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Court Rules On Criteria For "Participant-Directed" Plans

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A federal court of appeals in Chicago ruled recently in Jenkins v. Yager that a retirement plan may qualify as a “participant-directed” plan that involves reduced fiduciary responsibilities, even though the plan fails to satisfy the Employee Retirement Income Security Act of 1974 provision that establishes specific criteria for participant-directed plans.

Typically, investments for ERISA plans must be managed exclusively by trustees or other fiduciaries who may become liable for plan investment losses if they are inattentive or otherwise imprudent. However, plans that qualify as “participant-directed” may allow participants to make investment decisions for their accounts – e.g., allocating the account among a menu of mutual funds – rather than having the plan trustee or other fiduciaries determine those investments.

Because participants are responsible for managing their accounts directly, the trustee and other fiduciaries of participant-directed plans generally are not responsible for managing these accounts, and are not liable for losses resulting from the participants’ investment decisions.

ERISA contains a specific provision – Section 404(c) – which, along with accompanying Department of Labor regulations, establishes extensive criteria that must be satisfied for a plan to qualify as participant-directed. For example, the regulations under Section 404(c) require that participants must be able to change their investment elections at least quarterly (and in some cases more frequently).

However, the court in Jenkins v. Yager held that a plan which permitted participants to adjust their investment elections only once per year could nevertheless qualify as a participant-directed plan with reduced responsibilities for plan fiduciaries.

Jenkins v. Yager involved the following facts: Earlene Jenkins participated in a 401(k) plan that Mid America Motorworks Inc., Effingham, Ill., a company that Michael Yager owned and operated, had established in 1991. That plan allowed participants to defer up to 15% of their salary and invest it in 1 of 4 funds, with Mid America matching up to 6% of that deferral. Participants could change their investment elections only once per year (not quarterly, as required under the ERISA Section 404(c) regulations). Neither Yager nor any other plan fiduciary ever reviewed the participants’ investment decisions.

From 2000-2002, the plan, including Jenkins’s account, sustained significant investment losses. Jenkins sued, asserting that because the plan did not satisfy ERISA Section 404(c), it did not qualify for “participant-directed” status that would reduce the responsibilities of plan fiduciaries. She argued that Yager should have prudently reviewed and overridden participant investment decisions, and that he was liable for the investment losses suffered by her plan account. The federal district court that heard the case ruled for Yager, and Jenkins appealed.

The court of appeals held that although the Mid America plan did not satisfy ERISA Section 404(c), the plan could nevertheless qualify as “participant-directed,” thereby relieving Yager and other plan fiduciaries from the duty of managing the investments for participant accounts. In its analysis, the appeals court viewed ERISA Section 404(c) as a “safe harbor,” reflecting a general intent by Congress to permit the delegation of investment authority to participants. A plan that satisfies the Section 404(c) requirements will qualify as a participant-directed plan.

However, according to the court, if a plan that allows participants to make investment elections does not satisfy the conditions of Section 404(c), the actions of plan fiduciaries in delegating decision-making authority to plan participants should be reviewed to determine whether it is appropriate to treat the plan as participant-directed and limit fiduciary responsibility.

The court focused on whether Yager acted prudently in selecting and monitoring the investment funds made available under the plan and in providing information about those investments to plan participants. Notably, the appeals court held that fiduciaries of participant-directed plans are not required to review each participant’s investment decisions to ensure that they are appropriate for that participant.

To date, Jenkins v. Yager is the only appeals court decision to adopt this broader understanding of the range of plans that may qualify as “participant-directed.” Further, this decision appears to be inconsistent with the views of the Labor Department.

Consequently, sponsors and fiduciaries of plans that provide for investment elections by participants will likely continue to undertake to comply with the provisions of ERISA Section 404(c), to obtain some greater certainty that their plans will be considered participant-directed, and their fiduciary responsibilities will be limited.