Participant Direction without 404 (c) Compliance

The pension community has long debated the implications of failing to comply with the statutory requirements of ERISA 404(c). To what extent is a fiduciary at risk, if a plan with participant direction does not satisfy the requirements of Section 404(c)? A recent decision by the Seventh Circuit Court of Appeals makes it clear that ERISA 404(c) is merely a statutory safe harbor and that, in the absence of compliance with ERISA 404(c), whether a breach of fiduciary duty has occurred depends upon the conduct of the plan fiduciary.

Earlene Jenkins was a participant in the Mid America Motor Works, Inc. Profit Sharing Plan. Michael Yager, the owner of Mid America, served as plan trustee. The plan included a Section 401(k) provision with a matching contribution, and plan participants were permitted to make limited investment directions with respect to salary reduction and matching contribution amounts. Specifically, participants could choose among four funds marketed by American Funds: the Euro-Pacific Growth Fund, the Growth Fund of America, the Income Fund of America, and the Cash Management Trust of America. These were the only funds offered by the plan from 1991 through 2002, and participants could change their investment directions only once per year at the end of the calendar year.

The company sponsored an annual meeting in December of each year, during which information was distributed regarding the performance of the funds over the past year. (Ms. Jenkins attended only one of these annual meetings during her employment with Mid America.) Following the annual meeting, information regarding fund performance was left in the employee’s break room. However, participants received only annual statements of their accounts, and due to the timing of distribution of those benefit statements, plan participants had to make investment choices for the following year before they knew how their earlier fund choices had performed in the previous year. During the 2000 through 2002 calendar years, the plan's 401(k) assets sustained investment losses of over $700,000.

Ms. Jenkins brought suit against the Company and Mr. Yager, alleging that both had violated ERISA by delegating control over plan assets to plan participants. Her attorneys argued that Section 403 of ERISA requires plan assets to be invested by trustees who must have "exclusive authority and discretion to manage and control the assets of the plan." (There are to express exceptions under Section 403, but neither applied to this case.) Since the exception described in ERISA Section 404(c) had not been met, the delegation of investment discretion to participants violated the exclusive authority rule of Section 403.

The Court of Appeals agreed with the District Court's holding that an "implied exception" to the non-delegation provision in Section 403 exists for plans that allow participant control. The Court further held that Section 404(c) was not the exclusive method of creating a participant-direction exception to Section 403, relying in large measure on the Department of Labor’s interpretation of the statute as set forth in the regulations under Section 404(c).

In reviewing the actual conduct of the plan trustee, the Court determined that the trustee had used due care in initially selecting the funds, in monitoring the funds, and in providing participants with information regarding the funds' performance. Consequently, it found no breach of fiduciary duty.

Interestingly, the Court did not comment about the number of funds offered, the frequency with respect to which investment decisions could be changed, or the fact that investment performance information was provided only once per year. This suggests that a plan sponsor has a fair amount of latitude in designing his participant direction provisions.

Michael P. Coyne