The fiduciary may need experts to manage investments, fund selection, and oversight of investments > To assist the VRS Board, Title 51.1 provides for an Investment Advisory Board, the members of which “shall demonstrate extensive experience in any one or more of the following areas: domestic or international equity or fixed-income; securities: cash management; alternative investments; substantial real estate investments; or managed futures. – Section 51.1-124.26.H.

2727 Duty of Prudence – Delegation

> Documentation should be clear and consistent with respect to the process of delegation. > Specific duties and responsibilities of the delegate should be set out in writing, approved by the fiduciary, and accepted by the delegate. > Delegation is a fiduciary act – – Must delegate prudently and in accordance with the written plan. – Must monitor delegate. – Fees and costs must be reasonable.

2828

Duty of Prudence – Practical Impact

> Retain expertise when needed. > Develop written processes and methods of evaluations for making investment decisions. > Follow written procedures. > Establish internal controls to verify written policies are updated regularly and implemented appropriately.

2929 Duty of Prudence - Diversify

> In investing and managing assets of a retirement system, a fiduciary with authority to select assets shall diversify the investments. > Fundamental to the prudent management of risk to allow participants the opportunity to diversify their individual accounts.

- UMPERSA § 8(2); Restatement (Third) of Trusts, § 90(b); ERISA § 404(a)(1)(C); Section 51.1- 124.30.C. and -803.A.

3030 Duty of Prudence – Continuing Duty to Monitor > Common law of trusts recognizes a continuing responsibility to monitor investments after initial selection: “[A] trustee’s duties apply not only in making investments but also in monitoring and reviewing investments, which is to be done in a manner that is reasonable and appropriate to the particular investments, courses of action, and strategies involved.” Restatement (Third) of Trusts. > Supreme Court in Tibble v. Edison International looked to common law in finding that trustee has a continuing duty under ERISA to monitor and remove imprudent investment options.

3131 Continuing Duty to Monitor – Practical Impact > Conduct regular investment reviews comparing with peer groups and benchmarks. > Compare expenses and assets classes. > Determine whether certain investments should be placed on a watch list or replaced. > Consider adoption of Investment Policy Statement – Follow IPS – Document all decisions

3232 Duty to Follow Plan Documents

> Fiduciary duty to administer a plan in good faith in accordance with its written terms – “by the book.” – Plan includes the statutes, administrative rules, and administrative procedures. > Burden on fiduciary to understand the governing documents of the plans and the context in which the plans exist. - ERISA § 404(a)(1)(C); Restatement (Third) of Trusts § 76.

3333 Duty to Follow Plan Documents – Practical Impact > Consider whether documents address revenue sharing or other unallocated amounts – How such assets are these used? Plan expenses? Allocated to participants? – How often distributed?

3434 Negative Duties – Prohibited Transactions

A Deal with plan assets in his or her own interest. fiduciary may not: Pay unreasonable compensation for services performed.

Make a purchase for more than adequate consideration or a sale for less than adequate consideration (e.g. transactions involving the settlor).

Act on behalf of a party whose interests are adverse to the plan or participants.

Receive anything of value from any party in connection with a transaction involving plan assets.

3535 Key Takeaways

Highest duty known to law.

Objective standard: • Prudent "expert" standard. • Good faith is not sufficient. • If you don’t know, learn or hire an expert.

If it is not documented, it never happened.

3636 What about participant directed investments?

37 Responsibilities

> Participant – Exercise control (directly or indirectly) and are thus responsibility for investment outcomes > Plan Fiduciary – Educate participants • Newsletters, pamphlets, website, workshops, seminars, etc. – Select and monitor investment options and service providers – Control Plan expenses – May be relieved of liability – Section 51.1-124.30.E., -169.G.4.

3838 Litigation Overview

Over the past couple decades, defined contribution plans that permit participant-directed investments have been the target of fiduciary breach litigation.

This litigation has been costly, time consuming, and distracting.

The focus on fiduciary liability has, however, encouraged fiduciaries and sponsors of all types of DC plans to review their responsibilities and to adopt prudent practices.

3939 Defined Contribution Plans

> Many governmental defined contribution plans permit participant-directed investments. Such plans include: – 457(b) deferred compensation arrangements; – 403(b) tax-sheltered annuities; – 401(a) savings plans; and > Non-governmental defined contribution plans that permit participant-directed investments include: – 401(k) plans; – Profit sharing plans; and – 403(b) tax-sheltered annuities.

4040 401(k) Litigation

ERISA 401(k) plans are frequently the target of lawsuits brought by plan participants alleging breach of fiduciary duties. > Most of these cases focus on allegations that plan fiduciaries fail to act prudently in: – Selecting and monitoring plan investment options – Allowing investments with excessive fees – Paying excessive recordkeeping fees out of plan assets > And such fiduciaries breached their duty of loyalty by prioritizing administrative ease or unrelated business considerations ahead of the best interest of plan participants and beneficiaries.

4141 401(k) Litigation

> Led by a few plaintiffs’ law firms > Assert breaches of fiduciary duties of prudence and loyalty > Sued large employers, established precedent, sought settlements from smaller employers > Frequently, class certification is sought > Outcomes tend to be facts-specific > Win or lose, the litigation has been costly to plan sponsors

4242 403(b) litigation

In August 2016, fiduciary breach litigation expanded to ERISA 403(b) plans maintained by large private universities. > The initial suits filed against 12 universities were brought by Jerome Schlichter of the Schlichter Bogard and Denton law firm within a nine-day span. > These initial complaints were shaped by the Schlichter firm’s long and successful history of 401(k) fiduciary breach litigation. > The initial complaints raised numerous alleged violations of fiduciary duties and were substantially similar from university to university. > All of the targeted 403(b) plans had substantial assets, most in excess of $1billon.

4343 403(b) Litigation

Universities Sued • Yale University • University of Southern • New York University California • Columbia University • Emory University • Cornell University • Brown University • University of • University of Chicago Pennsylvania • Princeton University • Duke University • Washington University • Johns Hopkins • Georgetown Universities University • Vanderbilt University • Massachusetts • Northwestern University Institute of Technology

4444 403(b) Litigation

Plan participants alleged multiple breaches of fiduciary duties of loyalty and prudence because defendants: – Offered only mutual funds and annuities provided by plan’s recordkeeper – Had multiple recordkeepers, custodians, and trustees resulting in excessive fees – Failed to conduct a competitive bidding process for recordkeeping services – Offered higher-cost mutual fund share classes instead of institutional share classes or insurance company pooled separate accounts – Failed to use the plan’s bargaining power to secure lower investment management services fees – Offered underperforming investment options – Offered too many investment options, resulting in reduced bargaining power on fees and decision paralysis by participants

4545 403(b) Litigation

Universities Responded > Almost all Universities have filed motions to dismiss for failure to state a claim, arguing: – 403(b) plans are different from 401(k) plans because they originated as annuity products rather than investment accounts – No allegation of flawed investment decision-making process – Fact that there are so many similar lawsuits demonstrates that fiduciaries were doing what other fiduciaries in similar circumstances have done – Fees are only one factor in selecting recordkeepers – Prudence requires diversification of investments and the plans offered participants a choice of investment options

4646 403(b) Litigation

Orders have been issued in most cases ruling on motions to dismiss. > All allegations in the University of Pennsylvania case were dismissed by the federal district court. This case is currently on appeal to the Third Circuit Court of Appeals. > Most claims of excessive recordkeeping and investment fees have survived. > Most claims of excessive or duplicative investment options have been dismissed, but at least one court allowed the claim to proceed – Duke University case. > Most underperforming investment claims have survived.

4747 403(b) Litigation

The NYU case reached the trial stage in mid-April and was the first to be certified as a class action. > Alleging losses of over $358 million, the plaintiff accused the University of breach of its duty of prudence. The Duke University case was also certified as a class action in April. > Class certification is pending in Emory University and Massachusetts Institute of Technology cases.

4848 Are Governmental DC Plans Next?

Maybe… > Fiduciaries of governmental DC plans are subject to the same, or similar, fiduciary duties and standards as ERISA DC plans. > Many allegations raised in ERISA DC plan litigation could also be raised by participants in participant-directed governmental DC plans. > Many governmental DC plans have the same trustees, record keepers, annuity providers, and investment options as ERISA DC plans that are the target of fiduciary breach litigation. > Like the 403(b) plans of large private universities, the significant assets of some governmental DC plans could make them an appealing litigation target. However, public plan fiduciaries may have sovereign immunity or other statutory protections that reduce the likelihood of such litigation.

4949 Sovereign Immunity

> State constitution or statutes may provide some protection. > May also have public officer protection or other State employee immunity or indemnification. > Often will still require good faith demonstration.

Even if Sovereign Immunity is a valid defense, the perception of poor management of plan assets can be damaging to the locality maintaining the plan.

5050 Questions?

Marc Purintun Partner, Williams Mullen [email protected] 804.420.6310

Please note: This presentation contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Individuals with particular needs on specific issues should retain the services of competent counsel.

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