The U.S. Department of Labor requires administrators of employee benefit plans that are subject to the Employee Retirement Income Securities Act (ERISA) to send in annual reports - Form 5500 - on the characteristics and financial operations of their plans. When considering whether to structure your plan so that it must comply with the requirements of this section, Section 404(c), of ERISA, be sure to consider the pros and cons of doing so.

Section 404(c) protects the fiduciary of a participant-directed plan from liability for losses resulting from a participant's investment decisions. For instance, as a plan sponsor, you would not want to be held liable for losses to a 64-year old employee's account after she invested 100 percent of her 401(k) money in a hi-tech growth fund. Nor would you want to be blamed for the lack of growth in a 24-year old's account because he put everything in a money market fund.

If you haven't met all of the requirements of Section 404(c), you may be charged with fiduciary breach and could be held liable for a participant's lack of proper diversification.

There is more to meeting Section 404(c) requirements than offering three or more investment choices. You must provide the participants of your plan with:

• An explanation that the plan is intended to be Section 404(c) compliant and generally relieve the fiduciaries of the liability for any investment losses;
• The ability to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan;
• At least three investment alternatives consisting of a broad range of diversified investments that have materially different risk and return characteristics;
• A general description of the investment objectives and risk and return characteristics of each investment alternative;
• The type and diversification of assets in the investment alternative's portfolio investments that, when combined with the other investment alternatives, achieve returns and minimize risks appropriate for participant's financial goals;
• The opportunity to exercise control over assets by giving investment instructions and the right to receive written confirmation of those instructions;
• An explanation on how to give investment instructions, including restrictions on transfers;
• A description of transaction fees and expenses, including commissions, sales loads, deferred sales charges, redemption, or exchange fees;
• Procedures for the purchase and sale of employer's securities, if offered, and the name, address, and telephone number of the fiduciary responsible for monitoring compliance with these procedures;
• Identification of the investment managers;
• The name, address, and telephone number of the plan fiduciary responsible for providing certain information upon request;
• A copy of the most recent prospectus for investment alternatives subject to federal securities laws; and
• Any information regarding voting, tender, or similar rights, to the extent that these rights are passed through to participants.

In addition to the above, participants and beneficiaries should be able to receive the following information upon request from the plan fiduciary:

• Annual operating expenses, such as investment management fees, administrative fees, and transaction costs, of each investment alternative;
• Copies of financial statements and reports on the investment alternatives;
• A list of the assets in each investment portfolio;
• Past and current performance of shares in an investment alternative; and
• Information on the value of shares held in the participant's account.

A plan may impose reasonable restrictions on the frequency with which participants and beneficiaries may give investment instructions. The frequency must be appropriate for the investment alternative's expected volatility and must not be more than once within any three-month period.

Although not required by Section 404(c), employee education is a tool you can use in your effort to reduce your fiduciary liability for investment selections by participants. Many plan participants are afraid to make investment decisions. And when they do, they don't know why they did what they did. They are either too conservative or take on more risk than is necessary. By teaching your employees about asset allocation in relation to their individual goals, you will help them become better investors. They will better understand the risks and rewards of each of the investment alternatives in the plan and will be less likely to blame you whenever the markets are down.

By complying with Section 404(c) rules, prudently selecting and monitoring the investment alternatives, and offering investment education, you should be able to minimize the potential fiduciary liability for, and have a good defense to, participant claims due to investment losses in their accounts.

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Updated: January 1, 2013

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.