Q: We keep hearing about participant lawsuits against 401(k) plans, and strive to do our best to avoid situations that could lead to one. Part of that is using prudent processes in the plan. We have asked our advisor and done some searching on our own, but haven’t been able to define what processes are truly prudent in this context.
A: Since the inception of the Employee Retirement Income Security Act of 1974 (ERISA), the prudent person rule has provided a good rule of thumb. To paraphrase, it states that an appropriate decision is one that a prudent person, with similar skill and circumstances, would make. You are correct that it lacks precision, and that’s why process is so important; the Center for Retirement Research at Boston College studied the major causes of 401(k) lawsuits, and determined that they often hinge on whether or not a prudent process was followed. The study found that the most common reasons for participant legal action are excessive plan fees, poor investment options, and self-dealing behaviors. To illustrate: some plan sponsors fear incurring the higher fees associated with actively managed funds, so they offer only passive funds. But courts don’t automatically consider higher fees to be excessive, as long as they are clear and provide value in exchange for the fees. In fact, a too-conservative approach may also be detrimental to participants. A prudent process for selecting the funds may provide a satisfactory defense if a participant decides to sue. Our best suggestion is to thoroughly review all processes in the plan with prudence in mind. Read more at https://tinyurl.com/CRR-Prudent-Process.