The Unconscionable Three

There are a few states such as my own state of California, Washington and Texas, where officials at school districts with 403(b) plans have painfully few fiduciary obligations - even under state law (and none, as noted, under ERISA).

The law in these three states such as California Insurance Code section 770.3 removes the discretion of such officials to screen, limit, reject or terminate relationships with service providers such as insurance companies that provide annuity contract investment options to school district 403(b) plans. In other words, such laws require schools to give access to any retirement firm licensed to sell a product. No discretion, Jack, no duty.

In such states, then, not even state-level fiduciary duty exists. (School officials do, however, have limited fiduciary duties to ensure that no prohibited transactions or self-dealing arrangements occur between school officials and any service providers.)

Even in the three states cited, though, officials at school districts with 403(b) plans must comply with state-level fiduciary duties with respect to investment options comprised of 403(b)(7) mutual fund custodial accounts. (Such officials must also comply with state-level fiduciary duties in cases where their school districts have 457(b) plans.) Many of these duties are based on principles similar to those contained in ERISA such as modern portfolio theory and other generally accepted tenets of investing, the prudent man rule as well as the requirement to allow only 403(b) investment options that are reasonable in cost and broad in diversification.

The Future

The overall aim of the new regulations to take effect on January 1, 2009 governing 403(b) plans is to align the rules for such plans (that cover public school and other governmental employees as well as certain income tax-exempt IRC section 501(c)(3) organizations such as research foundations and private schools) with those for 401(k) plans (that cover corporate employees) and 457(b) plans (that cover employees of state and local government entities). This alignment will, among other things, make administration of 403(b) plans simpler and easier for school districts, thereby helping ensure compliance with the law - which is always a good thing.

Under the new 403(b) regulations, school districts will clearly become plan sponsors and be completely responsible for everything that touches their plan including investments, expenses and all administrative matters. School districts will also become the focal point of the Internal Revenue Service. They can delegate to a provider but if that provider gums up the works, the responsibility as well as the liability for same remains with the school districts. While school districts were always exempt from ERISA, they were never exempt from any rules. School districts must follow state laws on fiduciary duties as they were always required to do; they just didn't know they had to. Get practice-building tips and information from our team of experts delivered to your e-mailbox every Thursday. Sign up for our free Practice Builder e-newsletter.