In my previous post, Fixing ERISA to Protect Against High Plan Fees, I discussed the failure of many 401(k)/404(c) plans to comply with ERISA’s fiduciary requirement to control a plan’s costs and avoid excessive fee. I also discussed the fact that many 401(k) plans attempt, unsuccessfully, to qualify as Section 404(c) plans in order to avoid liability for any losses that plan participants suffer in their plan account.
The key threshold for qualifying for 404(c) is whether or not the plan provided participants and their beneficiaries with the opportunity to “meaningful control over the assets in their account.” Two of the key issues used in determining whether a plan has provided the required “meaningful control” are whether the plan provided plan participants with “sufficient information to make informed investment decisions,” and whether the plan provided participants with a sufficiently broad range of investment options to allow participants to effectively minimize the risk of significant losses.
Three constant themes run through ERISA – prudence, documentation and disclosure. Both the Department of Labor and the courts have adopted Modern Portfolio Theory (MPT) as the standard of assessing prudence. The cornerstone of MPT is the use of the correlation of returns between investments in effectively diversifying investment portfolios to minimize the overall risk of significant investment losses.
Since both the Department of Labor and the courts have adopted MPT as the applicable standard in assessing prudence in selecting a plan’s investment options, it would seem that an ERISA fiduciary would obtain and consider the correlation of returns data for all investments chosen for a plan. Having such information, it would seem reasonable under “sufficient information” requirement to require that such information be provided to plan participants in order to allow them the same opportunity to prudently manage their individual accounts, the opportunity to make “informed investment decisions” as required under ERISA Section 404.
And yet, ERISA currently does not require that plan participants and their beneficiaries be provided with information as to the correlation of returns data for investment alternatives within a plan. ERISA states that under the education exception you can provide plan participants with general information about the concept of correlations of returns , you can even explain why correlations of returns information is important in constructing an investment portfolio, but plans cannot provide participants with the correlation of returns information necessary to actually properly diversify their ERISA account and protect themselves against significant losses.
While various explanations have been given for not requiring the disclosure of such correlation of returns data, I would suggest that the real reason may be that such information would expose the fact that in many cases, the equity investment alternatives offered in 401(k) are highly correlated and do not effectively offer plan participants the opportunity to effectively diversify the equity portion of their 401(k) accounts as required under ERISA Section 404(c).
The past decade has seen a noticeable trend of increased correlation of returns among equity-based funds, both domestic and international funds. Correlations scores of 90 percent or more are common. In the international equity sector, the trend has been more pronounced for international funds for developed nations/markets than it has been for developing nations/markets.
The refusal to require disclosure of correlation of returns information for a plan’s investment alternatives therefore not only denies participants the guaranteed “sufficient information to make informed investment decisions,” but also allows plans and fiduciaries to conceal violations of their fiduciary duty to offer plan participants a “broad range” of investment options in order to minimize the risk of significant losses, thereby violating their fiduciary duties of prudence and loyalty.
The inequity in such situations is clearly obvious. So why have the Department of Labor, Congress and the plans themselves failed to take the initiative to identify same and act to protect workers in 401(k) plans?
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