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

Posted by admin on: 2007-07-19 15:47:34

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This is one of the best and most comprehensive
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understand their 401k plan fiduciary responsibility.

This is one of the best and most comprehensive
reports that 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 LAW AND THE 401(K) PLAN FIDUCIARY

In the relatively short period of time since their reintroduction in 1980, cash or deferred
arrangements, commonly referred to as 401(k) plans, have become the retirement plan of
choice for large and small employers alike. During much of this period of time, the fiduciaries
of 401(k) plans have operated in relative safety. The great bull market of 1982 to 1999 masked
occasional missteps, proving the old saw that a rising tide floats all ships.
The bear market that began in 2000 (and may or may not have ended), corporate scandals
best illustrated by the demise of Enron, and the more recent revelations concerning abuses in the
mutual fund industry have brought a new focus to the conduct of 401(k) plan fiduciaries. In light
of this increasing attention, the fiduciaries of 401(k) plans are well-advised to pay more attention
to their duties under the law.
Like the more traditional forms of retirement programs, 401(k) plans are characterized as
employee pension benefit plans for purposes of the Employee Retirement Income Security Act
of 1974 (ERISA).

Accordingly, the individuals who are responsible for the administration
and management of a 401(k) plan are characterized as fiduciaries

under ERISA and are
subject to the same fiduciary standards that apply to the fiduciaries of any other form of
retirement plan. These generally applicable fiduciary requirements are described in Section I,
below.
A number of issues that 401(k) plan fiduciaries confront on a regular or recurring basis
are addressed in Section II.
I. GENERAL EXPLANATION OF THE FIDUCIARY RESPONSIBILITY RULES
ERISA imposes certain obligations on the individuals or entities who are responsible for
the administration and management of employee benefit plans such as 401(k) plans. The
fiduciaries of a 401(k) plan are required to observe ERISA Exclusive Benefit Rule and its
Prudent Man Rule, both of which are described below. A 401(k) plan fiduciary also must

ERISA is codified at 29 U.S.C.A. 1001 et seq. All references in this paper are to the ERISA
section numbers.

ERISA section 3(21)(A) provides that a person is a fiduciary with respect to a plan to the extent
that he or she: (1) exercises any discretionary authority or control with respect to the management of the
plan or exercises any authority with respect to the management or disposition of plan assets; (2) renders
investment advice for a fee or other compensation with respect to any plan asset or has any authority or
responsibility to do so; or (3) has any discretionary responsibility in the administration of the plan.

Administer the plan in accordance with its terms and is subject to ERISA's co-fiduciary liability
and prohibited transaction rules.

A. The Exclusive Benefit Rule
ERISA section 404(a)(1)(A) requires that a fiduciary discharge his or her duties with
respect to a plan for the exclusive benefit of plan participants and their beneficiaries and for the
purpose of defraying the expenses of administering the plan.

Similarly, section 403(c) of
ERISA provides that the assets of a plan shall never inure to the benefit of any employer and
shall be held for the exclusive purposes of providing benefits to participants in the plan and their
beneficiaries and defraying reasonable expenses of administering the plan.
Although the Exclusive Benefit Rule of sections 403(c) and 404(a)(1)(B) is phrased in
terms of never, solely and exclusively, the courts have recognized that a literal reading of
the statute is nonsensical and have readily acknowledged that incidental benefits may flow to the
fiduciary or the plan sponsor as long as the fiduciary primary motivation is to benefit the plan.

B. The Prudent Man Rule
Under the Prudent Man Rule of ERISA section 404(a)(1)(B), a 401(k) plan fiduciary
must discharge his or her duties with the care, skill and diligence that would be exercised by a
reasonably prudent person who is familiar with such matters. Although some commentators
have suggested that section 404(a)(1)(B) imposes a prudent expert standard, the better view is
that the Prudent Man Rule is a restatement of the prudent person standard developed as part of
the common law of trusts.

For a more detailed discussion of ERISA fiduciary responsibility requirements, see Employee
Benefits Committee, Section of Labor and Employment Law, American Bar Association, Employee
Benefits Law, ch. 5 (BNA 1991) [hereinafter referred to as Employee Benefits Law].

The Exclusive Benefit Rule applies to all areas of plan administration and not merely the
investment of plan assets. 29 C.F.R. § 2550.404a-1 (1979).

See Hughes Aircraft v. Jacobson, 525 U.S. 432, 445-46 (1999). Also see Hlinka v. Bethlehem
Steel Corp., 863 F.2d 279, 286 (3rd Cir. 1988, superseded on other grounds); Oster v. Barco of California
Employees Retirement Plan, 869 F.2d 1215, 1217 (9th Cir. 1988, superseded on other grounds); Trenton
v. Scott Paper Co., 832 F.2d 806, 809 (3rd Cir. 1987), cert. denied, 485 U.S. 1022, 108 S.Ct. 1576 (1988);
United Steelworkers of America, Local 2116 v. Cyclops Corporation, 860 F.2d 189, 202 (6th Cir. 1988);
Morse v. Stanley, 732 F.2d 1139, 1146 (2nd Cir. 1984); and Donovan v. Bierwirth, 680 F.2d 263, 271
(2nd Cir. 1982). cert. denied, 459 U.S. 1069, 103 S.Ct. 488 (1982).

Employee Benefits Law, ch. 5, at 275. Thus, a fiduciary will be held to the standard of any
prudent fiduciary who is skilled in carrying out and familiar with the duties with which he or she is
charged. In Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983), the Fifth Circuit noted that
ome commentators have suggested that the reference in Section 404 to a prudent man familiar with
such matters creates a prudent expert standard under ERISA. However, a review of the relevant
history of Section 404 does not support this view; rather, it confirms that the emphasis of Section 404 is
on flexibility.

C.The Diversification Requirement
As a general rule, the investment diversification requirement of ERISA
section 404(a)(1)(C) places an affirmative duty on a plan fiduciary to diversify plan investments
unless, under the circumstances, it is clearly prudent not to diversify.

8 Under ERISA section 404(a)(2), an eligible individual account plan may acquire and
hold qualifying employer securities or qualifying employer real property without regard to the
diversification requirements or the diversification element of the Prudent Man Rule. Profit
sharing, stock bonus, thrift, or savings plans may qualify as eligible individual account plans
as may certain money purchase pension plans.

D. Compliance with Plan Documents
ERISA section 404(a)(1)(D) requires and allows a fiduciary to follow the provisions of
the plan, but only if the provisions of the plan are consistent with ERISA.

If the action called
for by the plan provision is inconsistent with ERISA, the fiduciary is obligated to ignore the plan
provision.
This principal is well illustrated by the position taken by the Department of Labor in its
amicus brief in Tatum v. R.J. Reynolds Tobacco Company.

In Tatum, the plaintiff claimed that
the fiduciaries of a 401(k) plan violated their fiduciary duties when they liquidated two
investment funds that held Nabisco stock following the spin-off of R.J. Reynolds Tobacco
Company. At the time of the liquidation, the Nabisco stock had slumped following the spin-off
of the tobacco operations. Several months following the liquidation of the Nabisco investment
funds, the Nabisco stock had rebounded. The defendants successfully filed a motion to dismiss
with the trial court, alleging that they simply followed the provisions of the plan which required
the elimination of the funds due to a recent plan amendment. The plaintiff appealed.
Additional support for this contention can be found in an advisory opinion issued by the
Department of Labor. Department of Labor Advisory Opinion 2002-14A (December 18, 2002), which is
available on the Department website (www.dol.gov/ebsa). Advisory Opinion 2002-14A addressed
whether an expert was needed in choosing an annuity provider. In the Advisory Opinion, the Department
stated that a fiduciary does not need to retain an independent expert if the fiduciary has a sufficient level
of expertise or knowledge to meaningfully evaluate the claims paying ability and credit worthiness of an
annuity provider.

See, for example, Etter v. J. Pease Construction Co., 963 F.2d 1005, 1010 (7th Cir. 1992)
(diversification requirement not violated where 90% of plan assets invested in single real estate
investment which yielded 65% return); and Reich v. King, 867 F. Supp. 341, 344 (D. Md. 1994).
ERISA 407(d)(3) (A) and (B).

The phrase documents and instruments governing the plan as used in section 404(a)(1)(D)
encompasses more than the plan document itself. Investment management agreements or investment
policies are also included. See Plan Fiduciaries Responsibilities for Voting Proxies, Pension and
Welfare Benefits Administration Interpretive Bulletin No. 94-2, Pens. Plan Guide (CCH) 19,971
(July 29, 1994) [hereinafter referred to as Interpretive Bulletin 94-2]. See also Dardaganis v. Grace
Capital, Inc., 664 F. Supp. 105, 108 (S.D.N.Y. 1987), affd, 889 F.2d 1237 (2nd Cir. 1989) (investment
manager held responsible for violating provisions of investment management agreement).

2004 WL 2857376 (4th Cir. 2004).

On appeal, the plaintiff claimed that the amendment did not actually require the
liquidation of the funds. The Secretary of Labor, in its amicus brief, also argued that if the
amendment did require the liquidation of the funds, the fiduciaries had an obligation to ignore
the language of the amendment if the liquidation would be imprudent.
The Fourth Circuit sidestepped the issue by concluding that the amendment did not
require the liquidation of the funds. The position taken by the Department in its brief, however,
clearly reveals that in the view of the Department certain fiduciary responsibilities cannot be
avoided by plan amendments.
The requirements of section 404(a)(1)(D) are particularly important in the context of a
401(k) plan that permits or allows investments in employer securities. For example, 401(k) plans
frequently provide that an employer's contributions will be made and continue to be invested in
employer stock. A plan fiduciary may be required to disregard these provisions if allegiance to
the plan language will violate the Prudent Man Rule or the Exclusive Benefit Rule.

E. Co-Fiduciary Liability
Under ERISA section 405(a), a fiduciary may be liable for the acts or omissions of a co-
fiduciary if the fiduciary knows that the person committing the act or omission is a fiduciary with
respect to the same plan, participates knowingly in the act or omission and knows that the act or
omission is a breach of fiduciary duty.

A fiduciary also may be held responsible for a breach
committed by a co-fiduciary if the first fiduciary breached his or her own responsibilities under
ERISA section 404(a), thereby enabling the second fiduciary to violate ERISA.

Finally, a
fiduciary will be held responsible for a breach committed by a co-fiduciary if the fiduciary has
knowledge of a breach committed by the co-fiduciary and fails to make reasonable efforts under
the circumstances to remedy the breach.

F. Co-Trustees
If a plan provides for co-trustees, plan assets are to be jointly managed unless the trustees
agree (in accordance with the trust instrument) to allocate specific responsibilities, obligations
and duties among themselves. If trustee duties are allocated in this fashion, a trustee to whom a
duty has not been allocated is not liable for losses due to acts and omissions of the trustee to
whom the duty has been allocated.

See In re Enron Corp. Securities, Derivative & ERISA Litigation, 284 F. Supp. 2d 511 (S.D.
Tx. 2003); In re Sprint Corp. ERISA Litigation, 2004 U.S. Dist. LEXIS 9622 (Kan. 2004).

ERISA 405(a)(1).
ERISA 405(a)(2).

ERISA 405(a)(3)
. Reasonable efforts can consist of rescinding the transaction, notifying the
plan sponsor of the breach, filing suit in a federal district court or contacting the Department of Labor
regarding the breach. The reasonableness of a fiduciary's efforts will be determined in light of the
surrounding circumstances, including the nature of the breach and the fiduciary's responsibilities.
Employee Benefits Law, ch. 5, at 296.
ERISA 405(b)(1)(B).

If plan assets are held in more than one trust, the trustee of only one of the trusts is not
liable under ERISA's co-trustee rules for the acts and omissions of the trustee of any other
trust.

G.Allocation of Trustee Responsibilities
Section 403 of ERISA provides that the trustees of a plan must have the exclusive
authority and discretion to manage and control the assets of the plan.

As mentioned above,
co-trustees may allocate so-called trustee responsibilities (which are responsibilities that relate
to the management or control of plan assets) among themselves, but trustee responsibilities
generally may not be allocated to others.

This general rule is subject to three exceptions.
Perhaps most importantly, a plan may provide that the trustee is subject to the direction of
a named fiduciary who is not a trustee.

A plan also may permit the appointment of an
investment manager with authority to manage, acquire or dispose of plan assets. If an
investment manager is properly appointed, the plan trustee no longer has the responsibility for
managing the assets controlled by the investment manager and is not liable for the investment
manager's acts or omissions.

In addition, a plan trustee may follow the directions of plan participants if the plan and the directions comply with the requirements of ERISA section 404(c).
The requirements of section 404(c) are discussed below.

H. Allocating and Delegating Non-Trustee Responsibilities
Named fiduciaries may allocate responsibilities other than trustee responsibilities (i.e.,
they may allocate responsibilities that do not involve the management and control of plan assets)
among themselves if the plan expressly provides a procedure for shifting non-trustee fiduciary
responsibilities.

If named fiduciaries follow the plan's allocation procedures, they are not
liable for the acts or omissions of the fiduciary assuming the transferred responsibilities. Named
fiduciaries are liable to the extent they violate their own fiduciary responsibilities under ERISA
section 404(a)(1) with respect to the actual act of allocation and they also remain subject to the
general co-fiduciary liability rules discussed above.

A named fiduciary also may delegate non-trustee fiduciary responsibilities to someone
other than a named fiduciary if the plan so permits. Responsibilities typically delegated include
the responsibility for day-to-day plan administration, the disbursal of plan benefits and claims

ERISA 405(b)(3)(A).

ERISA 403(a).

ERISA 405(c)(1).

ERISA 403(a)(1) and 405(b)(3)(B).

ERISA 402(c)(3), 403(a)(2) and 405(d)(1). In order for the trustee to be relieved of any
responsibility, the investment manager must satisfy the requirements of ERISA section 3(38) and the
delegation must be authorized by the plan documents. Whitfield v. Cohen, 682 F.Supp. 188, 196
(S.D.N.Y. 1988).

For a discussion of the responsibilities of a directed trustee, see section II K (Responsibilities of
Directed Trustees) below.

ERISA 405(c)(1).
ERISA 405(c)(2).

review. If proper delegation procedures are followed, the named fiduciary will not be liable for
the acts or omissions of the fiduciary to whom non-trustee responsibilities have been delegated.

Plan fiduciaries (including fiduciaries to whom duties have been delegated by named
fiduciaries) also may hire agents to perform ministerial tasks. If the fiduciary exercises prudence
in the selection and retention of such agents, the fiduciary may rely on information, data,
statistics and analysis provided by the agent without risking exposure.

Any delegation of a fiduciary responsibility should be made with the Exclusive Benefit
Rule clearly in mind. Responsibilities should never be delegated to friends, relatives or business
acquaintances if such a delegation would conflict with the requirement that the fiduciary
discharge his or her duties solely in the interest of participants and beneficiaries and for the
exclusive benefit of those individuals.

I.ERISA's Prohibited Transaction Rules
ERISA supplements its general fiduciary responsibility requirements by specifically
prohibiting certain transactions between a covered plan and related parties, referred to as parties
in interest.

Under section 406(a) of ERISA, a plan fiduciary is specifically prohibited from engaging
in certain transactions with a party in interest. The list of banned transactions includes: the sale,
exchange or lease of property; the lending of money or other extension of credit; the furnishing
of goods, services or facilities; or the transfer or use of plan assets. A plan fiduciary also is
prohibited from acquiring or holding any securities issued by the plan sponsor other than
qualifying employer securities.

The self-dealing prohibitions of section 406(b) also are quite significant.

Section 406(b) prohibits a plan fiduciary from dealing with the assets of the plan in his own
interest or for his own account or receiving any consideration for his personal account from any
party dealing with the plan in a transaction involving plan assets.

The self-dealing provisions
also prohibit a plan fiduciary from acting on behalf of a party whose interests are adverse to the
interests of the plan or its participants.

ERISA provides for certain exemptions from the prohibited transactions listed in
section 406. ERISA section 408(a) provides for administrative exemptions (granted by the
Secretary of Labor on a case-by-case basis) and statutory exemptions which permit certain
classes of transactions.
If a transaction is a prohibited transaction under ERISA section 406 and an exemption is
not available, the transaction must be undone or corrected. The fiduciary also will be liable

ERISA 405(c)(1) and (2).

29 C.F.R. 2509.75-8, FR-11 (1976).

ERISA 406. The term party in interest is defined in ERISA section 3(14).

ERISA 406(a) and 407(a).
ERISA 406(b)(1) and (3).
ERISA 406(b)(2).

to the plan for losses resulting from the prohibited transaction and will be required to disgorge
any profits.

Although section 406 of ERISA only imposes a duty on fiduciaries of covered plans, the
Supreme Court has held that a non-fiduciary may be held liable under section 502(a)(3) of
ERISA for participating in a prohibited transaction.

Section 4975 of the Internal Revenue Code of 1986 (the) also imposes an excise
tax on disqualified persons participating in the transaction in an amount equal to fifteen
percent of the amount involved in the transaction for each year in the taxable period.

If the prohibited transaction is not corrected in a timely manner after the receipt of notice to do so from
the Internal Revenue Service, a tax of 100% of the amount involved also may be imposed on the
disqualified person. The term disqualified personincludes, but is not limited to, plan
fiduciaries.

A fiduciary acting only as such is not liable for any excise taxes imposed by Code
section 4975.

II. RECURRING 401(K) PLAN ISSUES
The fiduciaries of a 401(k) plan, like the fiduciaries of any other employee benefit plan,
are subject to all of the fiduciary standards referred to above. The application of these standards
to situations that frequently confront 401(k) plan fiduciaries is described below.

A. Bundled Programs
Banks, brokerage houses, insurance companies, mutual fund companies and others now
offer a wide assortment of packaged or bundled 401(k) programs that include a plan document,
an investment program and plan administration services.

These bundled programs are
available to large and small employers alike and often are marketed and purchased like many
other financial products, with little or no thought given to the fiduciary responsibility provisions
of ERISA. The employer that blithely purchases a 401(k) program with the same amount of
diligence applied to the purchase of an auto insurance policy, however, may be making a grave
mistake.
When an employer purchases a particular bundled 401(k) plan, the employer actually is
making a series of decisions, several of which are subject to ERISA's fiduciary standards. By
adopting a bundled program, the employer either is establishing a new plan or modifying an
existing program. ERISA's fiduciary standards do not apply to the decision to adopt or amend a
plan. At the same time, in choosing a bundled program the employer also is selecting the related

ERISA 409(a).

Harris Trust & Savings Bank v. Salomon Smith Barney, Inc., 530 U.S. 238, 245 (2000).

IRC 4975(a).
IRC 4975(e)(2).

Investment companies and other service providers frequently team with each other in providing
bundled programs. If these parties share or split fees, prohibited transaction concerns may come into
play. See DOL Advisory Opinion 97-15A (May 22, 1997), reprinted in 24 Pens. & Ben. Rep. (BNA)
1327 (June 2, 1997) and DOL Advisory Opinion 97-16A (May 22, 1997), reprinted in 24 Pens. & Ben.
Rep. (BNA) 1329 (June 2, 1997).

investment program. This decision (as well as certain other decisions that are intertwined with
the selection of a particular bundled program) clearly is subject to ERISA's fiduciary standards,
including the Prudent Man Rule.

B. Choosing the Investment Alternatives
In designing a 401(k) plan, one of the first issues that must be addressed is whether plan
participants will be allowed to control the investment of their individual accounts. Years ago,
few plans allowed participants any say in the investment of their accounts. All plan assets were
invested by a trustee or investment manager and the participants shared in the gains or losses on
a common pool of investments. Most plans now provide participants with the opportunity to
direct the investment of their accounts. These programs typically allow plan participants to
choose from an array of available investment funds.

The individual or entity that selects the investment funds that will be made available to
the plan participants is a fiduciary and must comply with the Prudent Man and Exclusive Benefit
Rules described above. In this context, the Prudent Man Rule probably poses the most
significant challenge. Whether a particular decision is or is not prudent depends on the
circumstances, making it quite difficult to predict how a particular judge or the Department of
Labor will view a fiduciary's decision.
Although there is no failsafe list of steps that, if followed, will assure compliance with
the Prudent Man Rule, at a minimum, a well-advised fiduciary should consider taking all of the
following actions before selecting investment funds --

The fiduciary should become familiar with the available alternatives. For
example, banks, insurance companies, brokerage houses and mutual fund
companies all offer a wide array of products and the fiduciary should be aware of
and consider the available options.

The fiduciary should solicit information concerning several available competing
programs.

After the responses are received, the data should be assembled and analyzed.

The costs and past investment performance of the competing programs should be
compared, references should be checked and a considered decision should be
made.

In choosing between the old common pool approach and a participant directed investment
program, an employer is not subject to ERISA's fiduciary responsibility standards. Instead the employer
is exercising a settlor function and is free to design its plan in the fashion it deems appropriate. Once
this basic decision is made, however, ERISA's fiduciary standards come into play.

Depending on the fiduciary's personal experience and qualifications, expert assistance
may be helpful. But the fiduciary may not blindly rely on an expert's advice. The expert's
advice is merely a tool that the fiduciary should use in its decision making process.

In an effort to shield plan fiduciaries from claims of breach of fiduciary duty in
connection with the selection of investment funds, some advisors recommend specifically
designating particular funds in the plan document. The reason for this recommendation is that by
designating the fund in the plan document, the fund selection process arguably becomes a
settlor function rather than a fiduciary decision. Based on the position taken by the
Department of Labor in its amicus brief in Tatum v. R.J. Reynolds Tobacco Company, which is
discussed in Section I.D., one can assume that the Department will disagree with this analysis.

C.Monitoring the Investment Alternatives
Once the trustee, investment manager or investment funds are initially selected, the
fiduciary must monitor their performance. At least annually and preferably quarterly, investment
performance should be reviewed against standard market indices. Periodically, performance
should be compared against the performance of competing programs, following an approach
similar to the one used in making the initial selection. Once again, professional assistance may
be necessary, depending on the experience of the fiduciary.

The recent publicity concerning mutual fund abuses illustrates that the plan fiduciaries
must focus on more than mere investment performance. Potential abuses by mutual funds and
others also need to be taken into account. In a written statement issued on February 17, 2004,
Ann Combs, the Assistant Secretary for Employee Benefits Security at the Department of Labor,
provided much needed guidance for fiduciaries attempting to fulfill their responsibilities in the
wake of an ever expanding list of allegations regarding prominent mutual fund families.

According to Ms. Combs, if a plan holds mutual funds that have been charged with
improprieties, the fiduciaries much consider the nature of the abuses, the potential impact of the
abuses on the plan's investments, the actions taken by the fund to limit the potential for abuses in
the future and any remedial action that should be taken to protect plan participants. In the
absence of specific allegations, the plan fiduciaries should consider whether the investment funds
held in their plans have procedures and safe guards in place to avoid abuse in the future. In any
event, in deciding whether to take action with respect to a particular fund, plan fiduciaries need
to be mindful of the Prudent Man Rule, should follow prudent procedures and should document
their decisions.

In re: Unisys Savings Plan Litigation, 74 F.3d 420, 435-36 (3d Cir. 1996), cert. denied, 519 U.S.
810, 117 S.Ct. 56 (1996).

For a good explanation of the duty to monitor, see In re: Sprint Corporation ERISA litigation,
2004 U.S. Dist. LEXIS 9622, * 60-62, (D. Kan. 2004).

Ms. Combs letter is available on the Department of Labor's website (www.dol.gov/ebsa).

D.Expenses
1.Amount
The expenses associated with investment options and various administration programs
available for 401(k) plans can have a significant impact on the rate of return experienced by plan
participants. In order to satisfy the Prudent Man Rule, the plan fiduciaries who are charged with
the responsibility for selecting these products have an obligation to carefully identify all of the
charges that will be incurred by the plan and assure that the charges are reasonable in light of the
services provided and other available alternatives.

The so called mutual fund scandal has caused an increased focus on plan expenses.
Mutual fund fees come in many different forms and it is often quite a challenge for a plan
fiduciary to fully understand all of the charges that might be exacted by a particular fund.

2.Paying Expenses From Plan Assets
Plan fiduciaries also have an obligation to assure that only appropriate expenses are
charged against plan assets. In Advisory Opinion 2001-01, the Department of Labor provided
guidance regarding the types of expenses that may be paid from plan assets.

Advisory Opinion
2001-01 builds on Advisory Opinion 1997-03.

The basic premise of both Advisory Opinions is
that expenses associated with a so-called settlor function should be paid by the settlor or
employer. Expenses associated with the implementation of the employer's decisions and the
administration of the plan may be paid from the plan.

Some of the expenses that may be paid from plan assets include the following:

The cost of a plan amendment necessary to maintain the plan's tax qualified status
(but not the cost for consulting services associated with choosing between
alternative compliance strategies).

Normal discrimination testing expenses (but not testing expenses associated with
the design of various alternative benefit formulas or contribution allocation
approaches).

Expenses associated with requesting a determination letter from the Internal
Revenue Service.

Expenses incurred to amend a plan to assure compliance with an applicable law.

In 1998, the Department of Labor issued a participant's guide to 401(k) plan fees, A Look at
401(k) Plan Fees. The Department also prepared a more extensive study on 401(k) plan fees. Both the
participant's guide and the study are available on the Department's website (www.dol.gov/dol/ebsa).

DOL Advisory Opinion 2001-01A is available on the Department's website (www.dol.gov/ebsa).
DOL Advisory Opinion 1997-03A is available on the Department's website (www.dol.gov/ebsa).

On January 3, 2003, the Department of Labor provided additional guidance with the issuance of
several fact patterns. The fact patterns are available on the Department's website (www.dol.gov/ebsa).

Expenses incurred to determine the amount of plan assets that should be
transferred to a successor plan in connection with a spin-off, if the expenses are
incurred in connection with the implementation of a prior decision to spin-off the
participants and assets. The result would be different if the expenses were
incurred in connection with the plan sponsor formulation of its decision to
spin-off the assets.

Benefit calculations for a particular participant.

Expenses associated with plan communications.

Once a plan is amended to implement a loan program or other plan feature,
expenses attendant to operating or administering the feature.

Ongoing expenses of an outside administration company.

Other reasonable expenses of implementing a settlor decision.
On the other hand, the following types of expenses should not, as a general rule, be paid
from the assets of a plan:

Expenses associated with the initial decision to establish a plan as a qualified
plan.

Consulting services designed to assist an employer in choosing between
alternative strategies for assuring compliance with applicable requirements.

Plan design studies in the context of corporate combinations.

Plan amendments other than qualification amendments. For example, an
amendment that is intended to add a loan or hardship withdrawal feature to a plan
should not be paid from plan assets.

Plan amendments to provide for a spin-off in a corporate transaction.

Amendments that relieve an employer of its responsibility to pay plan expenses.

Any activities that take place in advance of or in preparation for a plan
amendment.

Cost projections to determine the financial impact of a proposed amendment.

Any expenses that the plan documents obligate the employer to pay.

Any calculations required for the employer's financial statements.

3. Allocating Expenses to Participants
In Field Assistance Bulletin 2003-3, the Department of Labor dealt with the allocation of
proper plan expenses between and among the plan participants.

FAB 2003-3 addresses the
allocation of expenses on a pro rata, rather than a per capita, basis as well as the extent to which
expenses may properly be charged to an individual participant rather than the plan as a whole.
The general theme of FAB 2003-3 is that plan sponsors and fiduciaries have considerable
discretion in determining, as a matter of plan design or a matter of plan administration, how plan
expenses will be allocated among participants and beneficiaries.
If the plan sponsor has specifically indicated in the plan document that a particular
expense is to be allocated on a pro rata or a per capita basis, a plan fiduciary has an obligation to
follow that directive unless the fiduciary concludes that it is inconsistent with ERISA. If the plan
document is silent with respect to the proper method of allocation, the fiduciary must make that
determination in the exercise of its fiduciary responsibilities. In order to satisfy the Prudent Man
Rule, the fiduciary must weigh the competing interests of the participants and assess the impact
of the allocation methods on the participants. While a selected method may favor one class of
participants over another, according to the Department if a method of allocation has no
reasonable relationship to the services furnished or available to an individual account, a case
might be made that the fiduciary breached his fiduciary duties to act prudently and solely in the
interest of the participants in selecting the allocation method.

In FAB 2003-3, the Department also discusses the allocation of expenses to individual
participants rather than the plan as a whole. Some of the expenses that may be charged to a
participant individually rather than the plan as a whole are the following:

The expenses associated with processing a qualified domestic relations order.

The expenses associated with processing a hardship withdrawal.

The expenses associated with calculating benefits payable under different plan
distribution options.

The expenses associated with processing a distribution.

Plan administration expenses associated with the accounts of terminated
participants.

In the final analysis, in deciding how to allocate the expenses that are properly chargeable
to a plan, the plan fiduciaries are obligated to follow the Exclusive Benefit Rule and the Prudent
Man Rule. FAB 2003-3 provides helpful guidance with respect to the performance of these
obligations in particular situations.

Field Assistance Bulletin 2003-3 (December 16, 2003) is available on the Department of Labor's
website (www.dol.gov/ebsa).

E.Negative Elections
Prompted in part by a ruling from the Internal Revenue Service,some employers have
added negative election (also known as automatic enrollment) features to their 401(k) plans.
With a negative election program, a prospective plan participant is notified that a certain
percentage of his compensation (e.g., 3%) will be withheld and will be contributed to a 401(k)
plan on his behalf unless he elects otherwise. While these arrangements are acceptable from an
Internal Revenue Code perspective, they do place some added burdens on the plan fiduciaries.

With a negative election program, the participants who participate automatically likely
will fail to issue any investment directions. As a result, plan fiduciaries will be responsible for
the investment of the contributions made by these participants.

If the fiduciaries invest the
contributions in an investment option that declines in value, the inadvertent participant may well
be unhappy and assert a claim.
In order for a negative election program to pass muster under Revenue Ruling 98-30,
plan participants must have an effective opportunity to elect to receive the contributions in cash,
which necessarily means that the participants must receive an advance communication from the
employer or some plan fiduciary. Of course, these communications must be accurate in order to
satisfy the fiduciary's duty to avoid misinforming a plan participant.

F.Conversions
A number of issues arise when an employer or another plan fiduciary decides to convert
from one bundled product or one set of investment alternatives to another.

1.General Fiduciary Standards
Of course, in selecting the new bundled plan or investment package, the responsible plan
fiduciary must analyze the underlying investment alternatives and comply with the general
fiduciary standards described above, including most importantly, the Prudent Man Rule. If the
conversion also involves a switch in plan administrative service providers, this selection, too,
Rev. Rul. 98-30, 1998-25 I.R.B. 8.

A negative election program necessarily involves withholding the amount of the default
contribution to the 401(k) plan from the participant's pay. A number of states prohibit withholding
amounts from an employee's pay in the absence of a written payroll deduction authorization. Whether
these state statutes are preempted by ERISA section 514 is unclear.

Another alternative is to designate a default investment option. As described below in
Section II H 6 (Complying with the 404(c) Regulations -- Default Investments), whether default options
are effective is questionable.

The fiduciaries also may have some duty to assure that the period of time during which the
participant may elect to receive cash is adequate under the circumstances. On the other hand, a relatively
good argument can be made that the establishment of the election procedure is a settlor function that is
not subject to the fiduciary standards.

must pass muster under the Prudent Man Rule, the Exclusive Benefit Rule and the other
fiduciary standards.

2.Blackout Periods
The plan fiduciary also should consider the impact of any blackout periods on plan
participants. Typically, whenever a plan converts from one set of investment funds to another,
participants are precluded from taking any action (such as taking a loan from the plan or
transferring amounts from one fund to another) for a period of time that is generally referred to
as the blackout period. A blackout period is inevitable and deciding to convert to a program
that includes a reasonable blackout period certainly cannot be a breach of the fiduciary standards.
The plan fiduciaries nonetheless should consider the impact of the blackout period on the plan
participants and make every effort to minimize its length. Perhaps most importantly, the plan
fiduciaries should make sure that the rules that will apply during the blackout period are
carefully and accurately communicated to the plan participants well in advance of the
commencement of the blackout period in order to enable the participants to take action before the
period begins.
Section 101(i) of ERISA now requires plan fiduciaries to provide participants with
advance notice of any blackout periods. Generally, the notice must be provided 30-days in
advance of the blackout period.

Plan fiduciaries also need to be careful to avoid the stubborn implementation of the
blackout period. In In Re Enron Corp. Securities, Derivative & ERISA Litigation,

the plaintiff's criticized the directed trustee for continuing the blackout period in the face of rapidly
declining stock values. The plaintiff's claim survived the trustee's motion to dismiss.
3.Mapping
If participants are allowed to direct the investment of their accounts between and among
various investment funds, the conversion from the old investment alternatives to the new can be
a challenge. One alternative is to collect new investment instructions from all of the participants.
This approach, however, can be problematic. Because of inertia alone, many participants may

In one relatively recent case, the plaintiffs unsuccessfully attempted to claim that they were
entitled to the continuation of a particular set of investment funds. Franklin v. First Union Corporation,
84 F. Supp. 2d 720 (E.D. Va.) (2000). The district court concluded that plaintiffs do not have a vested
right to their past investment choices under the Signet Plan that could not be overridden by a valid plan
amendment. Id. at 732. Nevertheless, the district court also concluded that those participants who were
not informed of the changes to the fund line-up might have a claim against plan fiduciaries for breach of
their duty to provide accurate information concerning the investment choices. In the words of the district
court, the defendants had a duty to inform the plaintiffs of the changes in the investment funds in such a
manner as to provide the plaintiffs the opportunity to make decisions regarding their options, as required
by the regulations addressing 404(c)Id. at 736.

The Department of Labor has issued regulations implementing the requirements of
Section 101(i). 29 C.F.R. 2520.101-3 (2002).

In re Enron Corp. Securities, Derivative & ERISA Litigation, 284 F. Supp. 2d 511 (S.D. Tx.
2003).

fail to return the new investment instructions and the end result may be an unacceptable
extension of the blackout period.
An alternative approach that is favored by many, if not most, employers and service
providers is a technique called mapping. With mapping, each of the displaced investment
options is compared to the new options. When the conversion takes place, amounts are then
automatically transferred or mapped from the displaced option to the most comparable new
option.
Although mapping may be the most administratively acceptable approach, it may deprive
plan fiduciaries of any protection under section 404(c) following the completion of the
conversion. Based on the regulations issued by the Department of Labor under ERISA
section 404(c), many advisors believe that 404(c) relief is only available if the participant has
exercised actual control over the investment of his or her account. With mapping, the participant
never actually selects the new fund. Rather, the participant selected the displaced fund from
which the participant's account was transferred.
If the mapping concept is carefully explained to participants in ample time for them to
make investment fund changes before the blackout period begins, it may be possible to argue that
the mapping process results in a silent direction by the participant to transfer his account to the
mapped successor funds.
Whether this silent direction argument will be successful is unclear.

G.Voting and Tender Decisions
The voting of any employer securities held by a 401(k) plan, and decisions concerning
the tender of securities, also can prove troublesome.
If plan fiduciaries are responsible for voting and tendering employer securities, they must
observe all of the fiduciary standards described above. Plan fiduciaries who also serve as
officers or directors of the plan sponsor must be particularly mindful of the Prudent Man and
Exclusive Benefit Rules as well as the conflict of interest prohibitions of ERISA section 406(b).
If the voting and tender decisions are passed through to the plan participants, the
fiduciaries should carefully consider the positions taken by the Department of Labor in a series
of advisory opinions. The plan fiduciaries also should consider the special employer security
provisions described in Section II H 5 (Complying with the 404(c) Regulations Employer
Securities).
The Department of Labor initially took the position that plan fiduciaries may not
automatically follow the directions of participants with regard to the voting or tender of shares
allocated to the participant's account. In an April 30, 1984 letter regarding the Profit Sharing
Retirement Income Plan for the Employees of Carter Hawley Hale Stores, Inc., the Department
advised the trustee of the plan that it could accept the participants directions only if the trustee

See the discussion in Section II H 6 (Complying with the 404(c) Regulations -- Default
Investments).

concluded that the participants had exercised independent discretion, had received complete and
accurate information and had not been subject to coercion by the employer.
In 1995, the Department changed its stance a bit. In a letter to Ian D. Lanoff, the
Department rephrased its position with respect to a fiduciary's acceptance of participant
directions.

According to the Lanoff letter, a fiduciary must follow a participant's directions
unless the fiduciary is able to articulate well-founded reasons why doing so would give rise to a
violation of titles I or IV . . . .

H.
Complying with the 404(c) Regulations
1.
General
Most employers that adopt 401(k) plans allow the plan participants some say in the
investment of their accounts by implementing a Participant Directed Investment Program
pursuant to which participants are allowed to invest their accounts in an array of investment
funds.
ERISA includes an eminently logical provision that serves as the legal underpinning for
Participant Directed Investment Programs. This provision, which is found in section 404(c) of
ERISA, provides as follows:
(c)
In the case of a pension plan which provides for individual accounts and
permits a participant or beneficiary to exercise control over assets in his account,
if a participant or beneficiary exercises control over the assets in his account (as
determined under regulations of the Secretary) --
(1) such participant or beneficiary shall not be deemed to be a
fiduciary by reason of such exercise, and
(2) no person who is otherwise a fiduciary shall be liable under
this part for any loss, or by reason of any breach, which results
from such participant's or beneficiary's exercise of control.
Section 404(c) certainly seems to say that if a participant in a plan controls the
investment of his or her account the plan fiduciaries are not responsible if the investment turns
sour. Section 404(c) also says, though, that the Department of Labor has the ability to issue
regulations defining the circumstances under which a participant will be deemed to have
exercised control over the investment of his account. The rather exacting standards prescribed
by these regulations have potentially limited the utility of section 404(c).

Letter from Robert Monks, Administrator Office of Pension and Welfare Benefits
Administration, to John Welch, Latham & Watkins, re Profit Sharing Retirement Income Plan for the
Employees of Carter Hawley Hale Stores, Inc. (April 30, 1984), reprinted in 11 Pens. & Ben. Rep. (BNA)
633 (May 7, 1984). See also Letter from PWBA to unnamed trustee regarding unnamed plan, reprinted in
16 Pens. & Ben. Rep. (BNA) 390 (March 6, 1989).

Letter from Department of Labor to Ian D. Lanoff (Sept. 28, 1995), reprinted in 22 Pens. & Ben.
Rep. (BNA) 2249.

Id. at 22 Pens. & Ben. Rep. (BNA) at 2250-51.

Under the regulations, a fiduciary is relieved of responsibility and liability for a
participant's investment decision only if the participant has exercised meaningful, independent
control over the investment of his account. The regulations go on to provide that for this
standard to be met the participant must have the opportunity to:

Choose from a broad range of investment alternatives and diversify investments
within and among investment alternatives;

Give investment instruction with a frequency which is appropriate in light of the
market volatility of the investment alternatives; and

Obtain sufficient information to make informed investment decisions.

As will be explained below, these seemingly reasonable objectives may be quite difficult to
satisfy in practice.
2. Broad Range of Investment Alternatives
To qualify for the relief offered by section 404(c), a 401(k) plan must afford participants
the opportunity to invest in at least three different investment alternatives.
The investment alternatives must be sufficient to provide each participant the opportunity
to diversify the investment of his or her individual accounts so as to minimize the risk of large
losses, taking into account the nature of the plan, investments offered under the plan, and the
portion of the participant's or beneficiary's accounts over which he or she is permitted to
exercise control.

The goal is to afford each participant a reasonable opportunity to materially
affect the potential return and the degree of risk. Frequently, the opportunity to invest in look-
through investment vehicles (i.e., mutual funds or similar products) is the only prudent means to
assure an opportunity to achieve appropriate diversification.

In these circumstances, at least
three look-through investments must be offered as investment alternatives.
At least three of the investment alternatives (the core investment alternatives) offered
under the plan must meet all of the following requirements:

Each core investment alternative must be diversified.
Each core investment alternative must have materially different risk or return
characteristics.

When aggregated, the core investment alternatives must enable the participant or
beneficiary by choosing them to achieve a portfolio with aggregate risk and return
characteristics at any point within the range normally appropriate for the
participant or beneficiary.
29 C.F.R. 2550.404c-1(b)(i) (1992).
29 C.F.R. 2550.404c-1(b)(3)(i) (1992).
29 C.F.R. 2550.404c-1(b)(3)(i)(C)(1992).

Each core investment alternative, when combined with investments in the other
alternatives, must tend to minimize through diversification the overall risk of the
participant's investments.

In practice, these requirements have prompted most advisors to conclude that a
Participant Directed Investment Program must offer, at a minimum, a stock fund, a bond fund
and a money market (or similar) fund.
3. Frequency of Investment Instructions (the Volatility Rule)
Plans may impose reasonable restrictions on the frequency with which participants may
give investment instructions, as long as the restrictions are uniform and nondiscriminatory.
The volatility rule included in the regulations requires 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. At a minimum, participants must be given the
opportunity to give investment instructions no less frequently than once within any three-month
period. For some alternatives, though, the volatility rule requires that more frequent switching
be available.

Participants also must be able to readily move from more volatile investment alternatives
to a less volatile investment alternative. The regulations afford some flexibility by offering
alternative means for handling transfers from volatile investments.
Participants must be given the opportunity to obtain written confirmation of their
instructions.

4. Information Requirements
Under the regulations, a participant is considered to exercise control over the assets in his
account only to the extent that the participant has an opportunity to obtain sufficient information
to make informed investment decisions.

Complying with these information requirements
proves to be the downfall of many plans.
Certain information concerning the plan and the available investment alternatives must be
furnished to all participants and certain other information must be furnished only when requested
by a participant.
Information which is required to be furnished automatically to all participants includes:

29 C.F.R. 2550.404c-1(b)(3)(i)(B) (1992).
29 C.F.R. 2550.404c-1(b)(2)(i)(C) (1992).
29 C.F.R. 2550.404c-1(b)(2)(i)(A) (1992).
29 C.F.R. 2550.404c-1(b)(2)(i)(B) (1992).
29 C.F.R. 2550.404c-1(b)(2)(i)(B)(1) (1992).

An explanation that the plan is intended to constitute an ERISA section 404(c)
plan and that plan fiduciaries may be relieved of liability for losses which are the
result of participants investment instructions.

A description of the investment alternatives available under the plan, including a
general description of the investment objectives and the risk and return
characteristics of each alternative.

Identification of any designated investment managers.

An explanation of how to give investment instructions, any limits or restrictions
on giving instructions and any restrictions on the exercise of voting, tender or
similar rights.

A description of any transaction fees or expenses which are charged to the
participant's account.

Immediately following an investment in an investment alternative subject to the
Securities Act of 1933 (such as a mutual fund or other publicly traded
investment), a copy of the most recent prospectus, unless the prospectus was
furnished immediately before the participant's investment. In some cases, a
profile is an adequate substitute for the prospectus.

Subsequent to an investment, materials provided to the plan relating to the
exercise of voting, tender or similar rights, to the extent such rights are passed
through to participants.

A description of the information available on request and the name, address and
phone number of the plan fiduciary responsible for providing that information.
As noted above, certain information must be provided only on request. Information
which is required to be provided on request includes:

A description of the annual operating expenses borne by investment alternatives,
such as investment management fees.

Copies of any prospectuses, financial statements and reports and other
information furnished to the plan relating to an investment alternative.

A listing of assets comprising the portfolio of an investment alternative which
holds plan assets, the value of such assets and, in the case of such assets which are
fixed rate investment contracts issued by a bank, savings and loan association or
insurance company, the name of the issuer of the contract, the term of the contract
and the rate of return on the contract.

DOL Advisory Opinion 2003-11A (September 8, 2003), which is available on the Department of
Labor's website (www.dol.gov/ebsa).

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

Information concerning the value of shares or units in investment alternatives
available to participants, as well as information concerning the past and current
investment performance of the alternative.

Information concerning the value of shares or units in investment alternatives held
in the account of the participant.
5. Employer Securities
In the case of a plan that offers an investment alternative that is designed to permit a
participant to directly or indirectly invest in an employer security, section 404(c) relief is
conditioned on the following requirements in addition to those set forth above:

The employer securities must, among other things, constitute qualifying
employer securities (as defined in ERISA section 407(d)(5)), be publicly traded
on a national exchange or other generally recognized market and be traded with
sufficient frequency and in sufficient volume to assure that directions to buy and
sell may be acted upon promptly.

The plan must establish procedures intended to ensure the confidentiality of
information relating to participant transactions involving employer securities,
including the exercise of voting, tender and similar rights. These procedures must
be reduced to writing and distributed to all participants and beneficiaries.
Additionally, the plan must designate a plan fiduciary who is responsible for
ensuring the adequacy of the procedures and for monitoring compliance with the
procedures. The participants and beneficiaries must be given the name of the
fiduciary so designated. Finally, the plan must appoint an independent fiduciary
to carry out any activities that the designated plan fiduciary determines involve a
potential for undue employer influence on participants with respect to their rights
as shareholders.

Voting, tender and similar rights relating to employer securities must be passed
through to the participants, as must information provided to shareholders
generally.

The fiduciaries of a plan that otherwise meets the requirements of section 404(c) will not
lose the protection of section 404(c) merely because an employer security investment alternative
fails to meet the conditions for section 404(c) relief. However, plan fiduciaries will not be
relieved of liability for employer security investments, even if the investments are participant
directed, unless the requirements for section 404(c) relief are satisfied with respect to the
investments.

29 C.F.R. 2550.404c-1(d)(2)(ii)(E)(4) (1992).

6. Default Investments
A frequently encountered problem is how to deal with a participant who has not given
any investment instructions. A common approach is to specifically state in the plan document
that if a participant does not provide investment instructions, the participant's accounts will be
invested in the most risk-free investment alternative available, such as a money market fund.
Under the regulations, plan fiduciaries are not relieved of any liability for investing a
participant's account unless the participant actually exercises control over the investment of the
account.

As a result, many advisors have assumed that these default investment provisions
are ineffective and have cautioned plan fiduciaries to prudently invest the accounts of any
participants who have not given specific instructions. In light of the Eleventh Circuit's decision
in Herman v. NationsBank Trust Company,

this position may be unnecessarily conservative.
The NationsBank case arose out of competing tender offers for the stock of Polaroid.
One of the tender offers was made by Shamrock Acquisitions and the other was a self-tender by
Polaroid. Both of the tender offers were described by NationsBank in a letter to plan
participants, who were asked to instruct NationsBank regarding the tender of the shares allocated
to them. The letter also informed the plan participants that a failure to respond would be treated
as a silent direction not to tender the shares allocated to them.
In the Eleventh Circuit, the Department of Labor argued that NationsBank could not rely
on the plan's silent direction provision to support its failure to tender the non-voted shares.
Although the court noted the deference that should be given to the Department, it nevertheless
rejected the Department's position. According to the Eleventh Circuit, as long as participants are
clearly advised that the failure to issue any directions will be treated as a silent direction to not
tender the stock, the trustee may honor the silent direction.
Based on NationsBank, if a plan provides the participant with adequate advance notice, a
colorable argument can be made that a participant's failure to issue explicit instructions is a
silent direction to invest the participant's account in the plan's default investment option.
Whether this argument will be successful is unclear.
7. Disregarding Directions
As a general rule, in order for the regulations to be satisfied, the plan must provide that a
participant's instructions will be honored by the plan fiduciaries. Nevertheless, the fiduciaries
are allowed to disregard the participant's instructions in certain, limited circumstances.

29 C.F.R. § 2550.404c-1(d)(2)(i) (1992). Additional support for this conclusion can be found in
paragraphs (a)(1) and (c)(2) of the same regulations and in the Preamble to the final regulations.

126 F.3d 1354 (11th Cir. 1997).

29 C.F.R. § 2550.404c-1(b)(2)(ii)(B) and (d)(2)(ii) (1992).

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

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