ERISA Alert
September 2008
Authors: Gary Young
The financial turmoil we are experiencing will undoubtedly result in substantial investment losses; investors in 401(k)s and other qualified pension plans who get hit hard will be looking to place blame. When there are extreme losses, the first impulse will be to sue somebody else. The first people they'll sue will be the plan fiduciaries, including the plan sponsor, corporate officers, trustees and others.
Prepare now, and start by conducting an internal compliance audit to ensure that you have fulfilled your fiduciary obligations. Where the plan sponsor has established "self-directed investment" for participants (under Section 404(c) of ERISA), we recommend that the plan's investment advisors meet with participants immediately to advise them about their investments. Unsophisticated investors often compound the damage by taking uninformed decisions motivated by panic.
The Rules
ERISA requires that every employee benefit plan "provide a procedure for establishing and carrying out a funding policy and method consistent with the objectives of the plan and the requirements of this title." ERISA also requires that fiduciaries generally act "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."
A funding policy, however, is not the same thing as an investment policy. In the context of a 401(k) plan in which participants select their investments from among a list of options chosen by the plan fiduciaries, ERISA does not explicitly require that the investment fiduciaries have a written policy regarding the selection and monitoring of the investment options. An Investment Policy Statement (IPS) could address the investment needs of a plan relative to issues such as the anticipated timing of the distribution of benefits and guidelines for investment decisions.
The Department of Labor explains in Interpretive Bulletin 94-2 that "the term 'statement of investment policy' means a written statement that provides the fiduciaries who are responsible for plan investments with guidelines or general instructions concerning various types or categories of investment management decisions...."
The key points covered by an IPS for a 401(k) plan would be:
- Investment structure
- Core funds
- Non-core funds
- Life-style or asset allocation funds
- Mutual fund window
- Stock brokerage accounts
- Employer stock
- Criteria and procedures for the selection, monitoring, removal, and replacement of each part of the investment structure, including standards for evaluating the designated core and non-core funds
- The services ancillary to the investments, such as investment education, investment advice to the investment fiduciary and the participants
However, the often-neglected fundamental Section 404(c) compliance requirement is the participant notice. A Section 404(c) notice must, among other things, (i) explain that the plan is intended to comply with Section 404(c) for the purpose of relieving the plan's fiduciaries of liability for losses resulting from a participant's investment directions under the plan, (ii) describe the plan's investment alternatives, including a general description of the investment objectives and relative risk and return characteristics of each, (iii) identify any designated investment managers, (iv) describe any applicable transaction fees and expenses that affect participants' accounts in connection with the investments, and (v) identify the name, address and telephone number of the persons responsible for providing information and documents to plan participants upon their request, as well as a description thereof, which includes the most recent mutual fund prospectus, information regarding passed-through voting, tender and similar rights, and descriptions of fund annual operating expenses. Consequently, not only do you need a compliant participant notice, but also an arrangement to receive and respond to participants' requests for covered information and documents.
The Risk
Most defined contribution plans and virtually all 401(k) plans permit participants to self-direct the investments of their individual plan accounts among a menu of mutual fund options available under the plan. However, unless the requirements of Section 404(c) of ERISA are met, the plan fiduciaries could have liability for participants' investment decisions which lead to losses in their plan accounts.
Conversely, if the fiduciaries' selection of the investment options is prudent, diversified and sufficiently broad (i.e., as to relative diversification, risk and rate of return characteristics), and the plan fiduciaries continue to appropriately monitor the investment options, compliance with Section 404(c) will insulate them from losses incurred by participants' plan accounts in connection with self-directed investment decisions.
What to Do
In general, complying with Section 404(c) is not difficult, especially where a consultant, broker or investment specialist earning a fee in connection with the plan's investments, as a commercial matter, will agree to prepare the notice and to respond to participants' requests for information and documents.
Perhaps most critical, you must provide the Section 404(c) notice to new plan participants and, if and when there are changes affecting the investment options, provide a revised notice to all participants. The mere existence of a compliant notice in the company's forms file will not suffice.
Please contact Gary Young at (973) 274-2035 or gyoung@herrick.com if you have any questions concerning ERISA Compliance.
Copyright © 2008 Herrick, Feinstein LLP. The ERISA Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
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