404(c)

[k man]

Lets say a fiduciary selects proprietary mutual funds that are essentially made up of numerous managed accounts with each fund having multiple money management firms running the assets. (these funds are managed by a well known consulting firm). the funds are still mutual funds by definition but the managers are hired and fired based on their performance.

Does this type of monitoring (even though not being done directly by the fiduciaries, meet the monitoring requirements of 404©? I believe it does not since what goes on behind the scences in invisible to the participants. they are still stuck with the same investment option and it should be replaced if it is underperforming.

Any views either agreeing or to the contrary would be appreciated.

[rcline46]

I would think not for a different reason. Prop fund zebra is listed as a value fund, so I choose it. The manager is replaced a year later due to poor performance. The new manager now changes prop fund zebra to a blended style. Am I notified so that I may change to a different value fund? If not, several 404© items have been violated.

Therefore, I do not think the posited situation satisfies 404©.

I also do not think offering only proprietary funds will satisfy 404© as a starter.

[Jon Chambers]

Assuming that the well-known consulting firm is not acting as a QPAM, then clearly the sponsor still has monitoring responsibilities. In the unlikely event that the consulting firm is acting as a QPAM, and meets the other ERISA requirements for a designated IM, then possibly the sponsor would be responsible solely for monitoring the consulting firm's activities (I know of at least one ERISA atty that takes this position).

I'm not sure why proprietary funds can't get 404© protection--I'd love to here more supporting that assertion.

[k man]

john, i also disagree with the point that a sponsor using "proprietary funds" can't get 404© protection.

[rcline46]

Ok, I will hit the highligts:

1. A fiduciary shall discharge his duties.. with the care, skill, prudence, and diligence..that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

Would a prudent investment person pick the proprietary funds?

2. "and investment will not be prudent if it would be expected to provide a plan with a lower rate of return than available alternative investments with commensurate degrees of risk, or is riskier than alternative available investments with commersurate rates of return". Most prop funds perform worse than equivalent open funds.

3. Check preambles to the 1987 proposed 404c regs and 1992 final regs.

4. consider - is the exclusive use of prop funds 'in the best interest of the plan participants and beneficiaries' or in the best interest of the purveyor of the funds?

5. Get the outline "401(k) Fiduciary Responsibilities" by C. Frederick Reish presented at th 2000 ASPA conference.

Proprietary funds may be perfectly acceptable when compared to other funds. However, I would be very suspect.

[Jon Chambers]

rcline46, while I don't disagree with your cites, I believe that they go to general prudence of fund selection, which is a 404(a) issue, not a 404© issue. And whether or not the proprietary funds are prudent goes to the facts and circumstances of the selection of the individual fund company and funds. Consider a plan using all Vanguard proprietary funds, and selecting index funds. You could have Vanguard's S&P 500 Index, small cap index, international index, and a very low cost money market. Based on the cost, diversification and market replication of the funds, it would be almost impossible to argue that they were imprudent selections, yet they would all be proprietary Vanguard funds. On the other hand, it would be almost impossible to come up with a prudent line-up of First Hand funds (First Hand is a fund company offering only technology and Internet sector funds).

I'm reasonably familiar with Fred's handout, and personally I know him reasonably well. I don't believe he takes the position that an all proprietary line-up is necessarily wrong. He just says that the line-up must be selected and monitored in a prudent manner.

[rcline46]

If you are talking about Vanguard's 401k plan investing in Vanguard's funds only as proprietary funds, I still think prudent procedures are required. If you are talking about Merrill Lynch's 401k plan investing in the Merrill Lynch funds, which are not publicly offered, it is really serious. In the first case, anyone can choose the Vanguard suite (and they do). In the second case only M/L clients can choose the funds (which is what I would call proprietary funds) and outsiders cannot invest in them. Also, independent performance comparisons are very difficult.

[Jon Chambers]

rcline 46, as you probably know, there is a prohibited transaction class exemption that permits fund companies to offer their own funds through their own plan. However, the PTE doesn't get the company past the general 404(a) requirement. We did some consulting work on the First Union case; FU kept citing the PTE, but ended up settling (in part, and in my opinion) because it wasn't clear that their fund selection protocol satisfied the 404(a) requirement. New York Life is currently making similar points in their current case.

My read of the term "proprietary" is that they are managed by the consulting firm, but the plan in question is not the consulting firm's plan. k man, is that read correct? In this case, there are probably no direct prohibited transactions to be concerned with, unless the consulting firm is acting in some other fiduciary capacity (e.g. trustee or investment advisor) and is recommending the use of their own investment funds. Thus, the issue gets back to k man's original question, which is whether the sponsor is responsible for monitoring the funds, even though the consulting firm is monitoring the investment managers (presumably subadvisors) that are managing fund assets. And the answer is almost certainly yes, unless there is some unusual additional relationship, with the consulting firm acting as a QPAM. Of course, if the consulting firm is a QPAM receiving fees, then they are an investment fiduciary, and their use of the related funds would probably be a prohibited transaction, absent any other exemption.

[k man]

John you are correct. I guess I am using proprietary in a different sense. I was using the term from the standpoint of that they are only available from certain vendors and that they use their own "proprietary" process in adding and subtracting sub managers.