404(c) is one of the four “safe harbors” for participant directed plans under the Employee Retirement Income Security Act (ERISA). The four safe harbors available for Investment Fiduciaries are:
• 404(a), which we often refer to as a General “safe harbor” “, regarding delegation of investment decisions to a prudent expert;
• comply with applicable 404(c) “safe harbor” provisions;
• engage a Fiduciary Adviser to provide participant-specific advice; and
• offer a qualified default investment alternative (QDIA).
What is the 404(c) safe harbor?
Those that drew up the Act must have had the feeling that many employees might make bad financial decisions. They also decided that those who chose to offer 401(k) and profit sharing plans would also be plan fiduciaries even when participants are allowed to manage their own investments. If you comply with all of 404(c)’s rules including providing three investment options with materially different risk/return profiles and helping educate employees on these options then you could insulate yourself from liability associated with certain investment-related decisions and acts.
In June 2009, the 7th Circuit ruled that an affirmative defense under ERISA Section 404(c) protects plan fiduciaries from liability for claims that the fiduciaries imprudently selected mutual funds with excessively high fees. The Court clarified in an addendum that its decision did not intend to approve a strategy whereby a fiduciary seeks to insulate itself from liability by simply including a very large number of investment alternatives in its portfolio.
How do you qualify for the 404(c) safe harbor?
There are about 20 qualifiers. We highlight a few here:
Participant Notification. Plan participants must be notified in writing that the plan sponsor intends to constitute a 404(c) plan, and seek liability relief through these safe harbor provisions.
Three different risk/return options. The participants be provided, at least, three different investment options, each with a materially different risk/return profile, to provide prudent diversification. Do you offer more than three options? Why? Do you know that you meet the different risk/return profile criteria?
Provide investment information. Participants need to receive sufficient education on the different investment options so that each can make an informed investment decision. Participant education should include:
- each investment option’s most recent prospectus, or similar document;
- a general description of the investment objectives and risk/return characteristics of each investment option;
- information on the fees and expenses associated with each investment option;
- a listing of the securities held by each option;
- the performance of each investment option; and
- Modern Portfolio Theory stats, such as the Alpha, Sharpe ratio, and standard deviation of each investment option.
Do you monitor your plan to see if you provide this information? If you don’t have access to the correlations of your menu how do you know if the choices are materially different in risk/return?
Contact us for a complete 404(c) list. Let your ERISA counsel help you determine if you are in compliance with 404(c).
Out of 404(c) safe harbor
Noted ERISA attorney Fred Reish has said that he has seen very few plans actually comply. I’ve actually seen plans where a fiduciary has checked off the box on the small business benefit plan tax filing (5500) indicating intent to comply. However, the person who signed had no idea of what it meant.
However when the Department of Labor investigator comes into your plan they’re going to ask for your file showing your compliance. You may want to seek the qualified default investment alternative (QDIA) safe harbor as a higher priority than 404(c). It is a bit more straightforward when you default people into a QDIA. However this approach requires prudent selection and monitoring. I recently evaluated a plan that is defaulting its employees into investments that fall and the lowest quartile of performance. You could also use an ERISA 3 (38) investment manager to delegate the selections for the investment menu.
Unsure of your 404(c) status?
I recommend that you get an audit by a retirement plan consultant that is an ERISA 3(21) investment fiduciary. You can also seek out ERISA counsel. Either way be sure not to sign on to an optional safe harbor that you don’t qualify for.
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