Marc Purintun Partner and Chair of Employee Benefits Practice

Fiduciaries of Governmental

Retirement Plans in Virginia

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> Who is a Fiduciary?

> Sources and Standards of Fiduciary Duties

> Overview of Litigation

Discussion Overview

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Who is a Fiduciary?

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> 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)

Fiduciary Defined

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> 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.

Who is Not a Fiduciary?

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> Entities or individuals that solely perform

administrative functions:

– Receives contributions and applies to accounts,

– Distributes educational materials,

– Implements rules, and/or

– Processes forms.

Who is Not a Fiduciary?

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Sources and Standards of

Fiduciary Duties

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Sources of Fiduciary Duties

Fiduciaries are held to extremely high standards of conduct

under the law.

Federal Law

• Internal Revenue Code

• ERISA (not directly applicable to governmental plans, but excellent resource)

State and Local Law

• State Constitution

• Statutory

• Municipal code

• Policies and regulations

Common Law

• Restatement (Third) of Trusts (collection of common law)

• Uniform Management of Public Employee Retirement Systems Act (UMPERSA) (not adopted by Virginia, but an excellent resource)

Plan and Plan-Related

Documents

• Municipal Code

• Administrative Code

• Plan Documents

• Trust Agreements

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> 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.

ERISA

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> 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.

ERISA (cont’d)

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Code of Virginia

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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.

Common Law of Trusts

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> 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)

Affirmative Fiduciary Duties

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Affirmative Fiduciary Duties (cont’d)

Duty of Loyalty

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 to act impartially among differing interests.

Duty of Prudence

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 to diversify investments.

Duty to Follow Plan Document

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> 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.

Duty of Loyalty

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>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.

Duty of Loyalty (cont’d)

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> 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)

Duty of Loyalty – Costs

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> 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.

Duty of Loyalty – Practical Impact

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> 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.

Duty of Prudence

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> 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.

Duty of Prudence – Delegation

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> 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.

Duty of Prudence – Practical Impact

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> 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.

Duty of Prudence - Diversify

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> 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.

Duty of Prudence –

Continuing Duty to Monitor

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> 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

Continuing Duty to Monitor –

Practical Impact

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> 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.

Duty to Follow Plan Documents

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> Consider whether documents address revenue

sharing or other unallocated amounts

– How such assets are these used? Plan expenses?

Allocated to participants?

– How often distributed?

Duty to Follow Plan Documents –

Practical Impact

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A fiduciary may not:

Deal with plan assets in his or her own interest.

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.

Negative Duties –

Prohibited Transactions

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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.

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What about participant directed

investments?

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> 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.

Responsibilities

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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.

Litigation Overview

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> 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.

Defined Contribution Plans

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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.

401(k) Litigation

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> 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

401(k) Litigation

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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.

403(b) litigation

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Universities Sued

403(b) Litigation

• Yale University

• New York University

• Columbia University

• Cornell University

• University of

Pennsylvania

• Duke University

• Johns Hopkins

Universities

• Vanderbilt University

• Northwestern University

• University of Southern

California

• Emory University

• Brown University

• University of Chicago

• Princeton University

• Washington University

• Georgetown

University

• Massachusetts

Institute of Technology

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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

403(b) Litigation

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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

403(b) Litigation

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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.

403(b) Litigation

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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.

403(b) Litigation

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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.

Are Governmental DC Plans Next?

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> 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.

Sovereign Immunity

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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.

Questions?

Marc Purintun

Partner, Williams Mullen

mpurintun@williamsmullen.com

804.420.6310