“No-Match” = No Good: New Regulations Governing Social Security No-Match Letters
by Ashley M. Galloway
The stock market troubles of recent months have focused many on their diminishing retirement nest eggs. Most 401(k) plans are “self-directed,” meaning plan participants decide, and are responsible for, how their accounts are invested. However, there are any number of potential hazards for 401(k) plan administrators, including under self-directed account plans, and these can take on a much greater significance during difficult economic times. As losses mount, plan administrators are increasingly more likely to be targeted for alleged breaches of their fiduciary obligations to plan participants.
Generally speaking, plan administrators can be held personally liable for imprudent plan investments that result in losses to participants’ accounts. However, ERISA Section 404(c) provides an exception to the otherwise applicable fiduciary rules for certain “self-directed” plans. Nevertheless, avoiding fiduciary liability entails much more than simply allowing participants to choose their own investments.
To avoid fiduciary liability for participant losses in self-directed accounts, the plan administrator must, among other requirements, first satisfy its fiduciary obligations to make available to participants diversified and prudent investment choices; allow plan participants adequate flexibility to change their investment selections; and provide participants with specific information concerning the risk and return characteristics of the available investment options, as well as the fees associated with them. It is generally advisable to have a written investment policy statement as a guide for the plan administrator or investment committee to assist in meeting the fiduciary responsibilities of selecting and monitoring plan investments. Also, participants must receive notice that plan fiduciaries, such as the plan administrator, may be relieved of liability for any losses suffered as a result of the participants’ investment instructions under the plan.
The importance of diligent plan administration in other respects can also help minimize a plan administrator’s risk of fiduciary liability. In 2008, the United States Supreme Court issued its much anticipated decision in the case of LaRue v. DeWolff, Boberg & Associates. The case involved a participant who alleged that the plan administrator’s negligence in failing to carry out the participant’s investment instructions resulted in losses of some $150,000 in his plan account.
In LaRue, the Supreme Court unanimously reversed a decision by the United States Court of Appeals for the Fourth Circuit in favor of the plan administrator. The Fourth Circuit had ruled that the participant lacked standing to sue for a breach of fiduciary duty resulting in losses only to the individual’s plan account and not suffered by the plan as a whole. The Supreme Court’s rejection of this position resolved a long-standing controversy among the federal appellate courts concerning the ability of a plan participant to recover losses in a participant’s individual account resulting from a breach of fiduciary duty.
The Larue case raises the stakes for fiduciaries of 401(k) plans relative to plan administration and potential fiduciary liability for errors or omissions in administering these plans. Most obviously, Larue makes clear that mistakes in processing a participant’s investment instructions under a self-directed plan can result in fiduciary liability for losses incurred, or profits unrealized, in the participant’s plan account. Moreover, participants may have their cake and eat it too, inasmuch as if the administrator errs in processing the participant’s investment instructions and the incorrect investments perform well, the participant will reap the benefits, while if the investments perform poorly, the participant may sue the plan administrator to recover any losses. The Larue decision has implications well beyond the facts of the particular case, and plan administrators must exercise care in all aspects of plan administration given the expanded potential for fiduciary liability as a result of this ruling.
Another area of potential concern for plan sponsors and administrators, especially during difficult economic times, is maintaining the practice of timely depositing participant deferrals into the 401(k) plan trust. Under the applicable Department of Labor regulations, employee deferral amounts are deemed plan assets as of the earliest date they can reasonably be segregated from the employer’s general assets (and in no event later than the 15th business day of the month following withholding of the deferral). The failure to timely deposit the funds to the plan constitutes a prohibited transaction subject to excise tax.
The Department of Labor recently announced a new safe harbor for depositing 401(k) deferral amounts for plans with fewer than 100 participants. The safe harbor provides that if the plan deposit is made within seven business days after the amount is withheld from the employee’s pay, then no prohibited transaction will be deemed to have occurred, even though the amount might reasonably have been segregated from the employer’s general assets and deposited within a shorter period of time. Though plan deposits made outside of the seven business days provided under the new safe harbor will not automatically result in a finding of a prohibited transaction, it may be necessary to substantiate the reasonableness of such a delay to the Department of Labor.
A difficult economy brings with it additional perils for 401(k) plan sponsors and administrators. Certain lax administrative practices that may go unnoticed during better times can become the subject of lawsuits and grounds for fiduciary liability in an economic downturn. It is therefore advised that plan sponsors and plan administrators review their various administrative practices under their plans to ensure that any deficiencies are addressed.