404(c) in the Modern World

Section 404(c) follows the Section 404(a) “prudent man standard of care” requirements and offers a type of “safe harbor” for plan sponsors who allow participants to direct the investments of their accounts. However, plan sponsors must meet requirements for investment selection, plan administration, and plan and investment disclosures before they are exempt from any fiduciary liability for losses participants incur as a result of their direction of investments.

“We’ve said for a long time that plan sponsors just blindly assume the requirements are satisfied,” Scott A. Webster, and attorney with Goodwin Procter LLP in Boston, tells PLANADVISER. He says it is still a valid question whether plan sponsors are complying with 404(c), but due to changes to the plan administrative landscape and more recent regulations, he believes most plan sponsors are complying.

“Before 404(a)(5) [participant disclosure requirements] it was all over the place what information plan sponsors provided. Some parts of the statute were not clearly written, and there was not much case law to guide them,” Webster adds.

He contends that most 404(c) requirements are not relevant to today’s environment. For example, the regulations require participants to have a choice to change investments at least once per quarter, but that is not relevant in today’s daily-valuation environment. In addition, information about investments is more available and easily accessible, especially online, making it easier to comply with the requirement that participants have all information available to them to make proper investment choices.

There are several prongs to the 404(c) requirements; one dealing with default investments when participants do not make investment selections. Webster points out that qualified default investment alternatives (QDIA) guidance from the Department of Labor (DOL), following passage of the Pension Protection Act of 2006 (PPA), made these requirements more clear (see “DOL Issues Final QDIA Rules—Without Stable Value”).

A look at the original text of ERISA 404(c) shows it requires default investments to “include a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both.” However, at the time, defined benefit (DB) plans were the dominant source of employer-provided retirement income; the move to mostly DC plans and more individual responsibility for saving and investing assets for retirement means the goal of “capital preservation” may leave participants short of what they need for retirement.

In addition, the statute requires participants are given notice of their savings being put into default investments “within a reasonable period of time before each plan year” and that they be given a “reasonable period of time” after receiving the notice to make their own investment selections. The QDIA rules make these requirements less vague for plan sponsors.

The DOL issued final participant fee disclosure regulations under 404(a)(5) in October 2010 (see “EBSA Releases Final Participant Fee Disclosure Rule”), with additional guidance issued in May 2012 (see“DOL Issues Additional Guidance for Participant Fee Disclosures”).

“The view of 404(c) changed after 404(a)(5) because it requires a lot of disclosure about fees and performance, and now employers are complying,” Webster says. “They realize the responsibility is on them, not their recordkeepers or providers.” He also points out that the DOL put these requirements under 401(a), not 404(c)—404(c) is permissive, 404(a) is a must—because they wanted to be able to enforce these requirements.

He adds that under 404(c), plan sponsors generally had to provide sufficient information about the plan and investment alternatives, not real detailed information. It was vaguely written, and that’s why people were concerned about being in compliance. “404(a)(5) gives a level of detail not provided before,” he says.

Webster adds that the biggest risk of not complying with 404(c) was concerning what funds plan sponsors made available. With 404(a)(5), the DOL has reiterated that plan sponsors have to be good fiduciaries in the selection and monitoring of funds. “They cannot just select and walk away. This is where most litigation has come up—concerning the selection of bad funds, expensive funds, retail funds. Just using the 404(c) defense doesn’t help, selection and monitoring is more enforced now,” he says.

Webster points out brokerage windows—investment vehicles which enable participants to select investments beyond those offered by the plan—continue to be an issue. “Even if they are limited to mutual funds, can participants invest in any mutual fund? What if they choose retail funds? Do plan sponsors have an obligation to monitor that?” he queries.

The DOL has attempted to clarify its position on brokerage windows, but many questions remain (see “Feature: Brokerage Window Issues Still Open”).

Even though the changing plan administrative landscape and additional guidance have made 404(c) compliance easier to understand and more likely, “if plan sponsors only comply with most requirements, it’s not enough,” Webster concludes. “It is important to have a process in place to comply with all requirements; to be a good fiduciary, you must have a good process.”