Managing Defined Contribution Plans: Legal Insights for Plan Managers in the U.S.

1. Emerging Issues for Defined Contribution PlansLegal Lessons from the U.S. for Capital Accumulation Plan PlanManagers Douglas L. Greenfield

2. Basic Conceptual Differences between Retirement Plans • Income Replacement v. Savings • Shifting of Investment and Longevity Risk to Employees • Removing Long Term Funding Obligation from Employers

3. U.S. Plan Design Fundamentals • Under U.S. Tax Code, qualified Retirement plans consist of Pension plans, Profit Sharing or Stock Bonus plans • Key distinction is between Individual Account Plans (Defined Contribution Plans) and Defined Benefit Plans • A common feature of Individual Account Plans is a Cash or Deferred Arrangement (“CODA”), described in Section 401(k) of the U.S. Tax Code – hence the ubiquitous reference to “401(k) Plans” often misspelled “401Ks”

4. U.S. Plan Design Fundamentals • Individual Account Plans do not need to be funded with an actual segregated portion of the Plan’s assets, but rather may consist of nominal recordkeeping accounts, and the Plan fiduciary could retain full discretionary authority over the investment of the Plan’s assets regardless of whether the assets are actually segregated into individual accounts • A common feature of Individual Account Plans, however, is to delegate authority for investment of individual account balances to the Plan participant • Under section 404(c) of ERISA, the Plan fiduciary would not be responsible for the discretionary decisions of the participants in the investment of their Plan account balance if certain safeguards are satisfied

5. Fundamental Fiduciary Requirements Applicable to U.S. Retirement Plans • Regulation of “plans” – a legal construct of ERISA – derives from the common law of trusts • Plans must be controlled by a “named fiduciary” and all discretionary decisions regarding the administration of the plan and the management of the plan’s assets are deemed to be fiduciary decisions • The law distinguishes these types of decisions from “settlor” decisions regarding whether to establish, modify, or terminate a plan and what benefits the plan provides to which employees or their spouses or dependents • Named fiduciaries may delegate fiduciary authority to investment managers, investment advisors, administrators, and service providers

6. Fundamental Fiduciary Requirements Applicable to U.S. Retirement Plans • Fiduciaries must exercise their discretionary authority with respect to a plan – • exclusively to provide benefits and to defray the cost of doing so; • solely in the interests of the plan’s participants and beneficiaries; • prudently, both in terms of process and substance; and • in accordance with the plan’s governing documents to the extent consistent with ERISA • Also fiduciaries are required to diversify the investment of plan assets to avoid large losses

7. Section 404(c) Plan • ERISA has always contained an exception to its fiduciary responsibility provisions for participant direction of investment of individual account plan balances • Section 404(c) of ERISA provides that, in the case of an individual account plan that permits participants or beneficiaries to exercise control over assets in their accounts, no person who is otherwise a fiduciary shall be liable under . . . ERISA for any loss, or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control • Although the U.S. Department of Labor has long regulated the conditions that must be present to be treated as “Section 404(c) Plan,” that is, to satisfy the safe harbor, in 2010 the Department applied new information disclosure rules on the administrators of all participant-directed individual account plans – incorporating these disclosures mandatory into the 404(c) requirements.

8. Section 404(c) Plan • Under the Department’s disclosure regulations, the administrator of a plan that allocates investment authority to plan participants must ensure that such participants, on a regular and periodic basis, are made aware of their rights and responsibilities with respect to the investment of assets held in, or contributed to, their accounts and are provided sufficient information regarding the plan and regarding designated investment alternatives, including fees and expenses attendant thereto, to make informed decisions with regard to the management of their individual accounts. The specific disclosure information includes:

9. Section 404(c) Plan Plan Information • An explanation of the circumstances under which participants may give investment instructions; • An explanation of any specified limitations on such instructions under the terms of the plan, including any restrictions on transfer to or from a designated investment alternative; • A description of or reference to plan provisions relating to the exercise of voting, tender and similar rights appurtenant to an investment in a designated investment alternative as well as any restrictions on such rights; • An identification of any designated investment alternatives offered under the plan; • An identification of any designated investment managers; and • A description of any “brokerage windows,” “self-directed brokerage accounts,” or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan.

10. Section 404(c) Plan Expense Information • an explanation of any fees and expenses for general plan administrative services (e.g., legal, accounting, recordkeeping), which may be charged against the individual accounts of participants and beneficiaries and are not reflected in the total annual operating expenses of any designated investment alternative, as well as the basis on which such charges will be allocated (e.g., pro rata, per capita) to, or affect the balance of, each individual account. • the explanation must include a description of the plan’s administrative expenses that were paid from the total annual operating expenses of one or more of the plan’s designated investment alternatives (e.g., through revenue sharing arrangements, Rule 12b-1 fees, sub-transfer agent fees). • an explanation of any fees and expenses that may be charged against the individual account of a participant or beneficiary on an individual, rather than on a plan-wide, basis (e.g., fees attendant to processing plan loans or qualified domestic relations orders, fees for investment advice, fees for brokerage windows, commissions, front or back-end loads or sales charges, redemption fees, transfer fees and similar expenses, and optional rider charges in annuity contracts) and which are not reflected in the total annual operating expenses of any designated investment alternative.

11. Section 404(c) Plan Investment Information • Identification. The name of each designated investment alternative; and the type or category of the investment (e.g., money market fund, balanced fund (stocks and bonds), large-cap stock fund, employer stock fund, employer securities). • Performance. For designated investment alternatives with respect to which the return is not fixed, the average annual total return of the investment for 1-,5-, and 10- calendar year periods (or for the life of the alternative, if shorter) ending on the date of the most recently completed calendar year; as well as a statement indicating that an investment's past performance is not necessarily an indication of how the investment will perform in the future; and For designated investment alternatives with respect to which the return is fixed or stated for the term of the investment, both the fixed or stated annual rate of return and the term of the investment. If, with respect to such a designated investment alternative, the issuer reserves the right to adjust the fixed or stated rate of return prospectively during the term of the contract or agreement, the current rate of return, the minimum rate guaranteed under the contract, if any, and a statement advising participants and beneficiaries that the issuer may adjust the rate of return prospectively and how to obtain (e.g., telephone or Web site) the most recent rate of return.

12. Section 404(c) Plan Investment Information • Benchmark. For designated investment alternatives with respect to which the return is not fixed, the name and returns of an appropriate broad-based securities market index over the 1-, 5-, and 10- calendar year periods (or for the life of the alternative, if shorter) comparable to the performance data periods, and which is not administered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter, unless the index is widely recognized and used.

13. Section 404(c) Plan Investment Information • Investment Expense. For designated investment alternatives with respect to which the return is not fixed: • the amount and a description of each shareholder-type fee (fees charged directly against a participant's or beneficiary's investment, such as commissions, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees, which are not included in the total annual operating expenses of any designated investment alternative) and a description of any restriction or limitation that may be applicable to a purchase, transfer, or withdrawal of the investment in whole or in part (such as round trip, equity wash, or other restrictions); • The total annual operating expenses of the investment expressed as a percentage (i.e., expense ratio); • The total annual operating expenses of the investment for a one-year period expressed as a dollar amount for a $1,000 investment (assuming no returns and based on the percentage; • A statement indicating that fees and expenses are only one of several factors that participants and beneficiaries should consider when making investment decisions; and • A statement that the cumulative effect of fees and expenses can substantially reduce the growth of a participant’s or beneficiary’s retirement account. For designated investment alternatives with respect to which the return is fixed for the term of the investment, the amount and description of any shareholder type fees and a description of any restriction or limitation that may be applicable to a purchase, transfer or withdrawal of the investment in whole or in part.

14. Section 404(c) Plan Other Regulatory Requirements • Management Rights. Each investing participant in a designated investment alternative must be provided any materials provided to the plan relating to the exercise of voting, tender and similar rights appurtenant to the investment, to the extent that such rights are passed through to such participant under the terms of the plan. • Information Requests. Each participant must be provided upon request, the — • Copies of prospectuses (or profiles) or similar documents relating to designated investment alternatives; • Copies of any financial statements or reports, such as statements of additional information and shareholder reports, and of any other similar materials relating to the plan's designated investment alternatives, to the extent such materials are provided to the plan; • A statement of the value of a share or unit of each designated investment alternative as well as the date of the valuation; and • A list of the assets comprising the portfolio of each designated investment alternative and the value of each such asset (or the proportion of the investment which it comprises).

15. Section 404(c) Plan Continuing 404(c) Regulatory Requirements • The new disclosure requirements were incorporated into the previous requirements ensuring that the participant in a Section 404(c) plan had reasonable opportunity to exercise control over the assets in his individual account in an effective manner by offering a broad range of investment alternatives, from which to invest some or all of the assets in the participant’s account. Specifically: • The participant must receive an explanation that the plan is intended to constitute a Section 404(c) plan, and that the fiduciaries of the plan may be relieved of liability for any losses which are the direct and necessary result of investment instructions given by such participant or beneficiary;

16. Section 404(c) Plan Continuing 404(c) Regulatory Requirements • The plan must offer investment alternatives that are sufficient to provide the participant with a reasonable opportunity to: • Materially affect the potential return on amounts in his individual account with respect to which he is permitted to exercise control and the degree of risk to which such amounts are subject; • Choose from at least three investment alternatives: • Each of which is diversified; • Each of which has materially different risk and return characteristics; • Which in the aggregate enable the participant or beneficiary by choosing among them to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant; and • Each of which when combined with investments in the other alternatives tends to minimize through diversification the overall risk of a participant's or beneficiary's portfolio; • Diversify the investment of that portion of his individual account with respect to which he is permitted to exercise control so as to minimize the risk of large losses, taking into account the nature of the plan and the size of participants' or beneficiaries' accounts.

17. Section 404(c) Plan Special Circumstances • In 2006 Congress amended 404(c) to extend the safe harbor to • “qualified changes in investment options” (mapping) • blackout periods • “qualified default investment alternatives”

18. Impact of Section 404(c) on Fiduciary Responsibility • Section 404(c) does not relieve the plan fiduciary from the responsibility for prudently selecting and monitoring the designated investment alternatives made available under the plan • The safe harbor is limited to allocation decisions among the designated investment alternatives made by the participant • The structure of the relief, provides a disincentive for plan fiduciaries to offer investment education to participants • No safe harbor protection would be afforded to a fiduciary who exercised influence over the participant with respect to any allocation decision • The provision of investment advice for a fee is a fiduciary function subject to duties of loyalty and prudence • The provision of investment advice that resulted in fees being paid by the designated investment alternative to the fiduciary adviser would constitute a prohibited transaction under ERISA • Accordingly, the Department clearly provides in its 404(c) regulations that a fiduciary has no obligation to provide investment advice to a participant

19. Investment Advice and Education • Congress attempted to loosen the disincentives for fiduciaries to provide investment assistance to participants in 2006 by providing a statutory exemption (Sections 408(b)(14) and (g) of ERISA) to the prohibited transaction rules for the provision of certain investment advice • Under the exemption “fiduciary advisers” – registered investment advisers, banks, insurance companies, broker dealers that are not otherwise fiduciaries of the plan – may receive compensation for investment advice to plan participants if the advice consists of either a “level fee” arrangement – an arrangement in which the compensation does not vary based on the investment option selected – or a computer model that uses unbiased data to provide generalized advice.

20. Investment Advice and Education Notwithstanding the availability of this relief to “fiduciary advisors,” most financial professionals do want to provide fiduciary advice, so plan fiduciaries may only provide investment education that does not constitute advice. The Department has identified the provision of following information as not fiduciary advice:

21. Investment Advice and Education Plan Information • Information and materials that inform a participant or beneficiary about the benefits of plan participation, the benefits of increasing plan contributions, the impact of preretirement withdrawals on retirement income, the terms of the plan, or the operation of the plan; or information on investment alternatives under the plan (e.g., descriptions of investment objectives and philosophies, risk and return characteristics, historical return information, or related prospectuses).  • Plan information may not reference to the appropriateness of any individual investment option for a particular participant under the plan.

22. Investment Advice and Education General Financial and Investment Information • Information regarding: (i) General financial and investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment; (ii) historic differences in rates of return between different asset classes (e.g., equities, bonds, or cash) based on standard market indices; (iii) effects of inflation; (iv) estimating future retirement income needs; (v) determining investment time horizons; and (vi) assessing risk tolerance. • The general financial and investment information may have no direct relationship to investment alternatives available to participants under a plan or to individual participants.

23. Investment Advice and Education Asset Allocation Models Information (e.g., pie charts, graphs, or case studies) that provide a participant with models, available to all plan participants, of asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles, where: (i) such models are based on generally accepted investments theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over define periods of time; (ii) all material facts and assumptions on which such models are based (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) accompany the models; (iii) to the extent that an asset allocation model identifies any specific investment alternative available under the plan, the model is accompanied by a statement indicating that other investment alternatives having similar risk and return characteristics may be available under the plan and identifying where information on those investment alternatives may be obtained; and (iv) the asset allocation models are accompanied by a statement indicating that, in applying particular asset allocation models to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and non-qualified plans) in addition to their interests in the plan.

24. Investment Advice and Education Interactive Investment Materials Questionnaires, worksheets, software, and similar materials which provide a participant the means to estimate future retirement income needs and assess the impact of different asset allocations on retirement income, where: (i) such materials are based on generally accepted investment theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over defined periods of time; (ii) there is an objective correlation between the asset allocations generated by the materials and the information and data supplied by the participant; (iii) all material facts and assumptions (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) which may affect a participant's assessment of the different asset allocations accompany the materials or are specified by the participant or beneficiary; (iv) to the extent that an asset allocation generated by the materials identifies any specific investment alternative available under the plan, the asset allocation is accompanied by a statement indicating that other investment alternatives having similar risk and return characteristics may be available under the plan and identifying where information on those investment alternatives may be obtained; and (v) the materials either take into account or are accompanied by a statement indicating that, in applying particular asset allocations to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and non-qualified plans) in addition to their interests in the plan.

25. Investment Advice and Education • But the Department also makes clear that any designation of a service provider to provide investment educational services to plan participants is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation are subject to a duty prudence and loyalty in both in making the designation(s) and in continuing such designation(s)

26. Case Law Developments Regarding Participant Directed Account Plans • Safe Harbor not Defense to Selection/Retention of Investment Alternative • Trible v. Edison Int’l, 729 F.3d 1110 (9th Cir. 2013); Pfeil v. State St. Bank & Trust, 671 F.3d 585 (6th Cir. 2012), cert. denied, 133 S. Ct. 758 (2012); Howell v. Motorola, 633 F.3d 552 (7thCir. 2011);DiFelice v. U.S. Airways, 497 F.3d 410 (4th Cir. 2007) • But see, Langbecker v. Electronic Data Sys., 476 F.3d 299 (5th Cir. 2007); In re Unisys Sav. Plan Litig., 74 F.3d 420 (3d Cir. 1996) (both cases pre-DOL rule) • But cf., Hecker v. Deere, 556 F.3d 575 (7thCir. 2009) modified by 569 F.3d 708 (7th Cir. 2009), cert. denied, 130 S. Ct. 1131 (2010) (excessive fee claim fails to state claim where large variety of choices of funds made available)

27. Case Law Developments Regarding Participant Directed Account Plans Excessive Fees • No duty to avoid mutual funds as a class because of retail fees or revenue sharing arrangements • Trible v. Edison Int’l, 729 F.3d 1110 (9th Cir. 2013); Loomis v. Exelon, 658 F.3d 667 (7thCir. 2001) • But fiduciaries have a duty to investigate institutional class v. retail class shares • Trible v. Edison Int’l, 729 F.3d 1110 (9th Cir. 2013) • And fiduciaries have a duty to investigate and monitor recordkeeping costs • Tussey v. ABB, Civ. Act. No. 12-2056 (8th Cir. Mar. 19, 2014) (fiduciary failed to calculate fee amount, determine competiveness of fees, or negotiate fee reductions)