404(c) & Defaults

[Guest tschenk]

Is there an inherent contradiction when a plan defaults a newly enrolled participant (who made no investment elections) into one of the plan's fund choices - yet claims to be a 404© compliant plan?

[Kirk Maldonado]

What action do you think would be consistent with Section 404© in those circumstances? Absent a default election, it would seem like the only other choice is for the amounts to be uninvested.

[R. Butler]

I agree with Kirk, what other choice do you have? The enrollment form however, should clearly state that a failure to provide investment selections will be treated as an affirmative election for the default fund. Without such a statement it is more likely that the default investment won't have 404© protection.

[mbozek]

Obviously contributions must be invested because failure to invest would be a breach of fid. duty. Therefore assets must be placed in a risk free investment such as a stable value or Govt T bill fund. It seems that the only risk the plan has is that it is not a 404© fund for participant but then the participant voluntarily chose not to invest funds. If u are not happy with that result then only other option would be to return participant contribtution within a fixed period if no investment election is made.

[Guest tschenk]

mbozek - I see a Catch 22 in your reply. Since the sponsor is indeed a fiduciary - and should act in a prudent manner - how can it be deemed prudent to place retirement savings (of say a 30 year-old) in a risk free investment? It was made with the best intentions, but I believe there's some case law from the 1980's that a sponsor put pension assets in T-Bills because he was afraid of the market and was found liable for the opportunity costs of not investing as others (peers) with like facts & circumstances.

And should the sponsor not be aware of the overwhelming industry data that says that participants usually stay in the default election (figuring that the company wouldn't have put them there if it wasn't a good idea!?!).

Going back to the original post, however, could it not be argued that the participant or beneficiary would not be considered to have "exercised control" when they were merely appraised of investments made on their behalf in the absence of instructions to the contrary? Does simple disclosure pre-empt exercising control?

[R. Butler]

tschenk,

Your last post indicates the very reason for clearly stating on the enrollment form that failure to make investment selections is deemed an affirmative election for the default fund. It would be difficult for a participant to claim he didn't exercise control if such a statement is clearly set forth.

[mbozek]

t:I think the case you are referring to involved a terminated employee who did not have an opportunity to select an investment. Here the facts are different since the employee can switch to an better investment by making an election that is required under the terms of the plan. If you think your position through logically the plan fiduciary is always liable-- for not investing the funds, for picking an investment that declines in value or for picking a risk free investment. The only way to avoid liability is to pick a fund that does not go down and beats a risk free rate--This what investment advisers do, not fiduciaries. Under 404© regs an individual can hire an investment advisor who becomes the fiduciary. I do not think a court would hold a fiduciary liable for lost earnings in a 404© account based upon the failure of a participant to make an investment election which is required under the terms of the plan.

[Guest tschenk]

m - Though I don't remember the name of the case, I do remember it was a DB plan, not a participant directed one. I remember reading about it in an article which was making 2 points: That a fiduciary could be held personally liable (I think he had to end up writing a check for a half-mil out of his own pocket and the other point was that he wasn't investing as a prudent man w/like facts and circumstances as others in his position. The article also stressed that the courts don't hold one liable for results of an investment per se if it was what your peers (prudent man) were doing - but they do hold you liable if you did something a peer in your position wouldn't do - in other words, no pension manager investing for the long term would put the whole ball of wax in t-bills - even if the results turned out positive, I think he could get sued for a breech of fid. duty. It was also a wake up call that the investment policy had better be in tip-top shape, too. The "process" is way more important than the "results" of the investment.

Could any atty's reading this possibly shed some light on this point?

R.B. - your reply is logical, but here again, I don't know if the courts have stated about disclosing that no affirmative election is an "exercise of control" (the necessary element for 404c). I just don't know.

[mbozek]

T:There is something wrong with your facts and your logic. In a DB plan the participant is entitled to the present value of the accrued benefit upon distribution... A fid does not invest funds for a participant in a DB plan. What u may be thinking of was a practice by certain DB plan administrators in cash balance plans who would transfer employee account balances to a mm fund if the employee quit and did not take a distribution. The IRS said it violated the 401(a)(11) requirement that an employee with a benefit in excess of $5000 could not be forced to withdraw the funds because of adverse employer action. I do not think there is any basis for comparing the DB case with a 404© plan where the participant has the right to direct an investment but refuses to act. Since the participant knows how the funds will be invested if no choice is made the participant could be said to have chosen the default fund by not making another election.

[Guest tschenk]

M- good point on the DB, it couldn't have been that.

But I still don't think it was a participant directed. I'm pretty sure however that the sponsor was in charge of directing the investments. Profit Sharing maybe??

[IRC401]

Unless someone can point to something in print to the contrary, I don't think that 404© protection extends to any amounts not invested by an affirmative election by a participant.

Therefore, in order to keep a plan in compliance with 404© a plan amdinistrator should not accept 401(k) contributions made on behalf of any participant who doesn't complete an investment election.

[mbozek]

in electronic and voice mail enrollments employee must make investment election in order to complete application.

[pjkoehler]

The 404c regs specifically limit fiduciary liability protection to transactions "where a participant or beneficiary has exercised control in fact with respect to the investment of assets in his individual account...." Sec. 2550.404c-1©. I'm not aware of any guidance that interprets this "in fact" language. It would be difficult to square with a transaction based upon a purely default election, i.e. where the participant's contribution is not tied to a continuing affirmative investment direction. Continuing investment directives based on the most recent affirmative election are probably ok, unless and until the range of investment options changes.

[Guest tschenk]

I just found this in IRS Revenue Ruling 2000-8.

/1/ The Department of Labor has advised Treasury and the Service that, under Title I of the Employee Retirement Income Security Act of 1974 (ERISA), fiduciaries of a plan must ensure that the plan is administered prudently and solely in the interest of plan participants and beneficiaries. While ERISA section 404© may serve to relieve certain fiduciaries from liability when participants or beneficiaries exercise control over the assets in their individual accounts, the Department of Labor has taken the position that a participant or beneficiary will not be considered to have exercised control when the participant or beneficiary is merely apprised of investments that will be made on his or her behalf in the absence of instructions to the contrary. See 29 CFR section 2550.404c-1 and 57 F.R. 46924.

So is it accurate to say that plans using a default investment have just had their (perceived) 404© protection go our the window?

[MWeddell]

Let me try to summarize because this issue just doesn't seem that hard to me.

If a default investment is used for participants who fail to make their own investment choices, then ERISA 404© is not available for that transaction.

The best course of action is to re-examine the enrollment process to eliminate or minimize the possibility of contributions being made for someone who has not made an investment election.

Second choice is to choose the default fund and let the participant clearly know what the fund is and the procedure for the participant to change the election. I lean strongly toward picking something in the middle of the risk / return spectrum, i.e. a balanced or asset allocation or lifestyle fund, although it's common for employers to pick the low-risk low-return option like a money market. While there's no 404© defense, most believe that this process complies with 404(a)'s fiduciary duties.

[MGB]

Pardon my ignorance, but can you retain 404© protection for a subset of participants when you have lost it on others?

If so, then the plan still has 404© protection with respect to those affirmatively electing investments, and the only problem is with respect to the auto enrollees. Right?

Then, the only worry is to prudently invest the auto enrollees' money. I agree that money market, no risk investments do not fill this bill and that a well-diversified fund seems to be more prudent for the fiduciaries.

[pjkoehler]

tschenk: I think the IRS notice is helpful but not necessarily dispositive. Firstly, its an IRS interpretation of a Labor Department regulation and, therefore, not formal guidance from the DOL. Second, the cited reg doesn't expressly say that. I think this is the IRS' interpretation of the "in fact" language that I cited earlier. It makes sense and I think this is probably the right interpretation, but I doubt that a court would treat the IRS notice as dispositive in a proceeding where 404c protection is at issue, whereas an official DOL release to this effect may have been.

Also, even if this is the DOL's formal interpretation, some of the earlier plan design suggestions in which the employee makes an affirmative election of a "default" option may still survive. A court could well distinguish a "default" option imposed by the plan (which clearly doesn't square with the IRS interpretation) from a"default" option affirmatively elected by a participant when he enrolls in the plan. It may be argued that such a default election is a form of continuing investment directive.

[mbozek]

It seems totally unnecessary to discuss what is the authoritative value of an IRS intepretation of a Dol regulation when the failsafe way to avoid the issue is to refuse to accept salary reduction money without an affirmative election by the participant to select an investment. That means that plan document should explicitly require that the participant select an investment when commencing salary reduction. This is required in electronic and voicemmail systems.

[MWeddell]

MGB, correct, one can have 404© protection regarding some but not all transaactions for a plan.

Pjkoehler, look at the section titled "Absence of Affirmative Instruction" in the prefatory discussion with the DOL finalized the 404© regulations. I've got an old hard copy from the 10/13/1992 Federal Register, so I don't know where this is on the Web. It's clearly a DOL interpretation that 404© protection doesn't apply to a default fund when a participant has not made an affirmative investment election.

[pjkoehler]

mjb: What about a plan that adopts your "failsafe" approach and duly collects default option elections from all new participants. Then one day the employer amends the plan and expands the range of investment fund options from which participants may choose a default option. Does that change impact the effectiveness of the prior election as an affirmative exercise of independent control under the 404c regs so that the employer has to collect new elections to maintain 404c protection for the fiduciaries? Ooops - so much for "failsafe." Here's another question: suppose the fund manager makes material changes in the investment objectives, portfolio asset allocation and/or style it employs in managing a default investment fund option. Does that change the effectiveness of the prior election as an exercise of independent control unless the employer provides the opportunity to change the election before the change goes into effect?

It may be on planet-mbozek that "failsafe" plan designs can be formulated without regard to official guidance regarding an ambiguous regulatory issue, but down here, the regulatory authorities tell us that consideration of their views rises to the level of "necessary."

[pjkoehler]

MWedell: Your referring to the "Preambles to the Final Regulations." 57 FR 46906 (October 13, 1992) and Para. 24,150A in the CCH Pension and Employee Benefits (1/1/02). In the Comments under Section IV you'll find the discussion entitled "Absense of Affirmative Election." There you'll find the following:

"Once a participant or beneficiary in a section 404© plan exercises independent control by giving investment instruction with respect to assets or future contributions, section 404© relief will continue to be available with respect to that instruction as long as the participant or beneficiary continues to have the opportunity to exercise control over such assets and contributions. Consistent with this principle, it should be recognized that, until an affirmative instruction is given, there can be no relief under ERISA section 404©."

My point is that a continuing default election is distinguishable from a plan mandated default election and is entirely consistent with this guidance.

[Guest bill mahoney]

The case you are talking about was for a company in San Fransico. The plan was a profit sharing plan and the owner who was also making the investment decsions invested all the money in treasuries. The employees sued under the prudent investor theory that the risk they were facing was loss of purchasing power and therefor the money should have been invested in the stock market. The court agreed and made the company make up the difference between what the T Bills earned, if I remember rightly roughly 7.5%, and what the S&P 500 made which was roughly 17% for the period in question. At the time the company did not have the assets to pay the judgement, therefore the owner had to make good out of his own personal assets.

[mbozek]

bill: was this a self directed account or was it a generic ps plan where the owner was the fiduciary for plan investments? If the latter then the case is consistent with other cases that have held that investing all plan assets in CDs is imprudent. However, the PWBA does not consider investing all assets in risk free assets to be an imprudent investment. A few years ago a PWBA official told me that the PWBA would not investigate a plan that invested all assets in CDS because there was no risk of loss to plan assets.

[Guest bill mahoney]

My understanding of the case was it was a stndard ps plan where the trustee ( the owner) was making all the investment decisions.