The Supreme Court Got Its 401(k) Decision Right

With so much at stake, it is critical for money managers everywhere to recognize their role as trustees of assets that do not belong to them.
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"More will follow," a friend whispered to me on the phone in a voice filled with disappointment and consternation. The two of us had just discovered that one of our favorite college professors was let go due to our alma mater's dire financial situation. The news of our teacher's misfortune brutally reminded us of our university's economic condition.

This past year, Moody's downgraded my former school's credit rating and indicated it was high risk. The firm attributed the poor financial performance to "weak financial management" and "[h]istorically ineffective internal controls and limited transparency."

But while my former school's financial woes can be facially dismissed as the result of poor investment choices, the underlying causes appear more nefarious. For instance, several years ago it was discovered that Bernie Madoff, a former member of the school's board of trustees, had stolen millions from the endowment. Even more wrenching, however, was the fact that the chairman of my school's investment committee first invested the endowment money into his own fund prior to investing with Madoff. Though the investment adviser could have put the money directly with Madoff, he instead invested the money into his own account to reap a 1.5% annual fee (or 150 basis points in industry terms), a further significant drain on my school's vital resources. By violating the trust of his friends and fellow community members, my school lost millions and is now forced to drastically scale back its academic program.

It seems that every other day we hear stories involving insider trading and unethical investing. The effects of unethical insider investing extend well beyond my school and into the life savings of American employees and retirees. However, this past week the Supreme Court granted a major victory to investors seeking to protect their assets in pension and 401(k)/defined contribution plans. In Tibble v. Edison, the Court interpreted the Employee Retirement Income Security Act (ERISA) to expand the fiduciary duties owed by managers of 401(k) plans.

In an opinion written by Justice Breyer, the court unanimously overruled a decision by the 9th Circuit that barred beneficiaries of a 401(k) savings plan from prevailing on a claim against Edison International for breaching its duty as a fiduciary. The petitioners claimed Edison acted irresponsibly by investing in certain mutual funds when other "materially identical" funds had existed at lower prices--the price differences were attributed to unnecessary administrative costs. The 9th Circuit held the beneficiaries could not prevail, because their claims were "untimely" under ERISA, which gives only six years to bring suit from the time of a breach or violation. On review, the issue came down to the interpretation of the words "action" and "omission" in ERISA's section on timeliness. The 9th Circuit previously held omission to mean a fiduciary only needs to reevaluate his or her investment decisions in the event of a "significant change in circumstances." The Supreme Court rejected that interpretation and asserted a fiduciary must act responsibly at all times, even in the absence of a significant change.

In its ruling, SCOTUS reaffirmed how the principles underlying a fiduciary's duty are derived from the "common law of trusts." Citing the Bogert treatise, it stated that a trustee--and therefore also a fiduciary--must continuously reevaluate its investments to ensure "that they are appropriate" and prudent. At the core of the Court's ruling is the imperative that money managers take their work seriously by placing their clients' interests ahead of their own. Instead of investing and then abandoning his or her clients' money in singular investments, a fiduciary must respond appropriately to encourage growth. As Bogert once said, a trustee must "display the same care and judgment that would be shown by an ordinarily able businessman in managing his own affairs."

As my alma mater attempts to regain its financial footing, the impact of unethical investment behaviors has already made its mark. Deceitful investing has brought devastating effects on my school's endowment. The projections are grim, and many students and faculty will undoubtedly suffer as a result--my friend and I have witnessed the damage through our professor. Millions of Americans are similarly placed at risk when investment firms responsible for managing people's life savings in 401(k)--and other pension plans--are not held to strict and clear standards of conduct.

Though the impact of the Tibble ruling is still unknown, the Supreme Court has reaffirmed its role in increasing the duties owed by money managers. With so much at stake, it is critical for money managers everywhere to recognize their role as trustees of assets that do not belong to them. But perhaps this principle is even older than the common law of trusts. After all, doesn't the Bible say love your neighbor as yourself?

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