ERISA Section 404(c): Another Way for Plan Sponsors to Limit Legal Risk

ERISA Section 404(c): Another Way for Plan Sponsors to Limit Legal RiskSponsoring a qualified retirement plan is a pretty convenient way to defer taxes AND offer your employees a valuable benefit.  It comes with some hefty responsibilities, too.  Among other things, you’re obligated to act in the best interests of your participants, monitor expenses & performance, and make sure everyone’s getting the proper disclosures.

However, to make your life easier ERISA includes six nifty safe harbor provisions.  By following a few additional guidelines your plan can qualify for these safe harbors, which relieves you of certain fiduciary responsibilities.

We covered one of the six safe harbors a few weeks back: auto-rollovers.  Today we’ll cover another safe harbor: section 404(c).  This section has to do with who is responsible for the investment performance in your participants’ accounts.

If you’re responsible for a qualified plan and are curious about how you can limit risk, read on.  You’re in the right place.

 

Qualified Plans & Fiduciary Responsibility

When you sponsor a qualified retirement plan (like a 401(k), 403(b), etc.), you are technically a fiduciary to your participants.  This means that the decisions you make about how the plan is operated must be made in your participants’ best interests.

Any time you breach your fiduciary duties, say for choosing overly expensive plan investments, you open yourself up for a lawsuit.  Your participants can form a class and sue you.  And over the last several years, litigation surrounding the breach of fiduciary duties have been on the rise.  (Check out Tibble vs. Edison, Patterson vs. Morgan Stanley, and McDonald v. Edward D. Jones & Co. L.P. et al  for more background.)

That means it’s more important than ever to make sure you’re making good decisions and/or limiting liability wherever you can.  Even the most well-intending people can make mistakes that subject themselves to legal action.  This is where ERISA’s safe harbors come into play.

 

Section 404(c)

Section 404(c) is one of these six safe harbors.  If your plan qualifies, you cannot be held responsible for your participants’ investment results.

This is a pretty big deal.  Think about a 65-year old employee who’s been at your company for 20 years.  They’ve contributed consistently to your 401(k) plan, and are planning to retire next year.  But, despite the steadfast contributions, your participant is an inexperienced investor.  He decides it’d be a good idea to invest 75% of his savings in small cap growth stocks, based on a report he saw on CNBC.  The market crashes, his account value plummets, and all of sudden he’s forced to push his retirement out another five years.

This is a pretty unfortunate situation.  But can you be held responsible for it?

It may seem unfair, but potentially yes, you can.  Even though you didn’t make the decision to invest in the small cap fund, you technically made the decision to include the fund in your plan lineup in the first place.  Even if there was widespread trouble in the markets that caused the fund to depreciate, you could be on the hook.

The only way to absolve yourself from this liability is to comply with section 404(c).  By doing so, you cannot be held for the outcomes of your participants’ investment decisions.

 

How to Comply with Section 404(c)

There are four requirements you’ll need to follow to comply with section 404(c).  And thanks to technology the process is not nearly as difficult as it used to be.  Here are the details:

1) Investment Menu

First, your plan must offer a sufficiently diversified menu of investment options for participants to choose from.  If your participants are to be held responsible for investment outcomes from your plan, they should have enough choices to customize their account, right?

In practice, this means you’ll need at least three core investment options.  All three need to have different risk and return characteristics, which is usually accomplished by offering at least one stock, bond, and capital preservation option.

2) Investment Discretion

Your participants must also have the ability to change their investment selections at least quarterly.  Plus, any restrictions from investment discretion must be applied uniformly to all participants.  That means that you can’t make changes to your own account each week, while only allowing other participants to do so once per quarter.

3) Independent Control

Participants must also be able to exercise independent control over their accounts.  This means that plan fiduciaries can’t try to persuade participants to purchase company stock or other specific investments in the plan.

4) Disclosure

You’ll also need to provide your participants certain information about the plan and its investment options.  This includes:

  • Periodic info about the plan and related investment options.  This is usually covered by participant-fee disclosure requirements in ERISA 404(a).
  • Notice that your plan intends to comply with ERISA 404(c).  This notice should include the fact that plan fiduciaries may be relieved of liability for participant investment losses.
  • If you offer company securities in your plan, you’ll need to share information about how you secure confidentiality.  This includes information about transactions, holdings, tender offers, and proxy voting activities.

In Practice

Most bundled 401(k) and 403(b) plans today are structured to comply with section 404(c) by default.  (I don’t think I’ve ever run across a plan that had fewer than 3 investment choices).  But even if a plan is structured to comply, you’ll need to keep up with the required disclosures, make sure your participants have discretion over their accounts, and apply the rules uniformly.  Or hire someone to do it for you.  It’s an easy way to reduce risk, and should be a no-brainer with all the litigation we’ve seen over the last several years.

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