June 2011 - Benefit Insights Newsletter

• Explanation of plan's intention to comply with 404(c) and that plan fiduciaries may be relieved of liability for losses that directly result from participant investment decisions;
• Description of each investment option available in the plan:
  • Objective,
  • Risk/return characteristics,
  • Investment managers, and
  • Most recent prospectus;
• Information on how participants give instructions to invest their accounts, including making transfers and exercising voting and tender rights;
• Transaction fees and expenses;
• Identification of and contact information for plan fiduciaries responsible for providing these disclosures.

• Description of annual operating expenses for each investment option:
  • Investment management fees,
  • Administrative fees,
  • Transaction costs;
• Prospectuses, financial statements and other reports for each of the plan's investment options;
• List of the underlying assets comprising each portfolio or mutual fund;
• Performance information (past and current);
• Current share values.

There are many opinions and a great deal of misinformation circulating about what, exactly, plan fiduciaries get for their efforts. These range from little more than that lousy t-shirt all the way to a "get out of jail free card" that provides complete immunity. The truth lies somewhere in the middle.

Compliance with 404(c) provides fiduciaries with relief from liability for investment losses that are the direct result of participant investment decisions. Sounds good, right? Well, the "catch" is in how that relief is provided. It is not a simple matter of just claiming 404(c) compliance; rather, it is what is referred to in legal terms as an affirmative defense.

ERISA litigation is very complex, but generally speaking, the party bringing the lawsuit (the plaintiff) must prove that the plan fiduciaries breached their responsibility and that the breach resulted in losses. The fiduciaries, on the other hand, seek to rebut the assertions made by the plaintiff. The plaintiffs prove; the fiduciaries rebut.

When plan fiduciaries claim a 404(c) defense, the roles reverse. The fiduciaries must prove that they complied with all aspects of 404(c), and the plaintiff tries to rebut that assertion. In short, 404(c) compliance does not guarantee a fiduciary can't or won't get sued. It just changes the manner in which that fiduciary demonstrates he or she is not responsible for the losses in question.

Complying with 404(c) is not as easy as it might seem. For starters, it is all predicated on the plan's investment menu being prudently selected and monitored. If, for example, a plan fiduciary followed a prudent process to select the menu a couple of years ago but cannot show that he has monitored the options on an ongoing basis, he is probably on shaky ground regardless of how faithfully he has provided all the required disclosures.

To further complicate matters, 404(c) is, in many ways, an "all or nothing" proposition. It is possible for plan fiduciaries to satisfy 404(c) for some participants but not others or for only certain investment options; however, if any single requirement is missed with regard to a participant or account, protection is completely lost. Consider the most recent prospectus in the Automatic Disclosure list above. If a plan sponsor provides all other disclosures but neglects to provide the most recent prospectus for any of the investment options, 404(c) protection is lost.

While the solution may seem simple—just make sure none of the disclosures are missed—the devil is in the details. Many employers and participants alike are accustomed to receiving information electronically. However, the Department of Labor (DOL) has very specific rules governing when and how electronic disclosure is permitted in the context of employee benefit plans. A sponsor that provides 404(c) disclosures electronically but does not follow the DOL's rules for doing so is deemed to have not provided the disclosures at all.

Something as simple as using a personal e-mail account instead of an employment-related account without proper consent could be treated as a missed disclosure resulting in loss of 404(c) protection.

Many recordkeepers have built systems to help plan sponsors comply with most of ERISA 404(c)'s requirements; however, given the potentially tenuous nature of the protection, it is worthwhile for employers to read the fine print in service-provider contracts to make sure they understand which parties have responsibility for the various aspects of compliance.

Working with a third party administrator, consultant or investment professional who has expertise in working with 404(c) can also be a great way to identify any potential gaps.

In some circles, there is a misperception that ERISA mandates compliance with 404(c). The reality, however, is that it is completely optional. Throughout the various rules governing qualified retirement plans, there are "safe harbor" provisions. Such provisions are generally offered as one option to comply with a more general rule. Since safe harbors provide some form of compliance assurance, they tend to offer less flexibility than their non-safe-harbor counterparts.

Take the safe harbor 401(k) plan as an example. It is possible to maintain a 401(k) plan with no company contributions and up to a six-year graded vesting schedule. However, if an employer is willing to commit to make a contribution and provide full vesting, they can get a free pass on the ADP and ACP nondiscrimination tests.

Like the safe harbor 401(k) plan, 404(c) is also a safe-harbor. It is a method to demonstrate compliance with one aspect of ERISA's fiduciary rules. To the extent a plan fiduciary prefers not to pursue this safe harbor, there is nothing inherently illegal, unethical or otherwise imprudent about choosing another means of demonstrating he or she has followed a prudent process in managing plan assets.

There are differences of opinion as to whether 404(c) is worth the effort, and it is really a decision that each plan fiduciary must make given their specific facts and circumstances. Some believe allowing participants to transfer among investments with regular frequency tends to yield less favorable investment results; therefore, they restrict transfers to the beginning of each year. That may be a prudent design given the circumstances, yet it does not satisfy 404(c)'s requirement to allow investment direction at least quarterly.

Others take a broader perspective. Since the general rule is that fiduciaries need to follow prudent processes when managing plan assets, they will use 404(c) as a part of their process rather than as the process in and of itself. This approach has an added benefit. If a plaintiff is able to rebut the 404(c) defense by demonstrating that the fiduciary missed one of the checklist items, the fiduciary can still fall back on the non-safe-harbor rule by showing that it had documentation of having followed a prudent process.