12.1 ERISA Requirements

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry. Understanding ERISA is essential for investment advisers who work with employer-sponsored retirement plans.

ERISA Coverage

Plans Subject to ERISA

ERISA applies to most private sector employer-sponsored plans:

Defined Benefit Plans: Traditional pensions

Defined Contribution Plans: 401(k), profit-sharing, money purchase

Welfare Benefit Plans: Health insurance, life insurance, disability

Plans NOT Subject to ERISA

Government Plans: Federal, state, local government employees. Reason: (government exemption)

Church Plans: Religious organization exemption

IRAs: Individual plans, not employer-sponsored

Workers' Compensation: Separate regulatory framework

Fiduciary Responsibilities

ERISA imposes strict duties on anyone who exercises discretionary authority or control over a plan. This creates a higher standard than ordinary care.

The Prudent Expert Rule

ERISA requires fiduciaries to act with the care, skill, prudence, and diligence that a prudent expert familiar with such matters would use. This is a higher standard than the "prudent person" rule:

Prudent Person: How a reasonable person would act

Prudent Expert: How a skilled professional with specialized knowledge would act

Courts evaluate the process of decision-making, not just the outcome. A bad investment result does not automatically mean a breach of duty if the decision was made prudently.

Core Fiduciary Duties

1. Duty of Loyalty (Exclusive Benefit Rule)

- Act solely in the interest of plan participants and beneficiaries

- Use plan assets exclusively for providing benefits or paying reasonable expenses

- Cannot favor one group of participants over another

2. Duty of Prudence

- Investigate investments before recommending

- Monitor investment options regularly

- Compare fees against marketplace rates

- Document decision-making process

3. Duty to Diversify

- Spread investments to minimize large losses

- Consider concentration risk

- Exception: Company stock may be offered but cannot be required

4. Duty to Follow Plan Documents

- Administer plan according to its terms

- Cannot deviate even if deviation would benefit participants

Who Is a Fiduciary?

ERISA defines fiduciaries functionally - based on what they do, not their title:

Named Fiduciary: Explicitly named in plan documents

Functional Fiduciary: Exercises discretionary control over plan assets or administration

Investment Adviser Fiduciary: Provides investment advice for compensation

On the Exam: The exam tests whether someone is a fiduciary based on their actions, not their job title. A person providing discretionary investment advice for compensation is a fiduciary, regardless of what they call themselves.

Prohibited Transactions

ERISA Section 406 prohibits certain transactions between plans and "parties in interest" to prevent self-dealing and conflicts of interest.

Types of Prohibited Transactions

Sale/Exchange of Property: Fiduciary sells own property to plan

Lending Money: Loans between plan and party in interest

Furnishing Services: Excessive or unnecessary fees

Transfer to Party in Interest: Moving plan assets to benefit insiders

Self-Dealing: Fiduciary acts in own interest

Parties in Interest

- Plan fiduciaries, trustees, and administrators

- Employers sponsoring the plan

- Employee organizations (unions)

- Service providers to the plan

- Relatives of any of the above

Consequences of Breach

Personal Liability: Make plan whole for any losses

Excise Tax: 15% of amount involved (can increase to 100%)

Restoration of Profits: Return any gains from the transaction

Removal as Fiduciary: DOL can bar person from serving

Disclosure Requirements

Summary Plan Description (SPD)

The SPD is the primary document explaining the plan to participants:

- Written in understandable language

- Provided within 90 days of becoming a participant

- Updated when material changes occur

- Describes eligibility, benefits, vesting, and claims procedures

Form 5500 Annual Report

- Filed annually with Department of Labor

- Financial statements and participant data

- Available to participants on request

- Due 7 months after plan year end

Participant Benefit Statements

Participant-Directed DC Plans: Quarterly

Other DC Plans: Annually

Defined Benefit Plans: Every 3 years

Key Takeaways

1. ERISA applies to private sector employer plans, not government, church, or individual plans

2. The prudent expert rule is higher than ordinary prudence - based on specialized knowledge

3. Fiduciary status is determined by function (actions), not job title

4. Prohibited transactions include self-dealing and transactions with parties in interest

5. Key disclosures include SPD, Form 5500, and benefit statements