Section 404c of the Employee Retirement Income Security Act of 1974 (ERISA) is a specific section that addresses an employee’s ability to direct all investment related decisions for their own retirement accounts.   Generally speaking, section 404(c) allows for a pension plan allows for its individual participants or beneficiaries the ability to exercise control over the assets in their accounts, the participant or beneficiary cannot be defined as a fiduciary over the pension plan assets simply because they are exercising control over their specific investments.  In addition, no other fiduciary of the pension plan would be liable should the participant or beneficiary selects investments that result in a loss.

ERISA is best known as a federal law that has established the standards for employee investment in retirement accounts like 403(b) and 401(k) accounts.  One may ask why an employee would want to direct his/her own retirement account.  Some employees may have extensive financial management experience and given that have a belief that their investing prowess would surpass those money managers managing their employer’s mutual fund options.   Section 404(c) allows employees to do precisely that.

In terms of misunderstood section of ERISA, Section 404(c) is right up there at the top.   The plan sponsor community has had rampant misconceptions about the section even before the participant fee disclosure provisions served add additional confusion to the mix.  One point to clarify is that when a retirement plan addressed all the required elements of section 404(c), a retirement plan fiduciary cannot be held liable for those losses that resulted from a direct exercise of the participant’s control of the investment decision in his/her retirement plan account.

In order to meet the definition of a section 404(c) plan, the plan must allow a participant or beneficiary the ability to exercise control over any assets currently in the employee’s retirement account, only if the pension plan terms indicate that the beneficiary or participant be afforded the opportunity to provide investment instructions for submission to the pension plan fiduciary.  That pension plan fiduciary is then obligated to be in compliance with the instructions detailed in the section.   The participant or beneficiary must also have the opportunity to obtain the necessary and sufficient information enough so that they are able to make informed decisions about the investment options available to them under the plan.

Is Education an Important Part of the Fiduciary Process?

Section 404(c) makes it clear that participants or beneficiaries must be given a certain amount of required information to be in a solid position to exercise control over their assets.  The process is vital.  Providing participants or beneficiaries with fund profiles solely will not rise to the level of sufficient information.  On the contrary, a participant or beneficiary does not need to be provided with an amount of information that would ultimately amount to an MBA education.   One could speculate that the level of information required should fall somewhere in the middle of that spectrum.

Necessary Investment Information to be Provided by the Plan Fiduciary

A plan fiduciary must be provide to a plan participant or beneficiary a detailed explanation the retirement plan was created with the intention of complying with the provision in section 404(c). In addition, the fiduciary must indicate that under the plan the fiduciary is likely relieved of any loss liability that arise directly from investment decisions executed by a participant or beneficiary.  The participant or beneficiary must also be provided investment alternative descriptions, which would include a broad description of the risks, expected returns and investment objectives of these alternative investments by the plan fiduciary.  Moreover, the fiduciary must provide the participant and beneficiary information related to the diversification of the alternative investment assets. 

In the spirit of providing the participant or beneficiary with sufficient information to execute his/her own investment decisions, the identification of investment managers designated by the fiduciary is also required.  Additionally, the participant or beneficiary must understand all circumstances upon which they may provide investment instructions and any detailed limitations on those instructions with the retirement plan.  Such limitations or restrictions would include a restriction on transferring assets to/from a specifically designated alternative investment or any restrictions related to exercising tender, voting or other specific rights that should follow through to the participant or beneficiary. 

The participant or beneficiary must also be provided with a detailed description of the full extent of transaction that will have a direct impact on the participant’s or beneficiary’s account value as it relates to any purchases or sales in the alternative investments under the plan.  The participant and beneficiary should also make a note for their records of the address, phone number, name and any other contact information for any of the retirement plan’s fiduciaries or persons who have been designated to act on the fiduciary’s behalf.

The plan fiduciary must provide the plan participant or beneficiary with specific additional information when an alternative investment may allow a participant or beneficiary to acquire, directly or indirectly, their employer’s securities, the plan fiduciary must provide the participant or beneficiary with a detailed description of the established procedures as they relate to maintaining confidentiality of the information as it relates to the purchasing or sale of employer securities.   As it relates to alternative investments in which the participant or beneficiary currently do not have invested assets and that are subject to the Securities Act of 1933, the plan fiduciary most provide the participant or beneficiary with the most recent prospectus for review.

The plan fiduciary must also provide the participant or beneficiary with a detailed description for each alternative investment that includes the annual operating expenses.  These operation expenses typically included investment transaction cost, administrative and investment management fees, which have the net effect of reducing the participant’s or beneficiary’s investment return.   The aggregate amount of these expenses should be detailed as an average net assets percentage of the alternative investment.

Financial statements, reports, prospectus and other related documentation must be provided to participant or beneficiary as it relates to each alternative investment option under the retirement plan.  Included within the other related documentation category would be a list of the portfolio assets for each alternative investment making up the retirement plan assets as well as the value of each asset.   Additionally, the participant and beneficiary must receive any information regarding the value of the alternative investments that are made available to the beneficiary and participant under the retirement plan.  Also, the current and past alternative investment performance, which must remove the expenses, should be provide on a consistent and reasonable basis.  Lastly, the participant and beneficiary must be provided with any and all information concerning the value of alternative investment shares that are presently held by the participant or beneficiary in a retirement account.

Why a Plan Does Not Fail to Provide an Opportunity for a Participant or Beneficiary to Exercise Control over His Individual Account?

In the previous section the importance of participant or beneficiary notification was highlighted and cannot be understated if a retirement plan intends availing itself of section 404(c).   A plan fiduciary is within the rights of the plan and section 404(c) to levy charges for reasonable expense on the accounts in which a participant or beneficiary exercise control.   However, the reasonable expenses must be related to investment execution and the plan fiduciary must develop procedures under the plan to notify participant or beneficiaries of the actual incurred expenses within their retirement account on a periodic basis.

In addition, a plan fiduciary is not required take action on all the participant’s or beneficiary’s investment instructions.   The plan fiduciary may in fact impose restrictions on the frequent of investment activity, so long as it is reasonable.  That said, the participant or beneficiary must be allowed to provide investment instructions at a frequency that is line with the market’s present volatility for which an alternative investment of that type would reasonable be subjected.

What is the Importance of 404(c) to an Employer Who Provides a Pension Plan to Employees?

The advantages of section 404(c) retirement plans for employees who are interested in acting as a participant or beneficiary has been laid out in the previous sections.   Why would an employer desire to provide such a plan?  Section 404(c) retirement plans provide the plan fiduciaries with a safe-harbor provision upon which they may rely so as not to be held liable for any losses incurred by plan participants or beneficiaries who have taken control of their investment decision making.  In essence, an employer cannot be liable in a court off law from the mistakes of their employees under this section.   In order for an employer to qualify to utilize this safe harbor, retirement plan sponsors are obligated to comply with provisions related to plan administration, investment plan disclosures and investment selection before the employer may take advantage of the exemption for fiduciary liability as it relates to participant or beneficiary direct invested losses.  Lastly, a plan fiduciary must allow participants in the retirement plan an opportunity to select from a broad array of investments, the manner which their accounts should be invested, which will afford participants the opportunity for investment diversity and the ability to control the investment selection in their accounts.

How Safe are ERISA 401k/404(c) Safe-Harbors?

Like all safe harbors, compliance is the most important factor in determining if an employer has met all the conditions required to take advantage of any safe harbor provisions.   While section 404(c) certainly allows employers the ability to avoid liability exposure as a result of self-directed investment decisions made by participants, there could be misunderstandings about the protections offered that ultimately end up exposing the employer to liability.   It is important for employers to understand that there is no absolute immunity due to the safe harbors, once explained.

What is the potential liability of Participant Directed 401k Plans?

Section 404(c) allows for a process to be followed by employers to allow participants the ability to self-direct investments in their retirement accounts.   There are specific sections and requirements that must be followed to ensure that the employer is protected from liability.  However, there isn’t complete protection or blanket protection under the Act.   That said, the more provisions within section 404(c) an employer follows a fiduciary operating in a prudent manger, the better protected the fiduciary will be from liability.   There is no such thing as plan sponsor being able to put their retirement program on auto pilot, it must be actively monitored otherwise a disastrous mistake could result in liability issues for the employer.   The investment selection process is best navigated through the use of a Financial Advisor, who is familiar with the intricacies of executing investment and business dealings with plan participants.  A Financial Advisor may likely advise the participant to create an investment policy statement, which can be used to show the rationale for selected specific investments and on what criteria.   An investment policy statement is meant to be a living, changing document.   Having an investment policy statement and not following it could result in liability for not following the document.

One of the biggest concerns around 401(k) plans is over the fees related to investments.  Often, the amount of money paid to a mutual fund admin, the use of proprietary funds on one plan or using expensive shares are issues that will get attention for impropriety.   In fact, the selection of mutual funds simply because the plan sponsor offers those funds or the fact that the mutual fund may reduce admin costs are not good reasons for choosing investment vehicles for the retirement plan.

If an employer wants to completely protect themselves under section 404(c), the employer must be sure to keep accurate and complete documentation, take minutes from all plan investment decision making, and track investment education materials that have been provided to plan participants.   This allows the employer to evidence from the records their protection from liability. 

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