ERISA LAW AND THE 401(K) PLAN FIDUCIARY part II

Posted by admin on: 2007-07-18 16:53:40

This is one of the best and most comprehensive
reports that could help companies to
understand their 401k plan fiduciary responsibility.

It was written Tom Hoecker. You can reach Tom at thoecker@swlaw.com

ERISA AND THE 401(K) PLAN FIDUCIARY part II

I.
Open Option Plans
1.
The Open Option Concept
As a general rule, an Open Option feature allows plan participants to select nearly any
available investment, subject to minimal restrictions.

An Open Option feature usually is
offered in tandem with an assortment of investment funds, but technically there is no
requirement that specific investment funds be designated.
Small professional organizations have offered programs with Open Option features for
years. Administrative problems and a general reluctance to allow participants who are, at best,
novice investors the opportunity to have near complete control over the investment of their
retirement funds has hindered the widespread use of Open Option programs by other types of
employers. Advances in technology and plan administration systems are quickly resolving the
administrative problems, though, and many small and large employers undoubtedly will consider
the addition of an Open Option feature to their 401(k) plans in the future.
A literal reading of section 404(c) of ERISA certainly seems to suggest that plan
fiduciaries should not have any liability for investments made by plan participants who utilize a
plan's Open Option feature. The regulations, which are described in detail above, however, do
pose a few potential hurdles for Open Option programs.
2.
Opportunity to Exercise Control
As mentioned above, the relief offered by section 404(c) is available only if participants
have the opportunity to exercise control over the investment of their accounts. According to the
regulations, a participant does not have the ability to exercise control over the investment of his
or her account unless the participant has a reasonable opportunity to give investment
instructions . . . to an identified plan fiduciary . . . .

Participants utilizing a plan's Open Option feature frequently work directly with the
broker of their choice and plan fiduciaries rarely, if ever, know of the participant's decisions as
they are made. This common, prevailing practice does not comply with the regulations and is ill-
advised. Instead, a plan that includes an Open Option feature should implement procedures to
assure that all investment instructions are channeled through a plan fiduciary.

An Open Option plan may limit a participant's selections to publicly traded securities and mutual
funds. If an Open Option program limits the choices of participants too severely (e.g., the mutual funds
offered by a particular fund family), the plan may actually be designating investment alternatives. In this
situation, a plan fiduciary will be responsible for assuring the prudence of all of the available alternatives.
In addition, the relief offered by section 404(c) is available only if a plan participant actually exercises
control over his or her account. 29 C.F.R. § 2550.404c-1(d)(2)(i) (1992). If no designated investment
funds are offered by a plan, some participants will decline to give any investment instructions, eliminating
any 404(c) relief for the plan fiduciaries.

29 C.F.R. 404c-1(b)(2)(i)(A) (1992). The Preamble to the regulation makes it very clear
that this requirement applies to all plans that seek the protection of section 404(c), including those which
do not designate investment alternatives, i.e., those plans which permit investments in any asset which is
administratively feasible for the plan to hold and do not specifically describe any investment alternative.

One possibility is to require that all investment directions be given to a plan fiduciary,
who then will instruct a broker to execute the trades. While this approach clearly satisfies the
requirements of the regulations, it is impractical and imposes a substantial paperwork burden on
the plan fiduciary.
Another possibility is to select one or more brokers to serve as the plan's designated
brokers. If the designated brokers are charged with the responsibility of assuring that the
instructions are proper, the brokers will arguably be plan fiduciaries and the requirements of the
regulations will be met. If the brokers have no discretion, their fiduciary status is suspect. In
this situation, the brokers, at most, are acting as the agents of a designated plan fiduciary. While
this approach should satisfy the regulations, there is no published guidance on point.
3.
Information Requirements
Under the regulations, a participant is considered to exercise control over the assets in
his or her account only to the extent that the participant has an opportunity to obtain sufficient
information to make informed investment decisions.

A plan with an Open Option feature should be able to easily satisfy most of the applicable
information requirements by including appropriate language in the summary plan description.
One requirement that is easily and often overlooked, though, is the prospectus requirement,
which is described as follows in the regulations:
[I]n the case of an investment alternative which is subject to the Securities Act of
1933, and in which the participant or beneficiary has no assets invested,
immediately following the participant's or beneficiary's initial investment, a copy
of the most recent prospectus provided to the plan [must be provided to the
participant]. This condition will be deemed satisfied if the participant or
beneficiary is provided with a copy of such most recent prospectus immediately
prior to the participant's or beneficiary's initial investment in such
alternative . . .

In the context of a plan that includes an Open Option feature, any investment a
participant may acquire through the plan is an investment alternative and the prospectus
requirement must be satisfied.

How can the plan fiduciaries possibly assure that this
requirement is met, since in most cases they will not know when trades are executed or what
investments are acquired?
Perhaps the most effective precautionary measures that plan fiduciaries can take to
minimize the impact of a violation of the prospectus requirement is to carefully select the

29 C.F.R. 404c-1(b)(2)(i)(B) (1992).
29 C.F.R. 404c-1(b)(2)(i)(B)(1)(viii) (1992).

Every plan that seeks section 404(c) relief must describe the investment alternatives available
under the plan. The Preamble to the final regulations states that this requirement is satisfied in the context
of an Open Option feature by a general statement describing the available investments. In the Preamble,
the Department does suggest that participants be encouraged to review pertinent information before
investing.

designated brokers and obtain written commitments from each designated broker that it will
comply with the prospectus requirement. But what happens if the plan fiduciaries prudently
select a designated broker and the designated broker inadvertently fails to send a prospectus in a
timely fashion?
If the designated broker is a plan fiduciary and the plan is properly drafted, the fiduciary
allocation provisions of section 403 of ERISA and the co-fiduciary liability provisions of section
405 of ERISA may adequately protect those plan fiduciaries who are not charged with any
investment responsibility by the plan documents.

The plan's investment fiduciaries (who for
this purpose are the fiduciaries responsible for investing the accounts of participants who fail or
refuse to issue investment instructions and who may or may not include the designated broker)
may not be able to avoid liability.

If the designated broker is not a fiduciary, the investment fiduciaries may have some
liability if the prospectus requirement (or any other informational requirement) is not observed.
Under the regulations, the relief provided by section 404(c) is not available unless all of the
requirements of the regulations are satisfied. The Preamble also states that while a plan fiduciary
may delegate the responsibility to provide the required information to others, the fiduciary
remains responsible for assuring that the information requirements are in fact satisfied.

As a result, if a broker agrees to provide the prospectus, as required by the regulations, and fails to do
so, the 404(c) relief available to the investment fiduciaries may be jeopardized.
4.
Frequency of Investment Instructions (the Volatility Rule)
The volatility rule included in the regulations and described above provides that
participants must have the opportunity to give investment instructions with respect to each
investment alternative with a frequency that is appropriate in light of the market volatility to
which the investment alternative may reasonably be expected to be subject. In order to satisfy
the volatility rule, a plan that includes an Open Option feature should allow participants to give
investment instructions on a daily basis. Any other arrangement will fail to satisfy the
requirements of the regulations.
5.
General Observations
Compliance with the regulations is a challenge for any plan that allows participants to
direct the investment of their accounts. Although the addition of an Open Option feature does

The Employee Benefits Committee of the Tax Section of the American Bar Association formed a
task force to consider a wide variety of issues arising in connection with Open Option plans. The task
force considered this and other issues and submitted a request for clarification to the Department of
Labor. The members of the task force included Jane Armstrong, Hilton S. Bell, William K. Bortz, John
W. Boyd, Jeffrey N. Clayton, Richard A. Gilbert, Steven Glaser, Thomas R. Hoecker, R. Scott
Kilgore, Fred C. Kneip, Kenneth Kneubuhler, Bernard F. Hare, David W. Rowan and Alan
Tawshunsky. No formal response has been received, but various members of the task force did meet with
the Department informally.

In these circumstances, the potential fiduciary liability presumably extends only to the decision to
purchase the investment for which the prospectus was not provided.

57 Fed. Reg. at 46,906.
-
not significantly increase the compliance burden, the risks of noncompliance may become more
significant.
The sponsor of the more typical or traditional Participant Directed Investment Program
can limit the risk of noncompliance with the regulations somewhat by carefully selecting the
investment options offered to its employees. If the investment options are selected with care,
the risk of substantial, sustained losses is diminished significantly and this diminished risk in
turn lessens the likelihood of participant suits and the importance of compliance with the
regulations.
With an Open Option program, every participant is given the opportunity to invest in
virtually anything. This added flexibility increases the chance of poor decisions, significant
losses and the likelihood that plan fiduciaries will be the subject of a suit by a disgruntled
participant. In order to provide the plan fiduciaries with the necessary protection, strict
compliance with the regulations is well worth the effort.
J.
The Unisys Case
1.
General
In re: Unisys Savings Plan Litigation

(or Unisys ) was the first reported appellate
decision squarely dealing with the application of the fiduciary standards of ERISA to a
Participant Directed Investment Program. The case arose out of the purchase of guaranteed
investment contracts or from Executive Life Insurance Company for the fixed income
funds offered under savings plans sponsored by Unisys. When Executive Life failed, several
different groups of participants in these plans brought 12 separate actions against Unisys and
other plan fiduciaries. The separate actions were consolidated for purposes of pre-trial matters.
The plaintiffs claimed that when Unisys and the other plan fiduciaries selected the
Executive Life GICs they violated the prudence and diversification requirements of section
404(a) of ERISA. They also claimed that Unisys violated its fiduciary duty to provide accurate
information to plan participants.
Unisys convinced the trial court that it had satisfied its prudence, diversification and
disclosure obligations and the trial court ruled in favor of Unisys by granting its motion for
summary judgment.

The Third Circuit reversed and in the process provided its views on the
application of the fiduciary standards of ERISA to participant directed account plans.

74 F.3d 420 (3d Cir. 1996).

1995 U.S. Dist. LEXIS 843 (E.D. Pa. 1995).

On remand, the district court, in essence, concluded that Unisys had satisfied its fiduciary duties.
1997 U.S. Dist. Lexis 19198, 1997 WL 732473 (E.D. Pa. 1997). The district court's decision was
affirmed on appeal. 173 F.3d 145, 1999 U.S. App. Lexis 4863, 1999 WL 164435 (3rd Cir. 1999). The
discussion of Unisys I is nonetheless instructive.

2.
Prudence
Citing a number of cases decided in other contexts, the court observed that prudence is
measured by an objective standard, focusing on a fiduciary's conduct in arriving at an
investment decision, not on its results, and asking whether a fiduciary employed the appropriate
methods to investigate and determine the merits of a particular investment.

the evidence
before the court in Unisys I suggested that rather than conducting an independent investigation,
the fiduciaries may have relied solely on the perceived views of a consultant. The Third Circuit
observed that blind reliance on a consultant opinion is inadequate:
While we would encourage fiduciaries to retain the services of consultants when
they need outside assistance to make prudent investments and do not expect
fiduciaries to duplicate their advisers investigative efforts, we believe that
ERISA's duty to investigate requires fiduciaries to review the data a consultant
gathers, to assess its significance and to supplement it where necessary. In our
view, a reasonable fact finder could infer from this evidence that Unisys failed to
analyze the bases underlying Johnson & Higgins opinion of Executive Life's
financial condition and to determine for itself whether credible data supported
Johnson & Higgins recommendation that Unisys consider investing plan assets
with the insurer. A reasonable fact finder could also conclude that Unisys
passively accepted its consultant's positive appraisal of Executive Life without
conducting the independent investigation that ERISA requires.

3.
Diversification
On the subject of diversification, the Third Circuit concluded that each investment fund
offered to participants must be diversified in and of itself. Unisys argued that the diversification
requirements were met as long as the plan as a whole was adequately diversified. Relying on the
legislative history of ERISA, the Third Circuit rejected this argument. Since the risk of loss on
the Executive Life contracts was not distributed throughout the plan, the Third Circuit concluded
that it would be inappropriate to measure compliance with the diversification requirements by
looking to the plan as a whole.
Based on the record before it, the Third Circuit could not determine whether the
diversification requirements had been satisfied and it remanded the case for trial on this issue.

4.
Duty to Disclose
The Third Circuit then turned its attention to the plaintiffs claims that Unisys had
breached its disclosure obligations by distributing misleading information concerning the risks
associated with investments in the GIC funds.

74 F.3d at 435-36. On remand, the district court found that Unisys had acted prudently and the
Third Circuit affirmed. 173 F.3d at 154, 1999 U.S. App. Lexis at 20, 1999 WL at 6.

On remand, the district court found that the Executive Life GICs made up approximately 20% of
the fixed income fund and that this concentration did not violate the diversification requirements. The
Third Circuit affirmed. 173 F.3d at 157, 1999 U.S. App. Lexis at 36, 1999 WL at 11.

The Third Circuit repeated its earlier findings that a fiduciary may not materially
mislead those to whom section 1104(a)[section 404(a) of ERISA] duties of loyalty and
prudence are owed.

Quoting from one of its earlier decisions, the court went on to hold as
follows:
[The] duty to inform is a constant thread in the relationship between beneficiary
and trustee; it entails not only a negative duty not to misinform, but also an
affirmative duty to inform when the trustee knows that silence might be
harmful.

Applying these standards to the situation in Unisys I, the court concluded that a number
of communications concerning the risks of investing in the GIC funds could have been
misleading. For example, the early versions of plan communications stated that the GIC funds
were designed to preserve capital and accumulate interest and that the GICs were guaranteed
by the issuing insurance companies. Only after Executive Life began experiencing difficulties
were revised prospectuses distributed that indicated that there was some risk of loss with these
investments. The Third Circuit concluded that whether these communications were misleading
and, if they were, whether the misrepresentations were material were issues that needed to be
determined at trial.

5.
The Section 404(c) Defense
The court then addressed Unisys contention that section 404(c) afforded it relief from
any liability. In essence, Unisys claimed that even if it violated the prudence and diversification
requirements in selecting Executive Life GICs for the funds, the losses suffered by the plaintiffs
stemmed from their exercise of control over the investment of their accounts and, accordingly,
Unisys was relieved of liability by reason of section 404(c).

Accepting Unisys basic premise, the court held that a fiduciary that breached its
fiduciary duty could nonetheless escape liability if it could establish that the participant's
exercise of control was the cause of the loss--
[T]he statute's unqualified instruction that a fiduciary is excused from liability for
any loss which results from a participant's or a beneficiary's exercise of
control clearly indicates that a fiduciary may call upon section 1104(c)
74 F.3d at 440.

74 F.3d at 441, (quoting Bixler v. Central Pennsylvania Teamsters Health and Welfare Fund, 12
F.3d 1292 (3d Cir. 1994)).

On remand, the district court found that the alleged disclosure problems were immaterial. The
Third Circuit adopted a different approach, finding that the plaintiffs failed to prove that the alleged
disclosure violation resulted in any damage to the plaintiffs. The district court found that Meinhardt and
the other class plaintiffs (1) already had actual knowledge of much of the information it is claimed that
Unisys failed to disclose, (2) did not read the Plan documents, and (3) testified that they would not have
withdrawn or transferred their money from the Fund even if they had known about Executive Life's
problems. 173 F.3d at 159, 1999 U.S. App. Lexis at 38, 1999 WL at 12.

In footnote 27 of the Preamble to its regulations under section 404(c), the DOL takes the position
that a participant's exercise of control is not the cause for a loss attributable to the imprudent construction
or selection of an investment alternative. The regulations were not applicable to the Unisys case.

protection where a causal nexus between a participant's or a beneficiary's
exercise of control and the claimed loss is demonstrated. This requisite causal
connection is, in our view, established with proof that a participant's or a
beneficiary's control was a cause-in-fact, as well as a substantial contributing
factor in bringing about the loss incurred. See Willett v. Blue Cross and Blue
Shield of Alabama, 953 F.2d 1335, 1343 (11th Cir. 1992) (Section [1109] of
ERISA establishes that an action exists to recover losses that resulted from the
breach of fiduciary duty; thus the statute does require that the breach of the
fiduciary duty be the proximate cause of the losses claimed . . . .; Brandt v.
Grounds, 687 F.2d 895, 898 (7th Cir. 1982) (Under 29 U.S.C. § 1109, where fiduciary . . . who . . . breaches . . . shall be personally liable to make good . . . any
losses resulting from each such breach, a casual connection is required between
the breach of the fiduciary duty and the losses alleged ). (Footnotes omitted.)

Based on the record before it, the court could not conclude that Unisys had established its
ability to rely on section 404(c) and it remanded the case for trial.

K.
Responsibilities of Directed Trustees
ERISA Section 403(a)(1) permits a trustee to follow the proper directions of another
fiduciary as long as the directions are in accordance with the terms of the plan and are not
contrary to this Act. Section 405(b)(3)(B) also provides that a trustee will not be liable for
following directions referred to Section 403(a)(1).
The scope of the responsibilities of a so-called directed trustee has been the subject of
some debate. Some courts have held that a directed trustee bears no liability for following
directions unless the directed trustee has actual knowledge that the directions are contrary to the

74 F.3d at 445.

In Unisys I, the Third Circuit did not find that Unisys had violated any of its duties to the plan
participants or that the section 404(c) defense was unavailable. Rather, the court simply concluded that
the standards for summary judgment had not been satisfied because genuine issues of material fact needed
to be resolved at trial in order to determine if Unisys had breached its duties and whether the prerequisites
for section 404(c) relief had been satisfied. In light of the Third Circuit's comments regarding the
prudence and disclosure requirements and its recitation or summarization of the factual background of the
case, Unisys chances of success on remand appeared to be slim at best. Nevertheless, after a trial, the
district court ruled in favor of Unisys. As noted above, the Third Circuit affirmed the district court's
decision.

plan or ERISA.

Other courts have taken the position that a directed trustee will be held
responsible if the directed trustee knows or should know that the direction is improper.

In Field Assistance Bulletin 2004-3,

the Department of Labor expresses its views on the
duties of a directed trustee. The Department starts its analysis by noting that a directed trustee is
always a fiduciary,a conclusion that is not shared by all. The Department then notes,
however, that Section 403(a)(1) significantly limits a directed trustee's responsibilities as a
fiduciary.
As noted previously, a directed trustee is subject to the proper directions of another
named fiduciary. According to the Department, a direction is proper only if it is made in
accordance with the terms of the plan and not contrary to [ERISA]. The Department then
concludes that when a directed trustee knows or should know that the direction from a named
fiduciary is not made in accordance with the terms of the plan or is contrary to ERISA, the
directed trustee may not, consistent with its fiduciary responsibilities, follow the direction.
According to the Department, in order to assure that the directions are consistent with the
terms of the plan, a directed trustee has a duty to request and review all documents governing the
plan. Not surprisingly, if a directed trustee either fails to request documents or fails to review
them, and as a result follows an improper direction, the trustee will be held responsible.
In the FAB, the Department also addresses the trustee's responsibility to assure that
directions are consistent with ERISA, noting that a directed trustee may not follow a direction if
the directed trustee knows or should know that the direction would result in a prohibited
transaction or violate the Prudent Man Rule.
With respect to prohibited transaction concerns, if the directed trustee receives written
representations that the directing fiduciary has implemented procedures in order to avoid
prohibited transactions, the Department's view, as expressed in the FAB, is that the directed
trustee is justified in relying on representations from the directed fiduciary that those procedures
have been followed, unless the directed trustee knows the representation is false.
Similarly, in the FAB, the Department notes that the named fiduciary issuing the
directions to the directed trustee has the primary responsibility for determining the prudence of
a particular transaction . . . .The Department goes on to state as follows:

See Koch v. Dwyer, 1999 WL 528181, *10 (S.D.N.Y. 1999); Kling v. Fidelity, 270 F. Supp. 2nd
121, 131-132 (D. Mass 2003) (citing Koch). See also, in re McKesson HBOC, Inc. ERISA Litigation,
2002 WL 31431588, *12 (N.D. Cal. 2002) (dismissing claim against directed trustee but allowing
plaintiff to amend complaint because plaintiff had not alleged sufficient facts to show that directed trustee
had knowledge that the directions were imprudent).

See FirstTier Bank v. Zeller, 16 F.3d 907, 910-913 (8th Cir. 1994); In re Enron Corp. Securities,
Derivative & ERISA Litigation, 284 F. Supp. 2d 511, 584 (S.D. Tex. 2003); In re WorldCom, Inc.
ERISA Litigation, 263 F.Supp. 2d 745, 761-63 (S.D.N.Y. 2003); In re Sprint Corp. ERISA Litigation,
2004 U.S. Dist. LEXIS (Kan. 2004). The most thorough analysis of directed trustee obligations to date
can be found in the district court's decision in Enron.

Field Assistance Bulletin 2004-3 is available on the Department's website (www.dol.gov/ebsa).

Accordingly, as the courts and the Department have long recognized, the scope of
a directed trustee's responsibility is significantly limited. A directed trustee does
not, in the view of the Department, have an independent obligation to determine
the prudence of every transaction. The directed trustee does not have an
obligation to duplicate or second-guess the work of the plan fiduciaries that have
discretionary authority over the management of plan assets and does not have a
direct obligation to determine the prudence of a transaction. (citations omitted.)
The Department then proceeds to discuss a directed trustee's obligation to question
transactions involving publicly traded securities. According to the Department, the directed
trustee's obligation to question these transactions is very limited:
If a directed trustee has material non-public information that is necessary for a
prudent decision, the directed trustee, prior to following a direction that would be
affected by such information, has a duty to inquire about the named fiduciary's
knowledge and consideration of the information with respect to the direction. For
example, if a directed trustee has non-public information indicating the
company's public financial statements contain material misrepresentations that
significantly inflate the company's earnings, the trustee could not simply follow a
direction to purchase that company's stock at an artificially inflated price.
Generally, the possession of non-public information by one part of an
organization will not be imputed to the organization as a whole (including
personnel providing directed trustee services) where the organization maintains
procedures designed to prevent the illegal disclosure of such information under
securities, banking or other laws. (footnotes omitted.) If, despite such
procedures, the individuals responsible for the directed trustee services have
actual knowledge of material non-public information, the directed trustee, prior to
following a direction that would be affected by such information, has a duty, as
indicated above, to inquire about the named fiduciary's knowledge and
consideration of the information with respect to the direction. Similarly, if the
directed trustee performs an internal analysis in which it concludes that the
company's current financial statements are materially inaccurate, the directed
trustee would have an obligation to disclose this analysis to the named fiduciary
before making a determination whether to follow a direction to purchase the
company's securities. The directed trustee would not have an obligation to
disclose reports and analyses that are available to the public.
The FAB also comments on a directed trustee's duty to question the prudence of a
direction to purchase publicly traded securities. In the view of the Department, a directed trustee
will only rarely have an obligation to question these directions as long as the directions are to
purchase securities at the market price. The Department in the FAB also provides the following
cautionary note:
In limited, extraordinary circumstances, where there are clear and compelling
public indicators, as evidenced by an 8-K filing with the Securities Exchange
Commission (SEC), a bankruptcy filing or similar public indicator, that call into
serious question a company's viability as a going concern, (footnote omitted) the
directed trustee may have a duty not to follow the named fiduciary's instruction
without further inquiry.
The Department also notes that when directions to purchase company stock are given by
a corporate employee following a formal charge by state or federal regulators of financial
irregularities, the directed trustee taking such facts into account, may need to decline to follow
the direction or may need to conduct an independent assessment of the transaction in order to
assure itself that the instruction is consistent with ERISA.
Although the FAB, as noted above, adopts the knows or should know standard, the
FABs discussion of a directed trustee's responsibilities should provide some comfort to directed
trustees. On the other hand, there is no assurance that a particular court will accept the
Department's analysis.
L.
The Duty to Inform
In a number of recent cases involving employer securities, the plaintiffs have successfully
defended a motion to dismiss their claims that appointing fiduciaries have a duty to inform their
appointees of information relevant to their decisions.
95
This theory was first advanced in the Enron litigation. In Enron, the plaintiff's claimed
that Enron, its compensation committee and Kenneth Lay were liable as co-fiduciaries for their
failure to inform the Administrative Committees about Enron's actual financial status . . . .

The court found these claims to be adequate to state a claim under Section 502(a)(3) of ERISA.
The district court reached a similar decision in In re Sprint Corp. ERISA Litigation.

Like the plaintiffs in Enron, the plaintiffs in Sprint claimed that Sprint and its directors violated
the provisions of ERISA by failing to disclose pertinent information regarding Sprint's financial
condition. They went on to claim that these same defendants breached their fiduciary duties by
failing to inform the Administrative Committee members regarding the imprudence of
purchasing Sprint stock. The district court addressed this claim in the following passage of its
opinion:
Whether the director defendants had a related duty to disclosure information to
the committees presents a more novel issue. It seems this allegation, if true, could
have determined the level of scrutiny the director defendants should have given to
their appointees. In any event, the court finds it unnecessary to precisely define
the contours of the duty to monitor at this early phase of the litigation, especially
given the regulatory directive that the appropriate monitoring procedure may
vary in accordance with the nature of the plan and other facts and circumstances
relevant to the choice of the procedure. This issue is one that would more
appropriately be resolved on the facts of the case. Suffice it to say that, for

In re Sprint Corporation ERISA Litigation, 2004 U.S. Dist. LEXIS 9622 *64 (KAN. 2004); In re
Enron Corporation Securities, Derivative & ERISA Litigation, 284 F. Supp. 2d 511, 661-662 (S.D. Tx.
2003).

In re Enron Corp. Securities, Derivative & ERISA Litigation, 284 F. Supp. 2d at 661-662.

In re Sprint Corp. ERISA Litigation, 2004 U.S. Dist. LEXIS 9622 (D. Kan. 2004).

purposes of resolving the Sprint defendants motion at this procedural juncture,
the court simply rejects the Sprint defendants argument that the directors were
free to appoint the committee members, and then turn a blind eye to the
appointees performance of their duties (citations omitted).

The Sprint court seems to view the duty to inform as stemming from the duty to monitor.
In other words, if a fiduciary has the responsibility for appointing another fiduciary and
monitoring that other fiduciary's performance, the first fiduciary has an obligation to make sure
that the second fiduciary considered the relevant issues in performing its duties.
In Field Assistance Bulletin 2004-3, discussed above, the Department of Labor reached a
similar result from the opposite direction. In the FAB, the Department dealt with the
responsibilities of a directed trustee. According to the Department, if the directed trustee has
material non-public information that is necessary for a prudent decision, the directed trustee,
prior to following a direction that would be affected by such information, has a duty to inquire
about the named fiduciary's knowledge and consideration of the information with respect to the
direction. The Department went on to note that. . . the individuals responsible for the
directed trustee services have actual knowledge of material non-public information, the directed
trustee, prior to following a direction that would be affected by such information, has a duty, as
indicated above, to inquire about the named fiduciary's knowledge and consideration of the
information with respect to the direction. Similarly, if the directed trustee performs an internal
analysis in which it concludes that the company's current financial statements are materially
inaccurate, the directed trustee would have an obligation to disclose this analysis to the named
fiduciary before making a determination whether to follow a direction to purchase the company's
securities.
M.
Missing Participants
In Field Assistance Bulletin 2004-2,
the Department of Labor provided much needed
guidance concerning the steps a fiduciary should take to locate missing participants, and make
distributions to missing participants, in the context of a terminating defined contribution plan.
As expected, the FAB emphasizes that fiduciaries must proactively attempt to locate
missing participants and requires the use of various search methods listed in the guidance. If,
following the use of appropriate measures, the fiduciary is unable to locate the participant and
the plan is terminated, the fiduciary may distribute the participant's account. The distribution
may be accomplished by rolling the amount distributable to the participant into an individual
retirement account. If the fiduciary is unable to find an IRA provider who will accept the
rollover, the fiduciary may distribute the account into an interest bearing savings account
established in the name of the participant or transfer the account pursuant to the applicable
state's unclaimed property laws. Based on conversations with Department of Labor
representatives, the use of a state's unclaimed property regime is only appropriate in the context
of a terminated plan.
2004 U.S. Dist. LEXIS at *63-64.

Field Assistance Bulletin 2004-2 is available on the Department's website (www.dol.gov/ebsa).

N.
Automatic Rollovers
The Economic Growth and Tax Relief Reconciliation Act of 2001 introduced the
automatic rollover concept. Essentially, these automatic rollover rules require plans to roll
involuntary cash outs of $1,000 or more into an individual retirement account unless the
participant requests a distribution. The Department of Labor has now issued regulations that
provide guidance with regard to automatic rollovers.

The new Department of Labor regulations provide plan fiduciaries with protection from
potential liability arising in connection with the designation of an institution to receive an
automatic rollover and the initial investment selections as long as the standards set forth in the
regulations are met. In general, in order to qualify for the protection provided by the regulations,
the present value of the distribution may not exceed $5,000. In addition, a number of other
requirements must be met. For example, the institution establishing the IRA must be a bank,
insurance company, financial institution or other IRA approved provider. The plan administrator
also must enter into a written agreement with the IRA provider that satisfies specified
requirements. In addition, the summary plan description must describe the automatic rollover
rules, provide a description of the investments to be made in connection with the automatic
rollover, and meet certain other requirements.
O.
Educating Participants
1.
The Need for Education
Plan sponsors are not legally required to provide investment education to plan
participants. The regulations under section 404(c) call for the provision of information
concerning the available investment alternatives, but the regulations do not require the sponsor or
anyone else to teach the participants how to use that information.
Despite the lack of an affirmative duty to educate, many plan sponsors have wisely
ventured into this area. Uneducated participants are likely to make mistakes. Some participants
might risk everything in aggressive stock funds while other participants may completely avoid
risk by investing in low return money market funds. A third group of participants may attempt to
time the market and, like most market timers, will eventually switch between the available
alternatives at precisely the wrong time. If a significant number of plan participants make these
common investment mistakes, the employer's retirement program will prove to be inadequate,
leading to a disgruntled and frustrated workforce that may demand a better (and more expensive)
retirement plan.
Poor investment decisions by participants also could increase the likelihood of claims
against plan fiduciaries. Participants who have experienced lackluster or disastrous investment
results are much more likely to look for someone to blame than participants who have done
reasonably well. To the extent that an investment education program improves investment
performance, then, it also may serve to reduce the risk of fiduciary liability claims.

29 C.F.R. § 2550.404a-2(2004). The new rules are effective for cash outs made on or after
oddly enough, a desire to minimize fiduciary liability actually may have chilled the
educational efforts of some employers. These employers have expressed the concern that by
providing an educational program to their employees they may be providing investment advice
and subjecting themselves to fiduciary liability. An Interpretive Bulletin issued by the
Department of Labor should ease these concerns.

2.
Educator as Fiduciary
Selecting and monitoring the educators is a fiduciary act and the employer or other
fiduciary responsible for the selection must act prudently and comply with all of the other
fiduciary requirements of ERISA. If the investment education program is well designed and
controlled, though, the provision of the education will not be a fiduciary act or lead to added
fiduciary liability exposure.
ERISA section 3(21)(A) defines fiduciary broadly to include anyone who:

Exercises discretionary authority or control respecting the management of the
plan or the management or disposition of its assets;

Provides investment advice for a fee or other compensation; or

Possesses any discretionary authority or responsibility regarding the
administration of the plan.
Whether investment education is a fiduciary act will depend on whether the educator
provides investment advice for a fee. Under regulations issued by the Department of Labor, an
investment educator will be considered to be rendering investment advice and will assume the
fiduciary mantle only if the educator provides advice as to the value of securities or other
property or makes recommendations as to the advisability of investing in or purchasing or selling
plan assets.

Even if the educator steps over this line, the educator will not be considered to be
rendering investment advice unless he also:

Directly or indirectly has discretionary authority or control (regardless of whether
the control or authority is pursuant to an express agreement or arrangement) with
respect to the purchase or sale of plan investments for the participant; or

Renders advice to the participant on a regular basis pursuant to a mutual
agreement, arrangement or understanding with the participant that the advice will
serve as a primary basis for the participant's investment decisions and that the
educator will provide individualized advice based on the participant's particular
needs.
If the courts accept the Department's regulations as a proper interpretation of the statute,
an employer should be able to construct an investment education program in which the educator
Department of Labor Interpretive Bulletin 96-1, Participant Investment Education, 61 Fed. Reg.
at 29586 (June 11, 1996), reprinted in 23 Pen. & Ben. Rep. 1594 (BNA) (June 17, 1996).

29 C.F.R. § 2510.3-21(c)(1)(i).
is not a fiduciary. The Interpretive Bulletin confirms this interpretation of the regulations and
provides safe harbors that an employer may use in designing its investment education program.
3.
Safe Harbors in General
According to the Interpretive Bulletin, an investment education program is not
investment advice if it is limited to providing plan information, general financial and
investment information, asset allocation models and interactive investment materials. These
materials may be provided in any medium (orally, in writing or through video or computer
programs), in any form (individually or in a group meeting) and in any combination.
4.
Plan Information
The investment education program may include any materials that inform the participants
about the plan or the benefits of plan participation as well as all of the information required by
the section 404(c) regulations concerning the available investment alternatives. The Interpretive
Bulletin recognizes that information is not advice and that providing information alone should
not lead to fiduciary status.
5.
General Financial and Investment Information
General financial and investment information also may be furnished to the participants
without risking fiduciary status. This category of information includes materials dealing with
risk and return, diversification and dollar cost averaging concepts as well as the historic
differences in return on different asset classes, the effects of inflation, investment time horizons,
retirement income needs and the assessment of risk tolerance.
As with general plan information, this general financial and investment information is not
advice.
6.
Asset Allocation Models
An investment education program also may offer model asset allocation portfolios of
hypothetical individuals. In order to avoid the characterization of this material as advice,
several precautions must be observed:

All of the models must be based on generally accepted investment theories that
recognize the historic returns of various asset classes.

The material facts and assumptions must be stated.

If the model matches one of the plan's investment alternatives with a particular
asset class, and other similar investment alternatives also are available, the model
must be accompanied by a statement that apprises the participants that other
similar investment alternatives are available and advises them how to obtain
information on the other alternatives.

The models must be accompanied by a statement that in applying any particular
asset allocation model to his or her circumstances the participant should consider
other assets, income and investments.
With all of this information in hand, the participant is in a position to analyze the
relevance or appropriateness of the model to his or her circumstances. As a result, by furnishing
this information the educator is not making a recommendation or furnishing advice.
7.
Interactive Investment Material
Computer software and other materials that enable the participant to estimate future
retirement income needs and how various asset allocation models will help the participant meet
those needs also may be included as part of an investment education program. These interactive
materials must be accompanied by all of the precautionary information required for asset
allocation models. In addition, there must be an objective correlation between the asset
allocations generated by the program and the information supplied by the participant.
8.
Other Information
In the Interpretive Bulletin, the Department is careful to note that an investment
education program also may offer other information to participants. Whether the provision of a
particular item or type of information will lead to the conclusion that the educator is providing
investment advice will require a facts and circumstances analysis.
9.
Risk to the Employer
Does an employer assume some fiduciary liability by offering an investment education
program? Certainly. As noted above, the employer or other fiduciary that selects the educator
must comply with ERISA's prudence and other fiduciary requirements in selecting, monitoring
and continuing the appointment of the educator.
By carefully designing the program to limit the sanctioned materials to those described in
the safe harbors outlined in the Interpretive Bulletin and expressly restricting the activities of the
educator to the provision of sanctioned materials and information, though, the risk assumed by
the employer should be insignificant. In fact, the risk may be less than the risk unwittingly
assumed by allowing an uneducated or uninformed group of participants to invest their
retirement funds.
P.
Providing Investment Advice
Recognizing that investment education may not provide participants with all of the
assistance they need, some employers are taking the next step and are offering participants
access to investment advisors. In this context, the advisors clearly are fiduciaries under ERISA,
making them subject to all of ERISA's fiduciary standards, including the prohibited transaction
rules. When it selects the advisor, the employer or other responsible plan fiduciary is exercising
a fiduciary function. As a result, it must satisfy the Prudent Man Rule in selecting the advisor
and monitoring the advisor's performance.

The investment advice package often comes in the form of a computer program.
Participants input relevant information and they are then provided with specific investment fund
recommendations. The selection of an electronic investment advice program requires the same
type of fiduciary due diligence as the selection of an individual investment advisor. Plan
fiduciaries responsible for selecting the advice program are performing a fiduciary function and
must take care to satisfy the Prudent Man Rule. At a minimum, the fiduciaries should
understand the investment methodology underlying the investment advice program and assure
themselves that the advice being provided is consistent with accepted investment theories. One
good approach is to input information for a number of hypothetical participants and then test the
advice given against the advice that would be given under similar circumstances by a skilled
investment advisor.
If the investment advice program is offered by a mutual fund or other financial institution
that also provides some of the investment options utilized by the plan, prohibited transaction
concerns need to be taken into account. The entity providing investment advice, as noted above,
is a plan fiduciary. As a result, the provisions of section 406(b) of ERISA, which are discussed
above, need to be taken into account. In order to avoid these concerns, some financial
institutions have sought prohibited transaction exemptions or advisory opinions from the
Department of Labor with respect to their particular programs.

Some mutual funds have taken
the position that they can provide investment advice without violating section 406(b). This
position certainly seems to be inconsistent with the Department's views.
Q.
Providing Investment Management
A further refinement on education and advice is actual investment management. A
number of mutual fund companies and others are now offering programs in which independent
professional investment managers will make the fund allocation decisions for plan participants.
Typically, these programs require that plans offer a certain number of funds in various
categories. Participants then either sign up for the service or the service applies unless the
participant opts out. Participants typically are charged a basis point fee for utilizing the service.
The appointment of an investment manager is governed by ERISA section 402(c)(3).
Under section 402(c)(3), the investment manager must be appointed by a named fiduciary.
Section 405(d)(1) of ERISA then relieves the plan trustee from any liability for the acts or
omissions of the investment manager. In Harris Trust & Sav. Bank v. Salomon Bros., Inc., the
district court concluded that section 405(d)(1) also provides protection to the named fiduciary
who appoints the investment manager.

Like the fiduciary who designs or offers an investment advice program, plan fiduciaries
who make investment management available to the participants are obligated to act prudently in
selecting and monitoring the managers. A good example of the process that should be followed

See, for example, Advisory Opinion 2001-09A (December 14, 2001) which is available on the
Department's website (www.dol.gov/ebsa). Advisory Opinion 2001-09A related to a program proposed
by SunAmerica Retirement Markets, Inc.

Harris Trust & Sav. Bank v. Salomon Bros., Inc., 832 F. Supp. 1169 (N.D. Ill. 1996), rev in
part on other grounds, 184 F. 3d 646 (7th Cir. 1999), cert. granted, 528 U.S. 1068 (2000) and judgment
rev'd on other grounds, 530 U.S. 238 (2000).
by the fiduciary was set forth by the district court in Whitfield v. Cohen.

According to the
court in Whitfield, a fiduciary charged with the responsibility to appoint investment managers
should follow a process similar to the following:
1.
Evaluate the person's qualifications including:
a.
His experience in the particular area of investments under consideration
and with other ERISA plans.
b.
His educational credentials.
c.
Whether he is registered with the Securities and Exchange Commission
under the Investment Advisors Act of 1940.
d.
An independent assessment of his qualifications by means of
(i)
A widely enjoyed reputation in the business of investments;
(ii)
Client references; and/or
(iii)
The advice of a professional third-party consultant.
e.
His record of past performance with investments of the type contemplated.
2.
Ascertain the reasonableness of his fees.
3.
Review documents reflecting the relationship to be entered into.
4.
Ensure adequate, periodic accountings in the future.
106
III. LIABILITY CONCEPTS
Any plan fiduciary who breaches ERISA's fiduciary responsibility provisions is
personally liable for losses resulting from the breach. Also, the plan fiduciary must disgorge any
profits realized through the use of plan assets in violation of his or her fiduciary obligations.

A.
Loss to Plan Unnecessary
ERISA section 409(a) requires that the fiduciary return to the plan all profits made by
virtue of the use of plan assets, even if no losses have been incurred by the plan.
682 F. Supp. 188 (S.D.N.Y. 1988).
Whitfield v. Cohen, 682 F. Supp. 188, 193 (S.D.N.Y. 1988).
ERISA § 409(a).

See Leigh v. Engle, 727 F.2d 113, 138 (7th Cir. 1984), in which the court found that although the
trust had enjoyed a 72% return on its investment, the fiduciaries had wrongfully risked plan assets in
furtherance of their own takeover interests rather than acting solely in the interest of plan participants.
The fiduciaries had profited by virtue of simultaneously holding shares of stock in the targets and were
required to disgorge their profits.

B.
Good Intentions
As the Fifth Circuit has stated, a pure heart and an empty head are not good enough.

C.
Punitive Damages
Although ERISA section 409(a) provides for other equitable or remedial relief as the
court may deem appropriate,a participant may not obtain punitive damages from a fiduciary
under section 409(a).

D.
Civil Penalty
The Secretary of Labor can assess a civil penalty in the case of any breach of fiduciary
responsibility . . . or any knowing participation in such a breach or violation by any other
person.

The civil penalty is equal to 20% of the applicable recovery amount, which is
defined in the statute as the amount recovered pursuant to any settlement agreement with the
Department of Labor or any court order in an action instituted by the Department of Labor. The
penalty may be waived or reduced if the Secretary determines that the fiduciary acted in good
faith or in cases of severe financial hardship

Mr Hoecker's web site ishttp://www.swlaw.com

Most 401k plans fail to address the many regulatory requirements!

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