401(k) Plan Fiduciary Obligations 101

Posted on February 15, 2012 by Sheryl Southwick in Benefits, Human Capital Management, Legal

We all know that a 401(k) plan is a popular employee benefit. Yet when a company decides to sponsor a 401(k) plan, it needs to be familiar with its responsibilities under the Employee Retirement Income Security Act of 1974 (ERISA) and related Department of Labor regulations and guidance. One of the key ERISA provisions is that 401(k) plan sponsors and other fiduciaries must discharge their duties with respect to a plan solely in the interest of the plan’s participants and beneficiaries, rather than for its own or another party’s gain.

The “Prudent Expert” Rule

401(k) plan sponsors and other fiduciaries must select and monitor the investment options that the plan will offer and must diversify plan investments:

  1. For the exclusive purpose of providing benefits to participants and their beneficiaries and defraying the reasonable expenses of administering the plan; and
  2. With the “care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims…”

In carrying out these responsibilities, the requirement that fiduciaries be “familiar with such matters” has led to this being dubbed “Prudent Expert” rule because of the stated requirement that the fiduciaries have the level of expertise of a knowledgeable investor. This is especially important when it comes to evaluating, selecting and monitoring the plan’s investment options.

Monitoring Plan Investment Options

More often than not, plan sponsors do not have the in-house investment expertise necessary to meet the “prudent expert” requirement. In order to comply with this requirement, many companies hire an independent, professional investment advisor to select and monitor 401(k) investment options.

An investment advisor can provide reports on a periodic basis to ensure each investment option stays true to its style (i.e., Large Cap Growth, etc.), performs consistently well over a long period of time, performs well relative to its peers, and does so at a reasonable price. An investment advisor may also assist with developing a plan investment policy statement, documenting the selection and monitoring processes, and establishing standards to determine when to make changes to the investment platform.

Selecting a 401(k) Investment Advisor

Selecting an investment advisor is an important fiduciary decision. Just like hiring any other plan service provider, a company’s plan sponsor may want to consider proposals from a number of potential providers, and document the comparison and selection process. Some questions a plan sponsor should consider asking:

  • Is your firm registered as an investment advisor with the SEC? Have you been the subject of any litigation or complaints from the SEC or any other supervisory authorities in the last three years?
  • Do you or a related company have relationships with or receive payments from money managers that you recommend?
  • Is your consulting fee asset-based or fee-for-service?
  • What percentage of your business is defined contribution investment consulting?
  • Describe your firm’s methodology and sources of data for analyzing and evaluating fund performance.
  • What are the certifications and qualifications of the individuals conducting investment analysis?
  • Do you consider yourself a fiduciary under ERISA with respect to the recommendations you provide to the plan and acknowledge this role in writing?

Now is the perfect time for 401(k) plan sponsors to make sure they have a sound investment selection and monitoring strategy in place. Working with an independent advisor and maintaining a documented due diligence review process will help plan sponsors satisfy ERISA requirements and potentially limit fiduciary liability.

This article is published for informational purposes only, to assist small businesses with some issues they may want to consider in connection with the provision of a 401(k) plan. This article is not intended to provide legal, tax or accounting advice. Nothing herein creates an attorney-client relationship. If you need legal, tax or accounting advice, please contact a licensed legal, tax or accounting professional.