ERISA section 404(c)--how does it really work, and what does it matter? (401(k) Investment Issues).(fiduciaries could be liable for imprudent 401k plan investments in participant-directed plans)

The bear market has caused large losses for participants in 401(k) plans. These losses have highlighted the need for fiduciaries to act prudently as required by ERISA Section 404(a) and to obtain the protections offered by ERISA Section 404(c). As explained in this column, if a participant directed 401 (k) plan does not satisfy the requirements in the 404(c) regulations, the fiduciaries will be responsible for imprudent participant investment decisions.

401(k) plans have become the plan of choice in the American workplace. The 1990s witnessed one of America's great bull markets, which has been only partially tarnished by the bear market of the early 2000s. The extraordinary performance of stocks in the 1990s obscured a fundamental weakness of participant-directed 401(k) plans--that investment decisions are often being made by inexperienced investors choosing among mediocre investment options.

Now that the rising tide that lifted all ships--the bull market--has receded, those employees are faced with the consequence of their lack of knowledge. Some are coping by delaying their retirement; some who bought at the top are selling near the bottom; others are refusing to look at their 401(k) plan statements, Only a few are responding by redirecting their accounts into well-structured investment portfolios--or, in the words of investment professionals, into strategic asset allocations.

At a policy level, the losses in 401(k) plans are focusing attention on the need to help participants with their investments, including possible solutions ranging from investment education and advice to professionally managed portfolios. It has also focused attention on the quality of the investment choices chosen by the 401(k) plan investment fiduciaries and the potential liability of those fiduciaries for participant investment decisions.

Many of the company officers who act as fiduciaries mistakenly believe that 401(k) plans provide a "liability-free" way to provide retirement benefits. While it's true that plan sponsors and investment fiduciaries can insulate themselves from some liability, there are a number of myths about how much protection is available and what it takes to get that protection. This column focuses on ERISA Section 404(c)--an often misunderstood provision that could become a battleground in 401(k) plan litigation.

Background

When picking investments for 401(k) plans, fiduciaries have a number of obligations under ERISA, including the duties to act:

1. Solely in the interest of participants {ERISA [section] 404(a)(1)};

2. For the exclusive purpose of providing retirement benefits and paying reasonable expenses {ERISA [section] 404(a)(1)(A)};

3. Prudently {ERISA [section] 404(a)(1)(B)}; and

4. According to the plan's terms, as long as they are consistent with ERISA {ERISA [section] …