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December 17, 2004
Memorandum For: Virginia C. Smith Director of
Enforcement, Regional Directors
From: Robert J. Doyle Director of Regulations
and Interpretations
Subject: Fiduciary Responsibilities Of
Directed Trustees
In the context of publicly traded securities, what
are the fiduciary responsibilities of a directed trustee?
Many employee pension plans use directed trustees
to carry out transactions according to instructions from a named
fiduciary of the plan. During investigations of such transactions by
the Department, difficult questions may arise regarding the scope of
the directed trustee’s fiduciary duties. Recent court decisions,
addressing this issue in the context of purchases and holdings of
publicly traded employer securities in particular, have focused
attention on the nature and scope of a directed trustee’s fiduciary
duties. This bulletin provides general guidance to EBSA regional
offices regarding the Department’s views on the responsibilities of
directed trustees under ERISA, particularly with respect to directions
involving employer securities.
Section 403(a) provides that a plan trustee “shall
have exclusive authority and discretion to manage and control the assets
of the plan.” Section 3(21)(A) provides that a person is a fiduciary
with respect to a plan “to the extent . . . he . . . exercises any
authority or control respecting management or disposition of its assets.”
A plan trustee, therefore, will, by definition, always be a “fiduciary”
under ERISA as result of its authority or control over plan assets. Not
all trustees, however, have the same authority or discretion to manage
or control the assets of a plan. In this regard, section 403(a)
specifically recognizes that a trustee or trustees will have limited
authority or discretion when:
(1) the plan expressly provides that the trustee or
trustees are subject to the direction of a named fiduciary who is not
a trustee, in which case the trustees shall be subject to proper
directions of such fiduciary which are made in accordance with the
terms of the plan and which are not contrary to this Act.
While section 403(a)(1) does not remove a directed
trustee from section 3(21)’s purview, it significantly limits such a
trustee’s responsibilities as a plan fiduciary. As the district court
in In re Enron Corp. Securities, Derivative & ERISA Litig., 284 F.
Supp. 2d 511, 601 (S.D. Tex. 2003), recognized:
At least some fiduciary status and duties of a
directed trustee are preserved, even though the scope of its exclusive
authority and discretion to manage and control the assets of the plan’
has been substantially constricted by the directing named fiduciary’s
correspondingly broadened role . . . .
The court in In re WorldCom, Inc. ERISA Litig.,
263 F. Supp. 2d 745, 762 (S.D.N.Y. 2003) also noted that, while the
directed trustee provision serves as a limiting principle, “section
403(a) does not . . . eliminate the fiduciary status or duties that
normally adhere to a trustee with responsibility over ERISA assets.” See
also FirsTier Bank, N.A. v. Zeller, 16 F.3d 907, 9110 (8th Cir.),
cert. denied sub nom, Vercoe v. FirsTier Bank, N.A., 513 U.S. 871
(1994); Herman v. NationsBank Trust Co., 126 F.3d 1354, 1361-62,
1370 (11th Cir. 1997).
The duties of a directed trustee under section
403(a)(1) are therefore significantly narrower than the duties generally
ascribed to a discretionary trustee under common law trust principles.(1)
Under section 403(a)(1), a directed trustee is
subject to proper directions of a named fiduciary. For purposes of
section 403(a)(1), a direction is proper only if the direction is “made
in accordance with the terms of the plan” and “not contrary to the
Act [ERISA].” Accordingly, when a directed trustee knows or should
know that a direction from a named fiduciary is not made in accordance
with the terms of the plan or is contrary to ERISA, the directed trustee
may not, consistent with its fiduciary responsibilities, follow the
direction.
In accordance with plan terms
Under section
403(a)(1), a directed trustee may not follow a direction that the
trustee knows or should know is inconsistent with the terms of the plan.
In order to make such determinations, directed trustees necessarily have
a duty to request and review all the documents and instruments governing
the plan that are relevant to its duties as directed trustee.
Accordingly, if a directed trustee either fails to request such
documents or fails to review the documents furnished in response to its
request and, as a result of such failure, follows a direction contrary
to the terms of the plan, the directed trustee may be liable for
following such direction because the directed trustee had a duty to
request and review pertinent plan documents and, therefore, should have
known that the direction was not in accordance with the terms of the
plan. If a directed trustee follows an improper direction, as would be
the case where the purchase of a particular stock at the direction of
the plan’s named fiduciary is contrary to the plan’s investment
policy, the directed trustee may be liable for a breach of its fiduciary
duty to follow only proper directions.
It is the view of the Department that a direction is
consistent with the terms of a plan if the documents pursuant to which
the plan is established and operated do not prohibit the direction. It
is also the view of the Department that if, in the course of reviewing
the propriety of a particular direction, a directed trustee determines
that the terms of the relevant documents are ambiguous with respect to
the permissibility of the direction, the directed trustee should obtain
a clarification of the plan terms from the fiduciary responsible for
interpreting such terms in order to ensure that the direction is proper.
In this regard, the directed trustee may rely on the interpretation of
such fiduciary.
Not contrary to ERISA
Even when a
direction is consistent with the terms of the plan, the direction may
nonetheless fail to be a proper direction because it is contrary to
ERISA. Under section 403(a)(1), a directed trustee may not follow a
direction that the trustee knows or should know is contrary to ERISA.
For example, the directed trustee cannot follow a direction that the
directed trustee knows or should know would require the trustee to
engage in a transaction prohibited under section 406 or violate the
prudence requirement of section 404(a)(1). The following discussion
further clarifies the duties of a directed trustee in this area.
Prohibited transaction determinations
A directed trustee must follow processes that are
designed to avoid prohibited transactions. A directed trustee could
satisfy its obligation by obtaining appropriate written
representations from the directing fiduciary that the plan maintains
and follows procedures for identifying prohibited transactions and, if
prohibited, identifying the individual or class exemption applicable
to the transaction. A directed trustee may rely on the representations
of the directing fiduciary unless the directed trustee knows that the
representations are false.
Prudence determinations
The named fiduciary has primary responsibility for
determining the prudence of a particular transaction, whether the
transaction involves buying, selling or holding particular assets.
Accordingly, as the courts and the Department have long recognized,
the scope of a directed trustee’s responsibility is significantly
limited. A directed trustee does not, in the view of the Department,
have an independent obligation to determine the prudence of every
transaction. The directed trustee does not have an obligation to
duplicate or second-guess the work of the plan fiduciaries that have
discretionary authority over the management of plan assets and does
not have a direct obligation to determine the prudence of a
transaction. See In re WorldCom ERISA Litig., 263 F. Supp. 2d at 761;
Herman v. NationsBank Trust Co., 126 F.3d at 1361-62, 1371 (directed
trustee does not have a direct obligation of prudence under ERISA
section 404; its obligation is simply “to make sure” the “directions
were proper, in accordance with the terms of the plan, and not
contrary to ERISA”).
Duty to act on non-public information
The
directed trustee’s obligation to question market transactions
involving publicly traded stock on prudence grounds is quite limited.
The primary circumstance in which such an obligation could arise is
when the directed trustee possesses material non-public information
regarding a security. If a directed trustee has material non-public
information that is necessary for a prudent decision, the directed
trustee, prior to following a direction that would be affected by such
information, has a duty to inquire about the named fiduciary’s
knowledge and consideration of the information with respect to the
direction. For example, if a directed trustee has non-public
information indicating that a company’s public financial statements
contain material misrepresentations that significantly inflate the
company’s earnings, the trustee could not simply follow a direction
to purchase that company’s stock at an artificially inflated price.
Generally, the possession of non-public information
by one part of an organization will not be imputed to the organization
as a whole (including personnel providing directed trustee services)
where the organization maintains procedures designed to prevent the
illegal disclosure of such information under securities, banking or
other laws.(2) If, despite
such procedures, the individuals responsible for the directed trustee
services have actual knowledge of material non-public information, the
directed trustee, prior to following a direction that would be
affected by such information, has a duty, as indicated above, to
inquire about the named fiduciary’s knowledge and consideration of
the information with respect to the direction. Similarly, if the
directed trustee performs an internal analysis in which it concludes
that the company’s current financial statements are materially
inaccurate, the directed trustee would have an obligation to disclose
this analysis to the named fiduciary before making a determination
whether to follow a direction to purchase the company’s security.
The directed trustee would not have an obligation to disclose reports
and analyses that are available to the public.
Duty to act on public information
Absent
material non-public information, a directed trustee, given its limited
fiduciary duties as determined by statute, will rarely have an
obligation under ERISA to question the prudence of a direction to
purchase publicly traded securities at the market price solely on the
basis of publicly available information. Three considerations counsel
in favor of this view: (1) markets generally are assumed to be
efficient so that stock prices reflect publicly available information
and known risks; (2) in the case of employer securities, the
securities laws impose substantial obligations on the company, its
officers, and its accountants to state their financial records
accurately; and (3) ERISA section 404 requires the instructing
fiduciary to adhere to a stringent standard of care.(3)
Furthermore, because stock prices fluctuate as a matter of
course, even a steep drop in a stock’s price would not, in and of
itself, indicate that a named fiduciary’s direction to purchase or
hold such stock is imprudent and, therefore, not a proper direction.
In limited, extraordinary circumstances, where
there are clear and compelling public indicators, as evidenced by an
8-K filing with the Securities and Exchange Commission (SEC), a
bankruptcy filing or similar public indicator, that call into serious
question a company’s viability as a going concern,(4)
the directed trustee may have a duty not to follow the named
fiduciary’s instruction without further inquiry.(5)
For example, if a company filed for bankruptcy under
circumstances which make it unlikely that there would be any
distribution to equity-holders, or otherwise publicly stated that it
was unlikely to survive the bankruptcy proceedings in a manner that
would leave current equity-holders with any value, the directed
trustee would have an obligation to question whether the named
fiduciary has considered the prudence of the direction.(6)
It also is the view of the Department that, in situations where
a fiduciary who is a corporate employee gives an instruction to buy or
hold stock of his or her company subsequent to the company, its
officers or directors, being formally charged by state or Federal
regulators with financial irregularities, the directed trustee, taking
such facts into account, may need to decline to follow the direction
or may need to conduct an independent assessment of the transaction in
order to assure itself that the instruction is consistent with ERISA.(7)
If, however, an independent fiduciary was appointed to manage
the plan’s investment in company stock, a directed trustee could
follow the proper directions of the independent fiduciary without
having to conduct its own independent assessment of the transaction.
It is the view of the Department that the nature
and scope of a directed trustee’s fiduciary responsibility, as
discussed herein, does not change merely because the directed trustee,
in carrying out its duties, raises questions concerning whether a
direction is “proper” or declines to follow a direction that the
directed trustee does not believe is a proper direction within the
meaning of section 403(a)(1). For example, information provided to a
named fiduciary concerning the prudence of a direction is not
investment advice for purposes of ERISA §3(21)(A)(ii). Similarly, if
a named fiduciary changes a direction in response to a directed
trustee’s inquiries or information, the directed trustee’s
fiduciary responsibility with respect to the changed direction remains
governed by section 403(a)(1). The directed trustee does not become
primarily responsible for the prudence of the direction.
Under ERISA section 405(a)(1), a fiduciary is
liable for the breach of another fiduciary if the fiduciary “participates
knowingly” in the breach of the other fiduciary. Accordingly, if a
directed trustee has knowledge of a fiduciary breach, the directed
trustee may be liable as a co-fiduciary unless the directed trustee
takes reasonable steps to remedy the breach. Thus, if the directed
trustee knew that the named fiduciary was failing to discharge its
obligations in accordance with ERISA’s requirements, it could not
simply follow directions from the breaching fiduciary. Efforts to
remedy a breach (or to prevent an imminent breach) may include
reporting the breach to other fiduciaries of the plan or the
Department of Labor.
Although its responsibilities are significantly
limited under the statute, a directed trustee is a fiduciary under
ERISA and must exercise its duties prudently and solely in the
interest of the plan participants and beneficiaries. Particularly in
the context of purchasing, selling or holding publicly traded
securities on a generally recognized market, the trustee may follow
the named fiduciary’s directions absent extraordinary circumstance
as discussed above.
-
It is assumed for purposes of this
guidance that discretionary authority or control over plan assets, beyond
that discussed herein as applicable to a person serving as a directed
trustee under section 403(a)(1), has not been conferred upon a directed
trustee under the terms of the plan, including trust and service provider
agreements.
-
The Department expresses no view as to
whether, or under what circumstances, other procedures established by an
organization to limit the disclosure of information will serve to avoid the
imputation of information to a directed trustee.
-
It should be noted that, in the case of an
individual account plan, the diversification requirements of section
404(a)(1)(C) do not apply to the acquisition or holding of qualifying
employer securities within the meaning of section 407(d)(5).
-
We note that section 409 of the
Sarbanes-Oxley Act of 2002, 15 U.S.C. 78(m)(l), requires public companies to
disclose “on a rapid and current basis” material information regarding
changes in the company’s financial condition or operations as the SEC by
rule determines to be necessary or useful for the protection of investors or
in the public interest. The SEC has recently updated its disclosure
requirements related to Form 8-K, expanding the number of reportable events
and shortening the filing deadline for most items to four business days
after the occurrence of the event triggering the disclosure requirements of
the form. 69 FR. 15594 (Mar. 25, 2004). Not all 8-K filings regarding a
company would trigger a duty on the part of a directed trustee to question a
direction to purchase or hold securities of that company. Only those
relatively few 8-Ks that call into serious question a company’s ongoing
viability may trigger a duty on the part of the directed trustee to take
some action.
-
A directed trustee’s actual knowledge of
media or other public reports or analyses that merely speculate on the
continued viability of a company does not, in and of itself, constitute
knowledge of clear and compelling evidence concerning the company sufficient
to give rise to a directed trustee’s duty to act.
-
Even under such circumstances, it might
not be imprudent to purchase or hold stock in a distressed company in
bankruptcy. There may be situations in which the plan’s fiduciaries could
reasonably conclude that the stock investment makes sense, even for a
long-term investor, in light of the proposed restructuring of the company’s
debts or other factors.
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Nothing in the text should be read to
suggest that a directed trustee would have a heightened duty whenever a
regulatory body opens an investigation of a company whose securities are the
subject of a direction, merely based on the bare fact of the investigation.
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