In this article, we address the question of whether a successor can become personally liable for a breach of fiduciary duty under ERISA (and the federal common law of trusts), if the breach occurred prior to the fiduciary’s appointment as trustee. We also will look into whether a successor trustee has a duty to investigate actions (or failures to act) by the prior trustee to determine whether they may constitute a fiduciary breach, prohibited transaction or other malfeasance.
Trustees come and go. So do Plan Administrators. No, not the recordkeeping firms, the named fiduciary kind, with a capital “P” and a capital “A.” Both trustees and Plan Administrators are fiduciaries under ERISA, with duties regarding plan assets and transactions and reporting, that are often misunderstood — until their successor takes over. It’s the successor trustee or Administrator that finds out how little they did, or knew, or understood, or heaven forbid, even cared about what transpired on their watch. Unfortunately it’s those who come later that are most often required to clean up. And why is that, other than the “left-holding-the-bag” rule? Well, the real answer, of course, is in the statute governing fiduciary duties of employee benefit plans. While institutional trust companies and independent fiduciary firms are well versed in these precepts (no … ERISA, not the left-holding-the-bag theory), individuals that are often left to serve these roles, by either appointment or default, need to be better versed and on guard to avoid being surprised by the scope of their duties as successor fiduciaries.
The Fundamental Fiduciary Duties
A fiduciary who breaches the fiduciary responsibility rules of Title I, Part 4 of ERISA can be held personally liable for any losses to an employee benefit plan resulting from the fiduciary breach. Even if there are no losses to the trust or plan, the fiduciary can be required to restore to the plan any profits realized by the fiduciary as a result of the fiduciary’s improper use of plan assets (see ERISA § 409).
The standards of conduct for fiduciaries include a duty of loyalty, a duty of prudence, a duty to diversify investments, and a duty to follow plan documents to the extent they are consistent with ERISA. Employee Stock Ownership Plans (ESOPs) and certain other retirement plans designed to invest in employer stock are exempt from the duty to diversify.
The almost intuitive rule regarding successor fiduciaries is found in ERISA section 409(b) and provides that if the breach occurs before or after a fiduciary’s tenure, then the fiduciary is not accountable for the breach or malfeasance. Sounds sensible, right? However, as we will explore in this article, this is only the general rule. There are situations in which a successor trustee may be liable for the uncorrected acts of his or her predecessor where the Federal common law of trusts imposes an affirmative duty to correct such breaches. Going even further, we will explore whether a successor fiduciary has a duty to investigate a predecessor’s actions.
In contrast, ERISA section 405 imposes direct personal liability on co-fiduciaries for breaches of any of the responsibilities, obligations or duties imposed by ERISA. In effect, this section imposes on every fiduciary an affirmative obligation to prevent or guard against other fiduciaries breaching their ERISA responsibilities, obligations or duties. Timing is apparently everything in this statute (i.e., co-fiduciary vs. successor fiduciary). A fiduciary should generally be careful as to when and with whom he or she serves.
ERISA was written to incorporate the core principles of the common law of trusts, with modifications appropriate for employee benefit plans. The legislative history of ERISA cautions those who interpret and apply ERISA’s fiduciary standards, however, to do so “bearing in mind the special nature and purpose of employee benefit plans.” The courts have thus followed the approach of interpreting these and other principles of ERISA by applying and developing the federal common law of trusts in the context of pension and welfare benefit trusts.
The Regulator’s Perspective
The DOL has issued no regulations, either proposed or final, that provide guidance as to the manner or extent the statutory provisions dealing with successor fiduciary liability or co-fiduciary liability under ERISA will be applied. They have, instead, left such guidance to administrative opinion letters and case law.
There are two DOL opinion letters, both issued shortly after the passage of ERISA, that deal with the issue of fiduciary liability for successor fiduciaries. In them, the DOL addressed the issue of whether ERISA section 409(b) is intended to exonerate a successor fiduciary from liability for the acts of their predecessors which occurred prior to the passage of ERISA. The DOL summarized its position as follows:
Section 409(b) of the act provides that no fiduciary shall be liable with respect to a breach of fiduciary duty under Title I of the Act, if such breach was committed before he became a fiduciary or after he ceased to be a fiduciary. Section 409(b) does not, however, exempt a fiduciary from carrying out his responsibilities to a plan imposed by various provisions of Part 4 of Title I of the Act. So, although a fiduciary may not be liable under section 409 of the act for the acts of predecessor fiduciaries, if he knows of a breach of fiduciary responsibility committed by a predecessor fiduciary, he would be obligated to take whatever action is reasonable and appropriate under the circumstances to remedy such breach, if failure to take such action would constitute a separate breach of fiduciary responsibility by the successor fiduciary.
What the Courts Have to Say
There are many cases that have dealt with the subject of fiduciary duties and liability for the breach of duty by a co-fiduciary. Relatively few cases, however, deal with the subject of fiduciary responsibility of successor fiduciaries.
In Silverman v. Mutual Benefit Life Insurance Co., 138 F.3d 98 (2nd Cir. 1998), the Second Circuit reviewed a situation where the plan trustees had embezzled funds from plan assets before transferring plan assets to a new successor trustee. The case also dealt with salary deferral contributions that were not forwarded to the successor trustee by the original trustees because such monies were being used to try to avert corporate bankruptcy. The plan sponsor eventually did go bankrupt. The court found the successor trustee liable for failing to act, noting that ERISA’s provisions are consistent with the common law of trusts, which imposes a duty on a successor trustee to remedy a breach of a prior trustee, and imposes liability for breach of this duty “to the extent to which a loss results from the successor trustee’s failure to take such remedial steps.”
The provision of the common law of trusts found in the Restatement of Trusts Second (Restatement), which was cited by the court states the general rule that, “A trustee is not liable to the beneficiary for a breach of trust committed by a predecessor trustee.” It goes on to state, however, that “A trustee is liable to the beneficiary for breach of trust, if he (a) knows or should know of a situation constituting a breach of trust committed by his predecessor and he improperly permits it to continue; or (b) neglects to take proper steps to compel the predecessor to deal the trust property to him; or (c) neglects to take proper steps to redress a breach of trust committed by the predecessor.”
The Restatement cited in the Silverman case has several examples that are instructive. One example involves a trustee who purchased securities which were not a proper trust investment. The trustee then resigns as trustee and a successor trustee is appointed by the court. The common thread moving through the examples in the Restatement is that the successor trustee (i) accepts the appointment as a successor trustee, (ii) has actual and apparent knowledge of a breach of trust, by the predecessor trustee, (i.e., assets are missing or per se impudent), and (iii) fails to take action, which would either benefit the trust by making it “whole” or which results in further losses to the trust.
So, What Do You Know, and Exactly What Did They Tell You?
Perhaps the rule for successor fiduciary liability should be, “A fiduciary may not be liable for the acts of a predecessor.” Then again, no one asked us to rewrite the statute. If we were though, we probably would add “a little knowledge can be a dangerous thing,” just so the standard is clear. Kidding aside, the matter of whether the trustee has knowledge of a breach of a predecessor is of key importance. The DOL opinion letters and the cases unfortunately are not clear or numerous enough to elucidate what constitutes “knowledge of such a breach.”
It appears that there is an obligation on the part of a successor trustee, within a reasonable time after assuming the position of successor trustee, to review plan investments and determine whether it would be imprudent to continue to hold any of the assets it received as successor trustee. This is what is often referred to as the trustee “marshalling the assets of the trust.”
It appears from the cases that are published that to the extent a successor trustee has actual knowledge, or acquires actual knowledge, of a fiduciary breach by a prior trustee, the successor would have an affirmative obligation to take whatever corrective actions are deemed appropriate, “depending upon the facts and circumstances” of each particular case.
The common law, as expressed in the Restatement, also appears to predicate liability on knowledge of an actual breach that is apparent and continuing. In each illustration in the Restatement, the successor has assumed his role as trustee subject to the apparent breach, which either was known as a condition of accepting the trust assets or which became apparent upon delivery of the trust assets (i.e., the trustee marshaled the assets, and there was the breach).
None of the cases we reviewed or other materials address the fundamental issue of what constitutes “knowledge of a breach” which, if imputed to a successor trustee, raises the specter of liability. Arguably, knowledge of a breach should be distinguished from “mere assertions” (i.e., by a third party) that one has occurred, where one is not apparent. Assertions may simply amount to suspicions, and may or may not create a duty of inquiry. By extension, assertions that one may have occurred, if not made by a fiduciary or someone with first hand knowledge of the facts, might not constitute knowledge of a breach. In contrast, for example, assertions that a prohibited transaction has occurred by someone with firsthand knowledge of the occurrence, might constitute knowledge of a breach (even if not otherwise apparent to the fiduciary by reviewing the trust assets) since prohibited transactions are per se breaches of fiduciary duty under Title I of ERISA.
The Silverman case and the Restatement also suggest that there must be a causal link between the fiduciary breach of a successor fiduciary and the loss to the plan. That is, the successor’s own breach due to inaction must cause the plan to suffer a loss or a further loss. Without the causal link, there is no liability to the successor fiduciary. While there is little in the cases to flesh out this requirement, something can be gleaned from a co-fiduciary case in the Ninth Circuit, which found no showing of causation where the statute of limitations had run and there was a lack of evidence that the loss could have been recovered, even if the successor attempted to do so. This case, the Barker case, discussed below, appears to stand for the proposition that if a loss has already occurred and cannot be remedied when assuming fiduciary appointment, there is no exposure to liability. (Sounds like a perfect jumping off point for another article…)
So, What if You Think You Smell a Rat?
As of this writing, we have been unable to locate case law or other authority for the proposition that a successor trustee has an affirmative obligation to investigate the actions of a predecessor, prior to appointment, to determine the existence of any, or dispel the rumors of the existence of any breach, as oppose to the actual knowledge of a fiduciary breach.
In contrast to the successor fiduciary cases, in Barker v. American Mobile Power Corp., 64 F.3d 1397 (9th Circuit, 1995), the court addressed whether a co-fiduciary had breached ERISA’s prudence standards by failing to investigate his suspicions that co-fiduciaries had mismanaged plan funds. The mismanagement had resulted in significant under funding for the plan.
ERISA imposes stricter duties on co-fiduciaries to monitor actions of a co-fiduciary for breach of fiduciary duty. Co-fiduciary liability will attach to a fiduciary if the fiduciary fails to comply with the general fiduciary obligations of ERISA and, “thereby, enables the other fiduciary to commit a breach; or has knowledge of a breach by such other fiduciary, unless he makes reasonable efforts under the circumstances, to remedy the breach.” Furthermore, the Ninth Circuit has interpreted this standard to include a responsibility to oversee the actions of a co-fiduciary and an obligation to investigate suspicions of co-fiduciary breach.
In Barker the co-fiduciary had “suspicions” which the court felt would lead most “reasonable and prudent individuals” to at least make further inquiries to ascertain with certainty whether breaches had occurred. At least in the Ninth Circuit, therefore, there appears to be an affirmative obligation on the part of a fiduciary to investigate suspected breaches a co-fiduciary if it would be reasonable and prudent under the circumstances to do so based on the suspicion that the co-fiduciary has (by omission or commission) engaged in a breach of fiduciary duty. The Ninth Circuit case dealt with an ongoing “cover up” by a fiduciary of the actions of the trustees of the plan who were then “co-fiduciaries.”
See No Evil, Hear No Evil?
A successor trustee may, of course, elect to review or investigate the actions of a prior trustee prior to accepting the appointment. In such cases, to the extent the successor trustee undertakes an independent investigation or evaluation of the actions of the prior trustee and to the extent that investigation uncovers wrong doing, we believe that the courts and regulators would find that the successor trustee has an affirmative obligation to investigate thoroughly and take whatever corrective actions are deemed appropriate under the circumstances. This would include seeking recompense on behalf of the plan for any losses suffered as a result of the fiduciary breach or other malfeasance, if the fiduciary appointment is accepted. So, is it a better course to not investigate, and to merely accept such an appointment? Maybe not. What if the breach is uncovered and the proposed trustee has not accepted the appointment? Hopefully the appointee in question is careful enough to ensure that they have not accepted until they are satisfied as to the condition of the trust and its assets and history. Even if they are not so careful (but a predecessor’s breach becomes apparent upon appointment), the requirement of causation and damage due to failure to act would be required for the successor trustee to incur liability.
What to Do?
So where then does a fiduciary appointee draw the line? At a minimum, the appointee should insist on the prior trustee’s accounting and asset valuation and work of any co-fiduciaries to be complete and error free. The contracts and agreements between service providers and other co-fiduciaries should be examined and should be clear as to who has discretion over what. Finally, the appointee should examine the plan and trust provisions regarding expenses (including legal fees) and indemnification are clearly spelled out; and when in doubt, be sure there is fiduciary coverage under applicable policies maintained by the sponsor or the plan itself — just in case something pops up.