Business Owners’ Retirement Fund Responsibility

By Franklin Santagate

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In the late 1990s, 401(k) investing seemed easy, for both employers and employees. A company selected brand-name mutual funds for its 401(k) plan, participants selected from the choices, and, with few exceptions, the earnings in their accounts compounded at double-digit rates.

The early 2000s brought a different story. Regardless of the funds selected by employers, the vast majority went down, especially the funds invested in stocks. Employees’ dreams of early retirement were crushed by the rapid decline of their accounts.

As a result, fiduciary litigation—employees suing employers—became front-page news. Officers of Enron, WorldCom, and Lucent have been named as defendants in lawsuits filed by class action attorneys on behalf of impacted employees. Company officials and owners are faced with the possibility of losing much or all of their personal net worth.

Business owners must recognize that they have a fiduciary responsibility in funding their employees’ retirement programs. Poor investment decisions can have a significant impact on business owners’ personal financial well-being.

The Employee Retirement Income Security Act

Section 404(a) of the Employee Retirement Income Security Act (ERISA) is known as the “prudent expert” rule and requires business owners to act at the level of a knowledgeable investor when selecting investment alternatives for employees’ 401(k) plan. More specifically, business owners must pick the right kind of investment options so that employees can build reasonable portfolios based on their risk tolerances and time horizons. As several courts have ruled, a “pure heart and an empty head” are no defense to claims of a fiduciary breach. Good intentions are not enough; the good intentions must be combined with knowledge about selecting investments for retirement.

Business owners must understand the investment concepts of modern portfolio theory, the efficient frontier, and correlation among asset classes. If not, the law requires the owner to acquire the expertise to make skillful and prudent decisions about the investments to offer participants. There are many questions to be answered: What kinds of investments should be offered? How many funds should be offered? Should the funds be actively managed or passive index funds? What are the criteria for selecting the funds?

Business owners can acquire the necessary knowledge in two ways:

  • They can become experts through study and investigation, which probably takes more time than most business owners have.
  • They can hire the expertise by retaining an individual investment advisor or working with a plan provider who combines investment management with fiduciary compliance.

Either way, the owners of the business are ultimately responsible for picking the right 401(k) investments for the plan. After the investments have been selected for the plan, there is also an ongoing fiduciary duty to monitor the investments and, where needed, to remove and replace them. The failure to prudently monitor, remove, and replace funds is a breach of fiduciary responsibility and could lead to personal liability. The business owner will be held to the same standard for monitoring the investments as selecting them.

Section 404(c) of ERISA is, in effect, an “insurance policy” for the business owner. If business owners prudently select and monitor the investment options in the plan and comply with 404(c) requirements, they will not be liable for investment decisions made by the participants.
If business owners do not comply with 404(c) requirements, they could be liable for losses due to poor participant investment decisions. The Department of Labor recently emphasized this point in its brief on Enron litigation: “The only circumstances in which ERISA relieves the fiduciary responsibility for a participant-directed investment is when the plan qualifies as a 404(c) plan.”

Ensuring Compliance Means Reduced Legal Liability

Business owners have choices in compliance. They can comply with 404(c) of ERISA either by working with an attorney or a consultant to ensure that the company is satisfying all of the 404(c) rules, or by working with a provider that is familiar with 404(c) compliance and that provides the business owner with the necessary checklists and notices for the company’s employees. Businesses should work with advisors or providers to ensure compliance that transfers legal liability for imprudent investment decisions to the participants.

There are approximately 20 steps to 404(c) compliance, all of which must be met. To be certain that a 401(k) plan satisfies 404(c) requirements, business owners should work with a provider that emphasizes 404(c) compliance and provides comprehensive materials for satisfying these requirements. By complying with 404(a) and 404(c) requirements, business owners can go a long way toward limiting their potential liability, while producing high-quality benefits for their employees.

Franklin Santagate is a vice president for Beneco, Inc., a Tempe, Ariz.–based company managing the retirement and health-care accounts for more than 750 companies.





















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