Restrict "Shuns"

By Fred Reish

Last month's article focused on the need to consider qualitative issues (such as the fund management's support of the objectives of long-term shareholders) in the prudent selection and monitoring of the investment options in their participant-directed plans, as well as trading restrictions that are, or may be, imposed on participants. However, fiduciaries should evaluate closely other participant account restrictions. For example, if a participant makes regular deferrals from his bimonthly paycheck, which are invested in the designated mutual funds, and then sells investment for a loan, a hardship withdrawal, or a distribution, is it reasonable or appropriate for the participant to be charged with a redemption fee on any deferrals invested in the last 30 or 60 days? In my experience, most fiduciaries would find that charge to be unreasonable, since it is unrelated to market timing or other conduct that could harm the remaining plan participants.

However, it appears that some providers may be contemplating imposing redemption fees on that basis. As a result, fiduciaries will need to examine carefully the operational impact of the proposed restrictions, and if they determine that the effect is inappropriate, then the fiduciaries may need to change investment providers and/or service providers (such as recordkeepers).

There is a duty to communicate properly with employees concerning the imposition of any trading restrictions. Remarkably, there are already two reported cases that involve that issue.

The plan document should allow for the imposition of such restrictions or, alternatively, should grant broad powers to the ERISA Plan Administrator (typically, the plan committee) to establish procedures for participant-directed investments. For example, it could be a breach of their duties for the plan fiduciaries to permit the recordkeeper to impose restrictions if the plan document specifically provides that the participants are permitted to manage their accounts on a daily basis. However, it is arguable that, where a plan is experiencing market timing, the fiduciaries have a duty to override the terms of the document in order to impose reasonable restrictions. However, there is no reason for fiduciaries to take any risk, when a review of the document (and a possible amendment) could eliminate any conflicts.

The participants should be notified of the nature and timing of the change. The notice should be given to the participants prior to the implementation of the new restrictions. The notice should be drafted with great care; alleged inadequacies in the notice pose the greatest risk for participant claims and possible litigation. In fact, there already has been one lawsuit against a plan sponsor based largely on the information in the notice.

The summary plan description (SPD) should be updated. Generally speaking, that would involve incorporating the terms of the notice into the SPD. While there are outer time limits for updating SPDs, it makes little sense to be distributing SPDs without dated information on investment trading privileges. As a result, I recommend that the SPD be updated as soon as possible (rather than continuing to use the old SPD with the notice attached).

The imposition of trading restrictions is, by and large, a fiduciary decision concerning the management of a participant-directed plan. As a practical matter, most of the proposed trading restrictions seem reasonable. However, fiduciaries still must do their job. The highest risks lie in:

Doing nothing. Fiduciaries need to review the restrictions and determine whether they are suitable and appropriate for their plan and participants.

Failure to notify participants or providing an inadequate notice. In order to draft notice, the committee members need to understand the restrictions and how they apply to participant transactions.

Plan fiduciaries will need to understand and evaluate the restrictions, to compare the restrictions of their current investments and providers with those in the market, and to make a decision in the best interest of their plan and participants. All of this will be subject to ERISA's requirement that fiduciaries act for the exclusive purpose of providing retirement benefits to participants and in a manner consistent with the prudent man rule.

© 2004 Article was reprinted, with permission, from Plan Sponsor magazine (November 2004). Copyright 2004 Asset International, Inc. All rights reserved.

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