Owners’ Retirement Fund Responsibility
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.
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.
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.
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.
Employee Retirement Income Security Act
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.
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
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
They can hire the expertise by retaining an individual
investment advisor or working with a plan provider who
combines investment management with fiduciary compliance.
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.
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.”
Compliance Means Reduced Legal Liability
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
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
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.