It was not the law that caused the shift from employer-directed to participant-directed 401 (k) plans. The Employee Retirement Income Security Act of 1974 (ERISA), which regulates all IRS-qualified 401(k) plans, does not require employers to offer participant-directed 401(k) plans. Many employers do precisely this, however, in response to employee demands (or demands by 401(k) activists) for as much participation and control as possible in the investing process.

Employee Demands Must Be Satisfied

Employees have not only demanded the right to make their own investment choices, they have asked for more choices. Here, too, employers have granted their wishes by stocking the plans with a myriad of new and more sophisticated investment options.

Now employees discover to their horror that they have obtained the responsibility they requested; it is up to them to sit on their own nest eggs and decide for themselves just what investment choices to make. Their anxiety has also been increased by the dire warnings about the inevitable demise of Social Security. According to a recent survey, only 8 percent of the nation's 30 million 401(k) participants are confident that they will have enough money to retire.

More Info Wanted

The result is that the employees who asked for more control and more choices are now asking for more information. ERISA requires that employees be given enough generalized information to enable them to make a reasonable investment choice. However, most employee participants are not asking just for more generalized information; they want specific investment advice that is tailored to their own particular needs. Even here, some trend-setting employers have complied with employee demands by offering personalized investment advice, at the employer's expense, through the Internet.

ERISA doesn't prohibit this but, as we shall see, it attaches fiduciary liability to the providers of such advice. This means they are personally liable for advice imprudently given. Even though the advice is to be given by a third party, an argument can be made that the employer (the plan sponsor) also assumes fiduciary liability for advice imprudently given if he or she has not taken steps to monitor the advice to ensure that it stays prudent.

Employee Activism and Litigiousness

The result of giving 401 (k) participants so much responsibility is that they may be more apt to make demands - and even start lawsuits. Two lawsuits that recently began the slow and tortuous route toward judicial resolution are, perhaps, omens of an ugly trend (see Money magazine, January 2000). One suit involves the quality of investment choices provided and alleges that the company, out of self interest, picked a poorly performing mutual fund; one that generated income for the employer's parent company. Allegedly, employee assets were dumped into this find against the wishes of employees and earned less than they would have had employees made their own choices. Another suit, against the same employer, alleges that the 401(k) plan was excessively expensive and did not provide enough investment choices.

The Communications Conundrum

ERISA provides, in Section 404(c), that where the investment decisions are in the control of the employee, the fiduciaries of the plan are not liable for losses resulting from the participant's exercise of control. This does not, however, relieve plan fiduciaries from the responsibility of providing investment information. The fiduciaries have a duty, under ERISA, to give plan participants sufficient information to enable them to make informed investment decisions. This brings us to the first communications conundrum: How much information is enough? The U.S. Department of Labor (DOL) regulations attempt to answer this question.

The second communications conundrum is this: When does the information provided cease being investment education and become investment advice, the kind of advice that makes the advisor a fiduciary? Again, DOL regulations attempt to solve this problem. It is a serious problem because, under ERISA, officers and benefits personnel may be deemed fiduciaries if they give investment advice as opposed to investment education. Telling participants what to do with their money is advice, not education, and creates fiduciary liability.

A third communications conundrum is this: Did benefits personnel, in their zeal to give investment education, somehow compromise the participant's free choice? Did the investment education, in the way it was given, somehow unduly influence the participant? One can imagine a situation where a participant has irrational fears of diversification and stubbornly keeps his or her whole nest egg in fixed assets. The benefits staffer makes a very strong presentation against fixed assets, causing the participant to go 100 percent into stocks. The market crashes-then the participant brings his lawsuit.

The Interpretive Bulletin

In mid-1996, DOL issued an Interpretive Bulletin (113 96-1) that identifies four general categories of information that will be considered investment education, not investment advice. The four categories are:

• Plan information-the benefits of plan participation, investments offered by the plan, etc.
• General financial and investment concepts
• Hypothetical models of asset allocation
• Estimating future retirement income needs

Category One: Plan Information

A person is not giving advice, and is thus not becoming a fiduciary, when providing information relating to such things as:

• How the plan works
• Characteristics of the fiind
• The benefits of plan participation
• The benefits of increasing contributions
• The impact of pre-retirement withdrawals on retirement income
• The risk/return characteristics of various investment alternatives

Category Two: General Financial and Investment Concepts

A person is not giving advice, and is thus not becoming a fiduciary when providing information relating to such things as:

• General financial and investment concepts, such as risk and return, diversification, dollar-cost averaging, compound return, and tax-deferred investments
• Historic differences in rate of return between different asset classes such as equities, bonds, and cash
• The effect of inflation
• Estimated future retirement income needs
• Determining investment time horizon
• Assessing risk tolerance

Category Three: Asset Allocation Models

A person is not giving advice, and thus not becoming a fiduciary, when he or she gives information that provides participants with models of asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles. The participant must be told, however, that he or she must consider his or her own financial situation in making decisions.

Category Four: Estimating Future Retirement Income Needs

A person is not giving advice, and thus not becoming a fiduciary, when he or she gives information that provides the means of estimating future retirement income needs.

Conclusion

If the investment information offered to participants falls within one of the four categories of DOEs Interpretive Bulletin, it is unlikely that the person providing such information will be found liable because a participant made an unwise investment decision. Our courts usually hold people responsible for the consequences of their own decisions. Of course, employers are still free to run the risk of giving investment advice and becoming fiduciaries. This requires them to make sure that such advice is always prudently given. As we suggested earlier, this could be a very tall order.