ERISA §404(c): The Requirement for a Broad Range of Investment Alternatives
Section 404(c) of ERISA permits retirement plans to transfer the responsibility -— and the liability -— for selecting among the investment options in a 401(k) plan (or other participant-directed defined contribution plan) to participants if—
- the participant actually directs the investment of his or her account, and
- the plan satisfies the requirements of the 404(c) regulations.
This column discusses one of those 404(c) requirements -— that the plan offer a “broad range” of investment alternatives. Most people think of 404(c) as requiring at least three diversified investment alternatives. That is one of the broad range requirements; however, there are two more -— and all three must be satisfied to get 404(c) protection. The investment alternatives must also be sufficient to permit a participant to: - materially affect the potential return on his or her account and the degree of risk; and
- diversify the investments to minimize the risk of large losses.
These are the legal requirements, but the determination of the number of investments and the types of asset classes and styles needed to satisfy these rules is the province of investment experts and not of lawyers. In a recent conversation, an investment consultant suggested that, to satisfy these standards of reward, risk and diversification, a plan would need to offer a minimum of six choices: a U.S. large capitalization (cap) equity growth fund; a U.S. large cap equity value fund; a U.S. small cap equity fund; an international equity fund; a bond fund; and a cash equivalency or stable value fund. While the investment fiduciaries of a participant-directed plan are not required to comply with 404(c) -— since it is optional to obtain its protections -— courts will probably apply the broad range requirement as a general fiduciary requirement for all participant-directed plans. We are not aware of any existing regulatory guidance or court decisions on that point, but it seems reasonable to assume that the courts will ultimately hold that the plan's investment fiduciaries must provide investment alternatives that would meet the “broad range” definition.
To comply with the broad range requirement, the plan fiduciaries must first decide on the asset classes (e.g., stocks, bonds and cash equivalencies) and styles (e.g., large cap U.S. equity growth fund, small cap U.S. equity value) for the “core” investments that constitute the broad range. The second step is to select the specific diversified investment vehicle to fill each of the asset class and style categories.
On an ongoing basis, the plan's investment fiduciaries must monitor the investment vehicles to insure that each continues to meet the criteria for the asset class and style and is performing well enough to continue to be offered to the participants. In addition, the investment options should be monitored for issues such as expenses and management turnover. If one or more of the investment vehicles fails to meet the plan's criteria or ERISA’s requirements, the investment fiduciaries must remove and replace them. Failure to remove a fund is a fiduciary breach under ERISA and can make the plan committee members or the responsible officers personally liable for any losses that result. While 404(c) can protect fiduciaries -— if the fund options are properly selected and monitored -— that protection is lost for any investment option that should have been removed if the plan fiduciaries had done their jobs.
This article was republished, with permission, from 401(k) Advisor, May 2000, Copyright 2000, Aspen Publishers, Inc. All Rights Reserved. For more information on this or any other Aspen publication, please call 800-638-8437 or visit www.aspenpublishers.com.
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