ERISA Tips: Section 404(c) Is the Exception, not the Rule
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403(b) Advisor, ERISA Tips. It arises from data on visits to the NTSA site and readership of its content, which indicates consistent interest in ERISA and how it is applied.
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This first tip is taken from Michael Webb’s article “The Top Five Things You Need to Know About ERISA 404(c),” which originally ran on Nov. 21, 2014.Section 404(c)
is a historically misunderstood part of ERISA, with misconceptions rampant even before the 404(a)(5) participant fee disclosure regulations added to the confusion. The general rule is that ERISA plan fiduciaries are liable for all aspects of selection and monitoring of plan investments, and are on the hook for any participant claims for fiduciary breaches should something go wrong.
Section 404(c) is a limited exception to this general rule. It only applies to individual account plans (including Code Section 403(b) and 401(k) plans, but NOT 457(b) plans, which are not subject to the fiduciary provisions of ERISA) whose participants can direct investment of their accounts. If the ERISA plan satisfies 404(c), fiduciaries would NOT be liable for any claim of a breach related to a participant’s selection of investments. However, since this is an exception, and not a rule, plan fiduciaries remain liable for the selection and monitoring of all investment options made available to the participant.
For example, let’s say Participant X, ignoring the principles of proper diversification, invests all of his assets in Plan Y’s emerging markets fund. The fund loses nearly half of its value in one year. The participant cannot make a claim for fiduciary breach related to his/her selection of the emerging markets fund, unless he/she can successfully claim that the plan did not properly follow 404(c). However, the participant could claim a fiduciary breach regarding Plan Y offering this particular emerging markets fund on its investment menu in the first place, if the selection/monitoring of the fund was imprudent. Thus the protection from fiduciary liability offered under 404(c) is quite limited. Practice Pointer: ERISA 404(c) is often misunderstood as providing far greater fiduciary protection that it actually does. The knowledgeable advisor should be able to clarify the scope of the protection of 404(c) for plan fiduciaries as well as the plans to which 404(c) applies (ERISA plans with participant-directed investments).