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Unpacking the Settlor - Fiduciary "Two Hat" Principle

The difference between an employer’s “settlor” and “fiduciary” role with respect to its employee benefit plans, the so-called “two-hat” principle, is a favorite topic in ERISA circles.

What’s it all about?

In a traditional trust, a trustee’s actions that affect the trust are always fiduciary and thus, the trustee wears just one hat. In contrast, when an employer sponsors an employee benefit plan, the employer’s actions that affect the plan may be either fiduciary or “settlor.” The employer’s potential to act in two different capacities, one “fiduciary” and one “settlor” is called the “two-hat” principle.

Why does it matter?

When the employer wears its fiduciary hat, its actions must comply with ERISA’s fiduciary requirements and if they do not, the employer faces potential fiduciary (and other) liability under ERISA. When the employer wears its “settlor” hat, even though its actions affect the plan, those actions are not governed by ERISA’s fiduciary rules (although the employer may face potential liability to its plan, participants, employees or others, under state and/or other federal law). There are other ramifications too. For example, although attorney communications with a fiduciary are generally not privileged as to plan participants, settlor communications likely would be privileged. Similarly, plan assets may be used to pay for plan administrative, but not settlor, plan expenses¹.

The Supreme Court, in Pegram v. Herdrich, 530 U.S. 211, 225, (2000) put it this way: Employers “can be ERISA fiduciaries and still take actions to the disadvantage of employee beneficiaries, when they act as employers (e.g., firing a beneficiary for reasons unrelated to the ERISA plan), or even as plan sponsors (e.g., modifying the terms of plan as allowed by ERISA to provide less generous benefits).” (emphasis added.) Just recently, the Ninth Circuit Court of Appeals, in Acosta v.Brain, 910 F3d. 502(December 4, 2018) addressed the two-hat principle. ² The lower court held that that a plan trustee breached a fiduciary duty by putting an employee on administrative leave allegedly to retaliate against her for, among other things, cooperating with aDOL criminal investigation of the plan. The Ninth Circuit reversed that holding and criticized the lower court for having not even addressed, much less answered, the “threshold question” of whether the trustee “was wearing his ERISA fiduciary hat” or taking a “corporate or business operations” action. The Ninth Circuit explained that the threshold inquiry “is important” because “virtually every business decision an employer makes can have an adverse impact on an employee benefit plan, but not all give rise to fiduciary concerns.”

So, how can an employer figure out which hat it is wearing?

There is no exact answer in ERISA. However, ERISA does provide a bit of guidance. It describes a person as a fiduciary only

“to the extent

i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan.”(emphasis added.)ERISA § 3 (21) (A)

By negative implication then, “to the extent” a person who might otherwise be a fiduciary, is not engaging in the conduct described in ERISA§ 3 (21) (A), his plan related actions generally should not be considered fiduciary.

How does an employer make that “to the extent” call?

First, the courts and the Department of Labor have generally agreed that some categories of action are not fiduciary and are generally considered “settlor” actions. They include:

  • Establishing a plan including plan design, plan adoption, plan document drafting

  • Amending a plan

  • Terminating or merging a plan

But actions to implement,design, amendment or termination of a plan are typically considered fiduciary functions. That having been said, there is not always a bright -line distinction between settlor and fiduciary functions and there has been substantial litigation over that distinction in the context of breach of fiduciary duty claims.

For example, even if, as a function of plan design, a retirement plan document specifies investment structure, a later plan amendment to change the investment in existing assets may be a fiduciary function. (See e.g., Nelson V. IPALCO Enterprises, Inc., 29 EBC 2665 (S.D.N.Y. 2003) (Although original plan design to invest in matching contributions in employer stock was a settlor function, amendment, after employer was acquired, to invest matching contributions in acquiring company’s company stock found to be fiduciary decision.)³

Similarly, even though a decision to transfer plan liabilities to a spin-off might generally be considered a settlor function (See, e.g., Sengpiel v. B.F. Goodrich Co., 156 F. 3d 660 (6thCir. 1998), the actions implementing that decision could be characterized as fiduciary depending on facts and circumstances. In Varity Corp. V. Howe, 526 U.S. 489, 505 (1996), the sponsor set up a new subsidiary but misrepresented that employees’ benefits in the new subsidiary would be equivalent to their old benefits. After the employees transferred, and the subsidiary failed, they sued Varity for breach of fiduciary duty. The Supreme Court affirmed the lower courts’ determinations that even though the representations were made in the context of a change of corporate structure, Varity’s communications to plan participants were plan administration acts and thus, fiduciary in nature. In other words, although the employer started off wearing a settlor hat, in deciding to form the new subsidiary and design a new plan for the subsidiary, it changed into its “fiduciary hat” when it provided misinformation to its participants.

Since obviously, learning for the first time after you have been sued that your employer actions are being characterized as fiduciary rather than settlor is “too little, too late,” employers should take proactive steps to protect themselves from the consequences of unintended fiduciary acts.

What steps might these include?

  • Distinguishing, and memorializing the distinction between, settlor and plan administrator/fiduciary duties:

o In service provider agreements

o In plan documents -scrutinize ambiguous provisions to make sure they won’t be interpreted to be fiduciary if the intent is settlor

o In plan governance -consider separate committees for each function, i.e., “hat”, with separate minutes, charters and other procedural document,

  • Being careful to separate settlor and fiduciary administrative communications with participants and third parties.

  • Ensuring that settlor communications with counsel are separate so as to protect the attorney-client privilege between settlor and counsel.

  • Obtaining appropriate fiduciary liability insurance covering fiduciary actions and making sure, to the extent possible, that settlor action is covered by general liability, director and officers insurance policies as fiduciary liability policy will generally exclude coverage for settlor acts;

  • Having a clear and preferably, a written policy with respect to the payment of settlor versus plan administration expenses and making sure that plan assets are not used to pay settlor expenses.

Please contact our Firm if you would like to discuss any of the foregoing information in greater detail. We would welcome the opportunity to consult with you.


¹ See FAQ in this issue regarding the definition of settlor vs. fiduciary.

² The Department of Labor sued a union trustee of five union-sponsored plans (and related defendants) for alleged violations of ERISA §510 (ERISA’s discrimination provision) and ERISA §404 (ERISA’s fiduciary provisions).The Ninth Circuit upheld the district court’s finding on the §510 claim.

³ Note as well that in the multi employer context, plan amendments are generally considered fiduciary acts (See, e.g., Siskind v. Sperry Retirement Program, Unisys, 47 F.3d. 498 (2d. Cir. 1995) and, an entirely different analysis also applies in the ESOP context, for example where an employer appoints an independent trustee/fiduciary.

© Boutwell Fay LLP 2019, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of January 31, 2019.

Unpacking the Settlor – Fiduciary “Two Hat” Principle Article
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