On October 24, 2007, the Department of Labor released final regulations implementing certain amendments to the Employee Retirement Income Security Act of 1974 (“ERISA”) that were enacted as part of the Pension Protection Act of 2006. Under the new regulations, a participant in a participant directed account plan will be deemed to have exercised control over the assets in his or her account if, in the absence of investment directions from the participant, the plan invests in a qualified default investment alternative. By complying with the new regulations, a plan fiduciary will not be held liable for any loss, or by reason any breach, which occurs as the result of these default investments. This final rule is effective December 24, 2007.
The Pension Protection Act of 2006 added provisions to ERISA to encourage plan sponsors to add automatic contribution arrangements to their 401(k) plans by which all eligible employees would be automatically enrolled in the sponsor’s 401(k) plan, unless the employee affirmatively opts out of plan participation. The automatic enrollment of participants increased fiduciary exposure since automatic enrollment often results in the automatic enrollment of employees into default investments selected by the plan sponsor.
The new regulations provide plan fiduciaries relief from liability relating to default investments whether arising out of automatic enrollment or other failure of an employee to direct the investment of his or her assets under a plan. The regulations are not the exclusive means by which a fiduciary may satisfy his or her responsibilities under ERISA. The regulations, however, provide an important safe harbor which, if complied with, will relieve a fiduciary from liability when utilizing default investments under a plan.
There are six (6) conditions that must be satisfied in order to qualify for relief under the regulations. Briefly summarized, the six conditions are:
- Assets invested on behalf of participants or beneficiaries must be invested in a “qualified default investment arrangement” (“QDIA”).
- . A participant or beneficiary must have had the opportunity to direct investment of the assets, but has not done so.
- An initial notice must be furnished to participants and beneficiaries 30 days in advance of the first investment in the QDIA, and an annual notice must be provided 30 days in advance of each subsequent plan year. If the plan provides for immediate eligibility, notice is required upon eligibility. The notice must include:(a) A description of the circumstances under which the assets in the individual account of the participant or beneficiary may be invested in the qualified default investment alternative. (b) A description of the qualified default investment alternative, including a description of the investment objectives, risk and return characteristics, fees, and expenses. (c) A description of the rights of the participants and beneficiaries on whose behalf assets are invested in a QDIA to direct the investment of those assets to any other investment alternative under the plan, including any restrictions, fees, and expense in connection with the transfer. (d) An explanation of where the participants and beneficiaries can obtain investment information concerning other investment alternatives under the plan.
- Material, such as investment prospectuses, statements, etc., provided to the plan relating to the plan’s investment in the QDIA must be furnished to participants and beneficiaries.
- Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly.
- The plan must offer a “broad range of investment alternatives” as defined in section 404(c) of ERISA.
A QDIA is an investment:
- which does not hold or permit the acquisition of employer securities (subject to limited exceptions),
- allows participants and beneficiaries to transfer all or part of the QDIA investment into other investment alternatives under the plan,
- is managed either by an investment manager, a registered investment company, a trustee or plan sponsor that meets certain qualifications, or an investment product or fund, and
- constitutes one of the following types of investments (a) an investment fund product or model portfolio that is designed to provide varying degrees of longterm appreciation and capital preservation through a mix of equity and fund income exposures based on the participant's age, target retirement date, or life expectancy. Such products change their asset allocations and associated risk levels over time with the objective of becoming more conservative. This option includes so called life-cycle and target-retirement date funds, (b) an investment fund product or model portfolio that is designed to provide long-term appreciation and capital preservation through a mix of equity and fixed income exposures consistent with a target level of risk appropriate for participants of the plan as a whole (such an option includes a balanced fund), or (c) an investment management service with respect to which an investment manager allocates the assets of a participant's account to achieve varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures, offered through investment alternatives available under the plan, based on the participant's age, target retirement date, or life expectancy. Such portfolios change their asset allocation and associate risk levels over time with the objective of becoming more conservative with increasing age. An example of such a service may be a professionally managed account. (d) an investment product designed to preserve principal and provide a reasonable rate of return (such as a money market or stable value fund) but only if the investment is limited to 120 days after the date of the first elective contribution.
Importantly, the new regulations do not provide fiduciaries any relief from their normal fiduciary obligations relating to the selection and monitoring of a QDIA. A fiduciary is still required to engage in an objective, thorough, and analytical process that involves consideration of the quality of competing providers and investment products, as appropriate. As with other investments, fiduciaries must consider investment fees and expenses when choosing a default investment alternative. In addition, the new regulations also provide no relief for prohibited transactions under ERISA.