Is it okay for a plan’s investment menu to include a non-diversified alternative?

A § 401(k) retirement plan provides participant-directed investment (with daily instructions).

The plan’s menu is filled with a broad range of diversified SEC-registered mutual funds.  (Assume these are prudently selected, prudently disclosed, and meet all ERISA § 404(c) conditions.)

Beyond those diversified investment alternatives, the menu for participant-directed investment includes an account that invests in the publicly-traded stock of an operating business.  The account is 1% “cash” (to facilitate transactions) and 99% the stock.  The stock is NOT employer securities.

Assume the plan’s administrator furnishes to participants every securities-law report and other disclosure the stock’s issuer has filed.  (The administrator sends these to participants’ work e-mail addresses and the plan’s website a few minutes after the document is filed with the SEC or the stock exchange.)

Is it enough that a participant can decide for himself or herself to invest in (or avoid) this stock?

Or must a fiduciary evaluate whether this stock account should remain an investment alternative?

If there is such a duty, under what facts and circumstances would a fiduciary find that a participant no longer should have the choice?

I think that the plan fiduciaries do have a continuing 'paternalistic' role in deciding which investments should and which should not be included.  John Deere gave 2,600 choices to its employees.  The 7th Circuit, as I recall, indicated that the plan fiduciaries are yet responsible for making sure that the choices presented to the employees on the "menu" from which they select are appropriate for retirement savings investments by employees.  I do think the fiduciaries have a role in evaluating an investment as a potential 'menu' item.  If something is too risky, or perhaps so conservative as to yield too little of a return, the plan fiduciaries should avoid it being on the menu.  I'd be concerned about a single company, particularly if its product focus is narrow in one industry or economic sector.

J Simmons, than you for your observations.

So let’s assume a fiduciary must prudently select and monitor any designated investment alternative.

What facts would cause a fiduciary to find that a publicly-traded stock involves a risk a participant no longer can evaluate for himself or herself?

Look at all the stock drop lawsuits. I believe a couple involve a single publicly traded company stock fund that used to be, but then was no longer, an employer security with respect to the plan (because of a spin-off/sale transaction). Not sure if the Deere case was one of those.

Basically, if ABC company wants to offer a Facebook only stock fund, then ABC fiduciaries have an ongoing responsibility to monitor and evaluate Facebook as a prudent investment for the plan.

Your scenario seems almost impossible to believe absent some self-dealing motivation on the part of the fiduciary making the decision to put that investment on the menu, thereby suggesting a possible 406(b) PT for which there is not likely an exemption.  Is there such a motivation?  If not, I assume I am not the only one curious to know what that motivation is.  Is it just a case of that particular fiduciary being "in love" with that stock?  If he falls out of love with that stock will he replace it with his next lover?      

jpod takes the practical approach.   Why do it?

Fred Reisch takes an impossible approach (which is contrary to the faulty basis of 404(c), so I have some sympathy for fighting fire with fire), which is the the fiduciaries have a responsibility to "know your customer" and gear all investment choices to the affected participants.  He has something of a point when it comes to a limitless menu, as has been echoed informally by some DOL officials.

Unless there is something weird about the investment option (as jpod questions, or worse), I think 404(c) throws participants to the dogs as far as investment risk goes, as long as disclosure and transaction execution rules are followed.  Company stock is a different matter because of the weirdness of insider issues.  And reasonable expenses (the only other area where fiduciaries do not get a free pass so far by the courts) are a different matter.  That falls under a different prudence regime.

If the fiduciary loves a particular stock so much, then he can add an open architecture feature to the plan and run around the office singing its praises to all who will listen.  Putting a single stock on the main menu is, to be kind, not wise.   

Leaving aside questions about whether a fiduciary’s decision to allow an investment alternative meets its duties of loyalty, situations of the kind my hypo suggests happen, and often happen in the way CuseFan mentions—a spinoff turns something that was employer securities into no longer employer securities.

Courts’ decisions following the Supremes’ Fifth Third pleading standard have shown that once a duty of diversification is excused, an investment in a publicly-traded security at an efficient-markets price is not inherently imprudent unless there is material information not disclosed to the investor.

Once a menu of investment alternatives has a sufficiently broad range that a participant could meet diversification, ERISA § 404(c) puts the burden on the directing participant.  If how much diversification an individual wants is the individual’s choice, might a fiduciary’s analysis about whether to allow or remove an investment alternative focus on whether a participant gets enough information to evaluate it for himself or herself?

Some years ago we managed the 401(k) for a successful private business. The owner was a big fan of transparency and published his own investment allocation, which was heavy with tech funds. Naturally, employees followed his lead. When the Dot-Com crash hit, the Plan assets went from $15 MM to $3 MM. Not a morale builder. I suggest that having a quirky single stock investment option is the same kind of accident waiting to happen. Unless the Plan has a uniquely sophisticated population, it's inclusion in the menu is a tacit recommendation that is all too likely to be followed.

Not exactly a spin-off but somewhat similar situation where private company retailer of a national brand wanted to include the publicly traded stock of the national brand as separate investment option in the plan.  Ultimately, we convinced them to drop it.  I understood the desire to include and the affinity for the brand and seeming loyalty and esprit d' corps of including but, to quote others above, it just seems like a really bad idea for a variety of reasons.

At the very least, I believe there is a duty to monitor and make fiduciary decisions with respect to whether that stock remains an appropriate stock to have in the plan.  Perhaps there is an argument that may mean never concluding they need to remove the stock--after all there is a ton of information available around the investment option and plenty of alternatives available--but that seems like a very risky and losing argument to me. 

If you assume that are situations where you may conclude you have to remove the stock, I think that just sets the fiduciaries up for potentially having to remove the stock, including potentially at a time when the company is hitting hard times or embroiled in negative issues, etc.  Not exactly as bad as with employer securities I suppose but it puts the fiduciaries in bad position of arguably turning on their loyal brethren and very reason for being at the worst possible time.  It also may raise other questions or concerns--i.e., the most know something either about the public company or the employer or both and where things are headed, etc.  I'm not sure why somebody would subject themselves to those issues when there is little to be gained.  Beyond that, I think it also creates the potential for other employment law type questions or concerns--i.e., do participants feel compelled to invest in the stock because it is offered; are they concerned management will know who invests in and thus "supports" the company?  

We suggested to the sponsor that if they really wanted to permit investment in that stock they could add a brokerage window.  They said they didn't want to do that because it was too risky.  While I get where they were coming from with that, it doesn't really square with offering a single stock. 

401 Chaos, thank you for sharing another perspective.

Do you think the plan sponsor you describe might have felt differently if they could engage an independent trust company to make decisions about whether to continue (or remove) the non-fund security as an investment alternative?

Perhaps.  There were a number of veterans of the big public company so they admittedly had a bias I think.  While the independent fiduciary would help insulate them a bit, I think you still have the concern that the stock / investment option may be an expected investment for participants though (not saying they would have ever looked at that but I worry about the perception) and also the possibility of sending a negative message with its removal. 

I guess my broader thought too probably colors this and I tend to believe if anybody is making an election to invest in individual stocks, they should have the means to do so with amounts other than 401(k) amounts and they could make that investment directly outside the plan.  That may be a jaded or inappropriate perspective in some ways but I have a difficult time getting past it.