Investment Management/
ERISA Fiduciary Alert
December 2007
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DOL Issues Final QDIA Regulation
The U.S. Department of Labor (“DOL”) has issued its long-awaited final regulation (the
“QDIA Regulation”) that describes “qualified default investment alternatives” (“QDIAs”)
for participant-directed 401(k) plans subject to ERISA. In general, where the requirements
of the QDIA Regulation, which is in the nature of a “safe harbor” for default investments,
are satisfied, plan fiduciaries are relieved of liability for losses resulting from participants’
“default investments” in QDIAs to the same extent as they are relieved of liability for losses
resulting from affirmative participant investment directions. The QDIA Regulation, which
is effective on December 24, 2007, is expected to have a significant impact on the structure
of investment options offered under 401(k) plans.
Background
As a result of changes made by the Pension Protection Act of 2006, employees may be
“automatically enrolled” in qualified cash or deferred plans, including 401(k) plans.
Automatically enrolled participants will have the opportunity to direct their individual
account investments, but experience has shown that, in many cases, participants are unable
or unwilling to make affirmative decisions, leaving the plan sponsor and other fiduciaries
to face the dilemma of what to do with the money. The Pension Protection Act came to
the rescue by amending ERISA specifically to provide that a “non-directing” participant
will be deemed to have directed an investment of his or her account if the plan invests the
participant’s assets in a “qualified default investment alternative,” or QDIA. In such cases,
plan fiduciaries are relieved of liability for losses resulting from the investment to the same
extent as if the participants had made affirmative investment decisions. QDIAs—especially
when coupled with automatic enrollment and automatic contribution arrangements—are
likely to substantially increase assets invested in 401(k) plans.
Important Changes from the Proposed Regulation
The QDIA Regulation differs in a number of important ways from the proposed regulation
issued on September 27, 2006 (the “Proposed Regulation”).1 The following summarizes
the most significant of these changes.
Stable Value
Although insurance companies and related industries lobbied heavily to have stable value
products qualify as QDIAs, the DOL concluded that these products, standing alone, generally
would not meet participants’ long-term retirement needs. The QDIA Regulation does permit
plan sponsors to use stable value funds for limited purposes, however:
„
1
Under the QDIA Regulation, a plan may provide for default investments in a stable value
product for up to 120 days after the date of the participant’s first elective contribution.
71 Fed. Reg. 56806 (Sept. 27, 2006). The DOL received over 120 comment letters on the Proposed
Regulation.
Investment Management/
ERISA Fiduciary Alert
„
As explained below, default investments in certain
stable value products and certain other capital
preservation funds made prior to the effective date
of the QDIA Regulation (December 24, 2007) are
treated as if made pursuant to a QDIA.
„
In the preamble to the final rules, the DOL went out
of its way to emphasize that the standards specified
in the QDIA Regulation are “not intended to be
the exclusive means” by which fiduciaries may
fulfill their responsibilities with respect to default
investments. Thus, other products, including stable
value products, may be prudent default investment
options even though they technically may not
satisfy the standards for qualification as a QDIA.
„
Finally, the DOL noted that stable value products
will likely be important components of QDIA
portfolio investments.
QDIA Managers
The DOL expanded the list of persons who are
permitted to manage the assets of a QDIA to include:
„
Plan sponsors that are named fiduciaries, and
„
Trustees (including bank trustees of collective
funds) who otherwise meet the definition of
investment manager.
Notice
The DOL added an exception to the requirement that
participants must receive at least 30 days advance
notice of investment of a participant’s individual
account assets in a QDIA, allowing notice as late as the
first date of plan eligibility, provided the participant has
the opportunity to make a permissible withdrawal, as
defined in Internal Revenue Code provisions relating to
automatic enrollment (generally, a tax free withdrawal
made within 90 days after the first contribution made on
behalf of a participant under an automatic contribution
arrangement).
Transfer or Withdrawal Restrictions
The DOL revised the Proposed Regulation’s
requirement that a participant must be allowed to
transfer out of a QDIA without financial penalty.
The QDIA Regulation requires: (1) during the first
90 days after the first default investment in a QDIA
made on a participant’s behalf, no restrictions, fees, or
expenses, including any surrender or redemption fees,
may be imposed, other than ongoing fees charged for
the operation of the fund itself, and (2) after the first
90 days, any restriction or fee imposed must be the
same for all participants regardless of whether the
participant affirmatively elected the investment or the
investment was made by default.
Fiduciaries may select “any” type
of QDIA
In the preamble to the QDIA Regulation, the DOL
expressly stated that fiduciaries are not required to
evaluate different types of QDIAs to determine which
is most suitable for participants in a particular plan.
The DOL also noted, however, that the responsible
fiduciary is obligated to prudently select the specific
QDIA arrangement within a particular class.
Conditions for Relief under the
QDIA Regulation
Relief from fiduciary liability is available under the
QDIA Regulation if:
„
Account assets of participants who have not
provided an affirmative investment direction are
invested in a QDIA.
„
Participants have been given an opportunity to
affirmatively direct their investments, but failed
to do so.
„
Participants are given both an initial and an annual
notice.
„
The initial notice may be made anytime on or
before the date the participant becomes eligible for
participation in the plan, as long as the participant
is allowed to make a permissible withdrawal.2
2
Pursuant to Code section 414(w), relating to automatic
enrollment, a participant generally has the ability to withdraw
from his or her defaulted investment without tax penalty (i.e., a
“permissible withdrawal”), within 90 days from the first contribution
made on the participant’s behalf under an automatic contribution
arrangement.
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Investment Management/
ERISA Fiduciary Alert
„
If the participant is not allowed to make a
permissible withdrawal as described above, the
participant must be given advance notice at least
30 days before the date the participant becomes
eligible for the plan or at least 30 days before the
first default investment in a QDIA.
„
Annual notice must be made at least 30 days before
the beginning of each plan year.
„
The notice must (i) describe how and when
assets will be invested on a participant’s behalf
and the participant’s right to opt out or invest
alternative amounts, (ii) explain the participant’s
right to direct his or her investments, (iii) describe
the QDIA including details such as investment
objectives, risks and returns, and fees and expenses,
(iv) explain the participant’s right to transfer to
alternative investments (and describe the costs
associated with such a transfer), and (v) let the
participant know how to obtain information on
other investments available under the plan.
„
Requirements for Qualification as
a QDIA
The QDIA Regulation includes four requirements for
a QDIA.
„
„
Participants defaulted into a QDIA receive the same
information that is passed through to participants
who elect to direct their investments under the
plan.3
„
Participants defaulted into a QDIA have the
opportunity to transfer out of the QDIA, in
whole or in part, at least as often as any other
participant and, in any event at least once every
three months.
„
Any transfer by a participant out of a QDIA within
the first 90 days after investments are first made
in a QDIA on his of her behalf may not be subject
to any restrictions, fees or expenses, except those
charged on an ongoing basis for the operation
of the investment itself.4 After the first 90 days,
transfers may be subject only to fees or restrictions
that would be imposed or not otherwise charged
to participants who affirmatively chose to invest
in the QDIA.
3
Specifically, the materials set forth in 29 C.F.R. 2550.404c-1(b)
(2)(i)(b)(1)(viii) and (ix) and 29 C.F.R. 404c-1(b)(2)(i)(B)(2).
4
Such as investment management fees, distribution and/or service
fees, 12b-1 fees, or legal, accounting, transfer agent and similar
administrative expenses.
The plan must offer a broad range of investment
alternatives.
A QDIA may not hold or permit the acquisition of
employer securities, subject to two exceptions:
–
Employer securities may be held or acquired
by a mutual fund or similar pooled investment
vehicle which itself is a QDIA or in which a
QDIA invests, if doing so is consistent with
the fund’s stated investment objectives and the
fund is independent of the plan sponsor or any
of the plan sponsor’s affiliates.
–
Employer securities may be held in a managed
account type QDIA as a matching contribution
from the employer/plan sponsor, or acquired
before the investment management service
began managing the account, as long as the
QDIA manager has the authority to dispose
of the securities.
„
A QDIA must allow any participant defaulted
into the QDIA to transfer all or part of his or her
investment from the QDIA to any other investment
available under the plan.
„
A QDIA must be managed by an “investment
manager,” as defined in section 3(38) of ERISA,5
or a trustee of the plan that otherwise meets the
requirements for treatment as an investment
manager, or must be an investment company
registered under the Investment Company Act
of 1940 (or a stable value QDIA in the limited
circumstances described below).
5
To be an investment manager pursuant to section 3(38) of ERISA,
a manager must have power to manage, acquire, or dispose of any
plan asset and be (i) registered as an investment adviser under the
Investment Advisers Act of 1940 or under the laws of the state of its
principal place of business, (ii) a bank, or (iii) an insurance company
qualified in more than one state to manage, acquire, or dispose of
any plan asset. The investment manager must also acknowledge in
writing its fiduciary status with respect to the plan.
December 2007 | 3
Investment Management/
ERISA Fiduciary Alert
„
A QDIA must be one of four types of investment
products:
–
Life-cycle Fund QDIA Type
This type of QDIA seeks to provide varying degrees
of long-term appreciation and capital preservation
through a mix of equity and fixed income exposures
based on a participant’s age, target retirement date,
or life expectancy. It must diversify investments to
minimize the risk of large losses and apply generally
accepted investment theories. It must change its asset
allocations to become more conservative as participants
in the target group age. “Target date” funds generally
would fall in this category.
–
–
Managed Account QDIA Type
This type of QDIA is an investment management
service in which a plan fiduciary applies generally
accepted investment theories to allocate assets of a
participant’s individual account to various investment
options available under the plan. The fiduciary
Stable Value QDIA Type
As noted above, stable value funds may qualify as
QDIAs only in limited circumstances:
„
For the first 120 days after the participant’s first
elective contribution only, an investment product
or fund designed to preserve principal and provide
a reasonable rate of return, consistent with
liquidity, may qualify as a QDIA. Such a product
or fund seeks to maintain a dollar value equal to
the amount invested and is offered by a state or
federally regulated financial institution.
„
An investment product that is designed to guarantee
principal and a rate of return generally consistent
with that earned on intermediate investment grade
bonds, while providing liquidity, and (i) imposes
no fees or surrender charges on withdrawals by the
participant, and (ii) guarantees principal and rates
of return by a state or federally regulated financial
institution may be treated as a QDIA, but only with
respect to assets invested in the product prior to the
effective date of the Final Regulation (December
24, 2007).
Balanced Fund QDIA Type
This type of QDIA seeks to provide long-term
appreciation and capital preservation through a mix
of equity and fixed income exposures consistent with
a targeted level of risk appropriate for participants in
the plan as a whole. It must diversify investments
to minimize the risk of large losses and must apply
generally accepted investment theories in developing
asset allocation. Certain “balanced” funds fall within
this category.
–
must base its allocations on the participant’s age,
target retirement date, or life expectancy and must
change allocations to become more conservative
as a participant ages. It also must seek to achieve
varying degrees of long-term appreciation and capital
preservation through a mix of equity and fixed income
exposures and be diversified to minimize the risk of
large losses. “Managed account” programs generally
fall within this category.
December 2007 | 4
Investment Management/
ERISA Fiduciary Alert
Please contact any member of the K&L Gates ERISA Fiduciary Group if you have further questions on the issues
discussed in this Alert. Members of the ERISA Fiduciary Group and their telephone numbers and email addresses
are listed below.
Los Angeles
Alexandra C. Sparling
William P. Wade
alexandra.sparling@klgates.com
william.wade@klgates.com
310.552.5563
310.552.5071
catherine.bardsley@klgates.com
susan.gaultbrown@klgates.com
david.pickle@klgates.com
william.schmidt@klgates.com
kristina.zanotti@klgates.com
202.778.9289
202.778.9083
202.778.9887
202.778.9373
202.778.9171
Washington, D.C.
Catherine S. Bardsley
Susan I. Gault-Brown
David E. Pickle
William A. Schmidt
Kristina M. Zanotti
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