Final regulations on participant-directed investments.

The Department of Labor (DOL) has issued final regulations on the liability of plan fiduciaries for investment losses resulting from participants' direction of investments under participant-directed individual account plans. These regulations update the proposed regulations issued in 1991 and are designed to address many of the problems that have been identified.

The Employee Retirement Income Security Act of 1974 (ERISA) governs, among other things, the conduct of fiduciaries responsible for investing trust assets. Under ERISA, a plan fiduciary is required to discharge his duties with the care, skill, prudence and diligence of a prudent investor and must diversify plan investments to minimize the risk of large losses. A plan fiduciary can be personally liable for a breach of this standard by a co-fiduciary.

Under ERISA and the final regulations, if a participant in a plan exercises control over the assets in his individual account, the participant will not be considered a fiduciary by reason of the exercise of control, and other plan fiduciaries will be relieved of liability for any losses resulting from such exercise (provided that the plan meets certain minimum standards set forth in the regulations). In general, if a plan does not satisfy these minimum standards, plan fiduciaries may be liable for losses resulting from participant investment decisions. (Compliance with the regulations is not required; the regulations merely provide protection from liability for participant investment choices if the minimum standards under the regulations are met.)

The final regulations retain most of the requirements from the proposed regulations, including: * A plan must offer at least three categories of investments with materially different risk and return characteristics. Investments within each investment category must be diversified to minimize the risk of large losses. * Participants should have reasonable control over the investment of the assets in their account and must be given the opportunity to provide investment instructions at least once every three months as to the three investment alternatives. In addition, depending on the volatility of a particular investment, the opportunity for investment direction may be required even more frequently. The final regulations provide new alternative techniques for handling transfers out of more volatile investments.

The major areas of change under the final regulations generally deal with the treatment of employer stock and the information that must be disclosed to participants on investment options. * For plans that permit investment in employer stock, the final regulations retain most of the requirements from the proposed regulations. Thus, under the final regulations, employer stock must be publicly traded, the same information provided to shareholders of the securities must be provided to participants, and voting and similar rights with respect to the securities must be passed through to participants. However, the requirement that an independent fiduciary be appointed to handle all activities relating to the purchase, sale and exercise of voting and similar rights of employer securities has been eliminated under the final regulations, provided the employer establishes procedures to ensure confidentiality as to activities relating to employer stock. However, if an activity involves a potential for undue employer influence on participants, an independent fiduciary must be appointed. * The final regulations contain detailed information on the type of information that must be provided to participants as to investment options under the plan. For example, participants must be provided with a description of investment alternatives under the plan, a description of any transaction fees or expenses charged to participants' account, and the procedures for providing investment instructions with respect to participants' accounts. In addition, participants must be allowed to request information on the annual operating expenses borne by investment alternatives, copies of prospectuses and other financial information relating to investment alternatives, and information on the assets in the portfolio of each investment alternative. * The final regulations were changed so that in-house managed funds, that is, those managed by a plan sponsor, could also receive protection. The proposed regulations would have made this impractical.

The final regulations are generally effective for plan years beginning on or after Oct. 13, 1994. Participant-directed transactions occuring before the effective date of the regulations will be governed by ERISA Section 404(c), without regard to the regulations.