Common Questions and Answers Relating to Investment of 401k Plan Assets

ERISA requires that retirement plan documents designate who is responsible for investment of plan assets. In the case of individual account plan like a 401k, a plan may permit participants or beneficiaries to make investment decisions with respect to their individual accounts. It is common for 401k plans to provide participants with investment authority with respect to their own elective contributions.

2. What is a plan fiduciary?

ERISA generally provides that a person is a plan fiduciary to the extent the fiduciary exercises any discretionary authority or control over management of the plan or exercises authority or control over management or disposition of its assets, renders investment advice for a fee or other compensation, or has any discretionary authority or responsibility in the administration of the plan.

The employer and officers or directors of the employer are only fiduciaries of a plan to the extent they meet ERISA's definition of a plan fiduciary. Such persons often are not fiduciaries with respect to a plan because they do not have authority or exercise authority with respect to fiduciary functions.

3. What is the responsibility of a plan fiduciary with respect to investment decisions made by the fiduciary?

ERISA contains general fiduciary standards that apply to all fiduciary actions, including investment decisions made by fiduciaries. ERISA requires that a plan fiduciary must discharge its duties solely in the interests of participants and beneficiaries and:

• for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying reasonable expenses of plan administration;
• with the care, prudence, and diligence under the circumstances then prevailing 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;
• by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and
• in accordance with plan documents insofar as they are consistent with ERISA.

Defined contribution plans like a 401k are not subject to the diversification requirement or the general prudence requirement (to the extent that it requires diversification) with respect to investments in employer stock.

A plan fiduciary that breaches its fiduciary duties is personally liable under ERISA to the plan for any losses resulting from such breach.

In addition, the Internal Revenue Code provides that a qualified retirement plan must prohibit the diversion of assets for purposes other than the exclusive benefit of employees and their beneficiaries.

4. Who is responsible for investment decisions made by plan participants?

Under a safe harbor rule, ERISA fiduciary liability does not apply to investment decisions made by plan participants if plan participants control the investment of their individual accounts. Many employers design plans to meet the safe harbor in order to minimize fiduciary responsibilities. If the safe harbor applies, a plan fiduciary may be liable for the investment alternatives made available, but not for the specific investment decisions made by participants. This includes investments in employer stock made at the direction of the participant. Failure to satisfy the safe harbor rule in its entirety means that plan fiduciaries may be held liable for the investment decisions of participants. This safe harbor is commonly referred to as the "404(c) safe harbor" because it is contained in section 404(c) of ERISA.

In order for the safe harbor to apply:

• the plan must provide at least three different investment options, each of which is diversified and has materially different risk and return characteristics;
• the plan must allow participants to give investment instructions with respect to each investment option under the plan with a frequency that is appropriate in light of the reasonably expected market volatility of the investment option;
• at a minimum, participants must be allowed to give investment instructions at least every three months with respect to least three of the investment options, and those investment options must constitute a broad range of options;
• participants must be provided with detailed information about the investment options, information regarding fees, investment instructions and limitations, and copies of financial data and prospectuses; and
• specific requirements must be satisfied with respect to investments in employer stock to ensure that employees' buying, selling, and voting decisions are confidential and free from employer influence.

In addition, the safe harbor applies only with respect to a transaction where a participant exercises independent control in fact with respect to the assets in his or her account. Whether a participant has exercised independent control in fact with respect to a transaction depends on the facts and circumstances of the particular case. However, a participant's exercise of control is not independent in fact if:

• the participant is subjected to improper influence by a plan fiduciary or the employer with respect to the transaction;
• a plan fiduciary has concealed material nonpublic facts regarding the investment from the participant, unless the disclosure of the information by the plan fiduciary to the participant would violate other law not preempted by ERISA; or
• the participant is legally incompetent and the responsible plan fiduciary accepts the participant's instructions knowing this.

5. How often must a plan permit participants to change investment decisions?

If the ERISA 404(c) safe harbor is being relied upon, then participants must be permitted to change investment decisions in a manner consistent with that safe harbor. Unless the ERISA 404(c) safe harbor is being relied upon, there are no specific rules regarding how often a plan must permit participants to change investments.

As a practical matter, time frames for permitting participants to change investments are determined by the plan and are often tied to the plan's administrative systems, including the frequency with which plan assets are valued. In addition, the plan will generally specify when a participant's investment directions will be executed. For example, a transfer from one investment to another may be made on the first day of the month after the month in which the participant requested the transfer.

6. Who bears the risk of investment loss in a qualified retirement plan?

In a defined contribution plan like a 401k, the benefit the participant is entitled to is the account balance. Thus, the plan participant bears the risk of investment losses, regardless of whether investment decisions are made by the participant or a plan fiduciary.

7. Are there any restrictions on the type of investments that can be made with qualified retirement plan assets?

Except as noted below, the Internal Revenue Code and ERISA do not contain any specific rules as to what types of investments are appropriate (or inappropriate) for 401k plan investments. Rather, ERISA's fiduciary standards govern whether investment decisions by plan fiduciaries are appropriate.

Both the Internal Revenue Code and ERISA contain prohibited transaction rules that prohibit plan fiduciaries and other persons with a close relationship to a plan from engaging in transactions with the plan. These rules are not targeted toward particular types of investments, but rather seek to prevent self-dealing transactions.

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