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404(c) Compliance: The Hidden Protection You Need

Updated: Nov 17, 2021

Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA) is an election that provides plan fiduciaries liability protection against participant investment losses incurred because of a participant investment selection. You may have elected it, but are you satisfying the requirements?

Offering a qualified retirement plan to your employees is an essential way to attract and retain the area's best talent to your business. Unfortunately, offering these plans comes with added responsibility and liability for the executive bodies that manage these programs on behalf of the business. Under ERISA, fiduciaries of retirement plans are responsible for all investment decisions, including those made by the participants in participant-directed plans, unless the plan is an “ERISA Section 404(c)" plan. What that means is there is an inherent responsibility to the plan sponsor and designated fiduciaries to ensure that the investment options inside your plan are suitable, of reasonable expense, and continuously monitored for quality for the benefit of the participants inside the plan. This liability can exist in two forms, the decision and process to offer or continue to offer a specific investment and the risk of (poor) investment outcomes driven by participant investment decisions. While the bulk of the marketing and press has focused on outsourcing the monitoring and selection process of investment menus to third-party financial professionals, such as Registered Investment Advisors, brokers, or insurance companies, the liability associated with individual investment decisions and performance has received very little mention.

For example, let’s say Participant Sarah Jones has limited investment education and background and invests all of her assets in ABC Corporation’s Gold Miners fund. The fund loses nearly half of its value in one year. Sarah cannot make a claim for fiduciary breach related to her choice of the Gold Mining fund unless she can successfully claim that the plan did not properly follow 404(c). However, the participant could claim a fiduciary breach of Plan ABC for offering this Gold Miners fund on its investment menu in the first place, if the selection/monitoring of the fund was imprudent. Thus, the two areas of responsibility must be satisfied.

So, now that we have a clear understanding of the exposed liability, you may be wondering how to go about shielding yourself from those risks. First, the liability associated with investment selection and monitoring cannot be removed entirely but is often outsourced to financial professionals acting in a fiduciary capacity such as an investment advisor. These relationships exist in two predominant engagements; a 3(21) or Co-Fiduciary or a 3(38) Investment Management role. After deciding which engagement is most appropriate for you and your plan, you must document and monitor your third-party fiduciary to ensure that he or she is adequately performing prudent investment due diligence processes and that their fees are in line with the services. As for the liability associated with participant investment outcomes you can declare that you are intending to be 404(c) compliant by implementing the following procedures to satisfy that declaration.

  • Plan participants must be notified that the Plan Sponsor intends to constitute a 404(c) Plan.

  • Plan participants will be provided at least three investment options that have a different risk/return profile.

  • Plan participants will have the opportunity to give investment directions.

  • Plan participants will have the right to diversify their investments.

  • Plan participants will be provided with basic information and/or education on the different investment options.

  • Plan participants will be permitted to change their investment strategy/allocation with a frequency that is appropriate in light of market volatility, but not less often than once within any three-month period.

  • The Plan administrator will comply with the participant disclosure requirements of 29 CFR §2550.404a-5.

While the requirements for upholding the rights provided to the participants, offering the appropriate number and kind of investments, and supplying the required notices are fairly easy to manage for most plans, the challenge lies in the determination of sufficiency when it comes to education, information sharing, and access to resources and disclosures. Plan sponsors are encouraged to put forth their best efforts to satisfy reasonable participant requests and lean toward providing substantial information. In addition to best efforts, upholding prudent investment procedures, including the implementation of a thorough investment policy statement that clearly defines goals and objectives for the plan, roles and responsibilities of service providers, and asset classes to be evaluated alongside their corresponding benchmarks, are crucial.

Although the legislation and compliance regulations have been in place for decades, recent heightened scrutiny and legal challenges across the U.S. have forced plan sponsors and fiduciaries to further evaluate their decision-making processes and implement safeguards to shield themselves from unwanted liability. The Siekmann Company has experience managing qualified retirement plans. Contact us today for support and consultation to ensure that you are adequately satisfying your responsibilities to the plan and its participants.

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