Publications

April 2000

401(k) Conversions: Legal, Fiduciary and Practical Considerations

By Sheldon M. Geller, Esq., Geller Group Ltd.

When ERISA fiduciaries decide to switch from one investment provider and custodian to another, there is typically a period during which participants are not permitted to make changes in their investment selections, known as the blackout period. Once the conversion is in process and the blackout period commences, participants can no longer direct the investments in their accounts. Because ERISA fiduciaries are liable for the performance of the investments during tbis time, they generally convert plan assets to cash just before it begins. Participants will not incur losses while invested in cash during the blackout period.

Employer Discretion

The summary plan description (SPD) typically is silent with respect to the rights of ERISA fiduciaries in conversions. The SPD for a 401(k) plan should summarize plan provisions that empower ERISA fiduciaries to establish rules for the investment of plan participants' account balances. The SPD should provide that ERISA fiduciaries will selea a series of mutual funds in which participants may invest their account balances and that ERISA fiduciaries, at their sole discretion, may change the menu of mutual funds available to plan participants at any time. ERISA fiduciaries should notify plan participants of any change in the plan's investment program.

Plan documents and trust agreements are typically silent with respect to the rights of ERISA fiduciaries in conversions. They should empower ERISA fiduciaries to administer the directed investment account provision and to apply procedures in a uniform and nondiscriminatory manner. The plan document should be the subject of a favorable determination letter from the IRS.

Safe Harbor

To be an ERISA section 404(c) safe harbor plan, Department of Labor regulations require a participant-directed 401(k) plan to provide, among other things, an opportunity for participants to 1) exercise independent control over the assets in their individual account and 2) choose from a broad range of investment alternatives.

Once participants in an ERISA section 404(c) plan exercise independent control by giving investment instruction with respect to existing account bat ances or future contributions, ERISA section 404(c) relief will continue to be available with respect to such instruction as long as participants continue to have the opportunity to exercise control over their existing account balances and contributions.

During the blackout period when participants are not be able to exercise independent control over the investment assets in their individual accounts, the 401(k) plan thus becomes a trustee-directed plan, much like a traditional pension plan. Accordingly, ERISA fiduciaries need to invest plan assets prudently and for the exclusive benefit of plan participants and their beneficiaries.

During the blackout period, the 401(k) plan would fail to meet the ERISA section 404(c) safe harbor requirement to provide for a broad range of investment options. Noncompliance with the safe harbor provisions does not mean that a plan violates ERISA. Rather, it means that the statutory relief from fiduciary liability for any losses due to participants' exercise of control is not applicable.

ERISA fiduciaries would only be liable for losses in participant accounts during a blackout period that resulted from imprudent investment decisions. Losses would be limited to declines in principal and not the opportunity loss of potential gains that might have been realized by not converting to cash.

Prudence

It would appear that no facts and circumstances test could find it imprudent for ERISA fiduciaries to convert existing plan mutual fund investments into cash during a blackout period. There is no other method appropriate for the switching of mutual funds to a successor-funding vehicle.

Thus, a conversion from mutual funds to cash and then back to the same or substantially simiLar mutual funds would not, in all likelihood, be construed as imprudent if such conversion were required by the change of independent custodians and trustees.