Fiduciary Focus: Protection Offered by ERISA Section 404(c)

Morningstar Advisor Magazine August/September 2010 Issue

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Fiduciary Focus: Protection Offered by ERISA Section 404(c)

by W. Scott Simon | 06-03-04

Continued from page 1.

Plan sponsors that understand these realities begin to get an idea of the vast number of potential opportunities available to attorneys that specialize in ERISA litigation. If the number of plan participants is large enough, of course, a plan sponsor needn't worry about a lot of individual lawsuits; ERISA litigation attorneys will oblige the sponsor with a class action lawsuit. Result misery.

It's probable that the great majority of 401(k) plan sponsors have no idea they have the duty to ensure that every one of their plan participants makes prudent investment decisions. Even many sponsors that are aware of this duty don't know how to carry it out. And many of those that attempt to carry it out fail to do so correctly.

Obtaining the Protection of 404(c)

A participant in a "participant-directed" 401(k) plan is not considered to have "effective control" over its plan account. (This terminology is a bit confusing since the words "directed" and "control" mean virtually the same thing outside ERISA law.) A participant is able to "exercise control" over the investments in its 401(k) plan account only when the plan becomes 404(c) compliant.

And only when a 401(k) plan complies with section 404(c) is the plan sponsor relieved of liability for any losses that plan participants incur as a direct consequence of their imprudent investment decisions. The Department of Labor could not be clearer about this: "The only circumstances in which ERISA relieves the fiduciary of responsibility for a participant-directed investment is when the plan qualifies as a 404(c) plan." ("U.S. Department of Labor Amended Brief of the Secretary of Labor as Amicus Curiae Opposing the Motion to Dismiss" in Tittle v. Enron Corp., Civil Action No. H-013913 (S. D. Tex.).)

Making a 401(k) plan 404(c) compliant seems, at first blush, pretty complicated. After all, the 404(c) regulations issued by the Department of Labor describe 20-plus requirements. While the requirements are somewhat extensive, they are really not that difficult to implement. The law firm of Reish Luftman Reicher & Cohen lists these requirements. In addition, a helpful 404(c) compliance checklist is offered by the law firm of Snell & Wilmer.

A 401(k) plan must meet every requirement under the 404(c) regulations in order for it to be 404(c) compliant. For example, even a very simple requirement that calls for the plan sponsor to merely inform plan participants that the 401(k) plan is a 404(c) plan must be met. If it isn't, the sponsor cannot use ERISA section 404(c) as a defense against participant lawsuits even if all the other requirements are met. The burden of proof is on the plan sponsor to show that it has complied fully with section 404(c) in order to obtain its protection.

In contrast to situations where a plan sponsor delegates its investment and management functions to an agent to avoid liability for its own investment mistakes, successful compliance with ERISA section 404(c) allows the sponsor to avoid liability for the investment mistakes made by plan participants. In both situations, though, the sponsor always retains the ultimate oversight responsibility for prudently selecting and monitoring the plan's investment options and--if delegation occurs--its investment agents.

Informing 401(k) plan sponsors of their duty to ensure that plan participants make prudent investment decisions and their ability to transfer the liability for that duty by complying with ERISA section 404(c) allows you to bring real value to them. When sponsors of 401(k) plans take this good advice to heart and then actually implement the 404(c) requirements: result happiness.

Sponsors of 401(k) plans that become 404(c) compliant can also help plan participants enhance their investment experience. After all, the primary reason for having 401(k) plans is to help participants retire comfortably so that they don't end up in a food line in their old age echoing the words of Oliver Twist, the title character of another Dickens novel: "Please, sir, may I have some more?"

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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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