(In this author’s opinion, ERISA-governed assets are an underappreciated factor in the U.S. economy, and ERISA rules are an underappreciated source of economic regulation. As a matter of scale, about 19 percent of U.S. household financial assets were held in defined-contribution and defined-benefit plans as of the first quarter of 2022, and nearly all such assets were governed by ERISA (exceptions include assets held in the Federal Employees Retirement System’s Thrift Savings Plan). That said, fiduciary duties generally bind the managers of non-ERISA-governed plans as well. See, e.g., 95 U.S.C. § 8477.)
Though the rules governing these relationships have a common ancestry, they now differ in material ways in the scope and enforceability of the obligations of the fiduciaries. For the most part, corporate fiduciaries are afforded significantly more latitude in their dealings.
Perhaps more saliently to practitioners, the law has continued to evolve, and practitioners may find it useful to refer to the underlying policy rationales when representing clients, especially insofar as the policy rationales may (or may not) justify differences between the rules in one relationship as compared with those in another.
Duty of Care/Prudence
With respect to the duty of care (or prudence), trustees are obligated to invest the trust corpus pursuant to the “prudent investor” standard. Restatement (Third) of Trusts § 90; Restatement (Second) of Trusts § 227. Likewise, ERISA places a material burden on plan fiduciaries to ensure that a plan’s investments are substantively sensible investments in terms of diversification, liquidity, and returns. 29 C.F.R. § 2550.404a-1. Defined-contribution plan fiduciaries in particular must further monitor all plan investment options and promptly remove any and all investments that are “imprudent.” Hughes v. Nw. Univ., 142 S. Ct. 737, 740 (2022). Such options may be considered imprudent for charging even a few tenths of 1 percent more fees than an alternative investment, provided that the alternative is otherwise sufficiently similar. Tibble v. Edison Int’l, 575 U.S. 523 (2015).
However, in the context of corporate management, the business judgment rule and director indemnification have neutered the force of the duty of care. Although the management of a corporation technically must “consider all material information reasonably available,” Brehm v. Eisner, 746 A.2d 244, 259 (Del. 2000), the duty of care is violated (at least in Delaware) only in the extreme situation where management acted with “gross negligence,” and even then, exculpatory clauses—which have become almost universal since Delaware enacted section 102(b)(7) of its General Corporation Law—eliminate directors’ monetary liability for breaches of the duty of care except in situations where the misconduct rises to the level of a duty of loyalty breach. Marchand v. Barnhill, 212 A.3d 805, 824 (Del. 2019).
In granting substantial leeway to corporate managers, courts generally cite the difficulty and imprudence of second-guessing those managers’ business decisions. (It has also been argued that shielding corporate managers from liability is necessary for firms to attract and retain high-quality management. Bankruptcy courts have used similar reasoning to shield liquidation trustees from liability. See In re Smyth, 207 F.3d 758, 762 (5th Cir. 2000).) At first glance, similar reasoning could apply to investment advisors and ERISA fiduciaries. Indeed, courts have stated as much. See Smith v. CommonSpirit Health, 37 F.4th 1160, 1160 (6th Cir. 2022). Nevertheless, the law—at least as written—requires courts to do exactly such second-guessing when it comes to investment management, given that it is undisputed that the prudent investor rule demands more than the business judgment rule. See, e.g., Donovan v. Mazzola, 716 F.2d 1226, 1231 (9th Cir. 1983) (rejecting the applicability of the business judgment rule to ERISA claims). With that said, it appears that that some courts’ reluctance to apply the law as written has created a fair amount of uncertainty in the investment management/ERISA context, as the disagreement leaves courts seemingly unable to even agree on when a claim is stated or when liability should attach, much less the magnitude of any damages.
Duty to Diversify
Long recognized as a method of reducing risk, diversification is an important part of the prudent management of financial portfolios. (As such, the duty to diversify may be considered a corollary to the duty of care.) Under modern portfolio theory, sufficient diversification can practically eliminate idiosyncratic risk, i.e., the risk particular to a given asset, which is uncompensated in asset returns. For investment trustees, the duty to diversify is recognized at common law, Restatement (Second) of Trusts § 228, and codified under section 3 of the Uniform Prudent Investor Act, which has been adopted by 44 states and the District of Columbia, and by ERISA at 29 U.S.C. § 1104(a)(1)(C).
Perhaps unsurprisingly, the duty to diversify loses all potency in the corporate context. Even absent the protection of the business judgment rule, no similar duty applies at all to corporate fiduciaries. In fact, since the heyday of the corporate conglomerate, investors have often demanded a discount for the shares of conglomerates compared with those of single-industry firms. The bases for such a difference in treatment are simple and understandable: (1) It is much easier to diversify a portfolio of financial assets than a portfolio of real assets; (2) as reflected in investors’ disinclination for diversified firms, diversification may be a drag on the risk-adjusted performance of a firm; and (3) diversification at the firm level is unnecessary insofar as investors can simply diversify their investments. Indeed, the duty owed to common stockholders is so great that management may well be obligated to increase the firm’s risk exposure in order to increase the expected value of equity, even if doing so reduces the expected value of the firm as a whole (which, of course, includes the value of the firm’s debt). See N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007).
Duty of Loyalty
The duty of loyalty, at its most basic, is a prohibition against self-dealing: Fiduciaries may not benefit from their positions by standing on both sides of deals.
But the general prohibition against self-dealing is subject to exceptions, the creation of which varies by field. For example, an ERISA fiduciary may not engage in certain prohibited transactions, 29 U.S.C. § 1106, and any exemptions can only be administratively created by the Department of Labor, 29 U.S.C. § 1108; plan participants may not create or ratify an otherwise prohibited transaction.
By contrast, in the other relationships this article analyzes, beneficiaries are often the ones who approve of any exceptions: In a corporation, the exceptions are created by stockholders, who may ratify any supposed self-dealing by corporate fiduciaries (in some cases, the directors, who of course are elected by the stockholders, may also ratify certain types of self-dealing). Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015); 8 Del. Code § 122(17). Likewise, investment advisors may be a counterparty when executing a client trade so long as the client gives informed consent, 15 U.S.C. 80b-6(3), and trust beneficiaries may ratify (or a trust instrument may authorize) conflicted transactions involving a trustee.
Duty to Inform/Disclose
Here, the ordinary hierarchy of beneficiary rights is scrambled: While trust beneficiaries and investment advisees have meaningful informational rights (see Restatement (Third) of Trusts §§ 82, 83; Restatement (Second) of Trusts § 173; 17 C.F.R. § 275.204-3), corporate investors also have wide-ranging rights to information. For example, corporate boards must disclose all material information when soliciting a stockholder vote, Stroud v. Grace, 606 A.2d 75, 84 (Del. 1992); must provide corporate books and records subject to a stockholder meeting the “lowest possible burden of proof” of a proper purpose, AmerisourceBergen Corp. v. Lebanon Cty. Emps.’ Ret. Fund, 243 A.3d 417 (Del. 2020); and, if the company is public, provide hundreds (if not thousands) of pages of regulatorily mandated disclosures each year.
Curiously however, even as ERISA plan participants have arguably the least freedom in their choice of fiduciary, such participants have also extremely limited rights to demand information from those fiduciaries. The reports provided by ERISA plan administrators contain essentially no information on the processes underlying plan management that are often necessary to prove (and sometimes even to plead) a breach of fiduciary duty, nor have courts recognized a clear right for participants to demand such information from the plan. See 29 U.S.C. §§ 1021, 1023, 1024(b)(4); Varity Corp. v. Howe, 516 U.S. 489, 506 (1996); Bogert et al The Law of Trusts and Trustees § 962 n.47.
Perhaps one of the most significant differences among the various types of fiduciary relationships is how they are enforced. Enforcement of the traditional trust is perhaps simplest (for a lawyer, anyway) to consider: The beneficiaries may bring an individual claim against a trustee for breach of fiduciary duty. Although there are some slight wrinkles regarding whether settlors may also qualify as beneficiaries, there are generally no particular procedural hurdles to bringing such suits.
By contrast, private investment advisees face rather more hurdles in seeking recompense against an advisor: Private plaintiffs can only recover advisory fees under the Investment Advisers Act, 15 U.S.C. § 80a-35; Jones v. Harris Assocs. L.P., 559 U.S. 335, 340 (2010), and often must arbitrate other claims against investment advisors through the Financial Industry Regulatory Authority due to nearly ubiquitous arbitration clauses. The Securities and Exchange Commission may also bring enforcement actions against investment advisors, but public enforcement has its obvious problems (among other things, the commission almost never prosecutes one-off cases of advisor negligence that only affect a single retail client or even a handful of clients).
For their part, ERISA beneficiaries may be required to satisfy onerous exhaustion requirements, though the issue has not been definitively settled by the Supreme Court. Compare Lanfear v. Home Depot, Inc., 536 F.3d 1217 (11th Cir. 2008), and Lindemann v. Mobil Oil Corp., 79 F.3d 647 (7th Cir. 1996), with Hitchcock v. Cumberland Univ. 403(b) Plan, 851 F.3d 552 (6th Cir. 2017), and Stephens v. Pension Benefit Guar. Corp., 755 F.3d 959 (D.C. Cir. 2014). Such exhaustion requirements are purportedly justified to provide a reviewing court with the benefit of a more complete factual record, “minimize the number of frivolous lawsuits, promote a non-adversarial dispute resolution process, and decrease the cost and time of claims settlement.” Lindemann, 79 F.3d at 650. Courts that have rejected exhaustion have done so on the basis that the claim concerned statutory rights (as opposed to contractual rights) or that exhaustion was futile. Hitchcock, 851 F.3d at 562; Stephens, 755 F.3d at 965.
Finally, in line with the permissive nature of their substantive duties, corporate fiduciaries are frequently shielded from suit by substantial procedural burdens. Among other things, most claims for breach of fiduciary duty by a corporate fiduciary must be brought as derivative claims, which are then subject to the onerous pleading burden of demand futility. (The Delaware courts have repeatedly grappled with the proper delineation between direct and derivative claims. It suffices here to say that recent decisions have narrowed what constitutes a direct claim, which is much easier to plead and sustain than a derivative claim.)
A Note on Alternative Business Entities
The fiduciaries in alternative entities such as limited partnerships and limited liability companies have arguably the most latitude of all, given that, per statute, they may be able to disclaim their duties and status as fiduciaries mostly or entirely. See, e.g., 6 Del. Code § 18-1101(c); 6 Del. Code § 17-1101(d); Uniform Partnership Act § 105(d)(3); Revised Uniform Limited Liability Company Act § 105(d)(3). This reflects the prevailing contractarian perspective that corporate law is and should be “largely enabling and provide a wide realm for private ordering.” See also Larry E. Ribstein, “Fiduciary Duties and Limited Partnership Agreements,” 37 Suffolk U. L. Rev. 927, 941 (2004).
However, although the historical origins of partnerships may be more contractual compared with that of corporations, which were originally chartered by the state, it is evident that in modern times, the investors and managers of corporations and alternative entities freely enter into such relationships. The legal basis of the greater freedom granted to alternative entitles lies in their enabling statutes, but it is unclear what, if any, economic realities justify the difference in treatment. For example, both corporations and alternative entities may be publicly traded, undermining the argument that fewer protections are needed in the alternative entity context due to investor sophistication. Cf. Myron T. Steele, “Freedom of Contract and Default Contractual Duties in Delaware Limited Partnerships and Limited Liability Companies,” 46 Am. Bus. L.J. 221, 237 (2009). (That said, Chief Justice Steele acknowledges that his conclusion that fewer protections are needed due to investor sophistication would not apply in many situations.)
Although trusts and trust law are hundreds of years old, the legal innovations they have inspired continue to evolve even to the present day. Of course, this has meant the continued evolution of the fiduciary duties that underpin trusts and their progeny, and even the most quotidian cases may well present an opportunity for practitioners to question the scope and scale of the fiduciary duties that tie their clients to the parties across the aisle.