IBEW/NECA Employee Benefits Conference Legal Update Naples, Florida January 2013 Shane N. Kramer Potts-Dupre, Difede & Hawkins, CHTD.

Prudent Investment Decisions Under ERISA Back to Basics Potts-Dupre, Difede & Hawkins, CHTD.

2007 Manager Selections Example Potts-Dupre, Difede & Hawkins, CHTD.

#1 11% Manager A 18% Manager B -12% Manager C Potts-Dupre, Difede & Hawkins, CHTD.

#2 11% High Yield Fixed Income (lower-mid quartile) big-name firm Manager A 18% Large Cap Value (top quartile) family-owned firm Manager B -12% Alternatives: Comics, Baseball Cards, and Poker Players niche, no-name firm Manager C Potts-Dupre, Difede & Hawkins, CHTD.

#3 11% High Yield Fixed Income (lower-mid quartile) big-name firm transparent process Manager A 18% Large Cap Value (top quartile) family-owned firm secretive process Manager B -12% Rare Comics, Baseball Cards, and Poker Players niche, no-name firm transparent process Manager C Potts-Dupre, Difede & Hawkins, CHTD.

11% picked by throwing darts Manager A TOTAL LOSS Recommended by consultant & selected with thorough due diligence and analysis Manager B -12% Recommended by consultant & selected with thorough due diligence and analysis Manager C #4 Potts-Dupre, Difede & Hawkins, CHTD.

What’s the Takeaway? ERISA regulates are irrelevant {Well, mostly…} Potts-Dupre, Difede & Hawkins, CHTD.

The Moral?

High Stakes “The fiduciary obligations of trustees [and other ERISA fiduciaries] are... the highest known to law.” Donovan v. Bierworth, 680 F.2d 263, 272 (2nd Cir. 1982) + Possibility of personal liability: – Restore losses to plan – Return ill-gotten gains – Equitable or remedial relief (such as removal) – Civil penalty (20% of amount recovered under ERISA § 502(l)) = … a lot of exposure! Potts-Dupre, Difede & Hawkins, CHTD.

Fiduciary Insurance Use of Plan Assets, where appropriate Proactive avoidance / Self-help – Focus on process – Delegation (getting off the fiduciary hook) Fiduciary Protection Potts-Dupre, Difede & Hawkins, CHTD.

Fiduciary Framework: ERISA § 404(a)(1) Duty of loyalty – Exclusive Benefit Rule Duty of care – Prudent Expert Rule Duty of diversification Duty to follow plan documents to extent consistent with ERISA Title I and Title IV Potts-Dupre, Difede & Hawkins, CHTD.

Functional test under ERISA § 3(21)(A) – your title is not determinative: – Do you have discretion or control over plan assets? – Do you render investment advice for a fee? – Do you have discretionary responsibility in the administration of the plan? Who’s on the Fiduciary Hook? Potts-Dupre, Difede & Hawkins, CHTD.

What is the “Prudent Expert” Standard of Care? [A] fiduciary shall discharge his duties with respect to the plan... with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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 Potts-Dupre, Difede & Hawkins, CHTD. ERISA § 404(a)(1)(B)

Prudence and Investment Duties The prudent expert standard is satisfied if the fiduciary: – Has given “appropriate consideration” to the facts and circumstances the fiduciary knows (or should know) are relevant to the investment (or investment course of action), including the role it plays in the investment portfolio AND – Has acted accordingly Potts-Dupre, Difede & Hawkins, CHTD. DOL Reg. § a-1b

How Do I Give “Appropriate Consideration”? Step 1: Make a determination that the investment is reasonably designed to further the purposes of the plan, taking into consideration the risk of loss and opportunity for gain (or other return) of the investment Potts-Dupre, Difede & Hawkins, CHTD.

And… Step 2: Consider the investment in light of the portfolio’s: – Diversification – Liquidity and current return relative to the plan’s anticipated cash flow requirements – Projected return relative to the plan’s funding objectives Potts-Dupre, Difede & Hawkins, CHTD.

Summary Statute: A fiduciary’s conduct is judged on a snapshot basis against what a competent, impartial, informed investment professional might do Regulations: A fiduciary should thoroughly investigate and analyze the F&Cs surrounding the investment – Consider the nature of the plan / diversification / liquidity / goals / etc. – Then, determine on the merits that it benefits the plan But... What if fiduciary doesn’t have the necessary expertise or time? Potts-Dupre, Difede & Hawkins, CHTD.

“... a pure heart and an empty head are not enough.” Good faith and ignorance are no defense If you have an empty head… – You’re not alone! – But, you must obtain the assistance of a qualified expert -- William Shakespeare

Self-Help Read to stay current and anticipate issues Use your consultant, counsel, actuary, investment staff, etc. Own the process: engage and ask probing questions Document your process Fiduciary investment training? Review plan text and trust documents - know your role Review Investment Policy Statement/Guidelines regularly – Fiduciary road map – Follow it! Potts-Dupre, Difede & Hawkins, CHTD.

IPS/General Guidelines Essentials Funding policy Goals and objectives Risk/return guidelines Permitted asset classes and sub- classes/styles Target asset mix, diversification, & rebalancing Liquidity considerations Role of independent consultant; actuary; custodial bank; etc. Selection & monitoring of asset managers Reporting and communications Procedures for reviewing performance relative to appropriate benchmarks Voting of proxies Review of fees for reasonableness Review of IPS/Guidelines Trustee / board / executive committee meetings Lay out ERISA prudence requirements Potts-Dupre, Difede & Hawkins, CHTD.

How to Get Help, Prudently, Of Course Non-Discretionary Investment Adviser – “3(21)” fiduciary Discretionary Investment Manager – “3(38)” fiduciary Potts-Dupre, Difede & Hawkins, CHTD.

Non-Discretionary Investment Adviser Potts-Dupre, Difede & Hawkins, CHTD. Evidence of thorough investigation and good process Not a shield to liability If you retain discretion and control, you are on hook for investment decision

Requirements for Reliance Investigate credentials and probe independence – Is expert qualified to make recommendation? – Is expert conflicted? Provide expert with complete and accurate information Evaluate recommendation before following it – No rubber-stamp approval Create paper trail Potts-Dupre, Difede & Hawkins, CHTD.

Discretionary Investment Manager Plan fiduciary is on hook for selection and monitoring Investment manager is on hook for actual investment decisions Potts-Dupre, Difede & Hawkins, CHTD.

Delegation Requirements – Must have discretion to manage plan assets – Must be registered investment advisor, bank or insurance company – Must acknowledge fiduciary status in writing Potts-Dupre, Difede & Hawkins, CHTD.

Checklist: Sample Criteria For Hiring A Manager Experience with benefit plan clients / AUM Reputation / references Organizational structure / financial health Performance (absolute / relative / consistency) Qualifications of key individuals Appropriate registrations Willingness to be on fiduciary hook Investment process Investment style Communications & reporting / transparency Litigation or enforcement actions Fees Bonding / Insurance to cover the fund QPAM status Potts-Dupre, Difede & Hawkins, CHTD.

Sample Checklist For Periodic Monitoring Review managers at reasonable intervals Were there any material changes in the status of hiring criteria? Was the mandate satisfied? Did performance meet the needs of the plan? Were there any compliance issues? – (e.g., guidelines / contractual / legal ) Was the reporting to expectations? Potts-Dupre, Difede & Hawkins, CHTD.

Review ERISA Prudence is flexible and based on CONDUCT Process is key and results are irrelevant (mostly) Self-help – Education – Use expert(s) when necessary – Be deliberate with due diligence – Make reasoned and independent decisions – Create a paper trail Potts-Dupre, Difede & Hawkins, CHTD.