Employer sponsors of defined contribution plans have traditionally created goodwill and improved employee morale by offering profit sharing and retirement savings programs. In the wake of some of the more recent stock market scandals, these plans have also created something more for employers; liability. However, some relief has arrived in the form of Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA) by providing a defense to participant's claims that stem from poor investment performance.
ERISA Section 404(c) applies to individual account plans, specifically: profit sharing plans, money purchase pension plans, and 401 (k) plans. This section provides where the fiduciary of a plan offers a broad range of investment alternatives and permits a participant to exercise control over assets in his or her individual accounts and that participant in fact exercises control, then the plan fiduciaries will not be liable for losses if they were directly a result of investment instructions given by the participants. In order for a plan sponsor to qualify for relief from liability, the Department of Labor has created a list of over two dozen requirements that need to be met.
The Broad Range of Investment Alternative
One of the principal requirements is that investment options must be sufficient to permit participants a reasonable opportunity to materially affect the potential return and degree of risk on their investments. At a minimum, the participants must have an opportunity to choose from at least three investments that:
- Are diversified;
- Have materially different risk and return characteristics;
- In the aggregate, enable the participant to achieve aggregate risk and return characteristics at any point within the range "normally appropriate for the participant;"
- Each of which, when combined with the other alternatives, tends to minimize, through diversification, the overall risk of the portfolio.
The participants must be given the opportunity to diversify the investments to minimize the risk of large losses, taking into account the nature of the plan and the size of participant accounts. These investment options should be reviewed at least annually preferably by an investment committee or investment advisor.
Information That Must Be Provided to Participants
Another requirement is that information provided must be generally sufficient to enable the participant to make informed investment decisions. Information that must be provided includes:
1. An explanation that the plan is intended to be a 404(c) plan.
2. An explanation that the fiduciaries may be relieved of liability for investment decisions.
3. A description of each investment alternative available under the plan, which can be general, but should encourage participants to review information on the investment.
4. Each designated alternative must include a general description of the investment objectives and risk and return characteristics, and information regarding the type and diversification of assets in the portfolio of the designated alternative.
5. The identity of any designated investment manager.
6. An explanation of the circumstances under which participants may give investment instructions including limitations on such instructions; restrictions on transfer; limitations on voting rights; and information on penalties or adjustments related to fund transfers.
7. A description of transaction fees and expenses chargeable against the participant's account.
8. Information on indemnification of the plan fiduciary responsible for giving information on request.
9. Information regarding investments in employer securities including a description of the procedure to provide for confidentiality and identity of the fiduciary charged with monitoring compliance with the confidentiality requirement.
10. A copy of most recent prospectus provided to the plan if the investment is subject to the Securities Act of 1933 (this can be given immediately before or after investment).
11. After investment, participants must be provided with plan materials related to the exercise of voting, tender, or similar rights. If there are plan provisions regarding the exercise of such rights, participants must receive a description of or reference to such provisions. While the plan is not required to pass through such rights, Section 404(c) relief is not available to the extent that plan fiduciaries exercise the rights.
Information to Be Provided to Participant upon Request.
Participant also must be provided certain information upon request. This material must be based on the latest information available to the plan, including:
1. A narrative of the annual operating expenses of each designated investment alternative, including investment manager fees, administrative fees, and transaction costs, which reduce the rate of return to the participant. The aggregate amount of such expenses must be expressed as a percentage of average net assets of the designated investment alternative. If the information is already in the prospectus, providing the prospectus is sufficient.
2. Copies of prospectuses, financial statements and reports, and other materials related to the investment alternatives to the extent the information is provided to the plan.
3. Regarding the designated investment alternatives: (a) a list of assets comprising the portfolio of the alternative that includes plan assets and the value of the assets, and (b) if the asset is a fixed rate investment contract, the name of the issuer of the contract, the term of the contract, and the rate of return on the contract.
4. The value of shares or units and past and current investment performance of each available alternative, net of expenses.
5. The value of the shares or units held in the particular participant's account.
Carrying Out Investment Instructions.
The opportunity of plan participants to exercise control requires that they may give investment instructions by any means but must have the opportunity to receive written confirmation of those instructions. The instructions must be given to an identified plan fiduciary who is obligated to comply and may be identified by position or function. The plan may impose a reasonable charge for carrying out investment instructions so long as it has a procedure to inform participants periodically of the actual expenses incurred with respect to their accounts.
Frequency of Giving Instructions.
Participants must be given the opportunity to change their investments as often as the volatility of the investment requires. They must be able to change core investment alternatives at least every three months.
If any investment alternative permits changes more frequently than once every three months, at least one core investment must permit the same frequency of change, and the investment into which participants can transfer must be income producing, low risk, and liquid. Non-core investments are not subject to the three month requirement but are subject to general volatility rule.
Investment transactions are prohibited which:
1. Are not permitted by or contradict the plan documents;
2. Would put the tax status of the plan at risk;
3. Could result in a loss exceeding the balance in your plan accounts;
4. Would generate income that would be taxable to the plan;
5. Could require the ownership of plan assets outside the United States;
6. Are otherwise prohibited by federal ERISA or IRS rules.
In addition, the following types of transactions between a plan participant or beneficiary and the employer or a fiduciary of the plan are NOT permitted:
4. Transfer to, or use by or for the benefit of a party in interest, of any assets of the plan;
5. Acquisition, on behalf of the plan, of any employer security or employer real property.
Is it Time for a Compliance Checkup of Your Plan?
The sponsor of a retirement plan cannot be complacent in carrying out their responsibilities as a fiduciary. An annual review of your plan by legal and investment counsel can afford an opportunity to incorporate valuable protections such as ERISA 404(c) as well as provide quality investment options for participants. The Law Offices of Marc J. Lane, A Professional Corporation, and its investment affiliates are available to assist you in these efforts.
John J. Lapinski serves as an Associate Attorney, and the Firm Administrator for The Law Offices of Marc J. Lane, a Professional Corporation, and its investment affiliates, Marc J. Lane & Company and Marc J. Lane Investment Management, Inc. Mr. Lapinski is a graduate of Chicago-Kent College of Law (J.D.) and Elmhurst College (B.S.).
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.