The Pension Protection Act provides relief to fiduciaries who are responsible for selecting a default investment fund. A default investment fund is the fund to which assets in a 401(k) plan are invested if a participant does not provide investment direction. The Department of Labor (the “DOL”) believes that the choice of a default investment fund is a fiduciary decision by the plan fiduciary and not a decision by the participant.

The relief is welcome news. By following the statute and DOL regulations, plan fiduciaries will be relieved of fiduciary responsibility for a participant’s failure to direct his or her investments. In addition, the statute and regulations will help fiduciaries get past their general preference of selecting a conservative default fund that primarily preserved capital such as a money market or stable value fund.

The DOL has recently released proposed regulations providing guidance on this topic. This advisory provides a summary of this guidance.

The Pension Protection Act requires the DOL to issue final regulations no later than February 17, 2007. By complying with the regulations, fiduciaries will not be liable for any loss or breach that is the direct and necessary result of investing all or part of a participant’s or beneficiary’s account in a qualified default investment alternative (or “QDIA”). As you might expect, however, fiduciaries are not relieved from their duties of prudently selecting and monitoring QDIAs or from liability resulting from a failure to satisfy these duties and are not granted relief from the prohibited transaction rules. The DOL also cautions that fiduciaries must carefully consider fees and expenses in choosing investment alternatives.

To qualify for the relief, the fiduciaries must satisfy six conditions:

1. The plan assets must be invested in investments that satisfy the requirements of a QDIA (as defined below);

2. Participants and beneficiaries must have had the opportunity to direct their investments and failed to do so; Participants must be provided with any materials relating to their investments in a QDIA (such as account statements, prospectuses, and proxy voting materials);

4. Participants must be able to transfer their assets, in whole or in part, to any other investment alternatives available under the plan without financial penalty at least once every three months;

5. The plan must offer a broad range of investment alternatives within the meaning of the DOL regulations under ERISA Section 404(c); and

6. Participants and beneficiaries must be furnished a 30-day advance notice explaining the QDIA, prior to the first investment and thereafter prior to the start of each subsequent plan year.

The notice must be written in plain language and contain the following information:

1. A description of when a participant’s assets will be invested in a QDIA;

2. A description of the QDIA, including investment objectives, risk and return characteristics, and fees and expenses;

3. A description of the participant’s right to transfer out the investments from the QDIA to another investment alternative under the plan without financial penalty; and

4. An explanation of where the participant can obtain investment information on other investments alternatives.

QDIAs must satisfy the following requirements:

1. Except in limited circumstances, employer securities cannot be held in a QDIA.

2. QDIAs cannot impose financial penalties or other restrictions on the ability of a participant or beneficiary to transfer, in whole or in part, any assets from the QDIA to any other investment alternative under the plan.

3. An investment manager within the meaning of ERISA Section 3(38) or an investment company registered under the Investment Company Act of 1940 must manage the QDIA.

4. The QDIA must be diversified to minimize the risk of large losses. The QDIA must constitute one of the three following types of investment products:

a. A life style or target retirement date fund;

b. A balanced fund; or

c. A professionally managed account through which an investment manager allocates the assets of a participant’s account to achieve varying degrees of long-term capital appreciation and capital preservation based solely on the participant’s age, life expectancy or target retirement date. Essentially this means that an investment manager will create a default fund from among the funds available in the plan.

The DOL proposed regulations specifically note that stable value and money market funds do not qualify as QDIAs. Many questions remain open. How does a fiduciary transfer existing funds in the default investment fund to the new QDIA? What about plans that intend to use auto enrollment and in which participants have 90 days to request a refund of their contributions. If the funds are deposited in the QDIA for a short period, investment losses are possible. Instead, can a plan keep these funds in a money market account for the first 90 days? How does a fiduciary give the notice 30 days in advance if the plan allows immediate eligibility?

Because of these and other open questions, plan sponsors and plan fiduciaries may wish to await the release of final DOL regulations before implementing a QDIA.