Fiduciary may be liable for losses if investments fail

Q In our retirement plan, employees can select the investments for their accounts from a menu of mutual funds. If an employee is disappointed with the investments' performance, can I be held liable?

In selecting the investment options, the responsible fiduciary must act "prudently" and is liable for losses resulting from an imprudent decision. In addition to the initial selection of the investment options, the responsible fiduciary must monitor the options to ensure that they continue to be a prudent choice for the plan.

As a practical matter, "prudent" in this context means selecting investment options expected to perform reasonably well relative to other similar investment products and against appropriate standard indices. In addition, it means periodically (eg, annually) reviewing how each investment has performed historically relative to others and to appropriate benchmarks, and making changes when reasonable.

For example, since your plan invests in mutual funds, the responsible fiduciary should review the performance of each fund at least annually against a comparable index of performance. The fiduciary should look to see if each fund compares favorably to the performance of other funds of the same type and with the same investment objectives. For example, you might use the S&P 500 Index to judge the performance of a large-cap equity fund. A small-cap equity fund could be compared with the Russell 2000 Index.

The responsible fiduciary should determine whether the funds have a poor rate of return relative to other, similar funds and in relation to the appropriate benchmark or index. If so, the fiduciary should consider switching funds and, at some point, a prudent fiduciary will be obligated to switch funds.

Simply conducting these comparisons is not sufficient, however. Fiduciaries must keep minutes of the meetings at which they conduct their review that reflect the alternatives considered and why they were chosen or rejected. Also, copies of the materials reviewed at the meeting should be attached to the minutes.

If the fiduciary exercises prudent selection of the investment options and proper monitoring of the investments, then two of the three basic steps have been taken that should avoid liability for any losses suffered by the plan participants on the investment options they select.

To effectively transfer responsibility for selecting among the investment options, the plan must also follow specific rules. These are found in the Department of Labor Regulations under ERISA Section 404(c). Employers are typically told that they must do only three things to comply with Section 404(c): give the employees three investment options, let the employees make their own choices among the investment options, and let the employees change the investments at least every 3 months. But depending on how the actual requirements of the Section 404(c) regulations are counted, there are actually 20 to 30 different conditions that must be met.