Managing a 401(k) Plan: Five steps for avoiding litigation
by: Roxanne Fleszar
from: The Fabricator
September 1999
Liability. We are all tired of the word and its implications, but from hot coffee to tobacco, every product is a potential liability, and 401(k) plans are no exception. When the trend in company-sponsored retirement plans shifted from defined benefit to defined contribution, a new area of liability was unlocked.
401(k) Background
The 401(k) plan was introduced in the early 1980s as a variation on the typical profit-sharing plan. By the end of that decade, the 401(k) was in full bloom as it lured employers with the opportunity to transfer a greater share of costs and investment responsibility to the individual participants. This was incentive enough for many employers to shut the door on their profit-sharing plans in which they provided 100 percent of the employer contribution and investment direction.
Some employees applauded the ability to amass greater tax-deferred retirement savings than IRAs allowed and preferred to control their investment choices.
Unfortunately, this trend has resulted in a burden to financially illiterate employees who now are expected to make responsible investment and contribution decisions. Should they fail in their attempts to accrue sufficient retirement funds, will full responsibility be borne by employees, or will blame be passed on , in part or full, to employers?
Recent Court Ruling
This issue was resolved in a 1999 court ruling (173 F.3d 145) in favor of Unisys Corp., which was sued by a number of employees for breach of fiduciary duties for the purchase of the 401(k) plan's government insurance contracts (GICs) through Executive Life, which later was taken over by state regulators. Although the case is not thought to have set any precedents, it does confirm that, regardless of poor investment performance, plan sponsors have met their obligations under the Employee Retirement Income Security Act (ERISA) if they can prove that the selection of investment providers and administration of the plan were conducted prudently.
Fortunately for those with responsibility for sponsoring 401(k) plans, five steps can be taken to improve a plan and diminish an employer's chances of becoming entangled in an unwelcome legal battle.
Step 1. Be aware of the fiduciary role played by each party involved in your 401(k) plan. According to ERISA, a fiduciary is any person exercising discretion or control over the management of the plan or its assets, or any person who is paid to provide investment advice regarding plan assets.
Typically, an individual or firm is not required to consent specifically to being a fiduciary even though it is acting in such a manner (with the exception of an investment manager or qualified professional asset manager). However, it is in the plan's best interest to obtain in writing from each party to the plan (investment advisor, plan administrator, investment provider, etc.) a declaration of whether the individual or firm accepts fiduciary responsibility for the plan, and, if so, to what extent.
Note that the plan sponsor always is a plan fiduciary, with ultimate responsibility for all decisions involving the plan.
Step 2. Provide consistent investment monitoring. In a bull market, even mediocre investment performance looks good to most unsophisticated investors. Participants may be pleased by a one-year return of 15 percent on their investment, but not if its benchmark comparison is yielding 18 percent for the same time period. Plan sponsors should review net investment performance at least quarterly against appropriate benchmarks such as a blanced fund against a balanced index and have policies in place to change investments accordingly.
Benchmarks are provided by a number of different companies and should be furnished by the investment provider or consultant on quarterly fund reports. If plan sponsors do not monitor investments regularly, an inadequate fund could remain a plan option for years and result in losses to investors.
Step 3. Implement and maintain an investment policy statement (IPS). The IPS is a blueprint of all the procedures a company should undertake to protect its employees' assets. A proper IPS sets forth the plan's objectives and goals and explains how progress is measured. In addition, the IPS outlines investment selection criteria and the circumstances that call for fund changes.
These criteria generally include, but are not limited to, past and present performance in comparison to peers, length of manager tenure, an evaluation of investment fees compared with peers, and the investment's ability to continue to meet the plan's goals and objectives.
Many providers supply the plan with a prototypical IPS that can be tailored to the plan's needs, or the trustees may opt to hire a consultant to assist in developing a customized document. The IPS should be reviewed at the annual trustees' meeting and whenever significant modifications have been made to the plan, with revisions made as necessary.
With this documentation in place, plan sponsors can be assured that they are acting prudently and with their employees' best interests in mind.
Step 4. Educate plan participants. Ongoing financial education plays a major role in reducing a company's liability. Because U.S. workers historically have been savers and not investors, an employer must teach employees the basics of investing.
Many tools exist that can help employers to educate their participants, including seminars, newsletters, internet and intranet sites, and interactive software. The makeup of a company's work force determines how these options should be combined to create an effective education program.
Step 5. Hold regular trustees' meetings. Plan sponsors should hold regular plan review meetings with their investment advisor and any other pertinent parties to the plan. These meetings should be held at least annually, or more frequently if concerns arise. Documentation of these meetings is good proof that the plan sponsors are managing the plan actively and working to keep it in line with the objectives set forth in the IPS.
Many plan sponsors do not have the time or expertise to make appropriate decisions regarding the plan, but this is no excuse for negligence. Steps can be taken to prevent a company from being found guilty of negligence in maintaining a company-sponsored retirement plan. After all, there is no guarantee that today's employee will not be tomorrow's plaintiff.