MUST READING FOR ALL EMPLOYEES
The following contains statements directly from the Federal Register that we believe are the key areas of the 404(c) regulations. I have provided additional commentary so it will make sense (after all, it is in governmentese) and give an interpretation on areas that have been the most misunderstood or misapplied by both employers and employees. It is critical that it be read by all employers- if they want to comply with the requirements and reduce or avoid fiduciary liability. It's mandatory for employees so they can recognize their responsibilities and the effort they have to put forth.
Per the Department of Labor, Pension and Welfare Benefit Administration, ERISA Code section 404(C) as defined in the Federal Register, Volume 57, No 198, October 13, 1992 (jot all this down, there's a quiz later), it clearly states on page 46906 that the beneficiary or plan participant must have the opportunity to:
1. choose from a broad range of investment alternatives which consist of at least three diversified investment alternatives, each of which has materially different risk and return characteristics
2. give investment instruction with a frequency which is appropriate in light of the market volatility of the investment alternatives, but not less frequently that once every three month period
3. diversify investments within and among the investment alternatives and
4. obtain sufficient information to make informed investment decisions with respect to investment alternatives available under the plan. (Most of this text is addressed in this area.)
Anyway, why all the fuss? Because of the discussion on page 46906, "Section 404(C).... provides that where a participant or beneficiary of an employee pension benefit plan exercises control over assets in an individual account maintained for him under the plan, the participant is not considered a fiduciary by reason of his exercise of control and other plan fiduciaries are relieved of liability for the results of the participants or beneficiaries exercise of control."
What it means is that if an employer properly provides reasonably diversified investments, time for the employee to make reasonable changes during the year and gives proper information on investing and investments, then the COMPANY IS RELEASED FROM AN OBLIGATION OF INSURING THAT THE INVESTMENTS WERE CORRECTLY MADE OR THAT THE END SUMS ARE SUFFICIENT FOR RETIREMENT OR OTHER PURPOSES OR EVEN IF ANY LOSSES ARE SUSTAINED. IT MAKES THE EMPLOYEE RESPONSIBLE FOR INVESTMENT DECISIONS WITHOUT (PROBABLE) RECOURSE TO THE EMPLOYER.
Page 46909 comments on investment information in part by stating, "with respect to the disclosure of investment information, the Department noted...... that the requirement that sufficient information be available to permit informed investment decisions but also to subsequent decisions with regard to that investment"
And, similarly, page 46910 comments that "the investment decision made by participants and beneficiaries in ERISA section 404(c) plans will directly affect the funds available to such individuals at retirement. For this reason , the participants and beneficiaries should be assured of having access to that information necessary to make meaningful decision. Further....... "the Department has concluded that fiduciaries of an ERISA section 404(c) plan should have an affirmative obligation to ensure that participants and beneficiaries are provided or can obtain basic information concerning the investment alternatives made available under the plan. The Department is persuaded that merely referring participants and beneficiaries to a source for investment information and requiring them to obtain the information is INSUFFICIENT to ensure that participants and beneficiaries are in a position to make informed investment decision.
Page 46910 goes on to further elaborate that ......"an ERISA section 404(c) plan will be considered to provide a participant or beneficiary an opportunity to exercise control over the assets in his account only if, in addition to affording the participant or beneficiary a reasonable opportunity to give investment instructions according to paragraph b2iA, the participant or beneficiary is provided or has the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan and incidents of ownership appurtenant to such investments in accordance with paragraph b2iB. And....." a participant or beneficiary will not be considered to have sufficient investment information unless certain delineated items of information concerning the plans and available investment alternatives are provided to the participant or beneficiary. The Department (of Labor) is persuaded that certain information is so fundamental to making informed investment decisions that such information should be available to all plan participant and beneficiaries."
My commentary: this is an extremely and, probably, the most important area of the rules and regulations. It means that the employer must make information available so that employees of any sophistication can understand the risks and merits of an investment. Most investment seminars currently offered by employers is sophomoric and incomplete and presented by instructors with woefully little background in securities. Specifically, the Department notes that certain delineated items of information must be provided. While the Rules and Regulations do not state specifically what those items must be, my review has clearly defined those areas that need to be addressed to employees and which are not currently being offered- again due to lack of knowledge and competency of employer or seminar provider. Obviously, simply telling an employee to buy this book or read this prospectus is insufficient. Further, reading a prospectus is NOT going to provide many people with the proper understanding of risk, reward or even the fund itself since everyone alive in the securities industry is fully aware of the inconsistencies in the type of information found from fund to fund and fund family.
Second is the issue that investment information must be ongoing- though the Department does not state that updates need to be required every three months, six months one year or whatever. Nonetheless, unless solid definitive information is provided, employees will continue to make uninformed investment decision.
Again on page 46910, regarding seminar requirements, the Federal Register states that ..."each participant or beneficiary is required to be provided the following information..... First an explanation that the plan is intended to constitute an ERISA action 404(C) plan... and that fiduciaries of the plan may be relieved of liability of any loses which are a direct and necessary result of investment instructions given by the plan participant or beneficiary. "
My comment: This is a reinforcement of the issues that the EE is responsible
for the investment, NOT THE EMPLOYER. But the employer must inform employees
that this is actually happening per law. The idea is to REINFORCE the employees
"awareness of the limited liability of the plan fiduciaries (the employer)
and of their own individual responsibility with respect to investment decisions
concerning their assets." In other words, if the employer does this correctly,
then the employee is limited in his or her ability to sue the employer due
to any losses sustained. However, this is rarely addressed to any seminar
attendees and I therefore think it potentially puts the employer at risk
for some fiduciary or financial liability. Admittedly, employers don't want
to make a "big thing" out of the law, but the non compliance with the law
does make it a "big thing" - particularly when they could get sued.
Same page continues with "a description of the investment alternatives available under the plan and, with respect to each designated investment alternative, a general description of the investment objectives and risk and return characteristics of each such alternative, including information relating to the type and diversification of assets comprising the portfolio of the designated investment alternatives. This requirement is intended to ensure disclosure of the most basic of information necessary to a participants or beneficiary's investment decision." Additionally, the investment managers must be identified. And, "with respect to each investment alternative, available under the plan, a description of any transaction fees and expenses which effect the participant or beneficiaries account balance in connection with the purchase or sale of investor in such investment alternative (e.g. , commissions, sales loads, deferred sales charges, redemption or exchange fees).
My commentary: most plan seminars never even discuss the various funds offered in the plan since they state that that would be giving advice (versus information) if it delved too deeply into the specifics. Garbage. Anyone who has ever read a prospectus clearly recognizes that the last thing a prospectus gives is advice. It provides information- lots and lots of it. Unfortunately it is sometimes so involved, convoluted and mind numbing that no one ever reads it (probably prepared by an attorney who is also a CPA). But this is exactly the information that needs to be digested into a "easy to understand" format and presented to employees. Just giving sophomoric info on some returns and miscellaneous risk is tantamount to a snow job that will get a company landed in a court sooner or later. It is my opinion that the reason that such material is not presented to employees is the fact that instructors totally lack the sophistication of an understanding of the material and, as a result, do not have the capabilities of presenting it correctly to seminar attendees.
Page 46912 is an extension of the commentary on fees and expenses and requires the plan provide "a narrative description of the annual operating expenses of each designated investment alternative, such as investment management fees, administrative fees and transaction costs, which reduce the rate of return to the participants or beneficiaries, and the aggregate amount of such expenses expressed as a percentage of average net assets of the designated investment alternative."
My comment: while the section does state that a prospectus is adequate presentation of these fees, we submit that any company that utilizes loaded funds with high expenses and 12b-1 fees will NOT be precluded from possible liability unless the company adequately and accurately compares such fees and expenses to other funds so that participants have a clear understanding of the ramifications of reward of the employer' fund selections. It is NOT adequate to simply say that fees and expenses are incurred unless they are put into perspective in the overall universe of funds so that employees can readily see the impact. Companies that have done extensive review and selected funds based on risk, performance and acceptable fees should definitely provide employees documentation to that effect. IT IS NOT REQUIRED BY THE DEPARTMENT. IT IS REQUIRED BY ETHICS AND INTEGRITY. FURTHER, A COMPANY THAT USES INVESTMENTS WITH AVERAGE OR LOWER EXPENSE RATIOS SHOULD SEE AN INCREASED ACCEPTANCE BY EMPLOYEES OF THE FUNDS AND RECOGNIZE THE COMPANY'S EFFORTS. After all, literally every magazine and text extols the virtues of low expenses and disdains the use of high fees.
Further on 46912: "....fiduciaries (employers) will have to consider, for example, whether any changes with respect to the investment portfolio of the investment alternative since the last annual report are sufficiently material that failure to disclose such changes would deprive the participant or beneficiary of the opportunity to make an informed investment decision."
My comment: Semi annual and annual reports from mutual funds will cover any changes made in the portfolio. However very, very few employees will read such reports and fewer still will truly understand the changes made by a fund, particularly where more risky investments have been substitute or where derivatives or hedging is utilize. We believe that in order for an employee to really understand the risks and merits of substantial changes to the portfolio that separate "real English" commentary or presentations be made available to employees.
Concerning the giving of investment advice which would have the employer retrain fiduciary liability, page 46913 states that "it is the view of the Department that providing the disclosures described....as well as other general information concerning available investment alternatives, including research materials, would not, in and of itself,, constitute the rendering of investment advice."
We agree but take considerable umbrage with those employers/instructors who are purposely avoiding even the remotest commentary about the funds available. Esoteric commentary about investing does little good unless it is put into correct focus for plan participants and the actual funds available. As stated previously, we believe that the lack of commentary is due to unknowledgeable instructions and possible bad funds and/or those with high fees. Otherwise an employer would be well served by providing understandable information on well chosen and acceptable funds.
Lastly, primarily as an added comment about the risks of diversification, the Department clearly focused on the elements of employee stock as one of the alternatives comprising the minimum of three varied investments that are required to be offered. It stated, "... the Department recognizes the a participant many need a substantial amount of investment capital to achieve diversification if investment alternatives are limited in direct investment in individual instruments (such as common stocks, bonds, etc.). However broad diversification may be achieved with a much smaller amount of capital where assets are held in the form of an undivided interest in a pool of broadly diversified investment instruments."
My comment: Literally all plans will offer mutual funds as the broadly diversified investments. Many employers will also offer individual securities- though perhaps only the employer stock. If unlimited individual stocks and bonds are offered as alternatives, it seems clear that the employer must provide employees a complete breakdown on risk and reward of individual securities since excessive risk could occur. If an employer offers just their own stock, it is true that the addition of other available investments such as mutual funds temper the overall risk. Nonetheless, significant risk may continue to exist in the overall portfolio, particularly if high betas or standard deviation has been identified on company stock.
These rules are subject to various interpretation but the areas indicated MUST be properly addressed to employees. A company that simply abdicates the responsibility over to a 401(k) provider and/or instructors who do not definitively offer the objective and comprehensive positions noted herein will continue to be liable to their employees for poor performance and inadequate retirement sums. I will testify to this interpretation
Investment Advice: (2004) This interpretive bulletin sets forth the views of the Department of Labor (the Department) concerning the circumstances under which the provision of investment-related information to participants and beneficiaries in participant-directed individual account pension plans will not constitute the rendering of ``investment advice'' under the Employee Retirement Income Security Act of 1974, as amended (ERISA). This guidance is intended to assist plan sponsors, service providers, participants and beneficiaries in determining when activities designed to educate and assist participants and beneficiaries in making informed investment decisions will not cause persons engaged in such activities to become fiduciaries with respect to a plan by virtue of providing ``investment advice'' to plan participants and beneficiaries for a fee or other compensation.