The Fiduciary Responsibility To Be Responsible
As I have pointed out in previous columns, 401(k) investment fiduciaries are legally responsible for the prudence of participant investment decisions, as well as for the suitability of the options. However, the legal responsibility for participant investment decisions can be shifted to the participants if a plan complies with the 20 to 25 404(c) conditions; and if participants actually direct their investments.
However, based on my experience, few plans comply with all of the 404(c) requirements. ERISA requires that the 401(k) investment options be "prudent and suitable." Would an investment be prudent and suitable if participants do not know how to use that investment in the appropriate way to assemble well-balanced portfolios? There is a growing body of evidence that many, if not most, participants lack the basic knowledge needed to use 401(k) investments properly. That raises the obvious question of whether an investment that is likely to be used improperly is a "suitable and prudent" choice.
Also, the meaning of "independent control" is not entirely clear. For example, if fiduciaries do not advise participants that, if the participants lack the ability to manage their own investments prudently, the fiduciaries will invest for them, have participants truly exercised independent control? It is clear that, under ERISA, participants cannot be forced to manage their own investments. It is equally clear that, if participants do not direct their investments, the fiduciaries must manage those investments prudently. What is not clear is whether fiduciaries must advise participants that they will manage the accounts of participants who do not want to direct their investments. The rules for summary plan descriptions require that participants be told of their rights under the plan. Is fiduciary investment management a participant "right"? That question is not answered clearly by the law. However, it is at least arguable that it is an ERISA right and that, therefore, participants must be informed of that fact in the summary plan description (SPD).
What should prudent and conservative fiduciaries do? First, fiduciaries should make reasonable efforts to comply with 404(c) that provides an important measure of protection that, in most cases, can be obtained at a relatively low cost in time and effort.
Second, fiduciaries should consider structuring their plan's investments to increase the likelihood of participants being well-invested, For example, fiduciaries should consider including lifestyle funds or asset allocation vehicles, and should insist that the plan provider highlight those vehicles as investment solutions rather than as investment choices. In addition, the investment fiduciaries should regularly (that is, at least annually) review the accounts of their 401(k) participants and the prudency of the investments.
For fiduciaries willing to think innovatively, there are solutions that may be even more effective. One example would be to provide an investment lineup that consists only ot professionally designed investment portfolios. Participants could be given questionnaires and other materials to assist them in selecting the portfolio that is appropriate for each participant's risk-and-reward profile. Plans that wanted to offer a wide range of investments could add a "window" to permit participants to use individual mutual funds.
An even more proactive employer could automatically place new participants in managed accounts based on information available to the plan (such as age, account balance, deferral rate, etc.). Participants would have the option of staying in the managed account, directing the investment of their account, or completing a questionnaire and providing additional information in order to have an account that is even more customized.
The ultimate objective of ER1SA is to provide retirement benefits. From an investment perspective, the key is for participants' accounts to be well-invested. Perhaps the best way to get there is for fiduciaries to accept a greater responsibility for the investment outcome and to structure the 40 1(k) investment lineup properly. Fiduciaries may already have that legal responsibility, so the conservative course is to accept the actual responsibility.
© 2005
Article was reprinted, with permission, from Plan Sponsor magazine (July 2005). Copyright 2005 Asset International, Inc. All rights reserved.
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