Breaking Down ERISA Section 404(c) to the Basics

Although retirement plan participants have the freedom to make their own investment decisions, plan fiduciaries are still responsible for providing a wide range of diversified investment options for them to choose from.  

Fortunately, however, fiduciaries are protected by ERISA Section 404(c)—a provision that shields plan sponsors from employees’ poor investment choices. In order to obtain Section 404(c) protection, fiduciaries must adhere to a number of requirements, issued in 1992 and amended in 2010, as part of the Department of Labor’s efforts to improve disclosure to plan participants. 

Before this provision was passed, it was unclear whether employers were liable for participants’ investment choices, says Michael Kreps, principal at Groom Law Group. 

“Absent 404(c), there’s this question of, ‘what if I give [participants] seven choices [of investment options] and an 80-year-old [invests] 100% into small-cap equities… is that my fault or theirs?’” Kreps says. 

After Congress passed the ERISA amendment, saying that employers are not liable for participants’ investment direction, the DOL clarified that the employer remains liable for selecting prudent investments, while participants are liable for choosing those investments. 

What are the Requirements Under 404(c)? 

To be 404(c) compliant, plan sponsors must first ensure that they are offering a broad range of investments, including at least three options, each of which is diversified and has materially different risk and return characteristics.  

Additionally, the plan sponsor must provide participants the ability to “transfer among investment options with a frequency appropriate for each investment’s market volatility” at least once in any three-month period, according to Fidelity Investments. Essentially, participants must be able to make changes to their investments at least quarterly. If a particular investment option is sufficiently volatile, more frequent opportunities to change investments may be required. 

“The whole point here is that participants are exercising discretion over their own account, and the employer is not liable for that,” Kreps says. “But if they don’t have [enough options], the [plan sponsor] doesn’t get that relief. Or if [the investments] have lockups, the [plan sponsor] doesn’t get that relief.” 

As per Section 404(c), plan sponsors are also responsible for delivering information to participants about the plan, its investment options and its operations before participants make investment decisions.  

If a participant requests additional information about the investment options, the sponsor must provide that information so that the participant can make informed investment decisions. An example of this type of information could be a description of the annual operating expenses for each investment option, which should be expressed as a percentage of average net assets in the investment. 

What About QDIAs? 

As many participants today do not actively make investment decisions and default into their plan’s qualified default investment alternative, Section 404(c) offers plan fiduciaries a measure of protection even if the participant does not provide any investment direction. 

In the Pension Protection Act of 2006, Congress created a safe harbor for plan sponsors using automatic enrollment in their plans, essentially treating a participant’s default into the QDIA as an investment direction. 

“The goal was, ‘let’s level the playing field,’” Kreps says. “You get this 404(c) protection, regardless of whether [the participant] is auto-enrolled or they make their own election.” 

Section 404(c) also provides protection for employee stock ownership plans, according to Fidelity. When employer stock is offered in the plan, there are additional requirements that fiduciaries need to meet in order to be protected by 404(c). For example, one of the requirements is that employer securities must be publicly traded on a generally recognized exchange with sufficient frequency and volume to enable prompt trades. Participants also must be provided with the same information as other shareholders.  

Understanding Compliance Status 

For plan sponsors who are unsure if they are complying with 404(c), Kreps says it is important for them to have conversations with their recordkeeper. 

Luckily, recordkeepers have automated a lot of this process to ensure that plan sponsors are following all the requirements. However, Kreps says employers should confirm with their providers that this automated process is working. 

“They should be talking to their recordkeeper or TPA to understand the process by which people are enrolled [and] the notices they get,” Kreps says. 

He adds that it is important for plan sponsors to ask their recordkeepers if they are providing an adequate number of investments on the platform, if they provide a diverse array of choice and if participants are receiving the right disclosures. 

Kreps finds there is often confusion, among sponsors, about the scope of relief that 404(c) provides. 

“I think sometimes 404(c) is thought [of] as complete relief for employers, like if you give people enough choice, then you’re off the hook,” Kreps says. “You’re responsible as a fiduciary for prudence—selecting and monitoring the investments that are available. What you get relief from is where the participant chooses among that. But putting [the investment options] on your platform to begin with is a fiduciary act.”