Default Investment Safe-Harbor
Rev. 10/27/06, E-mail Alert 2006-21

DOL Proposed Default Investment Rules
The Pension Protection Act of 2006 (PPA), amends ERISA Section 404(c) to provide that a participant who receives a notice that (1) explains his or her right to designate how contributions are invested and (2) describes the default investment into which contributions will be invested in the absence of his or her election, will be considered to have exercised control over the default investment. This provision was designed to assist plans with automatic enrollment and participant investment direction provisions. The Department of Labor was instructed to create safe-harbor criteria for default plan investments for participants who fail to make investment selections and has issued a proposed regulation for this purpose. The new regulation would apply for plan years beginning after Dec. 31, 2006. If the default investment meets the DOL criteria to constitute a Qualified Default Investment Alternative (QDIA), the plan fiduciary will not be liable for any loss that occurs as a result of such investment.

Notice Requirement
Participants and beneficiaries must be notified of the QDIA 30 days in advance of the first investment in a QDIA and annually at least 30 days before the start of each plan year thereafter. The notice must be provided with ample time for the participant to make investment choices before the plan year begins. The notice must describe the plan’s provisions governing the circumstances under which contributions or other assets will be invested in a QDIA. The notice must also provide the investment objectives of the QDIA and the right of the participant or beneficiary to move the money out of the QDIA without an investment penalty.

The DOL has asked for comments to be received by Nov. 13, 2006. The QDIA rules will become effective 60 days after the final regulation is published in the Federal Register.

Permitted Investments
Section 624(a) of PPA added a new section 404(c)(5) to ERISA. It provides that a participant in an individual account plan will be treated as having exercised control over those assets (including contributions and earnings) in his or her account that -- in the absence of an investment election -- were invested in accordance with regulations prescribed by the Secretary of Labor. The Committee Report explaining section 624(a) directed that the regulations provide guidance on the appropriateness of constructing a class of default investments which include a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both.
Previously, the DOL had emphasized preservation of capital when it drafted the automatic rollover default investment regulations. However, capital preservation funds are unlikely to yield an adequate investment return for most active participants or beneficiaries over the long term, so the DOL modified the QDIA rules based on the need to yield adequate retirement savings.

Fiduciary Relief
In DOL's view, the statutory language provides relief to the fiduciaries of any participant-directed individual account plan that complies with its document terms and with the Department’s proposed regulation under section 404(c)(5). Thus, relief is not contingent on a plan having ‘‘ERISA 404(c) plan’’ status or otherwise meeting the requirements of DOL Reg. Sec. 2550.404c–1.
However, nothing in the proposed regulation relieves an investment manager from its general fiduciary duties or from any liability that results from a failure to satisfy those duties, including a liability for investment losses. Therefore, investment fees and expenses must be carefully considered and if the plan offers more than one QDIA, fees and expenses will be an important consideration in choosing among them.

The Six Conditions for Fiduciary Relief

1. The participant's or beneficiary's assets be invested in a QDIA.
   
2. The participant or beneficiary had to have the ability to select the investments before the QDIA was used. Once the participant or beneficiary makes an investment election, the QDIA may not be used.
   
3. Notice must be provided at least 30 days in advance of the first investment in a QDIA and 30 days in advance of each subsequent plan year.
   
4. Investment material provided to the plan on the QDIA, such as, account statements, prospectuses, and proxy-voting materials, must be provided to the participant or beneficiary.
   
5. The participant or beneficiary in a QDIA must be permitted to transfer the QDIA without penalty to another plan investment; the transfer must be permitted with the same frequency that applies to other plan investments, but not less than on a quarterly basis.
   
6. The plan must offer participants and beneficiaries the opportunity to invest in a “broad range of investment alternatives,” as defined in DOL Reg. Sec. 2550.404c-1. A range of investment alternatives is defined as that sufficient to permit investment in a diversified portfolio. The ERISA 404(c) investment rules would be used as the standard for this determination.

QDIA Requirements
According to the proposal, a QDIA:

1. May not be invested in employer securities, with two exceptions:
   
   1. Employer stock held or acquired by an investment company registered under the Investment Company Act of 1940, or a similar investment vehicle regulated and subject to periodic examination by a State or Federal agency and with respect to which investment in such securities is made in accordance with the stated objectives of the investment vehicle and independent of the plan sponsor or an affiliate thereof.
      
   2. Employer securities acquired as a matching contribution from the employer/plan sponsor or at the direction of the participant or beneficiary prior to the QDIA. This is provided that there is no restriction on transferability. If there is a restriction, the safe-harbor would not be available until the restriction expires.
      
      This could occur if the participant or beneficiary had given direction with respect to employer securities but failed to provide a new investment direction after a change in investment alternatives, provided the plan terms indicated the subesquent investment in a QDIA would permit the investment management service to hold or manage those employer securities in the absence of direction from the participant or beneficiary. In such a case, the investment management
      could not acquire any additional employer stock.
      
      
2. May not restrict the participant or beneficiary from transferring the funds in a QDIA to any other investment alternative available under the plan; the transfer must be permitted with the same frequency that applies to other plan investments, but not less than on a quarterly basis and may not charge a financial penalty to move the funds in the QDIA to other plan investments;
   
3. Must be managed by an investment manager or an investment company registered under the Investment Company Act of 1940; thus, those responsible for the QDIA are “investment managers” within the meaning of ERISA section 3(38);
   
4. Must be diversified to minimize possible investment losses,
   
5. Must be one of the following three types of investment products
   
   1. A life-cycle or targeted-retirement-date fund. This option focuses on the participant’s age, target retirement date or life expectancy of an individual participant. The fund might be a “stand-alone” or “fund-of-funds” comprised of various investment options available under the plan for participant investment. A “fund-of-funds” may include a money market, stable value or similar capital preservation vehicles among the equity and fixed-income exposures.
      
   2. An investment fund product or model portfolio designed to provide long-term appreciation and capital preservation through a mix of equity and fixed income exposures consistent with a target level of risk appropriate for participants of the plan as a whole. The approach is based on the demographics of the plan’s participants. This approach would not require the age of an individual participant to be taken into account. An example would be a “balanced fund.” As with the first option, this may be a “stand-alone” or “fund-of-funds.” Demographic changes may require new or additional investment fund products.
      
   3. Professionally managed account. An investment management service for each participant based on the participant’s age, target retirement date or life expectancy. Becoming more conservative with the age of the participant, i.e. decreasing risk with increasing age. Note: this regulation does not require an investment manager to consider an individual’s risk tolerance, other investments or other preferences of an individual participant in the plan.

Note: A person who is named as fiduciary with respect to the control or management of the assets of the plan may appoint an investment manager to manage any assets of a plan. If an investment manager is appointed, then the trustee(s) shall not be liable for the acts or omissions of such investment manager(s) or to invest or manage any assets subject to the investment manager.

Plan fiduciaries remain responsible for the prudent selection and monitoring of the QDIA.