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DOL Issues Significant New Requirements for 401(K) Plans


     By Fulcrum Inquiry Damages, Appraisal, Accounting & Economics Expert Witnesses

PhoneCall David Nolte at (213) 787-4100


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The DOL proposed new rules that will be effective as early as January 1, 2009. Generally, the rules require additional disclosures regarding costs charged to participants, and make it easier for plan sponsors to qualify for protection from litigation. Given the shameful undisclosed marketing practices used by vendors of 401(k) plans and the costs paid by participants at many these plans, the additional disclosure will cause plan sponsors to finally pay much-needed attention to this area.
In late July, the U.S. Department of Labor (DOL) issued proposed regulations that require plan fiduciaries to disclose plan- and investment-related information for 401(k) plans and other participant-directed individual account plans. The regulations, which ran 31 pages in the Federal Register, require uniform disclosures intended to ensure that participants are (i) made aware of their rights and responsibilities regarding their investments; and (ii) provided sufficient information about the plan and its investment alternatives to make informed decisions.

The changes, particularly regarding cost disclosures, are certainly needed and have been anticipated for some time. Our earlier article on this subject warned of litigation if the status quo was not altered. The proposed new rules provide specific direction that will allow consistent implementation of obligations that existed previously. However, these prior obligations were largely ignored because of “accepted” practices and the lack of sufficient implementation guidance. With this additional disclosure, litigation risks for plans sponsors should decrease.

Summary of the New Rules

The required information would need to be provided when a participant becomes eligible to participate in the plan, and annually thereafter. The proposed regulation would become effective for plan years beginning on or after January 1, 2009, which provides a relatively short implementation period. Depending on the type of information involved, these disclosures generally may be provided as part of a plan’s Summary Plan Description, or an ERISA benefit statement.

The required information includes:

1. General plan information, including:

a. An explanation of how participants and beneficiaries may give investment instructions (and any specified limitations on those instructions, including restrictions on transfers among investment alternatives)

b. A description of plan terms addressing the exercise of voting, tender, and similar rights (and any restrictions on those rights), and

c. Description of a plan’s investment alternatives and investment managers, including:

i. Identifying information, including the names of investment alternatives, website addresses for those investment alternatives, investment category, and management type such as active or passive

ii. Past performance data for variable return investments

iii. Comparable benchmark returns – With some investments, it will be difficult to provide benchmarks (for example, lifecycle and target-date funds), since there is no general consensus on what those benchmarks should be.

iv. Fee and expense information for each investment option - The expense ratio does not include administration expenses (described below) that are charged to participants separately and that are disclosed each quarter as a dollar amount for each participant.

This investment-related information should be offered in a chart format that makes it easy to compare the plan’s investment alternatives. The regulation includes a model chart for this purpose.

Certain information must be provided only upon request, including prospectuses, financial statements or reports, and a statement of an investment share’s value (and valuation date).

2. Administrative expenses in addition to costs associated with investment alternatives, including:

a. An explanation of any fees and expenses not otherwise included in investment-related expenses that may be charged against an individual account – Examples are per account recordkeeping, maintenance, or accounting fees, loan costs, QDRO (“qualified domestic relations orders” associated with a divorce) processing fees, and fees for investment advice; and

b. A quarterly statement that includes the dollar amount actually charged during the preceding quarter to an individual account for such individual services, and a description of those services.

Changes from Current Practice

The proposed requirements are a substantial change from current practice, particularly in the area of fee disclosure. Most 401(k) participants do not have any idea what they are being charged for plan administration. For example:

1. In the area of investment expenses, current disclosure can vary considerably, depending upon the regulator that oversees that particular investment. For example, mutual funds generally have required fee disclosures that are considerably more detailed than what banks provide for collective investment trusts, and what insurance companies provide for their separate accounts.

2. Before the current proposal, there is no explicit requirement for fiduciaries and vendors to disclose compensation. Some have suggested that fiduciaries have a built-in conflict-of-interest that requires disclosure under ERISA, but this has not been an accepted practice.

Simplified Litigation Avoidance

ERISA Section 404(c) provides a safe haven against participant claims about poor investment performance IF certain detailed requirements are met. The concept is that participants should have responsibility for their personal investment decisions, but only if these detailed disclosure and other requirements are met. Failure to make any of these disclosures meant that the plan sponsor would not be eligible for relief from liability for participant investment decisions. Since ERISA Section 404(c) was itself optional, the related disclosures were optional. However, for obvious reasons, most plan sponsors attempted to comply with ERISA 404(c).

Under the new rules, the majority of these disclosures are deleted from Section 404(c)(1), and moved (with changes) to the 404(a)(5) requirements discussed above. Because the new requirements are not optional, most plans should also be ERISA 404(c) compliant.

An onerous portion of former 404(c) compliance has been eliminated. Currently, there is a requirement to give a prospectus involving all available investment choices to every participant, whether they ask for the prospectus or not. As a practical matter, this requirement is ignored by most plan sponsors, since the prospectus for every plan offering in a typical plan would total well over a thousand pages, which the vast majority of participants do not want and would never read. Nevertheless, ignoring this requirement means (at least under a technical reading of the ERISA 404(c)) that the plan sponsor has expanded liability possibilities.

To fix this problem, plan sponsors would have to provide a prospectus only if a participant requests it.

In the preamble to the proposal, the DOL stated its existing position that plan sponsors are responsible for selecting the available investment options. Section 404(c) provides relief only for the participant’s selection within the available options, but not the starting point for such elections. Although this is not a change, there is a widespread (but incorrect) belief that Section 404(c) compliance prevents claims over available options. Consequently, popular so-called “open window” plans (often offered to small business sponsors by certain brokerage firms) provide no liability protection if a participant makes an unsuitable decision from investments that (always with the benefit of hindsight) are claimed to not properly be part of a retirement plan. With the DOL’s further explanation on this point, there can be no confusion that this type of investment selection approach is a poor idea.

The deadline for comments on the proposed regulation is September 8, 2008.


Fulcrum Inquiry performs forensic accounting services.

ABOUT THE AUTHOR: David Nolte
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials, CPA, MBA, CMA and ASA.

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
For specific technical or legal advice on the information provided and related topics, please contact the author.

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