Failing to follow participant direction of investment choices

[Belgarath]

A somewhat simplistic example - Plan has a default investment - investment (A). Participant chooses to invest funds in (B) and (C). There is a failure on the part of the Employer/Plan Administrator to implement these investment choices, so for some period of time, Employer continues to deposit the Participant's funds into (A).

What is the proper remedy here, IF the default investment underperforms the investment returns under (B) and (C)? I can't find that this falls under one of the fiduciary breach correction options under VFC. It does appear that the Participant can perhaps seek relief under IRC 502, as per the LaRue case, but I'm no lawyer, and the implications of various court cases can best be interpreted by those who are! 

Can the fiduciary simply compare the returns, and if the Participant "lost" higher investment returns, just deposit the lost gain? If they don't, then does the Participant then have to go through the steps for an ERISA claim and first exhaust the administrative remedies available, then bring suit? (And an ERISA suit for very small returns would cost far more than the potential gain...)

I'm sure this can't be all that uncommon, yet I find very little discussion of specific remedies or options.

Maybe just a "regular" PT - correct and pay the penalty?

Thanks for any thoughts.

 

[Peter Gulia]

If, for an ERISA-governed retirement plan that provides participant-directed investment, the plan’s administrator did not follow the participant’s proper investment direction, a conscientious administrator should restore the participant’s account so it is credited with amount that would have resulted had the administrator promptly and correctly followed the investment direction. The administrator would credit the adjusted amounts to the participant’s selected investment alternatives in the proportions that would have resulted had the administrator promptly and correctly followed the investment direction. Ideally, the restoration should result in an account that, as nearly as possible, is what would result had no error happened.

If the failure to implement the investment direction was the employer/administrator’s breach of its fiduciary responsibility, the administrator should pay the amount needed for the restoration.

If the failure to implement the investment direction was the recordkeeper’s breach of its contract, the administrator should cause the recordkeeper to pay the amount needed for the restoration, to the extent the contract provides.

If a participant sues to get the restoration, a court may award attorneys’ fees and costs. ERISA § 502(g), 29 U.S.C. § 1132(g) http://uscode.house.gov/view.xhtml?req=(title:29%20section:1132%20edition:prelim)%20OR%20(granuleid:USC-prelim-title29-section1132)&f=treesort&edition=prelim&num=0&jumpTo=true.

But one hopes the person that erred will simply own its error and make the account right.

[Peter Gulia]

If the mistaken and selected investment alternatives all have daily prices, some recordkeepers will (at a customer’s request, and sometimes with an incremental fee) use system records and system or integrated software to generate the what-would-have-happened. Some of those generate an invoice for the restoration amount needed, and some also generate an instruction for the plan’s administrator to sign.

[Belgarath]

Thanks Peter. Assume this was a mistake by the employer/Plan Administrator. Aside from correcting, is this a Prohibited Transaction for a fiduciary breach, and the appropriate penalty tax should then be paid?

[Peter Gulia]

Under ERISA § 406 and Internal Revenue Code § 4975, what characterizes a prohibited transaction is that a person other than the plan has some use of money, rights, or other property that belongs to the plan’s trust.

Your example suggests that the employer promptly segregated contribution amounts from the employer’s assets and promptly remitted those amounts to the plan’s trustee or its agent. That the plan’s administrator did not direct the trustee to invest according to the participant’s direction did not cause the employer (or another fiduciary or party-in-interest) to have any personal use of the plan’s assets. If so, a mistake within how the plan’s trust invests might not result in a prohibited transaction.

If there is no prohibited transaction, neither an IRC § 4975 excise tax nor an ERISA § 502(i) civil penalty is owing.

[Belgarath]

Thank you for the information!!

[Paul I]

I agree that there is very little guidance/rules on what to do when investment directions are not followed, and whether a correction is made or determining the amount of the correction seems to be driven either by the plan administrator finding the error and calculating lost earnings or by the participant informally or formally requesting to be made whole.  This situation is fairly common but does appear anywhere as a prohibited transaction.

I find 1.415(c)-1(b)(2)(ii)(C) regarding restorative payments and what is or is not counted for purposes of applying the 415 limit illuminating even though this section, too, does not address a correction method:

Restorative payments. A restorative payment that is allocated to a participant's account does not give rise to an annual addition for any limitation year. For this purpose, restorative payments are payments made to restore losses to a plan resulting from actions by a fiduciary for which there is reasonable risk of liability for breach of a fiduciary duty under title I of the Employee Retirement Income Security Act of 1974 (88 Stat. 829), Public Law 93-406 (ERISA) or under other applicable federal or state law, where plan participants who are similarly situated are treated similarly with respect to the payments. Generally, payments to a defined contribution plan are restorative payments only if the payments are made in order to restore some or all of the plan's losses due to an action (or a failure to act) that creates a reasonable risk of liability for such a breach of fiduciary duty (other than a breach of fiduciary duty arising from failure to remit contributions to the plan). This includes payments to a plan made pursuant to a Department of Labor order, the Department of Labor's Voluntary Fiduciary Correction Program, or a court-approved settlement, to restore losses to a qualified defined contribution plan on account of the breach of fiduciary duty (other than a breach of fiduciary duty arising from failure to remit contributions to the plan). Payments made to a plan to make up for losses due merely to market fluctuations and other payments that are not made on account of a reasonable risk of liability for breach of a fiduciary duty under title I of ERISA are not restorative payments and generally constitute contributions that give rise to annual additions under paragraph (b)(4) of this section.

The focus of text in yellow includes recognizing a payment made to the plan to because of losses due to a fiduciary's failure to act and that failure creates a reasonable risk of liability.  Put another way, if you think you're going to get sued, fix it and its not an annual addition.

It is interesting that the text in green is added to cover a situation where the participant lost money due to market fluctuations and the fiduciary (out of the kindness of their heart I suppose) decides to put in a little something to make up for the loss.  The participant making an investment decision that did not work our does not have a reasonable risk of liability, so any such restoration of the loss to the participant is an annual addition.

We never know where we may find a little bit of guidance.

[Peter Gulia]

Thank you for remarking on the § 415 rule on when restoration is not an annual addition.

26 C.F.R. § 1.415(c)-1(b)(2)(ii)(C) https://www.ecfr.gov/current/title-26/part-1/section-1.415(c)-1#p-1.415(c)-1(b)(2)(ii)(C).

I lobbied for the predecessor—Revenue Ruling 2002–45—and the later rule. In the rulemaking, the Treasury department adopted my suggestion that the rule should cover not only ERISA fiduciary responsibility but also fiduciary responsibility under whatever Federal or State law governs the plan.

Limitations on Benefits and Contributions Under Qualified Plans [final rule], 72 Federal Register 16878, 16887 (Apr. 5, 2007) https://www.govinfo.gov/content/pkg/FR-2007-04-05/pdf/E7-5750.pdf.

The rule and the Treasury department’s rulemaking explanation of it make clear that the examples about ways a liability might be shown are nonexhaustive and nonrestrictive.

In my whole-text and contextual interpretation, a “reasonable risk of liability” does not require a finding that a person harmed by a fiduciary’s breach would or might assert her claim for legal or equitable relief. Rather, it is enough to find that the liability, even on an unasserted claim, exists.

Under ERISA § 409(a), a fiduciary that breached its responsibility is “personally liable to make good to such plan any losses to the plan resulting from each such breach[.]”

An upright or decent fiduciary corrects accounts without waiting to be asked.

[FormsRstillmylife]

Thank you, Paul I and Peter.  I was just looking for this guidance when asked about a market value adjustment assessment.  I knew I remembered it.  Business acquisitions can lead to unanticipated contract terminations when the acquiror's plan does not want the Stable Value Fund. If there is not a clear enough fiduciary violation, the parties may have to consider a new comparability profit sharing allocation = participant by participant contribution for those hit by the MVA subject to average benefit testing.