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| Fiduciary Focus: Protection Offered by ERISA Section 404(c) |
| by
W. Scott Simon
| 06-03-04 |
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Chapter XII of Charles Dickens' novel David Copperfield opens with these words: "Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."
Dickens reminds us how tiny differences can sometimes result in radically different consequences. It's sort of like being an A+ student and gaining admission to UCLA while being an A student and having to settle for the University of Michigan. (Don't ask, it's a family thing.)
Sponsors of 401(k) plans face the same stark consequences when it comes to securing--or not securing--the protection offered by section 404(c) of the Employee Retirement Income Security Act (ERISA). Plan sponsors that obtain 404(c) protection can virtually eliminate their exposure to a certain kind of liability: result happiness. Those that fail to obtain such protection expose themselves to that liability in an open-ended way: result misery.
401(k) Plan Sponsors Must Provide Participants with Healthy Food
Sponsors of 401(k) plans have a number of duties under ERISA. Whether you follow the fiduciary or even the anti-fiduciary model described in last month's article, you can bring real value to plan sponsors by alerting them to the existence of one of their duties and showing them how to shift the liability for that duty.
The duty to which I am referring is the duty of a 401(k) plan sponsor to ensure that every plan participant makes prudent investment decisions. Many sponsors are surprised to learn that they even have this duty. They think that all they have to do is provide their participants with a properly diversified variety of prudent 401(k) investment options (i.e., a healthy menu of foods to eat).
401(k) Plan Sponsors Must Make Participants Eat Their Food
Plan sponsors, however, have the additional duty to ensure that their participants actually invest prudently (i.e., eat their food). If participants invest imprudently (i.e., fail to eat their food or eat it and get sick), plan sponsors may incur liability as a result. Plan sponsors cannot delegate their fiduciary duty to ensure that every plan participant makes prudent investment decisions. The only way sponsors have of shifting the risk that their plan participants may not eat or that they will eat the wrong food and get sick is to secure the protection of ERISA section 404(c).
It may be hard to believe, then, but ERISA requires a plan sponsor to, in a way, "look over the shoulder" of each and every plan participant to ensure that he or she is "eating their spinach" with respect to making prudent investment decisions.
The Implications of Sponsor Liability without 404(c) Protection
Think of the breadth of this duty owed to plan participants and what ERISA, in effect, says to a 401(k) plan sponsor: "You bear personal responsibility for the investment decisions (such as asset allocations) made by each and every participant in your plan as if they were your own decisions." This means, for example, if a 60-year-old plan participant invests 100% of his or her plan account in an aggressive growth stock fund and the fund goes south--thereby devastating the value of the account--the participant could sue the plan sponsor for, in effect, not making the plan participant eat its spinach.
Now, think of the open-ended liability that can ensue for failing to carry out the duty to ensure that each and every plan participant makes prudent investment decisions. One way of thinking about this is to take the total number of investment decisions made by all the participants in a 401(k) plan over the course of their investment lives and multiply that by the number of participants (dozens, hundreds, thousands?) in the plan.
Added to the breadth of the duty and the vast liability for breaching it is the personal nature of that liability. ERISA Interpretive Bulletin 96-1 (now codified as a regulation at 29 CFR §2509.96-1) states: "Fiduciaries of an employee benefit plan [e.g., a 401(k) plan] are charged with carrying out their duties prudently and solely in the interest of participants and beneficiaries of the plan, and are subject to personal liability to, among other things, make good any losses to the plan resulting from a breach of their fiduciary duties."
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| W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing. Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals. For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. |
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