When Congress passed the Employee Retirement Income Security Act (ERISA) in 1974, it provided plan sponsors with some relief from liability as a fiduciary in defined- contribution plans. The idea behind the statutory safe harbor in the act's 404(c) provision is "that to the extent the participants have the ability to control investments in their investment accounts, the fiduciary will not be liable for those decisions," explains Robert Doyle, director of the office of regulations at the Department of Labor.
Doyle terms the regulations that the department issued in 1992 under rule 404 (c) "essentially a defense to liability" in the face of lawsuits charging breach of fiduciary duty. (See box, page 64, for compliance requirements.)
But most plan sponsors are unconvinced that 404 (c) offers much protection. "I don't think we know, because we haven't had a bear market yet," says Myra Drucker, assistant treasurer and chief investment officer at Xerox Corp., in Stamford, Connecticut. "Come the bear market, we'll find out how much protection it supplies," she adds, noting that's when the lawsuits will be filed and the courts will establish case law for this provision. So far, there is virtually no case law on 404(c) regulations.
So Drucker isn't taking any chances. Xerox has done everything it believes is necessary to comply with 404(c) regulations. It notifies participants that it is in compliance, has put in six investment options with different reward and risk characteristics, and is considering adding more later this year. Xerox also notifies participants that they are responsible for their investment decisions, and provides regular information on the historic and current performance of the investment options.
Another big sponsor, Exxon Corp., in Irving, Texas, has four options, is considering adding another, and provides daily valuation and frequent opportunities to switch among them.
Others are going even further. A 1997 survey by HayGroup, an international compensation consulting firm based in Philadelphia, found that 90 percent of 460 sponsors had four or more investment options. And the Labor Department's Doyle says most plans now have between 9 and 12, and they offer participants the opportunity to change investments daily. These design criteria are much more than the minimum required.
One might think sponsors' anxiety over fiduciary liability would have been eased by a recent court decision involving Unisys Corp, a computer company based in Blue Bell, Pennsylvania. The November 1997 federal-court decision involving Unisys held that 404(c) offers broader protections than those described by the regulations. But most plan sponsors don't read a lot into that.
One reason is that the case is being appealed. But the main reason is that the case was based on claims that originated prior to issuance of 404(c) regulations. In the future, courts are expected to take the regulations into account in their decisions, and the regulations require more of plan sponsors than did the standard to which Unisys was held. While the court concluded that the safe harbor of 404(c) could have protected Unisys even if the company had not been prudent in selecting three guaranteed investment contracts from Executive Life in 1987 and 1988 to put into its investment funds, the decision relied entirely on "a statutory approach explicitly rejecting reliance on the regulations," notes Brian T. Ortelere of Pepper Hamilton LLP, in Philadelphia, who represents Unisys.
What's more, the Department of Labor has since filed a brief in support of the plaintiff's appeal, which was filed in June. Neither the attorney for the plaintiffs in the Unisys case nor the Department of Labor would comment.
Clearly, however, the department's view of plan-sponsor liability is quite different from the court's. Even if a plan sponsor complies with all the provisions of the 404(c) regulations, the sponsor retains liability for choosing and monitoring the investment options in the plan, says Doyle. "The plan sponsor must be prudent in making those choices," he says.
ERISA attorneys who advise plan sponsors generally encourage the clients to heed the Department of Labor's interpretation of the 404 (c) safe harbor, expecting courts to weigh the department's views in its determination of future lawsuits. In general, employers "have to be able to show they acted prudently" in selecting and retaining either a type of investment option or particular fund, says Donald J. Myers, partner and head of benefits practice in the Washington, D.C., office of Reed Smith Shaw & McClay.
In any case, Myers says it is critical that a sponsor establish procedures and follow them, because this will allow the sponsor to document how it monitors investment options and money managers. He recommends beginning with an investment policy for the plan that explains the purpose of its particular set of options.
Beyond the minimums spelled out by the regulations, there is no correct number of options or types of options, Myers says. Whatever decision is finally made, "the employer can protect itself by carrying out every decision in a prudent manner," and documenting how that was done, Myers says. "The employer must be able to demonstrate he behaved in a prudent manner," he explains.
But even adequate documentation of prudence "is no guarantee an employer will not be held liable" in a future lawsuit, says Myers, though he contends "it will go a long way."
How far is open to question. Doyle says that if a plan sponsor includes an option "that has never been a meaningful investment in the marketplace, then the fiduciary may well be liable for imprudent designation of an investment option."
Doyle also suggests that sponsors should worry about their plan fees, because consideration of fees is part of the analysis of sponsor prudence. (For more on this subject, see "401 (k) Sticker Shock?" CFO, May 1998).
Myers suggests that a sponsor might be held liable for the service provider it hires to conduct investment education for its participants. The 404(c) regulations do not require participant education. However, sponsors have been encouraged to provide general investment education since 1996, when the Department of Labor spelled out how such education could be offered without creating fiduciary liability for investment advice.
Doyle says that sponsors remain liable for imprudent selection of any service provider, including one to provide investment education, if that provider were paid out of plan assets.
Not long ago, some pension lawyers suggested that an employer might be better off not complying with 404(c). Since compliance was no guarantee of a sufficient defense against a lawsuit, according to this view, it was not worth the trouble. Some lawyers even went so far as to suggest that the vague language regarding prudence in the 404(c) regulations could lead to greater liability.
But that view is rarely heard today, simply because so many plans have complied despite such concerns. "The marketplace has decided," says David Ball, the former Assistant Secretary of Labor who oversaw the issuance of the regulations.
In large measure, that reflects new technology that makes it much easier to offer participants more options and opportunities to make changes. However, expanding the number of options can also expose a sponsor to additional liability, according to Theodore Benna, president of the 401(k) Association, a Cross Fork, Pennsylvania-based advocate group for plan participants. "It can definitely come back and bite them," says Benna, "if a participant makes a bad decision in that environment." He questions plans that offer dozens or more investment options, especially when there is duplication.
Benna recommends that sponsors increase their educational efforts, and says they might also want to retain for participants an outside investment advisory firm that would agree to assume responsibility for its advice. As an alternative, he says, sponsors would generally have less liability if they limited investment choices to 6 to 12 standard options, which the plan would oversee for participants who didn't have the time or inclination to educate themselves about a broad array of investments, while allowing better-educated participants to choose more.
Given these alternatives, the Labor Department's Doyle says, "why someone would elect not to comply with 404(c)" is beyond his ken.
Plan sponsors tend to agree. "It is not particularly onerous to comply, and it is certainly no hardship," says Jim Bayne, manager of benefits finance and investment at Exxon, and chairman of the committee for the investment of employee benefit assets of the Financial Executives Institute. Plus, Bayne says, "it's nice to know some judge may refer to the regulations and take that into account should there be a lawsuit." He adds, "Certainly our lawyers feel it's worth complying."
Just keep your fingers crossed about the stock market.
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It took the Department of Labor almost 20 years to issue regulations under ERISA's section 404(c) spelling out how sponsors of 401 (k) and other defined-contribution plans might protect themselves from fiduciary liability. Sponsors can only hope it doesn't take another 20 years to find out just how much protection 404(c) provides. Here, in any case, is what the rules require:
Sponsors must offer plan participants a "broad range" of investment options, identified as at least "three diversified investment alternatives, each of which has materially different risk and return characteristics."
Participants must be able to make or change their choice of investments frequently, defined by the regulations as at least quarterly.
Sponsors must notify participants that they are responsible for their investment decisions. They must also provide "sufficient information [to enable participants] to make informed investment decisions." This includes information on the historic performance of the funds and changes in that performance.
While most sponsors have gone far beyond these minimum requirements, fiduciaries are still liable for their selection of an investment manager and for monitoring the performance of the manager, cautions David Ball, a former Assistant Secretary of Labor and the head of the Pension and Welfare Benefits Administration.
However, Ball, who oversaw the issuance of 404 (c) regulations during the final weeks of the Bush Administration and is now a managing partner in the Washington, D.C., law firm Williams Mullen Christian & Dobbins, is confident that complying with 404(c) protects a sponsor from the investment decisions that participants make. "This will be clear when we get litigation," he says.
Maybe so. But which sponsor wants to be the test case?