Misconceptions about ERISA 404(c)
Many Plan Fiduciaries fail to secure the statutory protection of ERISA 404(c) because they, or their advisors, either have a genuine misunderstanding of the requirements of 404(c), or have the inability to distinguish among service providers as to their abilities to help the Plan fulfill operational requirements.
Few Plan Fiduciaries have read ERISA, let alone the Department of Labor's various Regulations, Interpretative Bulletins or Field Assistance Bulletins-and this is perfectly understandable given that this should not be their area of expertise or focus. Sadly, this lack of study is also true for many Plan consultants. Most consultants have only read commentaries about ERISA rules and regulations. It is all too common to see mistakes in such commentaries.
Consequently, many Plan fiduciaries and their advisors operate under many misconceptions that only result in personal liability to the Plan fiduciary.
Liability is less
There's more liability with Trustee-directed portfolios
The alternative to a 404(c) plan in which participants and beneficiaries make investment decisions is for the Plan's Trustee to make all such decisions. This latter approach to the management of Plan assets is generally referred to as a Trustee-Directed Portfolio. A Trustee can obtain the liability relief of 405(d)(1) through delegation of the day-to-day management to an investment manager.
Therefore, an investment portfolio, whether it is a Trustee-directed pooled account or a "menu of funds" available for participant direction, requires a certain amount of oversight. The criteria that are reviewed, the frequency with which they are reviewed, and the decision matrix for making adjustments are substantially similar in both cases.
Participant-directed investment menus offered under 404(c) are subject to additional requirements that are not applied to Trustee-directed portfolios. Meeting these additional requirements (provision of proper and timely information, communication protocols, portfolio construction education, etc.) can be onerous and failure to meet them properly creates liability.
The decision to offer participant direction is more an Employee Relations issue than a successful effort to minimize fiduciary liability by shifting decision making to participants.
Certainly, a trustee-directed portfolio avoids the problem of deciding upon the one portfolio strategy that is best for a diverse employee population at different stages of their working careers. Plus, employees have come to expect the "freedom" inherent in daily valuation retirement plan platforms.
The fact that a Participant or beneficiary directs the investments within their account does not create the relief from liability.
The fulfillment of the conditions set forth in the DOL's Final Regulations by the Plan Fiduciary that characterizes a Participant's decision making as "independent control" creates the relief from liability.
More things can go wrong with the operation of a 404(c) plan than could go wrong with a trustee-directed plan.
Mandatory Direction—
Participants must make the decisions about the investments within their account
The Plan Fiduciary decides if the Plan will offer the opportunity for a Participant or Beneficiary to direct the investments within their account. The Participant must decide whether to exercise that privilege. He cannot be forced to direct the assets within his account.
Most Plans will specify that the account balances of participants and beneficiaries who fail to make investment decisions will be invested in a "default" option.
The Department of Labor has specifically stated that even with the disclosure of the Default option, a participant or beneficiary who fails to give instructions for the investment of their account has not made an affirmative election to have their account balance invested within the Default Option. Thus the Plan Fiduciary remains liable for the investment of all assets within the Default Option as if it were a Trustee-Directed portfolio.
Default Options—
The default option has to be a money market-type investment
Many Plans specify the Default Option as a Money Market or other incredibly, risk-adverse investment approach.
Would a fiduciary managing a Trustee-directed portfolio invest 100% of the Plan's assets in a money market-type investment? Under very rare circumstances could that approach be considered prudent and diversified investment oversight.
The Default Option is a trustee-directed portfolio in its purest form. The Plan Fiduciary must manage these assets in the same manner in which he would manage all of the Plan assets if participant-direction were not permitted.
Plan Fiduciaries are personally liable for losses that result from violations of fiduciary responsibility. A loss is not defined as a decline in the value of a participant's account. A loss can be the difference between what the participant earned and what he should have earned. The account still may have earned a positive investment return, but not as much as it could have been had prudent decisions been made!
Quarterly switching
The minimum frequency for switching privileges is quarterly
Regulation 2550.404c-1, subparagraph (b)) provides that "a plan may impose reasonable restrictions on the frequency with which participants and beneficiaries may give investment instructions."
404(c) further requires that the plan "permits participants and beneficiaries to give investment instructions with a frequency which is appropriate in light of the market volatility to which the investment alternative may reasonably be expected to be subject."
404(c) acknowledges that some investment providers restrict to certain dates distributions from investment alternative designated as "stable assets." Such restrictions are not in violation of 404(c) given that their market values are not subject to any significant market volatility. Regulations also permit an investment alternative to accept new investments that are the exchanges from more volatile investments with a frequency that is greater than the frequency from which distributions from that alternative are allowed.
With the proliferation (and operational advantage) of daily valuation plans, the issue of what is appropriate "in light of the market volatility" is moot.
Many options now exist that allow "stable value" investment alternatives to be "benefit sensitive." Daily exchange privileges exist for participant-directed investments in "non-competing" investment alternatives, i.e., a money market or short-term bond fund. Distributions from the Plan to eligible participants are also accommodated.
This contrasts sharply with guaranteed interest contracts that allow no distributions at any time without surrender penalty other than at the maturity of the contract, often upwards of five years.
Mandatory education
I must educate participants about investing
The statutory relief from fiduciary liability afforded by 404(c) does NOT require plan fiduciaries to educate participants about investing. Plan fiduciaries are required to provide very specific disclosures regarding the plan and its investment options that enable participants to make informed decisions regarding their investments. None of those disclosures are considered to be investment education.
Education equals liability
Providing investment education to participants creates liability
The Department of Labor issued Interpretive Bulletin 96-1 that described the types of investment education that a plan fiduciary may deliver without putting the plan fiduciary into the position of rendering investment advice (and thereby compromising 404c statutory relief for the specific affected transactions).
The scope of investment education identified by the DOL that is not considered "investment advice" is very extensive-and surprisingly NOT construed as investment advice.
Plan participants consistently cite as a major shortcoming in their 401(k) plans is the lack of investment education. Making available investment education will increase the satisfaction of employees in this important (and costly) benefit.
Mandatory Account Review
I must review the performance of participant' accounts
Nowhere in the 404(c) Regulations is there any statement that a Plan Fiduciary must regularly review participant's accounts with the intent of identifying those participants who are making poor or even disastrous investment decisions.
The plan fiduciary has no obligation to advise a participant regarding activity in their account under a 404c plan. It is, however, very important for plan fiduciaries to remember that under the prudent expert and co-fiduciary rules (ERISA Sections 404(a)(1) and 405(a)(2)) they have an obligation to regularly oversee and assess the appropriateness of the investment options offered by the plan and the performance of co-fiduciaries and investment managers. The Regulation's emphasis is on the suitability of the investment alternatives, not the suitability of the investment decisions made under independent control of the participant or beneficiary.
A fiduciary breach can occur by an investment manager selected or retained by a participant. That investment manager subsequently is liable to that participant. However, his breach and liability creates no breach or liability for the Plan Fiduciary
Models equal liability
Offering Model Portfolios creates fiduciary liability
Offering Model Portfolios does not constitute rendering investment advice under ERISA 3(21)(A)(ii) provided that the relevant information cited in DOL IB 96-1, (d)(3) is timely provided to participants. The models must be "based on generally accepted investment theories that take into account the historic returns of different asset classes. " and "all material facts and assumptions on which such models are based accompany the models "(DOL IB 96-1(d)(3)."
Because the information and materials described above would enable a participant or beneficiary to assess the relevance of an asset allocation model to his or her individual situation, the furnishing of such information would not constitute a "recommendation" within the meaning of 29CFR 2510.3-21(c)(1)(i).".
Model portfolios need not just be limited to making asset allocation decisions. They can explicitly recommend individual investment alternatives.