Participant Directed Plans

If your employees choose their own retirement plan investments, ERISA Section 404(c) provides guidelines that can help to limit your company’s exposure to liability. By complying with Section 404(c) your employees can be made responsible for the results of those investments and reduce your company’s liability. This is optional protection made available through tax law that all companies should consider.

Section 404(c) Protection. Employees enjoy the freedom of choosing their own investments in their retirement plan accounts, but this also serves a secondary purpose. It allows you to avoid some employer liability for poor investment decisions.

However, allowing your employees to make their own investment decisions doesn’t absolve your plan fiduciary responsibility. Plan sponsors and other plan fiduciaries continue to have a legal responsibility to act in the best interests of the plan’s participants and beneficiaries, regardless of who is making the final decisions on investments. It is due to this responsibility that you remain potentially liable for poor plan investment results.

For retirement plan fiduciaries that fall within the requirements for participant-directed investment, ERISA Section 404(c) expressly limits their liability. You do not need follow the guidelines, but if your plan is compliant with Section 404(c), you can avoid liability for the losses incurred as a result of a plan participant’s choice of investments.

In order to qualify for ERISA Section 404(c) protection, a plan must provide participants with independent and meaningful control over their investments. This means that the plan must offer a broad range of investments, allow participants to give investment instructions with sufficient frequency, and disclose relevant information about plan investment alternatives.

Investment Alternatives. Compliance with Section 404(c) requires abundant diversified investment alternatives. To satisfy this requirement you must offer at least three diversified investment choices, each with risk and return characteristics that are fundamentally different. An example of three investment opportunities with enough differences would be a diversified equity fund, a fixed-income fund, and a money market fund.

This allows the participating employee the opportunity to build a portfolio with risk and return characteristics that are appropriate for their current financial position. By giving your employees the ability to diversify their portfolios they are able to minimize their risks of significant losses.

In most cases, with their relatively small amounts, employees are unable to adequately diversify their portfolio by investing in individual securities. Because of this, your plan should offer “look through investment vehicles” such as:

• Common trust funds and other pooled investment funds
• Bank deposits
• Mutual funds
• Pooled separated accounts of insurance companies
• Certain group trusts
• Guaranteed investment contracts

Investment Alternatives. In an effort to reduce expense or to make a plan more convenient administratively, a lot of 401(k) and other retirement plans limit how often participants can alter their investments. However, Section 404(c) stipulates that participants must have a “reasonable opportunity” to issue instructions to an appointed plan fiduciary, who is obligated to comply with those instructions. The instructions do not have to be written, but the participant must be able to obtain written confirmation.

The regulations go on to define a “reasonable opportunity” to give instructions as once every three months, but there is an exception to this rule. A plan’s opportunity to give instruction must also be appropriate to the investment’s market volatility. So, a plan must allow for more frequent opportunity to transfer out of more volatile investments. In addition, when an investment allows for changes more than every three months, it must also:

• Allow for a transfer into one of the other investment opportunities with the same frequency.
• Have a “cash equivalency” type fund to hold investment funds until investment in an alternative is permitted.

Special Rule. If an employer security is offered as a plan alternative, participating employees must not be discouraged from transferring out of that security.

• All three investment alternatives must accept transfers as often as investment instructions for employer securities are permitted, or
• The plan must provide for an income producing, low-risk, liquid fund, subfund, or other account to hold the proceeds from an offered employer security until investment is permitted in another investment alternative.

Fiduciary Duties. Even with Section 404(c)’s provisions, fiduciaries still have a responsibility to fulfill the following duties:

• Carefully select the investment options of the plan.
• Periodically review all investment options’ performance.
• Review chosen investment options to ensure they are still suitable plan investment alternatives.
• Substitute investment options as necessary.

It is vital that you retain proof that you have performed all these oversight duties.

Should You Comply With Section 404(c)? Compliance with Section 404(c) is optional, but many companies choose to follow it due to the extra liability protection it affords. However, if you do choose to comply with Section 404(c) you are required to meet the pension law’s prudent investment requirements.

It’s conceivable that the courts may use the Section 404(c) to gauge the performance of a plan sponsor with participant-directed investments and if they have satisfied their fiduciary duties. It will be impossible to know for sure until Section 404(c) has been in practice for awhile.

For more information on Participant Directed Plans, don’t hesitate to contact one of our professionals today.