Compliance September 24, 2018

ERISA 404(c) Compliance Well Worth the Effort

Frederick Reish, partner in the Drinker Biddle & Reath Employee Benefits & Executive Compensation Practice Group and Chair of the Financial Services ERISA Team, suggests a good way to think about ERISA Section 404(c) is as “a relatively inexpensive insurance policy.”
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When followed in its entirety, Section 404(c) of the Employee Retirement Income Security Act (ERISA) provides a safe harbor for fiduciaries related to the investment actions of participants.

According to an informative white paper published by Wells Fargo, “Section 404(c) compliance: Added protection makes it worth the effort,” Section 404(c) of ERISA dates all the way back to 1974, but plan sponsors and fiduciary service providers are still trying to figure out what it means for their defined contribution (DC) plans. In a phrase, 404(c) is designed to protect plan sponsors from employees’ poor investment choices.

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“While the protection it provides to plan fiduciaries is valuable, the list of requirements can be intimidating,” the paper warns.

At the most basic level, to be 404(c) compliant, a DC plan must offer a broad range of investment options and make it possible for participants to easily view and control their investments. Again, while the prescription sounds simple, it can be quite confusing in practice, especially for new plan sponsors unfamiliar with complex jargon of ERISA requirements and enforcement.

Frederick Reish, partner in the Drinker Biddle & Reath Employee Benefits & Executive Compensation Practice Group and Chair of the Financial Services ERISA Team, suggests a good way to think about Section 404(c) is as “a relatively inexpensive insurance policy.” According to Reish, plan sponsors and fiduciaries should make every effort to obtain its protections.

“The investment provisions of ERISA are based on generally accepted investment principles, such as modern portfolio theory,” Reish explains. “Applied at the participant level, that means the law assumes that participants will be invested in portfolios. In other words, participants are expected to either select among the plan’s investments to craft portfolios in their accounts or, alternatively, to select professionally designed portfolios such as target-date funds.”

Unfortunately, Reish observes, most participants don’t know how to construct portfolios or don’t realize the importance of balanced portfolio investing. This is the basic reason why ERISA provides in 404(c) that, if plans satisfy certain conditions making participant investing success possible, fiduciaries will not be liable for imprudent investment decisions by participants.

“However, in my experience, many plans don’t satisfy all those conditions,” Reish warns. “In these cases, fiduciaries should protect against possible claims by helping participants improve their investing. And, even if a plan satisfies 404(c), giving fiduciaries a defense against claims for losses due to imprudent participant investing, there is an important reason for improving participant investing—to help participants reach their retirement goals.”

Despite such advice from experts like Reish, the Wells Fargo white paper suggests some plan sponsors inappropriately feel the cost of compliance with 404(c) is not worth the protection.

“While cost is always a valid concern, be sure to consider the long-term relief from the risk of liability for making investment decisions for participant retirement dollars in a 404(c) compliant plan and not simply the short-term costs of complying,” the paper states. “The passage of the Pension Protection Act offered clarification regarding some of the most controversial aspects of plan administration and 404(c) compliance. Armed with this information, almost any plan sponsor can become 404(c) compliant.”

Basic requirements of 404(c)

According to Reish and the Wells Fargo paper, to be 404(c) compliant, a plan must meet two general requirements. The first is that the plan must offer a “broad range” of investment options.

“A broad range is defined as at least three investment alternatives,” Wells Fargo explains. “Each option must be diversified, offer risk/return characteristics different from the others, and offer diversification for a participant’s overall portfolio when combined. Most defined contribution plans today already meet this requirement without a problem.”

The second requirement is a bit more confusing, the experts agree. This requirement is that the plan must make it possible for participants to become informed about and to smoothly direct their investments.

As the white paper explains, regulators tend to think about this requirement by asking whether or not plan participants can exercise informed control of their accounts—which means that a DC plan must allow participants to obtain written confirmation of their decisions, and to receive sufficient information to make informed investment decisions.

“In addition, participants must be able to make changes to their investments at least quarterly,” Wells Fargo explains. “However, if an investment option is sufficiently volatile, more frequent opportunities to change investments may be required. If your plan allows daily transfers for all options, you’ll fulfill this requirement without needing to quantify ‘sufficient volatility.’”

Important to note, beyond this type of information that must be automatically supplied to participants, there are other types of information that must be made available upon request. An example of this type of information includes a description of the annual operating expenses for each designated investment option—which should be expressed as a percentage of average net assets of the investment. Plan sponsors must also make available upon request copies of any prospectuses, financial statements, and reports, and any other materials relating to the investment options available under the plan, to the extent such information is provided to the plan.

The Wells Fargo paper further points out that there are special requirements under 404(c) when it comes to the treatment of employer stock. One such requirement is that the plan sponsor must formally establish procedures regarding the confidentiality of participant actions with regard to employer stock. Furthermore, a description of the procedures must be given to participants, and a fiduciary must be designated to ensure such procedures are met.

PPA impact on 404(c)

According to Wells Fargo, the Pension Protection Act (PPA) importantly clarified that a reasonable remapping of assets will not in itself jeopardize 404(c) compliance, even if there is a short-term blackout period for participants.

“This provision allows 404(c) plans to map funds from one investment to another, if the new investment is reasonably similar in characteristics,” the white paper explains. “Other conditions must also be met, including a notice to participants. 404(c) protection is also available for fiduciaries during blackout periods if the fiduciaries follow ERISA’s requirements related to blackout periods.”

Probably most important, the Pension Protection Act established a new safe harbor for plan sponsors selecting a qualified default investment alternative (QDIA) on behalf of participants that are automatically enrolled without making an investment selection on their own.

“This legislation and the proposed regulation were designed for the plan sponsor who wants both 404(c) protection and an automatic enrollment feature for their plan,” Wells Fargo explains. “Following the safe harbor for a QDIA allows the plan sponsor or plan administrator to place participant retirement dollars into a default investment option within the plan while still otherwise maintaining a 404(c) plan.”

Provider support

For plan sponsors unsure of their 404(c) compliance status, Wells Fargo says the first step should be to initiate a detailed discussion with the plan provider. Many providers can help set up automatic controls to help sponsors fulfill at least part of their ongoing 404(c) responsibilities.

“Find out which of the 404(c) requirements the plan provider offers and whether it creates a paper trail,” the white paper suggests. “After this important step, examine what requirements remain to be fulfilled and implement a process for completion. The process should include ongoing needs and creating the documentation to substantiate what you have done. By taking advantage of what may already be in place for your plan, the task of 404(c) compliance may be much less daunting than tackling the initial list on your own.”

The full Wells Fargo white paper, which includes much more detailed lists about what is required under 404(c), is available for download here.

Client Service September 21, 2018

The Importance of Addressing Participant Complaints

If a sponsor does not respond, they could face a civil and/or DOL lawsuit
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Participants do lodge complaints against their retirement plans from time to time, and all of these complaints should be addressed, experts say.

If a retirement plan sponsor ignores a participant complaint, that participant is liable to turn to the Department of Labor (DOL) on their own or hire a lawyer who will do so on their behalf, says Blaine Aikin, executive chairman of Fi360 in Pittsburgh.

“More than 60% of the audits that result from participant complaints result in action, which could include civil or criminal penalties and/or direct the sponsor to pay the participant’s attorney fees,” he says. “So, the sponsor could end up facing not just private class action lawsuits but lawsuits by the DOL as well. The plaintiffs are becoming more successful and sophisticated. Their attorneys are becoming quite skilled at drilling down on what resonates with the courts.”

Common complaints include a lack of access to education or resources about the plan, says Josh Sailar, an investment advisor with Miracle Mile Advisors in Los Angeles. “Such complaints have merit,” he says. “Participants should always be able to have questions about their plan answered, be that through online resources or the ability to reach out to a person.”

Another common complaint from participants is that they cannot access their funds, should the plan not permit loans or hardship withdrawals, says Tom Conlon, head of client relations at Betterment for Business in New York.

Kevin Haskell, a partner with Aegis Retirement Partners in Concord, Massachusetts, agrees: “The most common complaint we receive from participants is lack of access to their retirement funds,” he says. “Due to IRS [Internal Revenue Service] and plan rules, many employees are unable to take a distribution while they are still employed. Many plans also do not offer a loan provision, or, if they do, some plan sponsors restrict loans to only one or two outstanding at a time, or restrict the availability for only hardship withdrawals.”

Conlon adds: “There are also some participants who are hyper-concerned about fees, and this can also be a common complaint. If you have a lot of participants complaining about fees, you might find yourself litigating with them. It is very common for participants to sue fiduciaries over fees. If you have a process to determining that your fees are reasonable, you have less to be concerned about. If you don’t have the necessary tools to do this rigorous analysis, hire an ERISA [Employee Retirement Income Security Act] 3(38) fiduciary to provide assurance you are acting in the best interest of participants.”

The best way to avoid questions or complaints about fees to be fully transparent, Haskell says. “We spend a lot of time educating our plan sponsors and plan participants on how fees are applied,” he says. “Once participants are fully aware of all the rules and fees associated with their retirement plans, they have a higher comfort level and tend not only to stay in or opt into the plan, but to participate at higher contribution levels.”

DWC – The 401(k) Experts responds to questions about fees in person, says Keith Clark, a managing partner with the company, based in St. Paul, Minnesota. “If the complaints are about fees or investment options, the appropriate contact at the plan sponsor should take the time with the participant, in person, to reveal the due diligence reports from the selection process and the ongoing monitoring reports,” Clark says. “Full disclosure is the best approach. Some plan sponsors include participants on a plan advisory committee, which can make this process easier.”

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It is also very important to document all communication with the participant, Clark adds: “Document and follow up until the complaint is closed. It is closed when the participant acknowledges their question or issue has been satisfied. The best recordkeeping service provider call centers record and document all calls. The latter is especially important if a follow up is required to involve the appropriate party.”

Participants sometimes also complain if they are not offered mobile applications to access their accounts, says Joseph Conroy, a financial planner with Synergy Financial Group in Towson, Maryland. “Complaints about technology absolutely have merit,” he says. “Today’s participants want to enroll, access and rebalance their accounts from their smartphones. While they are willing to use paperwork and desktop computers to do those things for now—in a few years, they won’t”

Finally, participants often ask for additional asset classes to be included in the investment lineup. “If a lineup is missing asset classes, that is a huge deal,” Sailar says. “If they are asking about a specific sector, you can address that by offering an S&P 500 fund. Most sectors they ask about are typically in the fund lineup already. It is just a matter of educating the participant. For example, if the participant is asking about FANG stocks—Facebook, Apple, Netflix and Google—each of these make up a large portion of the S&P 500 index.”

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