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A prospective client has a 401(k) plan. The investment of the plan's assets is directed by the participants with the exception of the employer profit sharing contribution. That is invested at the discretion of the employer. What is the employer's potential fiduciary liability with regard to the profit sharing source?

A plan fiduciary who breaches any of the fiduciary responsibilities, obligations or duties imposed by ERISA is personally liable to the plan for any losses the plan suffers because of such breach (ERISA Sec. 409(a)).

The plan fiduciary (the employer, in this case) must invest these assets "with the care, skill, prudence, and diligence that a prudent person acting in a similar capacity would act under similar circumstances" (ERISA Sec 404(a) (1)).

A fiduciary must act prudently from a procedural standpoint (also known as "procedural diligence"), as well as from a substantive standpoint. Thus, fiduciary conduct will be evaluated not only according to the result of fiduciary action, such as the investment performance of plan assets (i.e., substantively), but also on how the fiduciary goes about reaching that result, such as the criteria considered in making an investment decision (i.e., procedurally).

The relative riskiness of a specific investment does not alone render it prudent or imprudent under ERISA. The prudence of an investment decision should be judged with regard to the role that the proposed investment plays within the overall plan portfolio.

The Fifth Circuit, in noting that ERISA's test of prudence is based on the conduct of the fiduciary and not on the performance of the investment, explained that the applicable standard is whether the fiduciary, at the time it engaged in the transaction, employed the appropriate methods to investigate the merits of the investment and to structure the investment. Specifically, a fiduciary must determine that a particular investment decision, as part of the portfolio, is reasonably designed to further the purposes of the plan by taking into account the risk of loss and the opportunity for gain associated with the investment choice. Further, the following criteria are to be considered by the fiduciary in making an investment decision:

1. the composition of the portfolio with regard to diversification requirements;

2. the liquidity and current return of the portfolio relative to the anticipated cash flow requirement of the plan; and

3. the projected return of the portfolio relative to the funding objectives of the plan.

ERISA Section 409, LIABILITY FOR BREACH OF FIDUCIARY DUTY

Act Sec. 409.(a) Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this title shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary. A fiduciary may also be removed for a violation of section 411 of this Act.

§2550.404a-1

Investment duties.

(a) In general. Section 404(a) (1) (B) of the Employee Retirement Income Security Act of 1974 (the Act) provides, in part, that a fiduciary shall discharge his duties with respect to a plan with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

(b) Investment Duties.

(1) With regard to an investment or investment course of action taken by a fiduciary of an employee benefit plan pursuant to his investment duties, the requirements of section 404(a)(1)(B) of the Act set forth in subsection (a) of this section are satisfied if the fiduciary (A) has given appropriate consideration to those facts and circumstances that, given the scope of such fiduciary's investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the plan's investment portfolio with respect to which the fiduciary has investment duties; and (B) has acted accordingly.

(2) For purposes of paragraph (1) of this subsection, "appropriate consideration" shall include, but is not necessarily limited to, (A) a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties), to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action, and (B) consideration of the following factors as they relate to such portion of the portfolio:

(i) the composition of the portfolio with regard to diversification;

(ii) the liquidity and current return of the portfolio relative to the anticipated cash flow requirement of the plan, and

(iii) the projected return of the portfolio relative to the funding objectives of the plan.

(3) An investment manager appointed, pursuant to the provisions of section 402(c) (3) of the Act, to manage all or part of the assets of a plan, may, for purposes of compliance with the provisions of paragraphs (1) and (2) of this subsection, rely on, and act upon the basis of, information pertaining to the plan provided by or at the direction of the appointing fiduciary, if -

(A) such information is provided for the stated purpose of assisting the manager in the performance of his investment duties, and

(B) the manager does not know and has no reason to know that the information is incorrect.

(c) Definitions. For purposes of this section:

(1) The term "investment duties" means any duties imposed upon, or assumed or undertaken by, a person in connection with the investment of plan assets which make or will make such person a fiduciary of an employee benefit plan or which are performed by such person as a fiduciary of an employee benefit plan as defined in section 3(21) (A) (i) or (ii) of the Act.

(2) The term "investment course of action" means any series or program of investments or actions related to a fiduciary's performance of his investment duties.

(3) The term "plan" means an employee benefit plan to which Title I of the Act applies.

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