John Eskew won't be caught napping in the woods when the bear arrives.
The CFO of Windermere Real Estate Services Co., a residential real estate brokerage firm based in Seattle, put together a comprehensive fiduciary liability program to reduce the company's — and his own — exposure to lawsuits alleging imprudent management of employee 401(k) retirement savings. "People forget that under ERISA [the Employee Retirement Income Security Act], anyone who has fiduciary authority for employee pensions is personally responsible to the full extent of his or her personal wealth to manage that plan in accordance with the law," says Eskew. "That's a lot of personal responsibility."
When Eskew came to Windermere as CFO in 1997, the company did not have a formal fiduciary management program. Knowing that he'd be on the hook personally for any fiduciary losses, that gave him pause. So Eskew assembled an in-house 401(k) committee that included himself, the CEO, and an employee representative; developed a written investment policy; hired outside investment advisers to select investment options; asked an ERISA attorney to review everything; then instituted a quarterly review process. These efforts were complemented by what Eskew considers the most important component of any fiduciary management program — insurance.
"Nobody thinks about fiduciary liability when the stock market is roaring," says Eskew. "But when it whimpers, employees and retirees look to blame someone, and the plaintiff's bar will see this as the next big payday. Without a fiduciary liability policy, you're risking everything you have ever worked for — your house, your retirement savings, everything."
As a corporate fiduciary, Eskew is not alone in fearing the consequences of a bear market, but he is one of the few doing something about it. While most corporations buy inexpensively priced fiduciary liability insurance (premiums are roughly 5 percent of coverage limits), few have put in place specific programs to manage, reduce, or mitigate such.
But insurance alone may not cover all sins. Cheaper coverage, for one thing, doesn't cover risks that stem from offering company stock as an investment option. Also, you can always be sued for more coverage than you have. And even with the broadest coverage, your company's reputation remains at risk from a nasty lawsuit.
That risk will come home to roost if the stock market decelerates. Currently, more than $1.5 trillion is invested in 401(k) plans representing roughly 40 million individuals, up from $92 billion and 7.5 million participants in 1984. "When your fund is earning so much, you tend not to think much about it," says Ann Longmore, ERISA practice leader at New York-based insurance broker Willis. "Consequently, there are a lot of violations going undetected, with few if any complaints raised. Companies are not kicking the tires here. If they did, they would be surprised how vulnerable they are."
Alden Bianchi, chairman of the employee benefits practice at Mirick O'Connell, a Worcester, Massachusetts-based law firm, is equally blunt. "The current boom is masking a lot of mistakes," Bianchi says. "Let's not kid ourselves. If you offer a technology stock in your 401(k) options, it will be hard to distinguish [whether] this is a prudent investment or a lottery ticket. Today, you're a hero for offering tech stocks, and employees think they're masters of the universe for selecting these investments. But if we hit a rocky patch in a few years, and baby boomers retire, they'll look for someone to blame for the poor performance of their pension plans. They'll whine and scream and sue their fiduciaries. Count on it."
Assessing ERISA
Ironically, many companies switched from defined benefit plans to defined contribution plans to get a better handle on the risks they confronted under ERISA. By giving employees the option to pick and choose among several investment options in a 401(k) plan, corporate plan sponsors passed on much of their fiduciary risk.
The law's 404(c) regulations, adopted in 1992, reassured most plan sponsors that they were protected from liability as long as they adhered to the guidelines for offering diversified investment options. And as long as they can document that they followed the guidelines, experts say, sponsors should be protected no matter how the options perform. But "you can never fully pass the baton," says Willis's Longmore.
However, documenting the process isn't necessarily easy. "You must show that you undertook whatever steps were necessary to ensure that the investment options you provided were not all three-legged horses when you selected them," says Longmore. "Unfortunately, many companies fail to document the steps they have taken — the reasons why they picked this investment over that one." If sued by disgruntled employees, those companies may find that 404(c) offers no protection.
Too often, in fact, fiduciary issues take second place to other worries. "Employee benefits tend to ride in the caboose," says Bianchi. "Senior management is more concerned with long-term planning, acquisitions, product cycles, and so on, and tend to think of benefits as 'that stuff over there.' "
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