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Why 401(k) advisers should be aware of contractual language limitations

A contract may not protect advisers to the extent they believe

Jan 18, 2018 @ 11:19 am

By Marcia S. Wagner

As counsel for investment managers and investment advisers, we endeavor to draft documents precisely, making clear the obligations of our clients and seeking to limit their exposures to the extent permissible by the Employee Retirement Income Security Act of 1974.

However, a recent district court decision from the Northern District of California, in the case Terraza v. Safeway, indicates limitations in the extent to which contractual language can protect investment advisers with respect to claims for breach of fiduciary duty under ERISA.

Aon, a co-defendant in the case, along with Safeway, argued that its master consulting agreement with Safeway established its robust process in providing ongoing consulting and performance evaluation, including detailed quarterly reports addressing fund structure, performance and other characteristics, quarterly meetings with the client and investment managers, and regular client communications.

While those actions are ones a prudent ERISA investment adviser would take, the district court judge was not persuaded that the terms of the document, standing alone, established that Aon had satisfied ERISA's duty of prudence. The judge explained: "That an agreement exists does not prove that it was followed, and that it might have been followed does not necessarily satisfy the duty of prudence."

Not only was the contractual language, in and of itself, insufficient to establish that the duty of prudence had been satisfied, but the same was true of the language of the detailed quarterly reports. As an example of the limitations of the quarterly investment reports, the district court concluded they would not establish the prudence of using J.P. Morgan Chase Bank benchmarks to measure the performance of the J.P. Morgan Chase Bank target-date funds, one of plaintiff's claims in the case.

(More: Excessive-fee litigation in retirement plan market moving downstream)

Second, the duty of the investment consultant was to provide prudent recommendations to the plan's fiduciary decision-makers, but the quarterly reports contained performance and other data without making any recommendations. Similarly, though Aon indicated it had made a recommendation to Safeway about a tiered investment structure, which Safeway ultimately didn't implement, the judge stated that the quarterly report didn't say anything about whether a prudent person in Aon's position would have tried to make this recommendation more than once or would have taken other steps to encourage Safeway to adopt the recommendation.

Advisers need to be aware of other limitations of contractual protection. For example, parties to a private contract are not permitted to modify the language of a statute or regulation.

For example, if there was some activity by an adviser with respect to which it was unclear whether the action constituted investment advice under the revised Department of Labor fiduciary rule, an agreement by the parties that the activity did not constitute investment advice would not preclude a court from concluding the contrary. Whether certain conduct is or isn't fiduciary in nature is a question of law, and not a matter of contract interpretation, although the parties' agreement could be a factor the court would take into account.

(More: Jerry Schlichter's fee lawsuits have left an indelible mark on the 401(k) industry)

Another limitation pertains to an individual's release of his/her claim against an investment adviser for breach of fiduciary duty. While such releases of claims by individuals are permissible, numerous courts have held that individuals do not have the authority to release the plan's claim, whether defined benefit or defined contribution, against a third party. So, the individual releasing his or her claim could still be the named plaintiff in a class-action lawsuit.

In short, while contractual language is obviously very important, investment advisers need to be aware of its limitations in certain situations.

Marcia S. Wagner is managing and founding partner of The Wagner Law Group.

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