What Is the Prudent Expert Act?
The Prudent Expert Act is a regulatory measure contained in section 404a1B of the Employee Retirement Income Security Act, or ERISA, that requires the fiduciary of a defined contribution retirement plan to use care, skill, prudence, and diligence, and to act in the same way that someone familiar with such matters would act.
- The Prudent Expert Act requires that defined contribution plan sponsors act in a way that is consistent with best practices and a fiduciary standard.
- The Prudent Expert Act, which applies to retirement plans like 401(k)s, contains stronger language than the prudent person rule guidelines which came before it.
- Under the Act, plan sponsors must perform due diligence, act with care, skill, and prudence, and offer investment options that fit with participants' time horizon, return expectations, and risk tolerance.
Understanding the Prudent Expert Act
Prudent Expert Act language creates an important distinction from the earlier prudent person rule in that it holds fiduciaries to a stricter standard. It also is called the prudent expert rule or prudent expert standard. The language that states, familiar with such matters, has been interpreted to mean expert.
A fiduciary is someone who is legally responsible for someone else's money, and who is legally required to manage that money in the best interests of its owner. Fiduciary best practices include identifying the client's time horizon, desired return and risk tolerance, choosing asset classes consistent with these guidelines, periodically reviewing investment performance and periodically reevaluating whether fiduciary standards are being met.
A fiduciary must not simply act with respect to an ERISA covered plan as any prudent person would. They must approach it as a prudent expert would. When dealing with investments, they are judged not as a prudent person, but rather as a prudent professional investment manager. A prudent person may perform one level of due diligence before making an investment, a prudent expert would presumably do much more. The prudent person standard is a starting point for ERISA fiduciaries as the standard applicable to them is considerably more stringent.
Benefits of a Prudent Expert
When 401k plans first became popular, some plan sponsors engaged the insurance agent who handled the company’s liability insurance, or a broker already known to management. Others contracted a large big mutual fund company. But choosing such generalists typically would fail to meet the fiduciary duty to prudently hire experts. Handling a 401k plan likely is too complex for someone without the necessary training, knowledge, and resources, and the companies would still have fiduciary liability.
Best practice would be contracting a fiduciary advisor who assumes and acknowledges fiduciary responsibility and discretionary decisions for a 401k program. Such an advisor can find and eliminate hidden fees and conflicts of interest and lessen a 401k plan sponsor’s fiduciary liability by monitoring the plan, the service providers and the investments. Under ERISA, hiring prudent experts is a fiduciary requirement when knowledge or services are needed by the plan.