Defined Contributions Insights MagazineJuly/August 2008
Qualified Default Investment Arrangements
The questions continue.
by Ian Kopelman
The Department of Labor has offered general guidance, through final regulations and Field Assistance Bulletin 2008-03, on the application of Section 404(c)(5) of ERISA and the use of a qualified default investment arrangement (QDIA) to limit fiduciary liability for investment losses where a participant has failed to make an affirmative investment election. These pronouncements represent a giant leap forward in the protections offered to plan decision makers in the implementation of default investment arrangements. However, plan decision makers continue to struggle to apply the rules in a way that maximizes the available protection.
Participant Re-Enrollment
It has been suggested that to take full advantage of the protection offered by the use of a QDIA, a plan sponsor should consider re-enrolling all participants in its plan, regardless of whether they have existing investment elections in place (including elections of funds other than the default). Re-enrollment would involve giving notice to all participants that all prior investment directions will become ineffective and that their account balances will be invested 100 percent in the QDIA unless they provide the plan sponsor with written direction to the contrary within a designated period (e.g., within 90 days). After the transfer, the participant could elect to transfer out of the QDIA as required by the QDIA rules. The rationale for this approach appears to be that this blanket re-enrollment would ensure that any participant from whom the plan sponsor has not received a new investment direction would be — by default — invested in the QDIA and thus the plan fiduciary would be protected from liability for any investment losses by that participant.
This proposal goes beyond re-enrolling participants who were defaulted into the plan’s current default fund or re-enrolling all participants invested in the current default fund when the plan sponsor cannot distinguish between defaulted participants and those who made an affirmative election to invest in that fund. Both of these situations apply only to investments in the plan’s current default fund and comply with the final QDIA rules. The plan-wide re-enrollment discussed above, however, goes beyond these accepted approaches and ignores potential problems for participants who already have an affirmative investment election selecting a fund other than the default.
Potential Impact of FAB 2008-03
When implementing this approach, it must be kept in mind that Section 404(c)(5) and the QDIA rules do not exist in a vacuum. Fiduciaries of participant-directed individual account plans must meet specific investment fund and participant disclosure requirements if they want to receive general protection under Section 404(c) from liability for losses resulting from investments made pursuant to participants’ affirmative elections. In addition to considerations of getting and keeping Section 404(c) general protection, plan sponsors and fiduciaries must take into account the impact of their decisions upon employees’ attitudes toward the employer and the plan. We believe that the plan-wide re-enrollment approach fails to address either of these issues.
The potential impact of transferring all investments on a plan’s general Section 404(c) protection will depend on the individual situation. However, by voiding the existing participant investment elections the plan sponsor will, in effect, be substituting its judgment for that of the impacted participants with respect to the investment of their accounts. Assuming that a plan is fully covered by Section 404(c) general protection, under this approach the plan sponsor or other decision maker will be assuming investment responsibility for the investment of accounts of participants who made a prior election and give up any claim to general Section 404(c) protection in the process. Further, we do not believe it is clear whether under the current QDIA rules or any current guidance that the investment of these participants’ accounts in the QDIA would qualify for QDIA protection because participants had in the past made an election directing investment in a fund other than the default fund. Thus, assuming the plan sponsor is reasonably confident that its plan currently satisfies the requirements for general Section 404(c) protection, it should carefully weigh the impact of the loss of general Section 404(c) protection against the potential value of transferring these participants to a QDIA.
We believe that another serious issue with a plan-wide re-enrollment is a non-legal one — the reaction of participants to receiving notice that if they do not provide written direction within 90 days, their prior investment election will be nullified and their accounts will be 100 percent invested in a fund they did not select. Requiring participants who already made an affirmative investment election to make a new election in order to avoid a change in their investments appears to directly contradict the plan sponsor’s efforts to both educate participants about investing and encourage them to take responsibility for their own retirement savings. At best this mixed message likely will discourage participants who have made elections in the past from doing so in the future. At worst a participant who had an investment election on file, failed to respond within 90 days and then was surprised when his account was transferred to the QDIA, could argue that the plan sponsor was liable to him for any investment losses resulting from the transfer out of his chosen investment options.
Conclusion
There are two clearly acceptable circumstances for getting QDIA protection for participants invested in the plan’s default fund — defaulting new participants into the QDIA and transferring participants’ investments in the plan’s default fund to the QDIA. Transferring participant investments outside these circumstances with a blanket re-enrollment of every plan participant for every investment in the plan in the hope of gaining increased fiduciary protection under the QDIA rules could mean the loss of any general Section 404(c) protection the plan has pursuant to participants’ prior investment elections without achieving corresponding QDIA protection, and triggering employee relations problems to boot. Each plan sponsor must decide how to implement a QDIA based on the individual situation, but in making this decision it is vital to remember that simply maximizing investments in the QDIA may raise more problems than it solves.
Ian Kopelman is a partner at DLA Piper Rudnick Gray Cary US LLP. Ian is also PSCA’s legal counsel.