DEPARTMENT OF LABOR Pension and Welfare Benefits Administration AGENCY: Pension and Welfare Benefits Administration, Department of Labor. 29 CFR Part 2550 Final Regulation Regarding Participant Directed Individual Account Plans (ERISA Section 404(c) Plans) 57 FR 46906 October 13, 1992 ACTION: Final rule. SUMMARY: This document contains a final regulation under section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA or the Act). That section provides that, where a participant or beneficiary of an employee pension benefit plan exercises control over assets in an individual account maintained for him under the plan, the participant or beneficiary is not considered a fiduciary by reason of his exercise of control and other plan fiduciaries are relieved of liability under part 4 of title I of ERISA for the results of the participant’s or beneficiary’s exercise of control. Section 404(c) specifically contemplates the issuance of regulations. The regulation describes the circumstances in which section 404(c) applies to a transaction involving a participant’s or beneficiary’s exercise of control over his individual account. In general, in order for a participant or beneficiary to exercise control over the assets in his account, the participant or beneficiary must have the opportunity, under the plan, to: (1) Choose from a broad range of investment alternatives, which consist of at least three diversified investment alternatives, each of which has materially different risk and return characteristics; (2) give investment instruction with a frequency which is appropriate in light of the market volatility of the investment alternatives, but not less frequently than once within any three month period; (3) diversify investments within and among investment alternatives; and (4) obtain sufficient information to make informed investment decisions with respect to investment alternatives available under the plan. The regulation will affect employee benefit plans, their sponsors, participants and beneficiaries as well as plan fiduciaries. EFFECTIVE DATE: This regulation is effective with respect to transactions occurring after the first day of the second plan year beginning after October 13, 1992, except with respect to transactions occurring under a plan maintained pursuant to a collective bargaining agreement. For plans maintained pursuant to one or more collective bargaining agreements, the regulation is effective after the later of the first day of the second plan year after October 13, 1992, or the date on which the last collective bargaining agreement terminates. FOR FURTHER INFORMATION CONTACT: Deborah S. Hobbs, or Katherine D. Lewis, Pension and Welfare Benefits Administration, U.S. Department of Labor, Washington, DC 20210, telephone (202) 219-7901; or Daniel J. Maguire, Esq., or Diane Pedulla, Esq., Plan Benefits Security Division, Office of the Solicitor, U.S. Department of Labor, Washington, DC 20210, telephone (202) 219-4592 or (202) 219-4597. These are not toll-free numbers. SUPPLEMENTARY INFORMATION: On September 3, 1987, the Department of Labor published a notice in the Federal Register (52 FR 33508) containing a proposed regulation (the "1987 proposal") that would describe the circumstances in which section 404(c) of ERISA).1 would apply to a transaction involving a participant’s or beneficiary’s exercise of control over his account and the effect of such application. The Department received more than 230 letters of comment regarding that proposal. A public hearing on the proposal was held in Washington, DC, on February 10 and 11, at which time 23 speakers testified. After consideration of the issues raised by the written comments and oral testimony, the Department made substantial changes to the regulation. In view of the significance of the changes made to the 1987 proposal, the Department decided that interested members of the public should be afforded the opportunity to comment on the changes prior to the adoption of a final regulation. Accordingly, the Department withdrew the 1987 proposal and proposed a revised section 404(c) regulation on March 13, 1991 (56 FR 10724) (the "1991 proposal" or the "proposal"). The Department received more than 100 letters of comment in response to the proposal. A public hearing on the proposal was held in Washington, DC on July 11 and 12, 1991, at which time 27 speakers testified. The following discussion summarizes the 1991 proposal and the major issues raised by commentators and explains the Department’s reasons for the modifications reflected in the final regulation that is published with this notice. DISCUSSION OF THE REGULATION AND COMMENTS I. The Statute Section 404(c) of ERISA provides that where a participant or beneficiary of an employee pension benefit plan that provides for individual accounts exercises control over assets in his account, then (1) the participant or beneficiary shall not be deemed to be a fiduciary by reason of his exercise of control; and (2) no person who is otherwise a fiduciary shall be liable under the fiduciary responsibility provisions of ERISA for any loss, or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control. The relief from the fiduciary responsibility provisions of ERISA that is provided by section 404(c) applies only to individual transactions that meet the criteria established by that section, i.e., the transaction must be executed pursuant to the kind of plan described in section 404(c) and the participant or beneficiary must actually have exercised control with respect to the transaction. Thus, a determination whether section 404(c)(1) and (2) apply can only be made on a case by case basis. It is the Department’s view that section 404(c) is similar to a statutory exception to the general fiduciary provisions of ERISA and, accordingly, the person asserting applicability of the exception will have the burden of proving that the conditions of section 404(c) and any regulation thereunder have been met.2 II. Consequences of Noncompliance With the Regulation In response to comments on the 1987 proposal, the Department attempted to make clear in the preamble to the 1991 proposal that the regulatory standards established with respect to ERISA section 404(c) plans are limited to describing the requirements for an ERISA 404(c) plan, and the type and degree of independent control on the part of a participant or beneficiary of such a plan necessary to provide the [57 FR 46907] transactional relief described in section 404(c) and, therefore, were not intended to establish, by implication or otherwise, standards for all ERISA-covered plans concerning the types of investments a fiduciary must make in order to maintain a prudent investment portfolio. The Department also noted that a plan which does not meet the requirements for an ERISA section 404(c) plan may, nonetheless, have a prudent and well diversified investment portfolio. However, a number of commentators on the 1991 proposal indicated that, while the preamble language was helpful, the Department should, in an effort to avoid any confusion, include a clarification with respect to the limited effect of the section 404(c) standards in the operative language of the regulation inasmuch as preambles are not published as part of the Code of Federal Regulations. In response to these comments, the Department has amended paragraph (a) in the final regulation to include a separate subparagraph (2) which specifically provides that the standards set forth in the regulation are applicable solely for the purpose of determining whether a plan is an ERISA section 404(c) plan and whether a particular transaction engaged in by a participant or beneficiary of such plan is afforded relief by section 404(c). This subparagraph (2) further provides that the standards of the regulation are not intended to be applied in determining whether, or to what extent, a plan which does not meet the requirements for an ERISA section 404(c) plan or a fiduciary with respect to such plan satisfies the fiduciary responsibility or other provision of title I of the Act. As was the case with the 1987 proposal, a number of commentators on the 1991 proposal suggested that the Department adopt the regulation as a "safe harbor" under ERISA section 404(c), thereby providing a fiduciary of a plan which fails to comport with the requirements of this regulation the opportunity to argue that the particular plan and any particular participant-directed transaction executed pursuant to such plan falls within the statutory definition, and, as such, should be afforded the exception to fiduciary liability described in ERISA section 404(c). After due consideration, the Department has decided not to adopt this suggestion. The Department continues to believe that it can best satisfy its statutory responsibility under ERISA section 404(c) by describing the basic framework necessary for a participant’s or beneficiary’s exercise of control, thereby providing guidance and clarification as to the application of ERISA section 404(c), while at the same time affording flexibility in the design of ERISA section 404(c) plans. Finally, as previously explained, non-complying plans do not necessarily violate ERISA; non-compliance merely results in the plan not being accorded the statutory relief described in section 404(c). III. ERISA Section 404(c) Plans In General The proposal defined an "ERISA section 404(c) plan" as an individual account plant account plan described in section 3(34) of ERISA that permits a participant to make an independent choice, from a broad range of investment alternatives, regarding the manner in which any portion of the assets in his individual account is invested.3 This definition permitted a plan to provide for participant control in many different ways and in varying degrees. For example, under the definition, a plan could meet the requirements for treatment as an ERISA section 404(c) plan notwithstanding that it only allows certain participants or beneficiaries to exercise control over their individual account balances and notwithstanding that it only permits participants or beneficiaries to exercise control over a specified portion of their account balances.4 However, if a plan does not permit a participant or beneficiary to exercise control over all of the assets in his account, the provisions of section 404(c) would not, in any circumstances, apply to transactions involving assets with respect to which the participant or beneficiary is not permitted to exercise control. Thus, until a participant or beneficiary exercises control with respect to assets contributed on his behalf, plan fiduciaries are subject to all of the fiduciary duties and obligations set forth in part 4 of title I of ERISA with respect to such assets.5 Two commentators requested clarification concerning whether relief is available under the regulation for transactions involving "hybrid" plans, i.e., plans which include defined benefit features. One commentator stated that, in certain of such arrangements, the individual account portion of the plan has no relationship to the defined benefit portion while in others benefits under the individual account plan are taken into account in determining the benefits payable to the participant or beneficiary under the defined benefit plan. Section 404(c) contemplates separate individual accounting so that the investment decisions of a participant or beneficiary affect only the account of that participant or beneficiary. Accordingly, relief would be available under section 404(c) for the individual account portion of a "hybrid" plan where the decisions of a participant or beneficiary can only affect the account of the directing participant or beneficiary, provided that the other conditions of the regulation are met. However, to the extent that a participant’s or beneficiary’s investment decisions can affect the benefits which may be paid to others under the particular "hybrid" arrangement, section 404(c) relief would not be available.6 One commentator expressed the view that the regulation should provide relief under section 404(c) for transactions in an employee stock ownership plan. In this regard, the commentator urged that the regulation except such plans from the requirement to provide a broad range of investment alternatives. Other commentators contended that 404(c) relief should be available for certain specified decisions by participants and beneficiaries in any plan, without regard to whether the plan satisfies the requirements of the 404(c) regulation. Examples of such decisions included: Voting shares of employer stock allocated to the participant’s or beneficiary’s account, responses to [57 FR 46908] tender and exchange offers, and decisions to withdraw from the employer stock fund where a plan’s investment alternatives do not satisfy the broad range of investments requirement of the regulation. Another commentator indicated that the regulation should not include any plan-wide requirements, but should only require participant control for relief on a transactional basis. The Department has not adopted these requested modifications to the regulation. The Department continues to believe that, while the availability of section 404(c) relief is conditioned on the actual exercise of control by a participant or beneficiary over the assets in his account and, therefore, is transactional in nature, the plan itself must meet certain minimum conditions, such as offering a broad range of investment alternatives, to ensure that participants and beneficiaries are afforded a reasonable opportunity to exercise meaningful control over the assets in their accounts. One commentator requested clarification as to whether relief would be available under the regulation when alternate payees direct investment of amounts which have been allocated to their accounts under qualified domestic relations orders. In this regard, the Department notes that alternate payees are considered to be beneficiaries under ERISA.7 Accordingly, if the conditions of this regulation are otherwise satisfied, relief under ERISA section 404(c) would be available when alternate payees exercise control over assets which have been allocated to their accounts under qualified domestic relations orders. The Department also received comments concerning several of the specific requirements of the definition of an ERISA section 404(c) plan contained in the proposal (paragraph (b)). These are discussed below. 1. Opportunity to Exercise Control Paragraph (b)(1) of the proposed regulation provided that, to be an ERISA section 404(c) plan, a plan must (among other things) provide an opportunity for a participant or beneficiary to exercise control over the assets in his individual account in the manner described at paragraph (b)(2). In turn, paragraph (b)(2) set forth the rules with respect to a participant’s or beneficiary’s opportunity to exercise control. First, the terms of the plan must provide that participants and beneficiaries have a reasonable opportunity to submit investment instructions to an identified plan fiduciary who is obligated to comply with such instructions. Second, a plan may impose reasonable restrictions on the frequency with which participants and beneficiaries may give investment instructions. Third, certain other reasonable limitations may be imposed on the participant’s or beneficiary’s ability to exercise control. As discussed below, the general rules of paragraph (b)(2) have been retained with some modification, including new disclosure provisions, in response to comments on the 1991 proposal. A. The Identified Plan Fiduciary Paragraph (b)(2)(i) of the 1991 proposal provided that a plan affords a participant or beneficiary with an opportunity to exercise control over assets in his account if, under the terms of the plan, the participant or beneficiary has a reasonable opportunity to give written investment instructions, or oral instructions followed by a written confirmation, to an identified plan fiduciary who is obligated to comply with such instructions. A number of commentators requested that the regulation be clarified so as not to preclude the use of electronic or telephonic communications of investment instructions. It was not the intention of the Department to preclude the use of such communications. Accordingly, paragraph (b)(2)(i)(A) of the final regulation requires only that the participant or beneficiary be afforded a reasonable opportunity to provide investment instructions (written or otherwise) and an opportunity to obtain a written confirmation of such instructions. The Department believes that the ability of a participant or beneficiary to obtain a written confirmation of his investment instructions is considerably more important than the means by which investment instruction is communicated. In this regard, the Department notes that, unlike the 1991 proposal, the final regulation requires that the opportunity to obtain written confirmation of investment instructions be extended to all participants and beneficiaries who give investment instructions. A commentator also requested that the Department clarify that the specific means by which investment instructions are communicated are not required to be described in the plan document. The Department does not believe that the specific means by which participants and beneficiaries are to communicate investment instructions necessarily has to be in the plan document as long as the plan has written procedures for such communications and information concerning those procedures is furnished to participants and beneficiaries (see 2550.404c-1(b)(2)). Other commentators requested that the Department clarify that the plan fiduciary responsible for receiving and acting on investment instructions may be identified in the plan by position rather than name inasmuch as responsible individuals often change and frequent plan amendments would be required to reflect such changes. It is the view of the Department that the identification of a fiduciary by position or function (e.g., plan administrator, investment committee, etc.) would satisfy the requirements of the regulation for an identified plan fiduciary under paragraphs (b)(2)(i)(A) and (b)(2)(i)(B)(1), and for a designated plan fiduciary for purposes of paragraph (d)(2)(ii)(E)(4)(viii ). In this regard, the Department notes that the requirement for an identified plan fiduciary who is obligated to comply with participant and beneficiary instructions is applicable to all ERISA section 404(c) plans, including those which do not designate investment alternatives, i.e.., those plans which permit investments in any asset which it is administratively feasible for the plan to hold and do not specifically describe any investment alternative. In order to make clear that a fiduciary’s obligation to follow investment instructions is not without limitation, the final regulation (paragraph (b)(2)(i)(A)) has been modified to recognize the exceptions to following investment direction described in paragraphs (b)(2)(ii)(B) and (d)(2)(ii). B. Disclosure of Investment Information The Proposal Under the 1991 proposed regulation, the obligation to disclose investment information was limited to only those investment alternatives which were intended to be taken into account for purposes of the "broad range" of investment alternatives requirement. Specifically, paragraph (b)(3)(iii) of the proposal provided that an investment alternative would not be deemed to be part of a broad range of investment alternatives unless sufficient information as to that investment is available to the participant or beneficiary so as to permit informed investment decisions. However, the proposal would not have established an affirmative obligation on the part of ERISA section 404(c) plan fiduciaries to furnish the required information to participants and beneficiaries. Rather, [57 FR 46909] broad public availability generally would have been sufficient. Where investment alternatives are limited to a designated group of investments, the proposal would have required that, at a minimum, an identified plan fiduciary be available to direct participants and beneficiaries as to means by with the required information could be obtained. With respect to the disclosure of investment information, the Department noted in the preamble to the proposal that the requirement that sufficient information be available to permit informed investment decisions applies not only to the initial investment decision but also to subsequent decisions with regard to that investment. The Department also noted that a participant must be given sufficient information to make informed decisions with regard to rights incident to the holding of an ownership interest in that investment in order for an investment to be taken into account for purposes of the broad range requirement. For example, in the case of a security, such information would include information sufficient to permit the participant to make informed decisions in exercising any voting rights attendant to such ownership. The disclosure provisions of the proposal were the subject of considerable comment and concern. In general, commentators on the proposal recognized the importance of ensuring that participants and beneficiaries have sufficient information about their investment alternatives to make meaningful investment choices. Many commentators suggested that the Department should enhance and broaden the disclosure requirements of the regulation and made specific suggestions as to what information should be required to be disclosed. Other commentators, while acknowledging the need for more disclosure, recommended the retention of a general disclosure rule (e.g., only require that sufficient information be made available to enable participants and beneficiaries to make informed investment decisions), with examples in the preamble of the types of disclosures that might be necessary to satisfy the general rule. The following represents a summary of some of the specific comments on the issue of disclosure. Comments Various commentators recommended that the Department require mutual fund prospectus-type disclosures for bank and insurance company fixed rate investment contracts (e.g., bank investment contracts, savings and loan investment contracts and "guaranteed investment contracts" issued by insurance companies) and other look-through investment vehicles. Some commentators recommended prospectus-type disclosure for all investments made available to participants and beneficiaries under an ERISA section 404(c) plan, while other commentators took the position that prospectus-type disclosures should not be required at all because such disclosures would generally not be understood by participants and beneficiaries. The information commentators suggested should be disclosed or made available to participants and beneficiaries included information concerning: The investment objectives, risks and rewards associated with available investment alternatives; a description of the investment philosophy of the investment alternative; the composition of the portfolio of investment vehicles offered to participants and beneficiaries; past performance of the investments; whether or not investments are subject to wide fluctuations in value; the identity and rating of issuers of fixed rate investment contracts (e.g., insurance companies); the proportion of fixed rate investment contracts of each issuer comprising an investment alternative; the average maturity of fixed rate investment contracts in an investment alternative; restrictions on transfers in and out of investments; current financial information regarding an investment alternative; fees and other expenses charged by an investment alternative; and criteria utilized in selecting, holding and selling investments in an investment vehicle designed to hold securities of multiple issuers. In addition to the comments from the general public, the Division of Market Regulation of the Securities and Exchange Commission (the "Division") submitted a number of recommendations relating to the disclosure of investment information to participants and beneficiaries in ERISA section 404(c) plans. Among other things, the Division recommended that the regulation require the identified plan fiduciary to, at a minimum, provide adequate investment information when requested regarding any investment permitted by the plan, including information about the current value of the investment and the financial condition of the issuer. The Division also expressed the view that the regulation should only provide relief for investment alternatives where participants and beneficiaries have access to readily available information about the alternatives. The Division recommended that the regulation specifically require the plan administrator to forward copies of prospectuses, proxies, periodic reports and similar materials to those who invest in registered securities. The Division further suggested that the final regulation require a disclosure concerning the limited liability of plan fiduciaries with regard to participant-directed investments and that ERISA section 404(c) plans include, as appropriate, certain legends in their Summary Plan Descriptions ("SPDs"). For plans which designate investment alternatives, the Division recommended a legend stating that important additional information about the plan’s designated investment alternatives is available and should be read carefully. For plans which do not designate investment alternatives but which allow investments in publicly offered securities, it recommended a legend encouraging participants to obtain and read a prospectus or other offering document, where available, and noting that public information is available with respect to investment managers who are registered under the Investment Advisers Act of 1940. For all ERISA section 404(c) plans, it recommended a legend disclosing the fact that fiduciaries of such plans may be relieved of certain fiduciary obligations and liabilities to which they would otherwise be subject. With respect to mutual funds, the Division commented that a prospectus should be available from the identified plan fiduciary where the plan designates a mutual fund as an alternative, and that plans should be required to disclose that the price of fund shares does not reflect the same kind of market information about the issuer that may be reflected in the share price of publicly-traded securities. The Division also recommended that, where investment managers are designated by a plan or manage alternatives designated by a plan, the identified plan fiduciary should be required to provide the brochure described in Rule 204-3 under the Investment Advisers Act to participants and beneficiaries on request. The Final Regulation: General Rule After careful consideration of all the comments concerning the disclosure of investment information, the Department has concluded that changes in the disclosure requirements contained in the 1991 proposal are necessary to ensure that participants and beneficiaries in ERISA section 404(c) plans have sufficient information to make informed [57 FR 46910] investment decisions. As recognized by many commentators, the investment decisions made by participants and beneficiaries in ERISA section 404(c) plans will directly affect the funds available to such individuals at retirement. For this reason, participants and beneficiaries should be assured of having access to that information necessary to make meaningful investment decisions. The following is a discussion of the changes in the disclosure requirements contained in the final regulation. First, the Department has concluded that the obligation of an ERISA section 404(c) plan fiduciary to disclose information should not be limited to information concerning those investment alternatives intended to satisfy the "broad range" requirement of the regulation, but rather should extend to information concerning the plan itself and each investment alternative made available under the plan. The Department can find no reasonable basis for distinguishing between information concerning investment alternatives which are intended to satisfy the "broad range" requirement and information concerning any other investment alternative made available under a plan in terms of value to participants and beneficiaries in evaluating their investment options and making informed investment decisions. Second, the Department has concluded that fiduciaries of an ERISA section 404(c) plan should have an affirmative obligation to ensure that participants and beneficiaries are provided or can obtain basic information concerning the investment alternatives made available under the plan. The Department is persuaded that merely referring participants and beneficiaries to a source for investment information and requiring them to obtain the information is insufficient to ensure that participants and beneficiaries are in a position to make informed investment decisions. While, as discussed below, there is nothing in the regulation which precludes a plan fiduciary from designating another person or persons to actually furnish the required information, the regulation contemplates that the identified plan fiduciary will remain responsible for ensuring disclosure. In implementing the foregoing changes, the "investment information" section of the 1991 proposal (2550.404c-1(b)(3)(iii)) has been eliminated and a new paragraph (b)(2)(i)(B) has been added to the final regulation. Under paragraph (b)(2)(i) of the final regulation, an ERISA section 404(c) plan will be considered to provide a participant or beneficiary an opportunity to exercise control over the assets in his account only if, in addition to affording the participant or beneficiary a reasonable opportunity to give investment instructions in accordance with paragraph (b)(2)(i)(A), the participant or beneficiary is provided or has the opportunity to obtain sufficient information to make informed investment decisions with regard to investment alternatives available under the plan and incidents of ownership appurtenant to such investments in accordance with paragraph (b)(2)(i)(B). Disclosures Made to All Participants In addition to the foregoing general rule, paragraph (b)(2)(i)(B) provides that a participant or beneficiary will not be considered to have sufficient investment information unless certain delineated items of information concerning the plan and available investment alternatives are provided to the participant or beneficiary and certain other information concerning both "designated investment alternatives"8 and other available investment alternatives is provided upon request to the participant or beneficiary. The Department is persuaded that certain information is so fundamental to making informed investment decisions that such information should be available to all participants and beneficiaries in an ERISA section 404(c) plan. This information is generally described in subparagraphs (1) and (2) of paragraph (b)(2)(i)(B) of the final regulation. Pursuant to subparagraph (1) of paragraph (b)(2)(i)(B), each participant and beneficiary is required to be provided the following information by an identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf). First, an explanation that the plan is intended to constitute an ERISA section 404(c) plan, as described in this regulation, and that fiduciaries of the plan may be relieved of liability for any losses which are the direct and necessary result of investment instructions given by the participant and beneficiary. The Department believes that such an explanation will serve to reinforce participant and beneficiary awareness of the limited liability of the plan fiduciaries and of their own individual responsibility with respect to investment decisions concerning their assets. Second, a description of the investment alternatives available under the plan and, with respect to each designated investment alternative, a general description of the investment objectives and risk and return characteristics of each such alternative, including information relating to the type and diversification of assets comprising the portfolio of the designated investment alternative. This requirement is intended to ensure disclosure of the most basic of information necessary to a participant’s or beneficiary’s investment decision. In the case of plans which permit participants and beneficiaries to invest in any asset administratively feasible for the plan to hold, a general statement so apprising participants and beneficiaries would be adequate, although participants and beneficiaries should be encouraged to obtain and review materials relating to potential investments prior to actually making an investment. In this connection, it should be noted that, to the extent that copies of prospectuses, financial statements and reports, or similar materials relating to the investment alternatives available under the plan, are furnished to the plan, such information would be required to be made available to the participant or beneficiary pursuant to paragraph (b)(2)(i)(B)(2 )(ii ). Third, if relevant, identification of any designated investment managers. Fourth, an explanation of the circumstances under which participants and beneficiaries may give investment instructions and an explanation of any specified limitations on such instructions under the terms of the plan, including any restrictions on transfers to or from a designated investment alternative, and any restrictions on the exercise of voting, tender and similar rights appurtenant to a participant’s or beneficiary’s investment in an investment alternative. This disclosure is intended to ensure that participants and beneficiaries are apprised as to how, when and to whom they may give investment instructions under the plan. This disclosure is also intended to ensure that participants and beneficiaries are aware of limitations on their ability to give investment instructions. For example, insofar as a withdrawal from an investment alternative prior to the maturity date of the investment may trigger a penalty or a valuation adjustment to the participant’s or beneficiary’s account, [57 FR 46911] information concerning the penalty or adjustment is required to be disclosed pursuant to subparagraph (iv) of paragraph (b)(2)(i)(B)(1). Finally, this disclosure is intended to ensure that participants and beneficiaries are aware of the extent to which voting, tender and similar rights attendant to ownership of an interest in an investment alternative are passed through to them under the terms of the plan when choosing to invest in such investment alternative. Fifth, with respect to each investment alternative available under the plan, a description of any transaction fees and expenses which affect the participant’s or beneficiary’s account balance in connection with the purchase or sale of interests in such investment alternative (e.g., commissions, sales loads, deferred sales charges, redemption or exchange fees). With respect to investment alternatives which are not designated alternatives, the description need only state whether, or to what extent, transaction fees and expenses incurred in connection with the purchase or sale of interests in the investment alternative will be charged against the account of the participant or beneficiary. This requirement relates to the disclosure of fees and expenses directly assessed against the participant’s or beneficiary’s account, not expenses, fees or commissions incurred by the investment alternative attendant to the operation and management of the investment alternative. Sixth, identification of the plan fiduciary (and, if applicable, any person or persons designated by the plan fiduciary) responsible for providing the information described in paragraph (b)(2)(i)(B)(2 ) upon request of a participant or beneficiary, and a description of the information described in paragraph (b)(2)(i)(B)(2 ) which may be obtained on request. As indicated earlier, plan fiduciaries may be identified by position (e.g., plan administrator, trustee, etc.), rather than by name, so long as participants have an available source for obtaining the information. Seventh, in the case of plans offering as an investment alternative the ability to directly or indirectly acquire or sell any employer security, a description of the procedures established to provide for the confidentiality of information relating to such investments by participants and beneficiaries and the identification of the plan fiduciary responsible for monitoring compliance with those procedures. The Department believes that, given the elimination of the independent fiduciary requirement for most transactions involving employer securities (see discussion relating to employer securities and subparagraphs (d)(2)(ii)(E)(4)(vii)-(ix) below), participants and beneficiaries should be apprised of the procedures which have been established to ensure the confidentiality of information relating to investments in employer securities and that there is a plan fiduciary who is responsible for monitoring compliance with those procedures. Eighth, in the case of an investment alternative which is subject to the Securities Act of 1933 (the Securities Act), and in which the participant or beneficiary has no assets invested, immediately following the participant’s or beneficiary’s initial investment, a copy of the most recent prospectus provided to the plan. Paragraph (b)(2)(i)(B)(1)(viii) provides that this condition will be deemed satisfied if the participant or beneficiary has been provided with a copy of such most recent prospectus immediately prior to the participant’s or beneficiary’s initial investment in such alternative. Thus, where a participant is furnished the most recent prospectus provided to the plan in connection with an opportunity to give investment instruction, and the prospectus is received by the participant prior to instruction being given, subparagraph (viii ) does not require a copy of the same prospectus to be furnished to the participant immediately following his initial investment. This disclosure requirement is intended to ensure that, either immediately before or immediately after an investment in an investment alternative required to prepare prospectuses under the federal securities laws, participants and beneficiaries are afforded the opportunity to review such prospectuses, without mandating that every prospectus furnished to the plan subsequent to a participant’s or beneficiary’s initial investment be passed through to the participants and beneficiaries. Having been afforded the opportunity to review a prospectus in connection with his initial investment, a participant or beneficiary will be in the best position to determine the extent to which such disclosures are necessary to his making informed investment decisions with respect to continued investments in such investment alternatives. It should be noted that all prospectuses furnished to the plan must be made available to participants and beneficiaries upon request pursuant to paragraph (b)(2)(i)(B)(2)(ii). Finally, subsequent to a participant’s or beneficiary’s investment in an investment alternative, the participant or beneficiary is required to be furnished any materials provided to the plan relating to the exercise of voting, tender or similar rights which are incidental to the holding in the account of such participant or beneficiary of an ownership interest in such investment alternative to the extent that such rights are passed through to participants and beneficiaries under the terms of the plan (paragraph (b)(2)(i)(B)(1)(ix)). Subparagraph (ix) also requires that, if there are any plan provisions which relate to the exercise of voting, tender or similar rights, participants and beneficiaries must be furnished either a description of or reference to such plan provisions. To the extent that a plan provides for the pass-through of voting, tender and similar rights, participants and beneficiaries must be provided that information furnished to the plan pertaining to those rights if the participant or beneficiary is to be considered to have exercised control with respect to such rights. See paragraph (c)(1)(ii). The department notes that, except for investments in employer securities, there is nothing in the regulation which requires a pass-through of voting, tender or similar rights to plan participants and beneficiaries. However, to the extent that a plan does not provide for such a pass-through of rights, no 404(c) relief would be available to the plan fiduciaries with regard to the exercise of such rights by such plan fiduciaries.9 With regard to the requirement that a reference to any relevant plan provisions be included with materials relating to incidents of ownership of an investment, the Department notes, for example, that, to the extent that there are plan provisions which govern voting, plan participants and beneficiaries should be on notice as to such provisions. This is particularly true where the plan provisions relate to situations where participants and beneficiaries do not affirmatively exercise their right to vote. This disclosure can either describe the applicable plan provisions, or reference participants to the relevant portions of the plan document where such provisions are described. [57 FR 46912] Disclosures Made Upon Request to Participants In addition to the general information required to be furnished to each participant and beneficiary, subparagraph (2) of paragraph (b)(2)(i)(B) of the final regulation requires that certain specified information relating to designated investment alternatives be furnished by an identified plan fiduciary or person(s) designated by the fiduciary to act on his behalf, to the extent not otherwise provided, upon request of a participant or beneficiary. This subparagraph requires that the plan provide the following information, which shall be based on the latest information available to the plan: first, a narrative description of the annual operating expenses of each designated investment alternative, such as investment management fees, administrative fees and transaction costs, which reduce the rate of return to the participants or beneficiaries, and the aggregate amount of such expenses expressed as a percentage of average net assets of the designated investment alternative (paragraph (b)(2)(i)(B)(2)(i)); and, second, copies of any prospectuses, financial statements and reports, and any other materials relating to investment alternatives available under the plan, to the extent such information is provided to the pan (paragraph (b)(2)(i)(B)(2)(ii)). The Department notes that, for example, to the extent that the operating expenses described in subparagraph (i) of paragraph (b)(2)(i)(B)(2) are included information required to be provided on request pursuant to subparagraph (ii), such as in a prospectus, the requirements of subparagraph (i) would be satisfied by providing the prospectus. This requirement is not intended to mandate that plan fiduciaries create materials relating to the investment alternatives available under the plan where they are not provided to the plan. However, because the general rule of paragraph (b)(2)(i)(B) (which requires that a participant or beneficiary must be provided or have the opportunity to obtain sufficient information to make informed investment decisions) remains applicable to all investment alternatives offered by a 404(c) plan, including, for example, investment alternatives managed by the plan sponsor, relief will not be available for investments in investment alternatives managed by the plan sponsor unless a participant or beneficiary is provided or has the opportunity to obtain sufficient information to make informed investment decisions with regard to investments in such alternatives. Paragraph (b)(2)(i)(B)(2) also requires the following to be disclosed upon request with respect to designated investment alternatives: a list of the assets comprising the portfolio of the designated investment alternative which constitute plan assets within the meaning of 29 CFR 2510.3-101, the value of each such asset (or the proportion of the investment alternative which it comprises), and, with respect to each such asset which is a fixed rate investment contract issued by a bank or similar institution (e.g., savings and loan association) or insurance company held in the portfolio of the investment alternative, the name of the issuer of the contract, the term of the contract and the rate of return on the contract (paragraph (b)(2)(i)(B)(2)(iii)). Subparagraph (iv) of paragraph (b)(2)(i)(B)(2) requires the disclosure of information concerning the value of shares or units in designated investment alternatives available to participants and beneficiaries under the plan, as well as the past and current investment performance of such alternatives determined, net of expenses, on a reasonable and consistent basis (taking into account the nature of the investment alternatives). Finally, subparagraph (v) of paragraph (b)(2)(i)(B)(2) requires the disclosure of information concerning the value of shares or units in designated investment alternatives held in the account of the participant or beneficiary. On the basis of a number of comments, the Department believes that, with the exception of certain plan and participant specific information, the information required to be furnished and made available to participants and beneficiaries pursuant to subparagraphs (1) and (2) is information which is typically furnished by, or readily available from, investment managers, investment advisers, and issuers of securities. In addition, although the information required to be furnished to participants and beneficiaries upon request must be based on the latest information available to the plan, it is expected that, in most instances, fiduciaries will not have to create special disclosures to satisfy individual requests if such requests do not involve the disclosure of information pertaining to an individual participant’s account. For example, paragraph (b)(2)(i)(B)(2)(iii) requires that an ERISA section 404(c) plan provide, on request, a list of plan assets, within the meaning of 29 CFR 2510.3-101, comprising the portfolio of each designated investment alternative and the value of each such asset (or the proportion of the investment alternative which it comprises). This information should be readily available to plan fiduciaries since it is essentially the same information required to be reported as part of a plan’s annual report (Form 5500) under ERISA. It is anticipated that the disclosure of plan asset information based on the plan’s latest annual report will satisfy the requirement of paragraph (b)(2)(i)(B)(2)( iii) so long as such information is sufficiently accurate to enable the participant or beneficiary to make an informed investment decision. Inasmuch as the exercise of control by a participant or beneficiary is dependent on the participant or beneficiary having sufficient information to make an informed investment decision, fiduciaries will have to consider, for example, whether any changes with respect to the investment portfolio of the investment alternative since the last annual report are sufficiently material that failure to disclose such changes would deprive the participant or beneficiary of the opportunity to make an informed investment decision. With regard to information concerning the value of shares or units in designated investment alternatives (paragraphs (b)(2)(i)(B)(2) (iv) and (v)), such information also may be based on the latest information available to the plan, which, in most cases, would be valuation information obtained in connection with the most recent opportunity afforded participants and beneficiaries to give investment instructions with respect to that investment alternative. Finally, the Department notes that the informational requirements of subparagraphs (1) and (2) of paragraph (b)(2)(i)(B) are described in the regulation in general terms in order to afford plan fiduciaries and plan sponsors the flexibility necessary to accommodate the variations in plan design and investment alternatives which may be available to participants and beneficiaries under the plan. For these reasons, compliance with the disclosure requirements of the final regulation should not impose any significant costs and burdens on plans or plan sponsors. Timing of Disclosures Several commentators on the 1991 proposal requested clarification regarding when investment information must be furnished. The following is intended to address these requests in the context of the disclosure requirements under paragraph (b)(2)(i)(B) of the final regulation. Under [57 FR 46913] paragraph (b)(2)(i)(B) of the final regulation, a participant or beneficiary will not be considered to have been provided an opportunity to exercise control over the assets in his account unless the participant or beneficiary is provided or has the opportunity to obtain sufficient information to make an informed investment decision. Accordingly, in order to ensure the availability of relief under section 404(c), plans must provide the required information to participants and beneficiaries in sufficient time to give the participant or beneficiary a reasonable opportunity to make informed decisions with regard to his investment options or, where rights are passed through to the participants or beneficiaries, incidents of ownership appurtenant to his investments (e.g., the exercise of voting rights). In this regard, it is expected that each participant and beneficiary will be furnished the information delineated in subparagraphs (i)-(vii) of paragraph (b)(2)(i)(B)(1) prior to the time he is permitted to give investment instructions and that any subsequent material changes in the information will be furnished in sufficient time to enable the participant to take into account such changes prior to making an investment decision. With respect to participant or beneficiary requests for copies of prospectuses (see paragraph (b)(2)(i)(B)(2)( ii)), and with respect to materials relating to the exercise of voting, tender and similar rights (see paragraph (b)(2)(i)(B)(1)(ix)), it is expected that the participant or beneficiary will be provided such information in a sufficiently timely manner to enable the participant or beneficiary to make informed investment and voting decisions. The Department notes that to the extent that any of the information required by the regulation has been included in a plan’s most recent summary plan description or otherwise provided to participants and beneficiaries prior to the effective date of this regulation, such information is not required to be provided again to such participants or beneficiaries subsequent to the effective date of the regulation unless changes in the information have occurred which are sufficiently material that failure to disclose such changes would deprive the participant or beneficiary of the opportunity to make an informed investment decision. Two commentators asked that the final regulation indicate that plans are not required to disclose the value of participants’ accounts. One commentator stated that this information is not relevant to making an informed choice to invest a percentage of the account in a particular investment alternative. Another stated that the valuation of investment alternatives is often not completed until after elections are made by participants and beneficiaries and monies are allocated to the chosen investments. The Department believes that information concerning the value of investments held in a participant’s or beneficiary’s account may be critical to a participant or beneficiary in evaluating investment performance and alternative investment options. For this reason, the Department believes that participants and beneficiaries should have access to information concerning the value of shares or units in investment alternatives held in their individual accounts. In this connection, the Department notes that such information is required to be disclosed upon request of a participant or beneficiary under paragraph (b)(2)(i)(B)(2)(v) of the final regulation. The Department also notes, however, that such requests may be satisfied by using the latest valuation information available to the plan. Inasmuch as valuations are necessary to effectuate investment instructions, the Department does not believe the provision of this information should result in additional costs. Furthermore, there is nothing in the regulation which would preclude a plan from establishing procedures which would serve to limit the frequency of requests for account balance information or from requiring that such requests be made only at particular times as long as such limitations did not result in participants or beneficiaries being prevented from obtaining sufficient investment information to make informed investment decisions within the meaning of paragraph (b)(2)(i)(B) of the final regulation. Disclosure: Miscellaneous Comments With regard to the types of information which the 1991 proposed regulation required to be made available, one commentator asked for clarification that plan sponsors are not required by the regulation to release information on competitors or to bring participants and beneficiaries up to the level of financial expertise of the fiduciaries of the plan. No such requirement is imposed by the final regulation. Several commentators requested a clarification that expenses which represent a share of general fees charged to a fund, such as investment management and brokerage fees, did not have to be disclosed pursuant to paragraph (b)(2)(ii)(A) of the proposal. The Department believes that information concerning such expenses is readily available to plan fiduciaries or investment managers and should be available to participants and beneficiaries because it is the type of information which may affect a participant’s or beneficiary’s investment decision. For this reason, and as noted earlier, paragraph (b)(2)(ii)(B)(2)(i) requires that participants and beneficiaries be provided, on request, a narrative description of each designated investment alternative’s annual operating expenses (e.g., the investment management fees, administrative fees, transaction costs) which reduce the rate of return to participants and beneficiaries on interests in the investment alternative, and the aggregate amount of such expenses expressed as a percentage of average net assets of the designated investment alternative. One commentator inquired whether plans are required to revise quarterly reports provided by investment advisers to make them more readily understandable before distributing them to participants and beneficiaries. The final regulation does not require any information forwarded to participants and beneficiaries regarding the investments held by the plan on their behalf to be revised. Another commentator inquired whether all proxies must be passed through the participants and beneficiaries. As stated previously, with regard to all investment alternatives other than employer security alternatives, the final regulation requires, as a condition to 404(c) relief, only that participants and beneficiaries be provided, subsequent to an investment, with materials relating to voting and similar rights if such rights are passed through to participants and beneficiaries under the terms of the plan (see paragraph (b)(2)(i)(B)(1)(ix)). Of course, if a plan does not provide for such a pass-through of rights, no 404(c) relief would be available to the plan fiduciaries with regard to the exercise of such rights by such plan fiduciaries. Lastly, several commentators expressed concern that the providing of investment information to participants and beneficiaries might be construed as rendering "investment advice", within the meaning of section 3(21)(A)(ii) of the Act, resulting in fiduciary responsibility with respect to such advice. It is the view of the Department that providing the disclosures described in subparagraphs (1) and (2), as well as any other general information concerning available investment [57 FR 46914] alternatives, including research materials, would not, in and of itself, constitute the rendering of "investment advice." C. Frequency of Opportunity to Give Investment Instructions The General Volatility and Three-Month Minimum Rules The Proposal Both the 1987 and 1991 proposals were based on the principle that the frequency of opportunity to give investment instructions (i.e., to transfer account assets to or from an investment) is properly judged in relation to the anticipated volatility of the investment. As was explained in the preamble to those proposals, in order to assure that participants and beneficiaries in fact exercise control over the investment of their plan accounts, they must have the ability to transfer their account assets from investment alternatives at intervals reasonably commensurate with the anticipated volatility of the investment in order to minimize the risk of loss. What is reasonable in turn depends on the nature of the investment alternatives which are made available to participants and beneficiaries by the plan. The 1991 proposed regulation provided a more specific framework than had the 1987 proposal with respect to this issue, while retaining the basic concept concerning the relationship between frequency of transfer opportunity and the volatility of the related investment alternative. This revised framework assigned a specific minimum frequency of transfer opportunity and the volatility of the related investment alternative. This revised framework assigned a specific minimum frequency of transfer opportunity to at least three investment categories made available by a plan to its participants and beneficiaries to satisfy the broad range requirement of paragraph (b)(3) of the proposed regulation. These three (or more) categories subject to the minimum are referred to elsewhere herein as the "core" investment alternatives or categories.10 Thus, paragraph (b)(2)(ii)(C) of the proposal provided generally that, with respect to each investment alternative made available by a plan, the opportunity to exercise control will not exist unless participants and beneficiaries are afforded the opportunity to give investment instructions with a frequency which is appropriate in light of the volatility to which the investment may reasonably be expected to be subject. This principle is referred to herein as the "general volatility rule". However, subparagraph (1) of paragraph (b)(2)(ii)(C) of the proposal required that, regardless of the frequency warranted by an investment’s volatility, with regard to at least three of the investment categories designed to satisfy the terms of paragraph (b)(3)(i)(B) (relating to a broad range of investment alternatives), an ERISA section 404(c) plan must at a minimum provide a participant or beneficiary an opportunity to give investment instructions at least once within any three month period (referred to elsewhere herein as the "three-month minimum"). Paragraph (b)(2)(ii)(C)(1) of the final regulation clarifies that the minimum of three core alternatives subject to the three-month minimum must itself constitute a broad range of investment alternatives. Comments A number of commentators asserted that the general volatility rule was unnecessary and should be eliminated in favor of transfers once every three months for all alternatives, regardless of their volatility. Others urged that, in view of the objective of pension plans to accumulate funds for retirement, the regulation’s transferability rules should be structured to require only infrequent ability to transfer to and from investment alternatives. The Department continues to believe that the ability to transfer to and from each investment alternative with a frequency commensurate with the volatility of the particular investment alternative is needed in order to permit participants and beneficiaries the opportunity to give investment instructions with a frequency commensurate with the volatility of an investment alternative within the framework of a pension plan in any way compromises the general purpose of a pension plan to provide retirement income. Inasmuch as section 404(c) relief under this regulation is conditioned on participants and beneficiaries having the opportunity to give investment instructions with respect to amounts invested in each investment alternative, with a frequency commensurate with the volatility of each such investment alternative, fiduciaries of an ERISA section 404(c) plan should periodically review the volatility of its investment alternatives to ensure that the transfer frequency permitted with respect to each alternative continues to be appropriate. Other commentators requested that the general volatility rule be clarified by way of example. In this regard, the Department notes that meaningful clarification by way of example is not feasible because the application of the general volatility rule depends upon the particular facts and circumstances which characterize each investment alternative, including its economic environment. A number of commentators requested clarification of the three-month minimum requirement. Some commentators were concerned that the requirement could be read to require that the three-month period within which participants and beneficiaries must be offered an opportunity to give investment instruction be determined with respect to each participant or beneficiary individually and measured from each individual’s last investment instruction. While a plan may offer transfer opportunities on a participant by participant basis, the regulation does not require a plan to do so. In this regard, the Department has included two examples in the regulation at subparagraphs (2) and (3) of paragraph (f) which are intended to clarify the application of this rule. One commentator inquired whether investment instructions must be permitted once within any three-month period with respect to each core investment alternative, or whether participants and beneficiaries could be limited to transfers with respect to a single investment alternative. The regulation requires that investment instructions must be permitted with respect to each core investment alternative. Several commentators asked if the three-month minimum is applicable only to transfers among the core investment alternatives. The three-month minimum is applicable only to such transfers and does not apply to transfers between core investment alternatives and other alternatives. For example, if an ERISA 404(c) plan offered participants and beneficiaries the opportunity to invest in real estate limited partnership which prohibited transferability of ownership during the first three years as one of only three investment alternatives available under the plan designed to satisfy paragraph (b)(3)(i)(B), the inability to freely transfer assets out of such investment at least once within any three month interval would cause the plan to fail to meet the requirements of paragraph (b)(2)(ii)(C)(1). If, on the other hand, an investment opportunity to invest in such [57 FR 46915] a limited partnership were offered simply as an additional investment alternative and the plan made available at least three other investment alternatives for purposes of satisfying the terms of paragraph (b)(3)(i)(B), and permitted investment instruction no less frequently than once within any three-month period with respect to each such alternative, the three-month minimum prescribed at paragraph (b)(2)(ii)(C)(1) would not apply to the limited partnership interests. Such an investment alternative would, however, be subject to the general volatility rule contained in paragraph (b)(2)(ii)(C) (which requires that the frequency of opportunity to give investment instructions be determined relative to the frequency of opportunity to give investment instructions be determined relative to the anticipated market volatility of the investment) as a condition to affording section 404(c) relief for amounts invested in that alternative. Some commentators did not view the three-month minimum as beneficial to plan participants and beneficiaries and requested either no minimum or a different minimum frequency requirement. For example, commentators were concerned that the three-month minimum could adversely impact on the rates of return provided in connection with fixed-rate investment contracts. The Department did not accept these comments. The Department believes that participants and beneficiaries must be afforded the opportunities to give investment instructions at least once within any three-month period if they are to have any meaningful control over the assets in their accounts. Moreover, the Department believes that, given the flexibility in plan design afforded by the final regulation, the adoption of the three-month minimum rule should have little, if any, impact on investment returns available to participants and beneficiaries. A number of commentators inquired about the result under the regulation where a plan which in all other respects meets the requirements for the ERISA section 404(c) plan offers, in addition to three investment alternatives constituting a broad range of investments, an investment alternative with restrictions on investment instructions which would cause the investment alternative to fail the general volatility rule in paragraph (b)(2)(ii)(C). The offering of such an investment alternative would not in and of itself cause a plan otherwise meeting the requirements for an ERISA section 404(c) plan to lose its status as an ERISA section 404(c) plan. However, there would be no section 404(c) relief accorded to plan fiduciaries with respect to amounts invested in an investment alternative which does not permit investment instructions with a frequency commensurate with the reasonably expected volatility of the investment alternative. With respect to the general volatility rule and the three-month minimum rule, the Department notes that while there is nothing in the regulation that precludes the assessment of a penalty or valuation adjustment for early or premature withdrawals from an investment alternative, any penalties or adjustments for such withdrawals must be reasonable in light of the investment. Substantial penalties or adjustments upon withdrawal from an investment alternative may have the effect of limiting the ability of participants and beneficiaries to give investment instructions in accordance with the general volatility or three-month minimum transferability rules of the regulation, thereby depriving participants and beneficiaries of the opportunity to exercise control with respect to such investment alternative.11 The Volatile Investment Transferability Rule The Proposal In addition to the foregoing rules, paragraph (b)(2)(ii)(C)(2) of the proposed regulation would have required that the least volatile of the core investment alternatives permit the participant or beneficiary to give investment instructions no less frequently than he is permitted to give such instructions with respect to the most volatile investment alternative made available by the plan (referred to elsewhere herein as the "volatile investment transferability rule"). The notice of proposed rulemaking explained that this rule was necessary because the ability to transfer assets to or from a volatile investment has meaning only where there is in fact another investment vehicle available which can just as readily transfer out or accept assets. Comments Many commentators expressed the view that the volatile investment transferability rule should either be eliminated or significantly changed. Several commentators indicated that the rule could interfere with the operation of fixed rate investment contracts. Other commentators expressed concern about the necessity of ongoing volatility measurements to permit compliance with the regulation, particularly with regard to core investment alternatives. Commentators also indicated that, if the rule were to be retained, the requirement should apply only to transfers out of the most volatile alternative into the least volatile core alternative, and not to transfer out of the least volatile core alternative. A number of commentators made specific suggestions concerning the kinds of alternatives which would be used to satisfy the requirement that an alternative be available to receive transfers out of the most volatile investments. Suggestions included: a default-type fund; any "temporary investment fund"; any "low-risk" vehicle; and any "less volatile" investment alternative. A number of commentators expressed the view that the general volatility rule should serve as the standard for determining the required transfer frequency under the volatile investment transferability rule. Accordingly, they urged that, with respect to a plan which permits transfers into and out of its most volatile investment alternative more frequently than would be required by the volatility of the fund, the regulation requires only that a participant or beneficiary be permitted to give investment instructions with respect to transfer into the least volatile core investment alternative no less frequently than would be required by the volatility of the most volatile investment alternative. The Department continues to believe that, given the transferability and diversification requirements applicable to core investment alternatives, participants and beneficiaries must be afforded the opportunity to direct their investments from more volatile investments into a core investment alternative with a frequency commensurate with the volatility of the more volatile investment alternative. However, in response to the concerns raised by commentators, the Department has provided additional flexibility under the final regulation, which is discussed below. The Final Regulation The volatile investment transferability rule contained in the final regulation is substantially different in a number of [57 FR 46916] respects from the rule that was proposed. First, the final regulation provides two alternative methods for accommodating transfers out of more volatile investments (other than investments in employer securities with respect to which a special rule has been adopted). Second, transfers from more volatile investments are not required to be accommodated by the least volatile of the core investment alternatives. Third, the final regulation requires only that a core investment alternative accept transfers into the alternative (rather than both into and out of the alternative) with a frequency commensurate with the more volatile investments. Fourth, the volatile investment transferability rule, as adopted, is framed in terms of when participants and beneficiaries are permitted to give investment instructions with respect to an investment alternative, rather than with respect to the volatility of the investment alternative. This change was made in view of the fact that an ERISA section 404(c) plan could provide for participant instruction with respect to an investment alternative more frequently than would be required by the general volatility rule, which provides that, as a condition to section 404(c) relief, participants and beneficiaries must, at a minimum, be permitted to give investment instruction with a frequency commensurate with the reasonably expected volatility of each investment alternative. Lastly, the volatile investment transferability rule, as adopted, assures that transfers are available from any investment alternative available under the plan which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period. The following is a discussion of the methods for accommodating transfers provided for in the final regulation. The first method for accommodating transfers is contained in paragraph (b)(2)(ii)(C)(2)(i). Under this method, at least one of the core investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) (rather than only the least volatile of the core investment alternatives, as in the proposal) must permit participants and beneficiaries to give investment instructions as frequently as they are permitted to give investment instructions with respect to any investment alternative made available by the plan which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period. In addition, as noted above, the core investment alternative selected to satisfy this requirement need only permit such instructions with regard to transfers into the alternative (rather than both into and out of the alternative, as in the proposal). Rather than permitting transfers directly to a core investment alternative, a plan may elect the alternative method for accommodating transfers, contained in paragraph (b)(2)(ii)(C)(2)(ii). In general, this method permits the establishment and use of a "cash-equivalency" type fund, subfund or account for the temporary holding of proceeds from investments pending the next opportunity afforded participants and beneficiaries to direct investments into one of the core investment alternatives. Specifically, the final regulation provides that, with respect to each investment alternative which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period, participants and beneficiaries must be permitted to direct their investments from such alternative into an income producing, low risk, liquid fund, subfund or account as frequently as they are permitted to give investment instructions with respect to the particular investment alternative. In addition, participants and beneficiaries must be permitted to direct investments from such low risk fund, subfund or account into one of the core investment alternatives (which must permit investment instructions at least once within any three month period pursuant to paragraph (b)(2)(ii)(C)(1)), as frequently as they are permitted to give instruction with respect to such core alternative. The following example illustrates the application of the second method. In addition to offering three core investment alternatives, which constitute a "broad range" of investments (alternatives A, B and C), Plan P offers a high risk equity fund which permits investment instructions more frequently than once within any three month period and a one year certificate of deposit which is fully insured by a Federal agency. Plan P permits participants and beneficiaries to direct investments from the equity fund into an income producing, low risk, liquid subfund of the equity fund as frequently as they are permitted to give investment instructions with respect to the equity fund. Subsequently, participants and beneficiaries are permitted to direct their investments from the subfund into core investment alternative A at such time as investment instructions are permitted with respect to alternative A. No similar direction into a low-risk fund, subfund or account is permitted with respect to investments from the certificate of deposit. Plan P meets the conditions of the second method for accommodating transfers, provided that the fiduciary of Plan P has determined that the volatility of the certificate of deposit does not require (and the Plan does not permit) investment instructions more frequently than once within any three month period with respect to the certificate of deposit. The foregoing methods of accommodating transfers apply to investment alternatives, other than investment alternatives which permit the direct or indirect acquisition or sale of any employer security ("employer security alternatives"). As noted earlier, a special rule is contained in the final regulation for employer security alternatives. The Department believes that a special rule for dispositions of interests in employer security alternatives is appropriate given the concerns of Congress and others about the potential for employer influence over participant investment decisions.12 In general, the methods for accommodating transfers from employer security alternatives are essentially the same as for other alternatives, except that participants and beneficiaries directing their investments from an employer security alternative (either directly to core investment alternatives or indirectly, through a low-risk, liquid fund, subfund or account, to core alternatives) must be afforded the opportunity to direct their investments from the employer security alternative into any of the available core investment alternatives. The Department believes that affording participants and beneficiaries the opportunity to invest proceeds from an employer security alternative in the core investment alternative of their choice is necessary in order to avoid the intentional or unintentional establishment of disincentives to dispose of interests in an employer security alternative. Such disincentives could result, for example, where plan design requires that participant proceeds from an employer security alternative may only be transferred to a particular core alternative. Specifically, the final regulation provides that, for each investment alternative which is designed to permit the direct or indirect acquisition or sale of any employer security, contained in paragraph (b)(2)(ii)(C)(3)(i) of the final [57 FR 46917] regulation, all of the core investment alternatives must permit participants and beneficiaries to give investment instructions with regard to transfer into each of the alternatives as frequently as participants and beneficiaries are permitted to give investment instructions with respect to the employer security alternatives(s). As an alternative, paragraph (b)(2)(ii)(C)(3)(ii) of the final regulation permits plans to provide for participant and beneficiary direction of investments from each employer security alternative(s) into an income producing, low risk, liquid fund, subfund or account as frequently as the participants and beneficiaries are permitted to give investment instructions with respect to the employer security alternative(s). Under this method, participants and beneficiaries must be permitted to direct investments from such low risk fund into each of the core investment alternatives as frequently as they are permitted to give investment instructions with respect to each such core investment alternative. The special rule is designed to assure that participants and beneficiaries will be permitted to choose from a broad range of investment alternatives when deciding to transfer assets from an alternative which permits the direct or indirect acquisition or sale of any employer security. The Uniformity Requirement Paragraph (b)(2)(ii)(C) of the proposed regulation provided that, in order for a restriction to be deemed reasonable, it must be applied on a uniform and consistent basis to all directing participants and beneficiaries of that plan (referred to herein as the "uniformity requirement"). A number of commentators believed that two requirements contained in the proposed regulation would, if finalized, conflict with the transfer restrictions set forth in the rules under section 16 of the Securities and Exchange Act of 1934 (the ’34 Act). These requirements were the uniformity requirement, and the general rule contained in paragraph (b)(2)(ii)(C), which required that the frequency of opportunity to give investment instructions with respect to an investment alternative must be determined relative to the anticipated market volatility of the investment. Section 16 of the ’34 Act imposes sanctions on "insiders", including officers and directors of an issuer of securities, if they do not comply with restrictions on transfers of securities of certain issuers. The restrictions generally impose sanctions if a purchase and sale occur within six months of each other. Rule 16b-3 provides that the plan itself may preclude certain transfers of securities as one method of complying with the restrictions contained in section 16(b). Under the proposal, if a plan imposed such restrictions only upon "insiders", the plan would lose its status as a section 404(c) plan as it would not comply with the uniformity requirements. In this regard, commentators urged the Department to provide in the final regulation that transfer restrictions on transactions in employer securities by insiders which are included in a plan to compel insiders to comply with section 16 of the ‘34 Act will not cause a plan to lose its status as an ERISA section 404(c) plan. Another commentator contended that the uniformity requirement should be deleted because there are situations in which plan sponsors have a legitimate need to make distinctions between participants. The commentator stated that a plan sponsor may want to have different rules for participants in a subsidiary’s portion of its plan, or for union and non-union employees. Another commentator noted in this connection that fixed rate investment contracts may prohibit the entrance of acquired company participants in order to make the provider’s costs and risks predictable. Other commentators were concerned that the uniformity requirement not be interpreted to prohibit variation in frequency restrictions among different plans maintained by the same affiliated group. In view of the concerns expressed by the commentators, the Department has decided to eliminate the uniformity requirement. Accordingly, under the final regulation, if a plan contains restrictions with respect to investments in securities in order to facilitate compliance with section 16 which are applicable only to "insiders", such restrictions will not affect the plan’s status as a section 404(c) plan; but if such restrictions are not consistent with the general volatility rule, investments in securities by "insiders" made subject to the restrictions will not be afforded relief by section 404(c). While the final regulation does not contain a uniformity requirement, the Department notes that section 401(a)(4) of the Internal Revenue Code prohibits discrimination in favor of highly compensated employees in the contributions or benefits provided under a plan and may be applicable to the specific restrictions contained in an ERISA section 404(c) plan. D. Other Limitations on the Exercise of Control The Proposal Paragraph (b)(2)(ii)(A) of the proposal provided that a plan did not fail to provide the participant or beneficiary with an opportunity to exercise control over his individual account merely because it charges the participant’s or beneficiary’s account for the reasonable expenses of carrying out his instructions, if reasonable procedures are established under the plan to inform participants and beneficiaries that such charges are made and to inform each participant and beneficiary periodically of the actual expenses incurred with respect to his individual account. Two commentators indicated that expense information is not currently provided and would be very costly to provide, and therefore, urged that only the nature of expenses charged against accounts should be required to be described in the SPD or another document. The Department continues to believe that participants and beneficiaries should be periodically apprised of the actual expenses charged to their respective individual accounts, as this information is directly relevant to the amount of assets in their account and future investment decisions. Accordingly, this requirement has been retained in the final regulation. However, paragraph (b)(2)(ii)(A) has been modified to delete the requirement to inform participants and beneficiaries that such charges are made inasmuch as this information is required to be disclosed to participants and beneficiaries pursuant to paragraph (b)(2)(i)(B)(1)(v) of the final regulation. One commentator inquired whether anything in the regulation would preclude a plan from charging only the accounts of former employees for the expenses of implementing their investment instructions. Nothing in the regulation would prevent a plan from charging such expenses only to the accounts of former employees. However, the Department notes that sections 403, 404 and 408(b)(2) of ERISA would require that such charges be reasonable.13 Paragraph (b)(2)(ii)(B) of the proposal provided that a plan did not fail to provide an opportunity for a participant or beneficiary to exercise control merely because the plan permits a fiduciary to decline to implement certain instructions of a participant or [FR 46918] beneficiary. As stated in the 1991 proposal, the delineated list was not intended to constitute an exhaustive list of allowable limitations on a participant’s or beneficiary’s exercise of control. In response to a request for clarification on this point, paragraph (b)(2)(ii)(B) of the final regulation has been modified to make clear that the instructions which a plan may permit a fiduciary to decline are not limited to those listed in the regulation.14 Paragraph (b)(2)(ii)(B) of the proposal had listed, among the instructions which a plan could permit a fiduciary to decline to implement, instructions which could result in a loss in excess of the directing participant’s or beneficiary’s account balance. In the final regulation, this type of instruction has been moved from paragraph (b)(2)(ii)(B) to paragraph (d)(2)(ii)(D)15 to clarify that a plan fiduciary would not be relieved of liability with respect to a participant’s or beneficiary’s instructions which could result in a loss in excess of that participant’s or beneficiary’s account balance. Another change was made to paragraph (b)(2)(ii)(B) of the final regulation relating to the types of instructions listed in paragraph (d)(2)(ii). Rather than listing instructions which are described at paragraph (d)(2)(ii), as did paragraph (b)(2)(ii)(B) of the proposal, paragraph (b)(2)(ii)(B) of the final regulation provides that a fiduciary may decline to implement participant and beneficiary instructions which are described at paragraph (d)(2)(ii) of this section, as well as instructions specified in the plan, including those which would result in a prohibited transaction and those which would generate income that would be taxable to the plan. This change was made in order to permit a fiduciary to decline to implement participant instructions where the regulation provides that he would not be relieved of any liability resulting from implementing such instructions (see paragraph (d)(2)(ii)), even where the plan does not specifically authorize him to do so. Comments Commentators asked for clarification regarding various technical aspects of plan operation which may impact upon a participant’s or beneficiary’s opportunity to exercise control within the meaning of paragraph (b)(2) or (b)(3) (relating to a broad range of investment alternatives) of the regulation. Some commentators inquired whether a plan may require notice before a designated transfer date to provide time for implementation of instructions. Other commentators requested clarification that, as long as transfer opportunities are provided, an affirmative election may be given effect with respect to all future contributions until it is affirmatively revoked. Similarly, one commentator expressed the view that, with respect to former employees, the requirement that participants be permitted to exercise independent control should be met where a plan provides that the account balances of former employees who are permitted to withdraw their funds at any time will be invested in accordance with the most recent investment election made prior to termination. Another commentator urged the Department to indicate that sufficient control exists where a plan provides that, if a beneficiary fails to direct with respect to assets in his account, the plan will promptly distribute the account assets to the beneficiary. The Department notes that there is nothing in the final regulation which precludes a plan from providing for a notice period to provide time for implementation of instructions, as long as such notice period does not interfere with or compromise a participant’s or beneficiary’s opportunity to exercise control. Also, as long as transfer opportunities are made available to participants and beneficiaries in accordance with the regulation, including former employee-participants, an affirmative election may be given effect until affirmatively revoked by the participant or beneficiary. With regard to the permissibility of providing that assets will be distributed to a beneficiary if he fails to direct, the Department notes that a distribution pursuant to such a provision would not constitute the exercise of control, within the meaning of the regulation, by the participant or beneficiary. Therefore, the relief afforded by section 404(c) would not be available with respect to the distribution. A number of commentators requested a clarification regarding the permissibility of specific types of transfer restrictions. For example, some urged the Department to permit provisions requiring direction with respect to specified increments of the account balance. One commentator requested that the Department specifically permit ERISA section 404(c) plans to place maximum limits on the portion of a participants’s account balance which may be invested in each equity fund offered by the plan. In this regard, it is the view of the Department that conditioning the ability of participants and beneficiaries to give investment instruction on the transfer of a minimum amount or percentage. e.g., $100 or 5%, of transferable assets would not, in and of itself, cause the plan to fail to be a section 404(c) plan, provided that the amount or percentage had some reasonable relationship to administrative costs attendant to such transfers and provided that such limitations are applied on a reasonable and consistent basis. On the other hand, it is the view of the Department that limitations on the maximum amount or percentage that a participant or beneficiary may invest in any investment alternative which is necessary to satisfy the broad range requirement of the regulation would so restrict a participant’s or beneficiary’s opportunity to exercise control that the plan would fail to be a section 404(c) plan. The imposition of such limitations on investment alternatives which do not constitute part of a plan’s broad range of investment alternatives, however, would not affect the status of the plan as a section 404(c) plan inasmuch as participants and beneficiaries would nonetheless have the opportunity to exercise control with respect to a broad range of investment alternatives. See example in paragraph (f)(4). One commentator inquired whether a plan may preclude transfers into an investment vehicle when it decides to eliminate the vehicle as an alternative. Although the regulation would not preclude such a restriction, the Department notes that the plan would nevertheless be required to offer a broad range of investment alternatives within the meaning of the regulation subsequent to elimination of the investment alternative as a condition for section 404(c) relief. 2. Broad Range of Investments The Proposal The 1991 proposal provided, in paragraph (b)(3)(i), that a plan offers a broad range of investments only where participants and beneficiaries are afforded a reasonable opportunity to materially affect the potential risk and return on amounts in their accounts; choose from at least three diversified investment categories; and diversify investments so as to minimize the risk of [57 FR 46919] large losses. Unlike the 1987 proposal, which described the specific categories of investments which were required to be made available by an ERISA section 404(C) plan, paragraph (b)(3(i)(B) of the 1991 proposal was based upon the general requirement that participants and beneficiaries have the opportunity to choose from at least three diversified categories of investments. Specifically, paragraph (b)(3)(i)(B)(1) required that each category have materially different risk and return characteristics. Paragraph (b)(3)(i)(B)(2) of the proposal required that the three categories of investments in the aggregate enable the participant, 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, thereby enabling participants and beneficiaries to construct a portfolio with risk and return characteristics appropriate to their circumstances. Finally, paragraph (b)(3(i)(B)(3) of the proposal required that each of the investment categories, when combined with investments in either of the other categories, must tend to minimize the risk of a participant’s portfolio at any given level of expected return. With the exception of certain minor modifications, discussed below, the Department has adopted the proposed broad range of investments requirement in the final regulation. Comments Most of the commentators supported the Department’s approach to defining a broad range of investment alternatives by reference to risk and return characteristics, rather than prescribing specific investment objectives, as was the case in the 1987 proposal. Nonetheless, a number of comments were submitted on the broad range of investment alternatives provisions of the proposed regulation. These comments are summarized and addressed below. Several commentators requested clarification that the regulation requires both that the categories be different from each other and that they contain diversified investments. One commentator pointed out that the other requirements in paragraph (b)(3)(i)(B) ensure that the categories must be different from each other, and suggested changing the language of this paragraph to "three categories of diversified investments". In response to these comments, the text of the regulation has been changed to make it clear that each of the three investment alternatives intended to satisfy the broad range requirement must be diversified. (See paragraph (b)(3)(i)(B)(1) of the final regulation).16 Several commentators argued that the regulation should only require two investment categories. One commentator urged the Department to adopt a special rule in this regard for collectively bargained plans. The Department continues to believe that a plan offers a broad range of investment alternatives only where participants and beneficiaries are provided with the opportunity to invest in at least three investment alternatives meeting the requirements of paragraph (b)(3)(i) of the regulation. The Department is unable to agree that participants and beneficiaries are afforded a reasonable opportunity to exercise meaningful control over the assets in their account where such participants and beneficiaries are limited to two investment choices. Accordingly, the Department has retained the requirement that participants and beneficiaries be provided the opportunity to choose among at least three investment alternatives. Two commentators urged that the regulation either require or endorse specific types of investment instruments. One of the commentators suggested that the regulation which contains instruments guaranteed either directly or indirectly by the U.S. Government, or permit participants to transfer at five year intervals to a plan in which the investment options are unlimited. The other commentator urged the Department to specify that U.S. Savings Bonds can serve as one of the minimum of three diversified categories required by paragraph (b)(3)(i)(B) and to except them from the minimum transfer opportunity requirement. The Department believes that the general approach of requiring at least three diversified investment alternatives with materially different risk and return characteristics will better serve the needs of both plant sponsors and participants and beneficiaries than would an approach which attempts to specify particular investment alternatives which are necessary to constitute a broad range of investments. Similarly, several commentators indicated that the standards contained in paragraph (b)(3)(i)(B) for the minimum of three broad range investment alternatives are vague and difficult to apply, and urged the Department to include examples in the final regulation of combinations of investment alternatives which meet the risk and return criteria of the regulation. The final regulation is intended to give plan sponsors broad latitude in developing combinations of investment alternatives which meet the broad range requirement. For this reason, the Department is concerned that providing examples of combinations of investment alternatives which meet the broad range requirement may be construed as an endorsement by the Department of such combinations of investment alternatives and thereby serve, directly or indirectly, to limit the flexibility in plan design intended by the regulation. Therefore, the Department has not adopted this suggestion. Two commentators raised the question of whether employer securities may be one of the minimum of three broad range investment alternatives. Inasmuch as employer securities would not themselves represent a diversified investment alternative, as required by paragraph (b)(3)(i)(B)(1), employer securities or a fund of such securities could not be used as one of the investment alternatives intended to satisfy the broad range of investments requirements of the regulation. A number of commentators asserted that the types of restrictions often contained in fixed rate investment contracts issued by banks and insurance companies should not cause the contracts to fail to qualify as one of the minimum of three diversified categories of investments required by paragraph (b)(3)(i)(B). The commentators mentioned a number of different types of restrictions, including "equity wash" restrictions, prohibitions on direct transfers from such investment contracts to competing fixed income funds, requirements that investments in contracts remain for a certain minimum period, and a fee or charge for pre-maturity redemption or a market value adjustment for suspension of a contract. An "equity wash" restriction is one which requires that transfers to and or from a fixed rate investment contract be made through an equity fund where the funds must remain for a specified period of time. There is nothing in the regulation which would specifically preclude offering a bank (or similar institution) or insurance company fixed rate investment contract as one of the investment alternatives intended to satisfy the broad range requirement merely because such contract imposes [57 FR 46920] fees or charges for premature withdrawals, provided that, as noted earlier, such fees or charges are reasonable in light of the investment and are not so substantial as to have the effect of depriving participants and beneficiaries of the opportunity to exercise meaningful control over such investment. To the extent that any investment alternative intended to satisfy the broad range requirement of the regulation contained restrictions that would effectively limit the ability of a participant or beneficiary to give investment instructions at least once within any three month period with respect to transfers between the core investment alternatives, the plan would fail to satisfy the requirements of paragraph (b)(2)(ii)(C)(1). Thus, an equity wash or similar restriction on any core investment alternative, such as a fixed rate investment contract, which would serve to preclude direct transfers from the core investment alternative to any of the other core investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) would prevent the investment alternative with such a restriction from serving as one of the core investment alternatives. However, there is nothing in the regulation which would preclude an investment alternative with an "equity wash" or similar restriction from being offered as an investment alternative in addition to the core investment alternatives. The mere fact that an "equity wash" restriction may require participants to transfer assets from such a non-core investment alternative into an equity fund, which is offered as one of the core investment alternatives, would not in and of itself affect a plan’s status as an ERISA section 404(c) plan, or the availability of section 404(c) relief with respect to transactions involving the non-core investment alternative. An ERISA section 404(c) plan must, however, permit any assets transferred from the non-core investment alternative pursuant to an equity wash or similar restriction to a core equity fund to be transferred to and from the other core alternatives as frequently as are other assets in the core equity fund, and, in no event, less frequently than once within any three month period. (See the general volatility rule in paragraph (b)(2)(ii)(C) and the three month minimum rule in paragraph (b)(2)(ii)(C)(1).) Two commentators requested clarification that the requirement in paragraph (b)(3)(i)(B)(1) (designated (b)(3)(i)(B)(2) in the final regulation) that each of the categories of investments have materially different risk and return characteristics does not require a 404(c) plan to offer either a very conservative or a very risky investment alternative. The Department notes that paragraph (b)(3)(i)(B)(2) of the final regulation merely requires that each of the categories of investments have materially different risk and return characteristics, without specification as to the nature of the risks. Paragraph (b)(3)(i)(B)(3) does, however, require, for purposes of the broad range of investment alternatives requirement, that the available investment alternatives enable participants and beneficiaries to achieve a portfolio with aggregate risk and return characteristics at any point within the range "normally appropriate for the participant." A number of commentators indicated that the language of paragraph (b)(3)(i)(B)(3) of the proposal (redesignated (b)(3)(i)(B)(4) in the final regulation) should be clarified. This paragraph required that each of the three investment categories intended to satisfy the broad range of investments in either of the other categories, tends to minimize the risk of a participant’s portfolio at any given level of expected return. Several commentators made suggestions on how to modify the language, while others suggested that this provision should be deleted or, at a minimum, explained. In an effort to provide clarification, the language of paragraph (b)(3)(i)(B)(3) of the proposal has been modified to read: "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".17 The Department believes that the criteria set forth in paragraph (b)(3)(i)(B) reflect well established investment principles which are appropriate to the defining of a broad range of investment alternatives. The Department also believes that adoption of these principles provides plan sponsors the design flexibility necessary to accommodate changes in participant needs and changes in investment products and markets. Accordingly, the Department has retained the criteria set forth in paragraph (b)(3)(i)(B), with the minor modifications discussed above. The purpose of the broad range requirement is to enable participants and beneficiaries to achieve various levels on the risk and return spectrum while at the same time minimizing the risk presented by their portfolio through the allocation of the assets in their accounts. A. Diversification In addition to requiring that participants and beneficiaries be provided a reasonable opportunity to choose from among at least three diversified investment categories, paragraph (b)(3)(i)(C) of the proposal required that ERISA section 404(c) plans provide participants and beneficiaries the opportunity to diversify the investments of that portion of their individual accounts with respect to which they are 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’ accounts. The proposal explained, in paragraph (b)(3)(ii), that where look-through investment vehicles are available as investment alternatives to participants or beneficiaries, the underlying investments of the look-through investment vehicle shall be considered in determining whether the plan satisfies the requirements of paragraph (b)(3)(i)(B) and paragraph (b)(3)(i)(C) (relating to diversification of investments).18 With regard to the diversification requirement contained in paragraph (b)(3)(i)(C), the Department recognizes that a participant may need a substantial amount of investment capital to achieve such diversification if investment alternatives are limited to direct investment in individual instruments (such as common stocks, bonds, etc.). However, broad diversification may be achieved with a much smaller amount of capital where assets are held in the form of an undivided interest in a pool of broadly diversified investment instruments. Therefore, paragraph (b)(3)(i)(C) of the final regulation stresses that where a plan provides the opportunity to invest [57 FR 46921] solely in individual investment instruments, such an opportunity will not meet the broad range requirement of paragraph (b)(3)(i) unless the portion of the account balance over which a plan participant or beneficiary is permitted to exercise control is large enough to permit diversification through that form of investment. Where such portion of the account balance of any participant or beneficiary is not sufficiently large, a plan can meet the requirements of paragraph (b)(3)(i) only by making available the opportunity to invest in look-through investment vehicles.19 Of course, a plan which permits a participant to invest his account assets in any available investment implicitly makes available all look-through investment vehicles and therefore would meet the requirements of paragraph (b)(3)(i) regardless of the account balances of the participants. One commentator requested that the Department clarify how frequently the underlying investments of look-through investment vehicles must be monitored for compliance with paragraphs (b)(3)(i)(B) and (b)(3)(i)(C) of the regulation. The extent to which fiduciaries are required to monitor any designated investment will depend on the facts and circumstances of each case and vary from investment to investment, depending on, among other things, the degree of risk and the economic environment. B. Definition of "Look-Through Investment Vehicle" Paragraph (f)(1) of the proposed regulation defined "look-through investment vehicle" as: (i) An investment company described in section 3(a) of the Investment Company Act of 1940, or a series investment company described in section 18(f) of the 1940 Act and the regulations thereunder,20 or any of the segregated portfolios of such companies; (ii) a common or collective trust fund or a pooled investment fund maintained by a bank, a bank deposit, or a guaranteed investment contract of a bank; (iii) a pooled separate account or a guaranteed investment contract or an insurance company qualified to do business in a state; or (iv) any entity whose assets include plan assets by reason of a plan’s investment in the entity. For purposes of the final regulation, paragraph (f) of the proposal has been redesignated paragraph (e). The types of vehicles encompassed within the definition of look-through investment vehicle were intended to be those for which the underlying assets could properly be considered in determining whether the diversification requirement of section 404(a)(1)(C) is met. In this regard, the Conference Report indicates at page 305 that a determination of diversification with regard to a plan investment in a mutual fund, a bank investment vehicle or insurance company contracts would be achieved through an examination of the underlying assets and investments of the bank or insurance company. Paragraph (e)(1) of the final regulation retains the definition of look-through investment vehicle contained in the proposal with minor modifications discussed below. As noted in the preamble to the proposal, in general, a determination of whether any particular investment vehicle comes within the definition of the term "look-through investment vehicle" is a factual determination and, thus, must be made on a case by case basis. However, the Department did note that group trusts as defined in IRS Rev. Rul. 81-100 would , at a minimum, meet paragraph (f)(1)(iv) of the definition (paragraph (e)(1)(iv) of the final regulation) since they are entities whose assets include plan assets by reason of a plan’s investment in them.21 As such, they would be considered look-through investment vehicles for purposes of the regulation. Commentators on the 1991 proposal were concerned about the status under the regulation of employer-managed arrangements,22 commonly referred to as "in-house funds", and which, according to these commentators, are not typically considered to be entities separate from a plan’s trust. As described, such arrangements, holding plan assets, would constitute look-through investment vehicles pursuant to subparagraph (iv) of paragraph (e)(1). Other commentators were concerned about the status of other portfolios and subfunds which are not typically considered to be entities separate from a plan’s trust. These arrangements also would constitute look-through investment vehicles described in subparagraph (iv) if their assets contain plan assets pursuant to 29 CFR 2510.3-101. Several commentators requested that the Department clarify whether the term "look-through investment vehicle" is applicable to certain arrangements involving fixed rate investment contracts and investment contract-type instruments and requested that, if not, the regulation be modified to include such investments. In this regard, commentators specifically mentioned "guaranteed investment contracts" funds, "synthetic guaranteed investment contracts", "immediate participation contracts" and "deposit administration contracts". In addition, several commentators urged the Department to amend the definition of look-through investment vehicle to include all insurance company general account products and annuity contracts. In general, the record does not contain sufficient information with respect to these contractual arrangements to permit the Department to make a determination as to whether and to what extent such contracts should constitute look-through investment vehicles for purposes of this regulation. However, the Department notes that funds of fixed rate investment contracts would appear to meet subparagraph (iv) of the definition of look-through investment vehicle because the contracts contained in the funds constitute plan assets. In addition, subparagraph (ii) of the definition of 46906 look-through investment vehicle, contained in paragraph (e)(1) of the final regulation, has been modified in the final regulation to indicate that, for example, fixed rate investment contracts issued by savings and loan associations are look-through investment vehicles for purposes of the regulation. Paragraph (e)(1)(ii) of the final regulation now reads: "[a] common or collective trust fund or a pooled investment fund maintained by a bank or similar institution, a deposit in a bank or similar institution, or a fixed rate investment contract of a bank or similar institution." [57 FR 46922] 3. The Special Rule for Designated Look-Through Investment Vehicles and Designated Investment Managers The proposed regulation included a special rule which would apply to plans which made available one or more designated look-through investment vehicles or one or more designated investment managers as investment alternatives. The proposal provided that a plan whose investment alternatives include any specified look-through investment vehicle or the right to appoint a designated investment manager is an ERISA section 404(c) plan only if, among other things, an independent plan fiduciary is required to designate the look-through investment vehicles or investment managers offered as investment alternatives. The proposal included an exception to the special rule for designated look-through investment vehicles and investment managers for plans sponsored by entities described in section 3(38) of ERISA. The exception permitted such entities (without using an independent fiduciary) to designate themselves or an affiliate as an available investment manager or designate a look-through investment vehicle managed by themselves or an affiliate as an available investment alternative under their own plans under certain limited circumstances. A number of commentators on the 1991 proposal expressed the opinion that the requirement for an independent fiduciary is unnecessary, since any fiduciary (independent or not) who selects a look-through investment vehicle or an investment manager must bear responsibility under the fiduciary responsibility provisions of ERISA to do so prudently and solely in the interest of participants and beneficiaries. After carefully reviewing the public comment on this matter, the Department has determined that the general fiduciary provisions are sufficient to ensure that the interests of plan participants and beneficiaries are protected. The Department emphasizes, however, that the act of designating investment alternatives (including look-through investment vehicles and investment managers) in an ERISA section 404(c) plan is a fiduciary function to which the limitation on liability provided by section 404(c) is not applicable. All of the fiduciary provisions of ERISA remain applicable to both the initial designation of investment alternatives and investment managers and the ongoing determination that such alternatives and managers remain suitable and prudent investment alternatives for the plan. Therefore, the particular plan fiduciaries responsible for performing these functions must do so in accordance with ERISA. For the aforementioned reasons, paragraph (c) of the proposal has been deleted from the final regulation and the remaining paragraphs of the regulation have been redesignated. IV. The Independent Exercise of Control The Proposal In view of the transactional nature of the relief provided by section 404(c), the 1991 proposal provided that a determination as to whether a participant or beneficiary has in fact exercised control must necessarily be made on a case by case basis, taking into account the relevant facts and circumstances. The proposal also stated that sections 404(c)(1) and 404(c)(2) apply only where the participant’s exercise of control has been independent. This is consistent with the Conference Report discussion of section 404(c).23 In this regard, the proposal described certain factors that indicate the absence of independent control. These are: (1) Improper influence by a plan fiduciary or plan sponsor with respect to the transaction; (2) concealment from the participant or beneficiary by a plan fiduciary of material nonpublic facts regarding the transaction that are known by the plan fiduciary, unless the disclosure of such information by the plan fiduciary to the participant or beneficiary would violate securities or banking laws; and (3) the legal incompetence of the participant or beneficiary where the plan fiduciary accepting his instructions knows him to be incompetent.24 Paragraph (d)(3) of the proposal (redesignated paragraph (c)(3) in the final regulation) also stated that where a participant or beneficiary exercises control over the assets in his account to engage in a sale, exchange or leasing of property, or a loan with a plan fiduciary or an affiliate of such fiduciary, such exercise of control will not be "independent" (regardless of whether it meets the other requirements of the regulation) unless the terms of the transaction are fair and reasonable to the participant or beneficiary at the time of the transaction. A transaction will be deemed to be fair and reasonable to the participant or beneficiary if he pays no more than, or receives no less than, adequate consideration as defined in section 3(18) of the Act in connection with the transaction. These standards were adopted from established principles relating to the circumstances under which consent of a beneficiary of a trust will relieve a trustee from liability for breach of his fiduciary duties.25 The Department points out that, for some instructions which would result in a direct or indirect transaction between an ERISA section 404(c) plan and a plan fiduciary or an affiliate of such a fiduciary who is also a plan sponsor or an affiliate of the sponsor, paragraph (d)(2)(ii)(E) provides that no relief is available under section 404(c). For other instructions which would result in such transactions, paragraph (d)(2)(ii)(E) provides that no relief is available unless certain conditions are satisfied. Paragraph (d)(4) of the proposed regulation (paragraph (c)(4) of the final regulation) contained a provision intended to clarify the effect of the independent exercise of control on the duties of plan fiduciaries. It stated that a fiduciary has no obligation to provide advice to a participant or beneficiary with respect to an investment made pursuant to the participant’s or beneficiary’s independent exercise of control under an ERISA section 404(c) plan. The wording of paragraph (c)(4) of the final regulation has been modified to clarify that there is no obligation to provide investment advice at any time. [57 FR 46923] Comments The Department received substantive comment on several areas of paragraph (d) of the proposal, i.e., improper influence by a plan fiduciary or the plan sponsor, disclosure of material information, the failure to provide for fiduciary relief in the absence of affirmative instruction, and the lack of an obligation to advise. One commentator asked for clarification regarding what constitutes improper influence within the meaning of proposed paragraph (d)(2)(i) (paragraph (c)(2)(i) of the final regulation). While the Department is not prepared to give specific examples, the question of whether there has been improper influence by a plan sponsor or fiduciary in a given situation is inherently factual in nature and can only be determined on a case by case basis, taking into account all surrounding facts and circumstances. A number of commentators urged the Department to either eliminate or clarify or narrow the scope of the disclosure requirement of paragraph (d)(2)(ii) of the proposed regulation. In response to the concerns of the commentators, the Department has modified the disclosure requirement, now set forth in paragraph (c)(2)(ii) of the final regulation. As modified, paragraph (c)(2)(ii) provides that a plan fiduciary must reveal material non-public information regarding the investment unless such disclosure to the directing participant or beneficiary would violate any provision of federal law or any provision of state law which is no preempted by the Act. The only exceptions to this disclosure requirement under the proposal were violations of securities or banking laws. The Department also notes that the regulation is not intended to require a plan fiduciary to disclose information to the general public. Two commentators expressed concern that paragraph (d)(4) of the proposed regulation might be interpreted to suggest that, in the case of a non-404(c) plan which provides for some degree of participant and beneficiary direction, there may be an affirmative duty to advise participants and beneficiaries. The Department notes that fiduciaries of a plan that is not a section 404(c) plan are not afforded the transactional relief from the ERISA fiduciary responsibility provisions provided by ERISA section 404(c). A discussion of the duties of fiduciaries of non-404(c) plans is beyond the scope of this regulation. Absence of Affirmative Instruction A number of commentators on the 1991 proposal requested that section 404(c) relief be extended to certain situations where there is an absence of affirmative participant direction. Such relief was provided in the 1987 proposal if, among other conditions, amounts were invested in a "safe fund", which was required to be one of two specifically described vehicles -- i.e., an interest-bearing deposit in a bank or similar financial institution fully insured against loss by the United States or an agency of the United States, or a pooled investment fund, the assets of which consist solely of cash and securities issued or guaranteed by the United States or one of its agencies. This "safe/default" fund was not included in the proposal because commentators indicated that obtaining relief under an approach requiring that amounts be invested in the vehicles described in 1987 proposal would interfere with the operation of fixed rate investment contract alternative26 and that sponsors would rather retain fiduciary responsibility for contributions as to which participants and beneficiaries have not submitted instructions than avail themselves of the relief described in the proposal. Further, the comments and the statistical evidence submitted indicated that very few plans providing for direction by participants and beneficiaries offered the vehicles specified, and that for plans which did, a negligible amount of plan assets was directed into such, options. Some commentators on the 1991 proposal favored a reinstatement of the 1987 approach, modified to permit the use of other vehicles. Suggestions included: Any "safe" investment vehicle which is "designed to preserve principal and provide income and liquidity", and adding to the types of vehicles included in the 1987 proposal money market mutual funds and bank collective investment funds. In view of the record indicating that the vehicles described in the 1987 proposal would reduce flexibility in plan design and investments, in addition to the fact that such options were rarely offered or utilized when offered, the Department has decided not to reinstate a default option in the final regulation. Accordingly, the final regulation retains the approach of the 1991 proposal, pursuant to which plan fiduciaries will not be relieved of responsibility for investment decisions under an ERISA section 404(c) plan unless those decisions have affirmatively been made by participants and beneficiaries who have exercised independent control. In this regard, it should be noted that, as in any other type of ERISA-covered plan, fiduciaries of ERISA section 404(c) plans have a duty to provide for the investment of idle plan assets, and lack of participant direction will not absolve a fiduciary from such duties. The Department also notes that plan provisions providing for investments in the absence of an affirmative exercise of control may be followed only if the fiduciary determinations that following such provisions would not violate his fiduciary duties, including his duties under sections 404 and 406 of ERISA. Once a participant or beneficiary in a section 404(c) plan exercises independent control by giving investment instruction with respect to assets or future contributions, section 404(c) relief will continue to be available with respect to that instruction as long as the participant or beneficiary continues to have the opportunity to exercise control over such assets and contributions. Consistent with this principle, it should be recognized that, until an affirmative instruction is given, there can be no relief under ERISA section 404(c). Finally, although the regulation requires an affirmative investment instruction from a participant or beneficiary in order for the relief provided by section 404(c) to be available, the final regulation also provides that a participant or beneficiary will be deemed to have exercised control with regard to the exercise of voting, tender and similar rights under the circumstances described in new subparagraph (ii) of paragraph (c)(1). Paragraph (c)(1)(ii) of the final regulation provides that, once 404(c) relief is provided for an investment held in a participant’s or beneficiary’s account as a result of the independent exercise of control within the meaning of paragraph (c) of this regulation, a participant or beneficiary will be deemed to have exercised control with respect to the incidents of ownership of such investment (i.e., voting, tender and similar rights) to the extent that: (1) The participant or beneficiary is provided a reasonable opportunity to give instruction with respect to such incidents of ownership, including the provision of the information described in paragraph (b)(2)(i)(B)(1)(ix), and (2) the participant or beneficiary has not failed to exercise independent control with respect to such incidents of ownership by reason of the circumstances described in paragraph [57 FR 46924] (c)(2)). The Department notes, however, that, because the right to tender is fundamental to the ability of a participant or beneficiary to exercise control over his investment in an investment alternative, notwithstanding the fact that the investment was itself the result of an exercise of control within the meaning of paragraph (c) of this section, if an opportunity to exercise the right to tender occurs with respect to the investment and such right is not passed through to the investing participant or beneficiary, the investment will cease to be considered to be held as the result of an exercise of control within the meaning of this section. Two commentators suggested that a participant or beneficiary should be considered to have made an affirmative instruction where the Summary Plan Description (SPD) discloses the investment alternative which is used when no affirmative instruction is received and where the participant or beneficiary signs an instruction form which notifies him of what will be done with money contributed to the plan if no instruction is received. The Department notes that a participant or beneficiary will not be considered to have given an affirmative instruction merely as a result of being apprised that certain investments will be made on his behalf in the absence of instructions to the contrary. On the other hand, a participant or beneficiary will be considered to have given affirmative instruction where the participant or beneficiary signs an instruction form specifying how assets in his account will be invested if he has exercised independent control in fact within the meaning of paragraph (c) of this section with respect to such signature. In this regard, the Department notes that the form and manner in which investment alternatives are presented to participants and beneficiaries of a plan would be facts taken into consideration in determining whether a participant or beneficiary, in fact, exercised independent control in giving investment instructions. V. Effect of Independent Exercise of Control In general. As provided in section 404(c)(1), paragraph (e)(1) of the proposal (paragraph (d)(1) of the final regulation) stated that, if a participant or beneficiary of a 404(c) plan exercises independent control in the manner described in paragraph (d) of the proposal (paragraph (c) of the final regulation), such participant or beneficiary is not a fiduciary by reason of such exercise of control. The two primary effects of this provision are: (1) Because a participant or beneficiary is not a fiduciary, he would not violate the prohibited transaction provisions of Title I of ERISA if he exercises control over assets in his account to engage in a transaction with a party in interest; and (2) other fiduciaries generally would have no co-fiduciary liability under section 405 of the Act with respect to participant and beneficiary investment decisions under ERISA section 404(c) plans. With regard to other plan fiduciaries, section 404(c) provides that plan fiduciaries are relieved of liability for losses, or with respect to breaches of the requirements of Title I, which "result" from a participant’s or beneficiary’s exercise of control over individual account assets. Thus, given the transactional nature of the relief provided by section 404(c), it is necessary to determine in any particular case whether alleged losses or violations resulted from participant’s or beneficiary’s investment decision. It should be noted that, in following any particular participant’s or beneficiary’s instruction under a section 404 (c)plan, a fiduciary is relieved of liability only with respect to the consequences to the account of the individual participant or beneficiary whose instruction he is following; that fiduciary is not, however, relieved of any fiduciary obligation he may owe to any other plan participant or beneficiary. The proposal illustrated the scope of the relief provided by section 404(c) by giving an example which stated that, if a participant in an ERISA section 404(c) plan directs the investment of a portion of his individual account in a bank-managed collective trust fund pursuant to an arrangement with the bank manager of the fund under which the manager will loan a portion of the fund’s assets to the participant’s cousin, who is a service provider to the plan, the fund manager may be relieved of liability with respect to losses sustained by the account of the directing participant by reason of section 404(c), but would not be relieved of liability with respect to any other plans or plan participants that have interests in the collective trust fund. Four commentators asserted that section 404(c) was intended to further limit liability on the part of plan fiduciaries. After careful consideration, the Department has determined not to change the scope of the limitation of liability afforded by the regulation. The proposal stated that a fiduciary is relieved of responsibility only for the direct and necessary consequences of a participant’s exercise of control. n27 Accordingly, if a participant gives investment instruction to a plan fiduciary, and, due to the imprudence of the fiduciary in carrying out the instructions, the participant suffers a loss, then the fiduciary is liable for such loss because it resulted from a breach of his duties as a fiduciary rather than from the participant’s exercise of control.27 Similarly, the preamble to the proposal stated that if a participant gives investment instructions that may be carried out in more than one way, and the fiduciary chooses a method of carrying out the instructions that results in a breach of his obligations as a fiduciary, then he is liable for any resulting losses because such losses would not be a necessary consequence of the participant’s exercise of control. Thus, if a participant directs a fiduciary to acquire certain securities, but does not specify the manner in which the acquisition is to be effected, and the fiduciary causes a party in interest to execute the transaction, the fiduciary would be liable with respect to the resulting prohibited transaction (unless an exemption is otherwise available) notwithstanding the participant’s exercise of control. Example 7 in paragraph (f) of the final regulation contains a similar illustration. Paragraph (e)(2)(iii) of the (proposal (d)(2)(iii) of the final regulation) also specifically stated that the individual investment decisions of an investment manager are not direct and necessary results of the participant’s designation of the investment manager or of investment in a pooled investment fund managed by the investment manager. However, the proposal also provided that this rule should not be construed to [57 FR 46925] impose co-fiduciary liability on a fiduciary who would otherwise be relieved of liability under section 404(c). Thus, if a participant chooses an investment manager who imprudently invests plan assets, the investment manager will not be relieved of liability because his imprudence is not a direct and necessary result of the participant’s exercise of control. However, other plan fiduciaries would be relieved of liability under section 405, even if, for example, they had knowledge of the investment manager’s imprudence decisions. The preamble to the proposal explained that a fiduciary that designates an investment manager or pooled fund would, however, be required to take any known imprudence of the manager into account in determining whether to continue the designation of the manager.28 This paragraph has been retained in the final regulation, and examples 8, 9, 10 and 11 in paragraph (f) of the final regulation illustrate these statements. Comments A number of commentators raised questions about liability on the part of both fiduciaries and participants and beneficiaries in 404(c) plans. One commentator asked for clarification that section 405 of ERISA remains applicable to determinations of fiduciary liability in a 404(c) plan. Where a fiduciary is not relieved of co-fiduciary liability by reason of section 404(c)(2), section 405 remains applicable. See examples 7 and 8 in paragraph (f) of the final regulation. A question was asked about the possible results where a plan permits a fiduciary to decline to implement certain described instructions, but the fiduciary implements one of the described instructions. Under these circumstances, the plan fiduciary has discretion with respect to whether to implement the instruction, and would be responsible for exercising such discretion in a prudent manner (see ERISA section 404(a)(1)(B)). If the fiduciary exercises his discretion in a prudent manner, he would be relieved of responsibility for the results of such decision under paragraph (d)(2) of the final regulation.29 Under paragraph (d)(1) of the final regulation, the directing participant or beneficiary would continue to be relieved of liability under section 404(c) whether or not the plan fiduciary acts prudently with respect to such instructions. 1. Limitation on Liability of Plan Fiduciaries Paragraph (e)(2)(ii) of the 1991 proposal (redesignated paragraph (d)(2)(ii) of the final regulation) contained four exceptions to the general rule regarding the relief provided to a fiduciary. Under these exceptions, a plan fiduciary would not be relieved of liability with respect to a participant’s instructions which: (a) Would not be in accordance with the documents and instruments governing the plan; (b) would cause a fiduciary to maintain the indicia of ownership of any assets of the plan outside of the jurisdiction of the district courts of United States (other than as permitted by section 404(b) of the Act); (c) would jeopardize the plan’s tax qualified status under the Code; or (d) would result in a direct or indirect: (1) sale, exchange, or lease of property between a plan sponsor or any affiliate of the sponsor and the plan except for the purchase or sale of any qualifying employer security which meets the conditions of section 408(e) of ERISA and paragraph (e)(2)(ii)(D)(4) of the proposal (redesignated paragraph (d)(2)(ii)(E)(e) of the final regulation), (2) loan to a plan sponsor or any affiliate of the sponsor, (3) acquisition or sale of any employer real property, or (4) acquisition or sale of any employer security, whether or not the transaction involved the employer, unless it meets the conditions of paragraph (e)(2)(ii)(D)(4) of the regulation (paragraph (d)(2)(ii)(E)(4) of the final regulation). The final regulation adds two provisions to paragraph (d)(2)(ii) to clarify the intent of the proposed regulation. First, as discussed earlier, instructions which could result in a loss in excess of a participant’s or beneficiary’s account balance have been moved from paragraph (b)(2)(ii)(B) to clarify that a plan fiduciary would not be relieved of any liability resulting from implementing such instructions. Second, in response to a request for clarification concerning the effect of implementing an instruction to purchase an interest in a plan sponsor-managed arrangement, often called in "in-house fund", subparagraph (E)(1) of paragraph (d)(2)(ii) has been modified to make clear that the relief provided by paragraph (d)(2)(i) of the regulation would not be unavailable to a plan fiduciary for implementing an instruction to purchase or sell any interest in a fund, subfund or portfolio managed by a plan sponsor or an affiliate of the sponsor merely because such an instruction may result in a direct or indirect sale or exchange of property between a plan sponsor or an affiliate of the sponsor and the plan. However, the Department notes that the relief provided by paragraph (d)(2)(i) of the regulation is inapplicable to any section 406 violation which may occur based on a fiduciary’s designation of an affiliated entity as an available investment alternative under the plan. Paragraph (e)(2)(ii) of the proposal (paragraph (d)(2)(ii) of the final regulation) made the exceptions listed therein applicable only to plan fiduciaries. Thus, the effect of paragraphs (1) and (2) of paragraph (e) of the proposal was to provide that plan participants and beneficiaries who exercise independent control to instruct a fiduciary of an ERISA section 404(c) plan to engage in a transaction described in paragraph (e)(2)(ii) were, nonetheless, not fiduciaries by reason of such exercise of control. One commentator inquired whether the distinction between plan fiduciaries and participants and beneficiaries was intended. The distinction was intended. No changes have been made to these provisions in the final regulation. The Department received a number of comments relating to participant loans and employer securities. Each of these is discussed below. A. Participant Loans As noted above, paragraph (e)(2)(ii)(D)(2) of the 1991 proposal provided that the relief from fiduciary liability provided under ERISA section 404(c) does not extend to transactions in which assets of a participant’s account are loaned to the plan sponsor or any affiliate of the plan sponsor. Paragraph (f)(4) of the proposal defined an "affiliate" of a person as including an employee of that person. Therefore, no relief from fiduciary liability was available under the 1991 proposal for loans of a participant’s account assets to the participant. A number of commentators argued that 404(c) relief should be available for participant loans [57 FR 46926] which comply with the terms of ERISA section 408(b)(1), the statutory exemption for such loans. Several of the commentators indicated that the effect of giving 404(c) relief for such loans would be to obviate the need for a prudence determination as to the availability of these loans. Compliance with the conditions of section 408(b)(1) requires, among other things, that loans bear a reasonable rate of interest and are adequately secured. These and the other conditions of the statutory exemption require a plan to make determinations which are similar to prudence determinations. Therefore, including a provision in the final regulation which would extend section 404(c) relief to participant loans would potentially undermine compliance with the conditions of the statutory exemption. Accordingly, the Department has decided not to extend relief under section 404(c) to such loans. The terms of paragraph (e)(2)(ii)(D)(2) of the proposal have been adopted in paragraph (d)(2)(ii)(E)(2) of the final regulation, without change. B. Employer Securities Paragraph (e)(2)(ii)(D)(4) of the 1991 proposal stated that the relief from the fiduciary responsibility provisions provided by section 404(c) of ERISA would extend to any participant instruction which, if implemented, would result in the acquisition or sale of any employer security unless certain conditions were met. The condition which elicited the most comments was the requirement that activities relating to the purchase, sale, and exercise of voting and similar rights with respect to such securities must be the responsibility of an independent fiduciary who carries out such activities on a confidential basis. The proposal provided that, for this purpose, a fiduciary is not independent if the fiduciary is affiliated with any sponsor of the plan. The Independent Fiduciary and Confidentiality Requirements A significant number of commentators argued that the independent fiduciary and confidentiality requirements of the proposal are unnecessary. Some of the commentators argue that the general rule in paragraph (d)(2)(i) of the proposed regulation (paragraph (c)(2)(i) of the final regulation), which states that no relief is available under section 404(c) where a participant or beneficiary is subjected to improper influence by a plan fiduciary or the plan sponsor, provides sufficient protection. Other commentators argued that the fact that the burden of proving compliance with section 404(c) is on the person asserting applicability of the section, when combined with all of the provisions of paragraph (d)(2), offered sufficient protection to participants and beneficiaries. A number of commentators stated that the independent fiduciary and confidentiality requirements should be limited to particular situations where the potential for undue influence is greatest, such as tender offers, exchange offers and contested board elections. Others stated that the requirements may be justified for all voting decisions. Many commentators argued that, in most or all situations, the regulation should permit internal administration of employer securities transactions as long as adequate safeguards with respect to confidentiality and insulation from improper influence are provided, with the burden of proving that confidentiality had been maintained being placed on the plan sponsor. In this regard, they stated that plan sponsors that had invested significant resources in establishing in-house plan administration should not be forced to choose between restructuring their plan administration and relief under section 404(c) for investments in employer securities. The discussion in the Conference Room on section 404(c) expresses concern regarding participant-directed investments which may inure to the benefit of a plan sponsor and indicates that Congress expected that regulations under section 404(c) would impose stringent standards with respect to such investments.30 In this regard, the Department notes that it received over 32 written comments on the independent fiduciary and confidentiality requirements of the proposal, in addition to testimony at the public hearing. With the exception of one comment from a service provider who offers employer securities administrative services, there were no comments or testimony in support of the proposal’s requirement for an independent fiduciary to handle all activities relating to the purchase, sale, and voting of employer securities. Virtually all of the comments on this aspect of the regulation expressed strong objection to the proposal’s requirement for an independent fiduciary. These commentators argued that the final regulation should permit in-house administration of employer securities. The majority of these commentators indicated that internal safeguards can be established to ensure that participant investment information relating to employer securities is maintained on a confidential basis and that such safeguards should be required. The majority of commentators also recognized that there may be instances when the engagement of an independent fiduciary may be appropriate, but not with respect to every transaction involving employer securities. There were no comments which suggested that the establishment of internal plan procedures would be inadequate to ensure the confidentiality of participant-directed investments in employer securities. On the basis of these comments, the Department has determined to modify the conditions under which 404(c) coverage would be extended to participant-directed investments in employer securities. In this regard, the final regulation eliminates the requirement that an independent fiduciary must be responsible for activities relating to the purchase, sale and exercise of rights with respect to employer securities except in situations which involve a potential for undue employer influence. This condition has been replaced by a requirement that an ERISA section 404(c) plan have in place procedures designed to safeguard the confidentiality of information relating to the purchase, sale and holding and exercise of voting and similar rights with respect to such securities. Further, an ERISA section 404(c) plan must designate a plan fiduciary to monitor plan compliance with these procedures. These requirements are contained in paragraphs (d)(2)(ii)(E)(4)(vii)-(ix) of the final regulation. It should be noted that the confidentiality requirements of the final regulation are not limited to only purchases and sales of employer securities, but also apply to the holding of such securities by participants and beneficiaries. In addition to requiring that a designated plan fiduciary be responsible for monitoring compliance with the confidentiality procedures, paragraph (d)(2)(ii)(E)(4)(ix) of the final regulation requires that an independent fiduciary [57 FR 46927] be appointed to carry out activities relating to any situations which the designated plan fiduciary (i.e., the fiduciary responsible for monitoring the confidentiality procedures) determines have a potential for undue employer influence upon participants and beneficiaries. The Department agrees with the commentators who indicated that situations where the potential for undue employer influence may exist include tender offers, exchange offers and contested board elections. The Department believes that the aforementioned requirements for procedures to ensure confidentiality, for the designation of a plan fiduciary, who is responsible for monitoring compliance with such procedures, and for the appointment of an independent fiduciary when the designated plan fiduciary determines a potential for undue employer influence exists, when combined with the disclosure requirement of paragraph (b)(2)(i)(B)(1)(viii), the other requirements in paragraph (d)(2) of the final regulation, and the general rule in paragraph (c) of the final regulation that the relief provided by section 404(c) is available only where a participant or beneficiary has exercised independent control in fact with respect to the investment of assets in his individual account, significantly limit the potential for undue influence by the employer. For purposes of subparagraph (ix), a fiduciary is not independent if the fiduciary is affiliated with any sponsor of the plan. The term "affiliate" is defined in paragraph (e)(3) of the final regulation. One commentator inquired whether a bank which serves as the transfer agent for a plan sponsor’s stock could be an independent fiduciary. In general, any party, including the transfer agent for a plan sponsor’s stock, which is not an "affiliate" of the plan sponsor, as defined in paragraph (e)(3), may be an independent fiduciary for purposes of paragraph (d)(2)(ii)(4)(ix). However, whether any non-affiliated party is capable of discharging his duties as an independent fiduciary solely in the interest of the plan’s participants and beneficiaries and independently of the plan sponsor is a factual determination which must be made on a case by case basis by the designated plan fiduciary responsible for appointing the independent fiduciary. Lastly, it should be noted that the appointment of an independent fiduciary is itself a fiduciary act governed by the provisions of sections 403 and 404 of ERISA. Publicly Traded Securities The requirements in paragraphs (e)(2)(ii)(D)(4) (iii) and (iv) of the proposal that employer securities be publicly traded on a national exchange or other generally recognized market with sufficient frequency and in sufficient volume to assure prompt execution of buy and sell orders were proposed to ensure that participants can dispose of such securities in a public market which is not subject to the influence of the employer. These conditions, which have been retained in the final regulation in paragraphs (d)(2)(ii)(E)(4) (iii) and (iv), also limit the potential for overreaching by ensuring that participants have ready access to price quotations for the securities, as well as the ability to direct trades which will be promptly executed. The requirement in paragraph (e)(2)(ii)(D)(4)(iv) of the proposed regulation that employer securities for which 404(c) relief is available must be traded with sufficient frequency and in sufficient volume to assure that participant directions to buy or sell the security may be acted upon promptly and efficiently concerned a number of commentators. They urged the Department to permit plan fiduciaries to exercise discretion, while retaining 404(c) relief, in timing the execution of participant instructions to buy and sell employer securities in order to minimize the impact on the market for the employer’s securities. In this regard, the Department notes that the relief provided by section 404(c) is transactional in nature and applies only to the direct and necessary consequences of a participant’s exercise of control. Therefore, a fiduciary who exercises discretion as to the timing of the execution of transactions in employer securities would be responsible under Part 4 of Title I of ERISA for the exercise of discretion in timing of the purchase or sale. Shareholder Information One commentator asked for clarification of the scope of the requirement in subparagraph (v) of the proposed regulation that information provided to shareholders of employer securities be provided to participants and beneficiaries with accounts holding such securities. Subparagraph (v), which is retained in the final regulation, requires that participants and beneficiaries receive all information provided to non-plan shareholders of employer securities. Pass-Through of Voting and Similar Rights Two commentators requested either clarification or elimination of the requirement in subparagraph (vi) of the proposal that voting and similar rights with respect to employer securities be passed through to participants and beneficiaries with accounts holding such securities. With regard to this requirement, the Department notes that the word "tender" has been added to subparagraph (vi) in the final regulation in order to clarify that tender rights with respect to employer securities must also be passed through. Similarly, the word "tender" has also been added to subparagraph (vii) of paragraph (d)(2)(ii)(E)(4) of the final regulation to indicate that information relating to the exercise of tender rights with respect to employer securities must be maintained in accordance with procedures designed to safeguard the confidentiality of such information. Subparagraph (vi) of the final regulation requires that all proxies be passed through to participants and beneficiaries. Further, if both information and voting, tender and similar rights are not passed through, no relief under this regulation would be available with respect to any transaction involving employer securities, including the acquisition, holding and sale of such securities. However, the Department notes that paragraph (c)(1)(ii) of the regulation provides that a participant or beneficiary will be deemed to have exercised control with respect to the incidents of ownership of an interest in any investment alternative held in his account as a result of the independent exercise of control if he has a reasonable opportunity to give instruction with respect to such incidents of ownership, and the participant or beneficiary has not failed to exercise control by reason of the circumstances described in paragraph (c)(2). Thus, where participants and beneficiaries have the opportunity to vote securities and the trustee of an ERISA section 404(c) plan has not received direction, the trustee generally has no obligation to vote securities which are held in the accounts of participants and beneficiaries as a result of the independent exercise of control.31 [57 FR 46928] If the trustee does exercise voting rights in such cases, it would be responsible under Part 4 of Title I of ERISA for the exercise of such discretion. Confidentiality Requirement A number of commentators perceived a conflict between the confidentiality requirement and the reporting requirement under section 16 of the Securities Exchange Act of 1934 (the ‘34 Act). Under section 16 of the ‘34 Act, officers, directors and ten percent beneficial owners of a company’s class of equity securities registered under the ‘34 Act ("insiders") are required to file reports with the SEC concerning their ownership of an transactions in any class of equity securities of the company. Insiders are required to file copies of these reports with the issuer (typically the plan sponsor), and the issuer is required to monitor these filings and disclose in Form 10-K reports, Form N-SAR reports and proxy and information statements any violations of reporting requirements. Commentators urged the Department to either specifically exclude purchases and sales by persons covered by section 16 from the confidentiality requirement or clarify that compliance with the securities laws does not cause plan fiduciaries to lose 404(c) relief. The Department agrees that the confidentiality requirement would, if implemented, present the potential for the conflict described by the commentators. Accordingly, the final regulation contains an exception to the confidentiality requirement contained in subparagraph (vii) of paragraph (d)(2)(ii)(E)(4) which permits disclosure as necessary to comply with other Federal laws or state laws not preempted by the Act. Employer Stock Funds Several commentators requested clarification regarding the treatment under the regulation of employer stock funds, in which participants and beneficiaries receive units of interest. They stated that these funds are widely used, and were concerned that the regulation might be read to provide relief only where identified securities are allocated to the accounts of participants and beneficiaries. The final regulation does not preclude the use of such funds. However, the requirements of the regulation, including all of the requirements of paragraph (d)(2)(ii)(E)(4), remain applicable to transactions in units of interest in an employer stock fund. Therefore, the underlying securities in the fund must be traded with sufficient frequency and in sufficient volume to assure that participant and beneficiary instructions to buy or redeem units in the fund may be acted upon promptly and efficiently. Further, information provided to non-plan shareholders of employer securities, as well as voting, tender and similar rights with respect to the securities in the fund, must be passed through to participants and beneficiaries invested in the fund. Also, the fund must permit participants and beneficiaries to give investment instructions with a frequency appropriate to the anticipated volatility of the underlying securities. Qualifying Employer Securities A number of commentators asked that the regulation permit other types of qualifying employer securities to qualify under paragraph (e)(2)(ii)(D)(4) of the proposal (paragraph (d)(2)(ii)(E)(4) of the final regulation) for section 404(c) relief. One commentator asserted that convertible securities which have the same dividend and liquidation rights as publicly traded stock should be permitted. Another stated that non-publicly traded securities that are subject to put options should be included. Two stated that publicly traded partnership interests which are qualifying employer securities within the meaning of section 407(d)(5) should be permitted. Finally, one argued that 404(c) relief should be available for all qualifying employer securities. The Department believes that, for purposes of 404(c) relief, important protections are provided by the requirements relating to employer securities that such securities must be qualifying employer securities which are stock which is publicly traded with sufficient frequency and in sufficient volume to assure that participant and beneficiary instructions to buy or sell the securities may be acted upon promptly and efficiently. The commentators have not suggested alternate mechanisms which would offer similar protections. Therefore, the final regulation retains these conditions (with one modification) in paragraphs (d)(2)(ii)(E)(4) (i), (ii), (iii), and (iv) (paragraphs (e)(2)(D)(4) (i), (ii), (iii), and (iv) of the proposal). However, because section 407(d)(5) of ERISA defines the term "qualifying employer security" to include certain publicly traded partnership interests, and because such securities are publicly traded, the Department has amended paragraph (d)(2)(ii)(E)(4)(ii) to include such publicly traded partnership interests which are equity interests. All of the requirements of paragraph (d)(2)(ii)(E)(4) are applicable to such partnership interests. For example, such partnership interests must be traded with sufficient frequency and in sufficient volume to assure that participant and beneficiary directions to buy or sell the interests may be acted upon promptly and efficiently. Effect of Failure to Comply A number of commentators asked for clarification that a plan which fails to comply with the requirements of paragraph (d)(2)(ii)(E)(4) loses section 404(c) protection only for transactions in employer securities. A plan which otherwise qualifies as an ERISA section 404(c) plan would not cease to be an ERISA section 404(c) plan merely because a particular non-core investment alternative offered under the plan (e.g., an employer security investment alternative) fails to meet the requirements for section 404(c) relief. Accordingly, to the extent that an employer security investment alternative fails to comply with the requirements of paragraph (d)(2)(ii)(E)(4), the fiduciaries of a plan which otherwise meets the requirements of section 404(c) would lose section 404(c) protection and would be responsible as fiduciaries only with respect to transactions involving the employer security investment alternative. Relief under section 404(c) for other investment alternatives would not be affected. 2. Tax on Prohibited Transactions Paragraph (e)(3) of the proposal explained that the relief provided by section 404(c) of ERISA applies only to the provisions of part 4 of Title I of ERISA. There is no provision in the Internal Revenue Code corresponding to section 404(c) of Title I. Thus, there is no statutory exemption from the excise taxes imposed by the Code on prohibited transactions involving an ERISA section 404(c) plan. Moreover, the authority to grant administrative exemptions for section 404(c) transactions remains with the Treasury Department pursuant to the Reorganization Plan No. 4 of 1978. Thus, nothing in section 404(c) or the regulation would relieve a disqualified person from the taxes imposed with respect to prohibited transactions by section 4975 of the Internal Revenue Code even though the transaction was a direct and necessary result of a participant’s instructions. Two commentators expressed the opinion [57 FR 46929] that disqualified persons should be relieved of those taxes. Section 404(c) of ERISA expressly states that where a plan participant exercises control over his account assets in the manner contemplated by that section, no fiduciary with respect to that plan will be liable "under this part," i.e., under Part 4 of Title I of ERISA. No similar relief is granted with respect to any other provision of law, including the Internal Revenue Code. Moreover, as explained in the preamble to the proposal, the Department has no authority to provide exemptive relief for a disqualified person’s liability for the excise taxes imposed by section 4975 of the Code with respect to a transaction that results from a participant’s exercise of control. The Internal Revenue Service (the Service) has, however, informed the Department that interested parties who wish the Service to consider exemptive relief for participant-directed transactions with respect to which section 404(c) relief would be available under this final regulation, but which may nevertheless result in a prohibited transaction under section 4975 of the Code, should file an exemption request with the Service in accordance with Rev. Proc. 75-26, 1975-2 C.B. 722. For the foregoing reasons, the provisions of paragraph (e)(3) of the proposal have been retained without modification as paragraph (d)(3) of the final regulation. VI. Reporting and Disclosure As with the proposal, the final regulation does not address the reporting and disclosure provisions of ERISA with respect to their applicability to ERISA section 404(c) plans. The Department invited comments in the proposal discussing the application of the existing reporting and disclosure requirements of ERISA to such plans and whether it would be appropriate for the Department to develop an alternative method of compliance under section 110 of ERISA for ERISA section 404(c) plans. No comments were received regarding this issue. Therefore, the final regulation does not address the reporting and disclosure provisions of ERISA. VII. Effective Date The 1991 proposal provided that the regulation would have been effective with respect to transactions occurring 180 days after the date of publication of a final regulation. Many commentators expressed the view that the proposed effective date did not provide adequate time for modifying existing self-directed plans to conform with the regulation. Several commentators suggested a special effective date for collectively bargained plans. Other commentators suggested special effective dates or other provisions to accommodate plans with insurance company or bank fixed rate investment contracts entered into prior to the effective date of the regulation and which do not expire until a date subsequent to the effective date of the regulation. In order to provide existing participant directed plans more time to accommodate the provisions of the final regulation, the Department has extended the effective date of the final regulation. In this regard, the final regulation will generally be effective with respect to transactions occurring on or after the first day of the second plan year beginning after the date of publication of the final regulation. Further, in response to comments, the regulation provides for a special effective date for collectively bargained plans. For these plans, the regulation is effective for transactions occurring after the later of the date determined under the general rule or the date on which the last collective bargaining agreement terminates, determined without regard to any extension or renegotiation of such agreement which is ratified on or after October 13, 1992. The Department believes that the extended effective dates will serve to accommodate many of the problems identified by the commentators. Moreover, the Department believes that, given the significant modifications contained in the final regulation, sponsors and fiduciaries will be able to conform to the requirements of the regulation in a shorter period of time than that which may have been required under the 1991 proposal. Finally, the regulation provides that transactions occurring before the applicable effective date of the final regulation will be governed by section 404(c) of the Act without regard to the regulation. VIII. Regulatory Impact of the Regulation In the preamble to the 1991 proposal, the Department expressed the view that, as a result of the plan design flexibility afforded by the regulation, adoption of the proposal as a final regulation would have little, if any, impact, economic or otherwise, on the establishment and maintenance of participant directed individual account plans. In order to fully analyze the effect of the proposed regulation, however, the Department invited interested parties to include with their comments information and data on questions relating to the following topics: Investment alternatives; frequency of investment direction, investments selected by participants; and administrative costs. The following discussion summarizes the questions posed by the Department and information received by the Department which addressed those questions. In general, information received by the Department in response to these questions supports the Department’s view that adoption of the proposed regulation would have little, if any, adverse impact on the establishment and maintenance of participant directed individual account plans. The Department believes, moreover, that to the extent that the regulation does have any impact, it will encourage the establishment and maintenance of participant-directed individual account plans by clarifying, through the establishment of general principles, the circumstances under which relief is afforded by section 404(c) of ERISA, while at the same providing plan sponsors with the plan design flexibility necessary to accommodate changes in the needs of plan participants and beneficiaries and changes in investment vehicles and markets. 1. Investment alternatives. The Department asked several questions relating to the number and types of investment alternatives offered in participant-directed plans, the number of plans offering competing interest-sensitive investment alternatives (such as a fixed rate investment contract issued by an insurance company or a bank -- a "GIC" or "BIC" -- and a money market fund) and any conditions imposed with respect to transfers between such alternatives. The Department also asked about the effects that the proposed regulation might have on participants, investment alternatives and rates of return thereon, various industries, and the economy as a whole. Information received by the Department indicated that the vast majority of participant-directed plans offer specific combinations of investment alternatives, and that most currently offer at least three investment alternatives. According to information provided in the form of both surveys and comments, the most frequently offered investment alternatives were "GICs", diversified equity funds, employer stock funds, money market mutual funds, balanced funds, and bond funds. Commentators indicated that competing interest-sensitive investment alternatives (e.g., fixed rate investment contracts issued by banks, savings and loans or insurance companies and money market funds) were not uncommon. Where such competing investments were offered, comments [57 FR 46930] indicated that the majority of such plans did not permit direct transfers between the competing investment alternatives, but did allow indirect transfers provided that assets were first transferred into a third fund (often an equity fund) for some period of time, usually three to six months. Some commentators indicated that, if frequent opportunities for direct transfers between competing interest-sensitive investments were to be necessary for compliance with section 404(c), rates of return on fixed rate investment contracts would be reduced. In this regard, the Department notes that the final regulation’s three-month minimum transfer opportunity requirement applies only to the three core investment alternatives, and not to additional investment alternatives that may be offered by a plan. Thus, this problem is avoided if only one of the competing interest-sensitive investments is used as one of the three core alternatives. Furthermore, the preamble explains that an equity fund to which assets are required to be transferred (from a non-core interest-sensitive investment alternative) which permits transfers at least once within any three month period could itself serve as a core alternative if it meets the other requirements of the regulation. According to the information received, the types of investment alternatives generally offered did not seem to be affected significantly by plan size, although larger plans were somewhat more likely to offer more investment alternatives. Some commentators indicated that they would have to add investment alternatives in order to comply with the proposed regulation. A few commentators indicated that adding additional investment alternatives would be costly to the plan and not important to participants. Although one commentator felt that the regulation might have a deleterious effect on the insurance industry, this did not appear to be the view of most insurance industry commentators. Another commentator stated that extra paperwork and administrative costs will be inefficient for the economy. While a few commentators suggested that the regulation would cause some plans to terminate and therefore have an adverse effect on coverage, those comments appeared to be based in large part upon a misunderstanding of section 404(c) of ERISA, which is not mandatory. 2. Frequency of transfer opportunities. The Department requested information with regard to how often participants are permitted to transfer between investment alternatives and how often they make transfers; what restrictions exist with regard to transfers; and the incremental costs of increasing transfer opportunities from two to three times a year and from three times a year to quarterly. The Department also asked who bears transfer costs, and what factors affect the types of restrictions that are placed on transfers. Responses indicated that a majority of participant-directed individual account plans permit quarterly or more frequent transfers. According to information received, quarterly or more frequent transfer opportunities were more common in plans with 500 or more participants and plans offering mutual fund investments. One large survey that broke down frequency of transfer opportunities by plan size found that approximately 46 percent of plans with 250 or fewer participants, and also of plans with 250 to 500 participants, offer quarterly or more frequent transfer opportunities. According to this survey, between 53% and 69% of larger plans offered quarterly or more frequent transfers. This information also showed that approximately 80% of the plans that did not permit quarterly or more frequent transfer opportunities allowed transfers on a semiannual basis. Comments consistently indicated that the majority of participants transfer much less often than they are permitted to under the plan. Comments also indicated that restrictions on transfers vary widely. Commentators stated that most plans having competing interest-sensitive investment alternatives do not allow direct transfers between such interest-sensitive alternatives. Others indicated that they restricted or did not permit transfers out of the employer stock fund or ESOP. Some plans reported that they offered more frequent opportunities to re-allocate new contributions than to transfer amounts already in the plan’s investment alternatives. Comments indicated that many plans require changes in specific percentage increments, most often in increments of 5% or 10%. While several commentators stated that their plans required transfers in increments of 25%, information included with another comment indicated that there was a movement among such plans to change to 10% increments. Only one commentator mentioned plans requiring transfer in increments larger than 25%. Some plans reported no transfer restrictions. Other commentators stated that their plans require that any changes be requested in writing a certain number of days before the effective date of a transfer. The Department received only two comments that specifically addressed a question regarding the incremental costs of increasing the frequency of investment direction opportunities from two to three times a year and from three to four times a year. These two commentators estimated cost increases of 30 and 50 percent for changing frequency of transfer opportunities from two to three times a year, and of 33 and 60 percent, for increasing transfer opportunities from three to four times a year. Most commentators who attempted to answer this question stated that they did not know what additional costs would be incurred. A number of other commentators commented on the general issues of costs associated with the proposal’s requirements regarding frequency of transfer opportunity. While some indicated that they expected no additional costs or that any additional costs would be negligible or not unduly high, others stated that a quarterly or more frequent transfer opportunity requirement would impose significant or high additional costs, primarily due to more frequent valuations, and additional accounting and transfer costs. One of these commentators estimated that moving from annual to quarterly transfer opportunities would increase administrative costs by approximately 200 percent to 250 percent. Others projected increases of varying amounts due to plan amendments and communication materials, transaction fees, and reprogramming of accounting systems. One plan projected savings as a result of changes it was making which were consistent with the proposed regulation. The extent to which additional administrative costs were expected to be incurred as a result of increasing the frequency of transfer opportunities appeared to vary depending upon the types of investment alternatives offered, the frequency with which they were valued and the size of the plan. The costs of moving to quarterly transfers appeared to be of greatest concern to smaller plans (200 or fewer participants) with investments that are not frequently valued, many of which indicated that they currently permit only semi-annual or annual transfers. Two commentators that provide services to smaller plans indicated that their fees would increase substantially due to increases in the number of investment alternatives to be accounted for, increased frequency of transfer opportunities, and increased administration of transfer activity. Several commentators also expressed concern that additional transfer opportunities would encourage plan participants to attempt to "time" the [FR 46931] market, thereby reducing returns on their investments. Commentators indicated that, in general, all administrative costs associated with investment transfers (e.g., allocation costs) are borne by the plan sponsor. Operating costs are borne by the funds experiencing those costs (e.g. investment management fees), which in turn are allocated among participants investing in the fund. A few commentators stated that they anticipated that as plan-level administrative costs rise, some of the costs associated with transfers may be shifted from plan sponsors to participants, possibly in the form of transfer fees. 3. Investments selected by participants. The Department asked about the value of assets in participant directed individual account plans; the percentage of assets invested in various types of investment alternatives and whether this varied by plan size or other factors; and what effect investment preferences of plan participants had on the investment alternatives offered. Information about the value of assets in participant directed individual account plans showed that these plans vary widely in asset size. None of the commentators attempted to provide information on what the total value of such assets might be. Comments on the percentages of assets invested in various types of investment alternatives varied widely but indicated that, in general, over half (approximately 50 to 70 percent) of all plan assets was invested in fixed rate investment contract-type funds. The next largest percentages (approximately 10 to 50 percent) were reported to be in diversified equity funds or employer stock funds, followed by smaller percentages in balanced funds, money market mutual funds, government securities funds and other bond funds. The percentages of assets invested in various alternatives did not appear to vary much by plan size, but did seem to be affected by other factors. For example, commentators noted that some employers offer matching contributions to participants investing in employer stock and/or restrict transfers out of the employer stock funds. Another commentator stated that its 401(k) plan provided fewer investment options for amounts representing "before-tax contributions" than for amounts representing "after-tax contributions". Comments consistently indicated that participants tend to put the largest percentage of their account assets in what they perceive to be the safest investment alternatives. Comments indicated that the preferences of participants have little, if any, effect on investment alternatives offered by a plan, although some plans reported that they do take such preferences into consideration. Most who responded to this question stated that they generally select a set of investment alternatives that meet employee needs and that give participants distinct choices in terms of risk and return. One commentator noted that plans of law firms and medical partnerships were more likely to reflect participant preferences than plans of other employers, and that participants in these plans tended to be more risk tolerant. 4. Administrative costs. Information was requested on what, if any, increases in administrative costs would result from requiring a minimum of three diversified investment alternatives having different risk and return characteristics and to what these costs would be attributable. The Department also asked how plan size would affect these administrative costs, and to what extent any increases in administrative costs attributable to plan changes required to accommodate the regulation would outweigh the benefits of limiting fiduciary liability. Finally, the Department asked what cost savings would be attributable to limiting fiduciary liability. Several commentators indicated that they would have no additional costs as a result of meeting the three diversified investment alternatives requirement, or that any such costs would be nominal. As mentioned earlier, a few commentators stated that adding additional investment alternatives would be costly. Further, several others indicated that plans needing to add investment alternatives to their plans will incur some additional administrative expense in connection with selection of managers, recordkeeping, monitoring the experience of the added alternatives and effecting transfers. One commentator estimated the additional costs associated with the establishment and maintenance of one additional investment alternative to be approximately 15 percent of the plan’s administrative costs for a typical plan with three investment alternatives including an employer stock fund. Commentators indicated that administrative costs for small plans tend to be larger as a percentage of assets than they are for larger plans, because of economies of scale. In general, however, the requirement of a minimum of three diversified investment alternatives with different risk and return characteristics did not, in and of itself, cause a great deal of concern among commentators about costs. Rather, commentators were more concerned by additional administrative costs incurred in connection with complying with the requirements of the proposed regulation regarding frequency of transfer opportunities, as well as its requirements that an independent fiduciary designate "look-through investment vehicles" which are managed in-house, and that an independent fiduciary be retained for plan administration in plans desiring section 404(c) protection for employer stock funds. In response to the Department’s inquiry into whether cost savings would be attributable to limiting the liability of the plan fiduciaries, some commentators stated that any such cost savings are uncertain. Others indicated that there would be no cost effect. The Department also asked to what extent any increases in administrative costs attributable to plan changes required to accommodate the regulation would be outweighed by the benefits attributable to limiting the liability of plan fiduciaries. The Department received a wide variety of responses to this question. Some commentators stated that any increased compliance costs would be more than outweighed by the benefits of the limitation on liability. Others stated that the costs and benefits of the regulation represented a modest trade-off or that the benefits were somewhat outweighed by the additional costs that would be incurred to comply. Many commentators indicated that they did not know whether any increases in costs would be outweighed by the benefits of limiting the liability of plan fiduciaries. A few commentators expressed the view that the regulation does little to limit the liability of plan fiduciaries, and some commentators stated that the costs of compliance with the proposed regulation would not be outweighed by its limitation of the liability of the plan fiduciaries. Other commentators mentioned other benefits of the regulation, such as the ability of plan participants to exercise greater control over their investments. The Department notes that several modifications have been made in the final regulation to accommodate concerns expressed by commentators about administrative costs. As noted in the discussion of the final regulation elsewhere in this notice, the Department has substantially curtailed or eliminated the requirements that were of most concern to commentators. For example, [57 FR 46932] the Department eliminated the requirement that an independent fiduciary must be responsible for activities relating to the purchase, sale, and exercise of rights with respect to employer securities, except for situations which a designated plan fiduciary determines involve a potential for undue employer influence, such as tender offers or contested board of directors elections. Paragraph (c) of the proposal, which contained the requirement that an independent fiduciary designate any designated look-through investment vehicles and investment managers was also eliminated from the final regulation. Technical Revisions Pursuant to recent amendments to the rules for publication of the Office of the Federal Register, this final regulation contains an amendment of the authority citation for part 2550 of chapter XXV of title 29 of the Code of Federal Regulations. Executive Order 12291 Statement The Department has determined that this final regulatory action would not constitute a "major rule" as that term is used in Executive Order 12291 because the action does not result in: an annual effect on the economy of $100 million; a major increase in costs or prices for consumers, individual industries, government agencies, or geographic regions; or significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of United States-based enterprises to compete with foreign-based enterprises in domestic or export markets. Regulatory Flexibility Act Statement The Department has determined that this regulation would not have a significant economic impact on small entities. While small plan sponsors that want to take advantage of the relief provided by this regulation may need to amend their plans in order to meet the requirements necessary to obtain relief under the regulation, no small entity is required to amend its plan under the regulation. Thus, unless a small entity voluntarily decides to modify its plan, this regulation would not impose any increased burden on small entities that sponsor pension plans that conform with ERISA generally. Although it would not be appropriate to provide simplified requirements for small entities under the regulation, it should be noted that in response to public comments the burden associated with plan amendments necessary to obtain relief has been reduced for all plan sponsors regardless of size. Paperwork Reduction Act Statement This regulation is not subject to section 3504(h) of the Paperwork Reduction Act, 44 U.S.C. 3504(h), since it does not involve the collection of information from the public. Statutory Authority The final regulation set forth herein is issued pursuant to sections 404(c) (Pub. L. 93-406, 88 Stat. 877, 29 U.S.C. 1104) and 505 (Pub. L. 93-406, 88 Stat. 894, 29 U.S.C. 1135) of the Act and under Secretary of Labor’s Order No. 1-87. List of Subjects in 29 CFR Part 2550 Employee benefit plans, Employee Retirement Income Security Act, Employee stock ownership plans, Exemptions, Fiduciaries, Investments, Investments foreign, Party in interest, Pensions, Pension and Welfare Benefit Programs Office, Prohibited transactions, Real estate, Securities, Surety bonds, Trusts and Trustees. In view of the foregoing the Department proposes to amend part 2550 of chapter XXV of title 29 of the Code of Federal Regulations as follows: PART 2550 -- RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY 1. By revising the authority citation for part 2550 to read as set forth below and the authority citations following all the sections in part 2550 are removed. Authority: 29 U.S.C. 1135. §2550.401b-1 also issued under sec. 102, Reorganization Plan No. 4 of 1978 (43 FR 47713, Oct. 17, 1978), effective December 31, 1978 (44 FR 1065, Jan. 3, 1979), 3 CFR, 1978 Comp., 332. § 2550.404c-1 also issued under 29 U.S.C. 1104. § 2550.407c-3 also issued under 29 U.S.C. 1107. § 2550.412-1 also issued under 29 U.S.C. 1112. § 2550.414b-1 also issued under 29 U.S.C. 1114. Secretary of Labor’s Order No. 1-87. 2. By adding a new § 2550.404c-1 to read as follows: §2550.404c-1 ERISA section 404(c) plans. (a) In General. (1) Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA or the Act) provides that if a pension plan that provides for individual accounts permits a participant or beneficiary to exercise control over assets in his account and that participant or beneficiary in fact exercises control over assets in his account, then the participant or beneficiary shall not be deemed to be a fiduciary by reason of his exercise of control and no person who is otherwise a fiduciary shall be liable for any loss, or by reason of any breach, which results from such exercise of control. This section describes the kinds of plans that are "ERISA section 404(c) plans," the circumstances in which a participant or beneficiary is considered to have exercised independent control over the assets in his account as contemplated by section 404(c), and the consequences of a participant’s or beneficiary’s exercise of control. (2) The standards set forth in this section are applicable solely for the purpose of determining whether a plan is an ERISA section 404(c) plan and whether a particular transaction engaged in by a participant or beneficiary of such plan is afforded relief by section 404(c). Such standards, therefore, are not intended to be applied in determining whether, or to what extent, a plan which does not meet the requirements for an ERISA section 404(c) plan or a fiduciary with respect to such a plan satisfies the fiduciary responsibility or other provisions of Title I of the Act. (b) ERISA section 404(c) plans -- (1) In general. An "ERISA section 404(c) Plan" is an individual account plan described in section 3(34) of the Act that: (i) Provides an opportunity for a participant or beneficiary to exercise control over assets in his individual account (see paragraph (b)(2) of this section); and (ii) Provides a participant or beneficiary an opportunity to choose, from a broad range of investment alternatives, the manner in which some or all of the assets in his account are invested (see paragraph (b)(3) of this section). (2) Opportunity to exercise control. (i) a plan provides a participant or beneficiary an opportunity to exercise control over assets in his account only if: (A) Under the terms of the plan, the participant or beneficiary has a reasonable opportunity to give investment instructions (in writing or otherwise, with opportunity to obtain written confirmation of such instructions) to an identified plan fiduciary who is obligated to comply with such instructions except as otherwise provided in paragraph (b)(2)(ii)(B) and (d)(2)(ii) of this section; and (B) The participant or beneficiary is provided or has the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under [57 FR 46933] the plan, and incidents of ownership appurtenant to such investments. For purposes of this subparagraph, a participant or beneficiary will not be considered to have sufficient investment information unless -- (1) The participant or beneficiary is provided by an identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf): (i) An explanation that the plan is intended to constitute a plan described in section 404(c) of the Employee Retirement Income Security Act, and title 29 of the Code of Federal Regulations Section 2550.440c-1, 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; (ii) A description of the investment alternatives available under the plan and, with respect to each designated investment alternative, a general description of the investment objectives and risk and return characteristics of each such alternative, including information relating to the type and diversification of assets comprising the portfolio of the designed investment alternative; (iii) Identification of any designated investment managers; (iv) An explanation of the circumstances under which participants and beneficiaries may give investment instructions and 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, and any restrictions on the exercise of voting, tender and similar rights appurtenant to a participant’s or beneficiary’s investment in an investment alternative; (v) A description of any transaction fees and expenses which affect the participant’s or beneficiary’s account balance in connection with purchases or sales of interests in investment alternatives (e.g., commissions, sales load, deferred sales charges, redemption or exchange fees); (vi) The name, address, and phone number of the plan fiduciary (and, if applicable, the person or persons designated by the plan fiduciary to act on his behalf) responsible for providing the information described in paragraph (b)(2)(i)(B)(2) upon request of a participant or beneficiary and a description of the information described in paragraph (b)(2)(i)(B)(2) which may be obtained on request; (vii) In the case of plans which offer an investment alternative which is designed to permit a participant or beneficiary to directly or indirectly acquire or sell any employer security (employer security alternative), a description of the procedures established to provide for the confidentiality of information relating to the purchase, holding and sale of employer securities, and the exercise of voting, tender and similar rights, by participants and beneficiaries, and the name, address and phone number of the plan fiduciary responsible for monitoring compliance with the procedures (see paragraphs (d)(2)(ii)(E)(4) (vii), (viii) and (ix) of this section); and (viii) In the case of an investment alternative which is subject to the Securities Act of 1933, and in which the participant or beneficiary has no assets invested, immediately following the participant’s or beneficiary’s initial investment, a copy of the most recent prospectus provided to the plan. This condition will be deemed satisfied if the participant or beneficiary has been provided with a copy of such most recent prospectus immediately prior to the participant’s or beneficiary’s initial investment in such alternative; (ix) Subsequent to an investment in a investment alternative, any materials provided to the plan relating to the exercise of voting, tender or similar rights which are incidental to the holding in the account of the participant or beneficiary of an ownership interest in such alternative to the extent that such rights are passed through to participants and beneficiaries under the terms of the plan, as well as a description of or reference to plan provisions relating to the exercise of voting, tender or similar rights. (2) The participants or beneficiary is provided by the identified plan fiduciary (or a person or persons designated by the plan fiduciary to act on his behalf), either directly or upon request, the following information, which shall be based on the latest information available to the plan: (i) A description of the annual operating expenses of each designated investment alternative (e.g., investment management fees, administrative fees, transaction costs) which reduce the rate of return to participants and beneficiaries, and the aggregate amount of such expenses expressed as a percentage of average net assets of the designated investment alternative; (ii) Copies of any prospectuses, financial statements and reports, and of any other materials relating to the investment alternatives available under the plan, to the extent such information is provided to the plan; (iii) A list of the assets comprising the portfolio of each designated investment alternative which constitute plan assets within the meaning of 29 CFR 2510.3-101, the value of each such asset (or the proportion of the investment alternative which it comprises), and, with respect to each such asset which is a fixed rate investment contract issued by a bank, savings and loan association or insurance company, the name of the issuer of the contract, the term of the contract and the rate of return on the contract; (iv) Information concerning the value of shares or units in designated investment alternatives available to participants and beneficiaries under the plan, as well as the past and current investment performance of such alternatives, determined, net of expenses, on a reasonable and consistent basis; and (v) Information concerning the value of shares or units in designated investment alternatives held in the account of the participant or beneficiary. (vi) A plan does not fail to provide an opportunity for a participant or beneficiary to exercise control over his individual account merely because it -- (A) Imposes charges for reasonable expenses. A plan may charge participants’ and beneficiaries’ accounts for the reasonable expenses of carrying out investment instructions, provided that procedures are established under the plan to periodically inform such participants and beneficiaries of actual expenses incurred with respect to their respective individual accounts; (B) Permits a fiduciary to decline to implement investment instructions by participants and beneficiaries. A fiduciary may decline to implement participant and beneficiary instructions which are described at paragraph (d)(2)(ii) of this section, as well as instructions specified in the plan, including instructions -- (1) Which would result in a prohibited transaction described in ERISA section 406 or section 4975 of the Internal Revenue Code, and (2) Which would generate income that would be taxable to the plan; (C) Imposes reasonable restrictions on frequency of investment instructions. A plan may impose reasonable restrictions on the frequency with which participants and beneficiaries may give investment instructions. In no event, however, is such a restriction reasonable unless, with respect to each investment alternative made available by the plan, it permits participants and beneficiaries to give investment instructions with a frequency which is [57 FR 46934] appropriate in light of the market volatility to which the investment alternative may reasonably be expected to be subject, provided that -- (1) At least three of the investment alternatives made available pursuant to the requirements of paragraph (b)(3)(i)(B) of this section, which constitute a broad range of investment alternatives, Permit participants and beneficiaries to give investment instructions no less frequently than once within any three month period; and (2)(i) At least one of the investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) of this section permits participants and beneficiaries to give investment instructions with regard to transfers into the investment alternative as frequently as participants and beneficiaries are permitted to give investment instructions with respect to any investment alternative made available by the plan which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period; or (ii) With respect to each investment alternative which permits participants and beneficiaries to give investment instructions more frequently than once within any three month period, participants and beneficiaries are permitted to direct their investments from such alternative into an income producing, low risk, liquid fund, subfund, or account as frequently as they are permitted to give investment instructions with respect to each such alternative and, with respect to such fund, subfund or account, participants and beneficiaries are permitted to direct investments from the fund, subfund or account to an investment alternative meeting the requirements of paragraph (b)(2)(ii)(C)(1) as frequently as they are permitted to give investment instructions with respect to that investment alternative; and (3) With respect to transfers from an investment alternative which is designed to permit a participant or beneficiary to directly or indirectly acquire or sell any employer security (employer security alternative) either: (i) All of the investment alternatives meeting the requirements of paragraph (b)(2)(ii)(C)(1) of this section must permit participants and beneficiaries to give investment instructions with regard to transfers into each of the investment alternatives as frequently as participants and beneficiaries are permitted to give investment instructions with respect to the employer security alternative; or (ii) Participants and beneficiaries are permitted to direct their investments from each employer security alternative into an income producing, low risk, liquid fund, subfund, or account as frequently as they are permitted to give investment instructions with respect to such employer security alternative and, with respect to such fund, subfund, or account, participants and beneficiaries are permitted to direct investments from the fund, subfund or account to each investment alternative meeting the requirements of paragraph (b)(2)(ii)(C)(1) as frequently as they are permitted to give investment instructions with respect to each such investment alternative. (iii) Paragraph (c) of this section describes the circumstances under which a participant or beneficiary will be considered to have exercised independent control with respect to a particular transaction. (3) Broad range of investment alternatives. (i) A plan offers a broad range of investment alternatives only if the available investment alternatives are sufficient to provide the participant or beneficiary with a reasonable opportunity to: (A) 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; (B) Choose from at least three investment alternatives: (1) Each of which is diversified; (2) Each of which has materially different risk and return characteristics; (3) 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 or beneficiary; and (4) 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; (C) 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. In determining whether a plan provides the participant or beneficiary with a reasonable opportunity to diversify his investments, the nature of the investment alternatives offered by the plan and the size of the portion of the individual’s account over which he is permitted to exercise control must be considered. Where such portion of the account of any participant or beneficiary is so limited in size that the opportunity to invest in look-through investment vehicles is the only prudent means to assure an opportunity to achieve appropriate diversification, a plan may satisfy the requirements of this paragraph only by offering look-through investment vehicles. (ii) Diversification and look-through investment vehicles. Where look-through investment vehicles are available as investment alternatives to participants and beneficiaries, the underlying investments of the look-through investment vehicles shall be considered in determining whether the plan satisfies the requirements of subparagraphs (b)(3)(i)(B) and (b)(3)(i)(C). (c) Exercise of control. (1) In general. (i) Sections 404(c)(1) and 404(c)(2) of the Act and paragraphs (a) and (d) of this section apply only with respect to a transaction where a participant or beneficiary has exercised independent control in fact with respect to the investment of assets in his individual account under an ERISA section 404(c) plan. (ii) For purposes of sections 404(c)(1) and 4040(c)(2) of the Act and paragraphs (a) and (d) of this section, a participant or beneficiary will be deemed to have exercised control with respect to the exercise of voting, tender and similar rights appurtenant to the participant’s or beneficiary’s ownership interest in an investment alternative, provided that the participant’s or beneficiary’s investment in the investment alternative was itself the result of an exercise of control, the participant or beneficiary was provided a reasonable opportunity to give instruction with respect to such incidents of ownership, including the provision of the information described in paragraph (b)(2)(i)(B)(1 )(ix) of this section, and the participant or beneficiary has not failed to exercise control by reason of the circumstances described in paragraph (c)(2) with respect to such incidents of ownership. (2) Independent control. Whether a participant or beneficiary has exercised independent control in fact with respect to a transaction depends on the facts and circumstances of the particular case. However, a participant’s or beneficiary’s exercise of control is not independent in fact if: (i) The participant or beneficiary is subjected to improper influence by a plan fiduciary or the plan sponsor with respect to the transaction; (ii) A plan fiduciary has concealed material non-public facts regarding the investment from the participant or beneficiary, unless the disclosure of [57 FR 46935] such information by the plan fiduciary to the participant or beneficiary would violate any provision of federal law or any provision of state law which is not preempted by the Act; or (iii) The participant or beneficiary is legally incompetent and the responsible plan fiduciary accepts the instructions of the participant or beneficiary knowing him to be legally incompetent. (3) Transactions involving a fiduciary. In the case of a sale, exchange or leasing of property (other than a transaction described in paragraph (d)(2)(ii)(E) of this section) between an ERISA section 404(c) plan and a plan fiduciary or an affiliate of such a fiduciary, or a loan to a plan fiduciary or an affiliate of such a fiduciary, the participant or beneficiary will not be deemed to have exercised independent control unless the transaction is fair and reasonable to him. For purposes of this paragraph (c)(3), a transaction will be deemed to be fair and reasonable to a participant or beneficiary if he pays no more than, or receives no less than, adequate consideration (as defined in section 3(18) of the Act) in connection with the transaction. (4) No obligation to advise. A fiduciary has no obligation under part 4 of Title I of the Act to provide investment advice to a participant or beneficiary under an ERISA section 404(c) plan. (d) Effect of independent exercise of control -- (1) Participant or beneficiary not a fiduciary. If a participant or beneficiary of an ERISA section 404(c) plan exercises independent control over assets in his individual account in the manner described in paragraph (c), then such participant or beneficiary is not a fiduciary of the plan by reason of such exercise of control. (2) Limitation on liability of plan fiduciaries. (i) If a participant or beneficiary of an ERISA section 404(c) plan exercises independent control over assets in his individual account in the manner described in paragraph (c), then no other person who is a fiduciary with respect to such plan shall be liable for any loss, or with respect to any breach of part 4 of Title I of the Act, that is the direct and necessary result of that participant’s or beneficiary’s exercise of control. (ii) Paragraph (d)(2)(i) does not apply with respect to any instruction, which if implemented -- (A) Would not be in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of Title I of ERISA; (B) Would cause a fiduciary to maintain the indicia of ownership of any assets of the plan outside the jurisdiction of the district courts of the United States other than as permitted by section 404(b) of the Act and 29 CFR 2550.404b-1; (C) Would jeopardize the plan’s tax qualified status under the Internal Revenue Code; (D) Could result in a loss in excess of a participant’s or beneficiary’s account balance; or (E) Would result in a direct or indirect: (1) Sale, exchange, or lease of property between a plan sponsor or any affiliate of the sponsor and the plan except for the acquisition or disposition of any interest in a fund, subfund or portfolio managed by a plan sponsor or an affiliate of the sponsor, or the purchase or sale of any qualifying employer security (as defined in section 407(d)(5) of the Act) which meets the conditions of section 408(e) of ERISA and section (d)(2)(ii)(E)(4) below; (2) Loan to a plan sponsor or any affiliate of the sponsor; (3) Acquisition or sale of any employer real property (as defined in section 407(d)(2) of the Act); or (4) Acquisition or sale of any employer security except to the extent that: (i) Such securities are qualifying employer securities (as defined in section 407(d)(5) of the Act); (ii) Such securities are stock or an equity interest in a publicly traded partnership (as defined in section 7704(b) of the Internal Revenue Code of 1986), but only if such partnership is an existing partnership as defined in section 10211(c)(2)(A) of the Revenue Act of 1987 (Public Law 100-203); (iii) Such securities are publicly traded on a national exchange or other generally recognized market; (iv) Such securities are traded with sufficient frequency and in sufficient volume to assure that participant and beneficiary directions to buy or sell the security may be acted upon promptly and efficiently; (v) Information provided to shareholders of such securities is provided to participants and beneficiaries with accounts holding such securities; (vi) Voting, tender and similar rights with respect to such securities are passed through to participants and beneficiaries with accounts holding such securities; (vii) Information relating to the purchase, holding, and sale of securities, and the exercise of voting, tender and similar rights with respect to such securities by participants and beneficiaries, is maintained in accordance with procedures which are designed to safeguard the confidentiality of such information, except to the extent necessary to comply with Federal laws or state laws not preempted by the Act; (viii) The plan designates a fiduciary who is responsible for ensuring that: The procedures required under subparagraph (d)(2)(ii)(E)(4) (vii) are sufficient to safeguard the confidentiality of the information described in that subparagraph, such procedures are being followed, and the independent fiduciary required by subparagraph (d)(2)(ii)(E)(4)(ix) is appointed; and (ix) An independent fiduciary is appointed to carry out activities relating to any situations which the fiduciary designated by the plan for purposes of subparagraph (d)(2)(ii)(E)(4)(viii) determines involve a potential for undue employer influence upon participants and beneficiaries with regard to the direct or indirect exercise of shareholder rights. For purposes of this subparagraph, a fiduciary is not independent if the fiduciary is affiliated with any sponsor of the plan. (iii) The individual investment decisions of an investment manager who is designated directly by a participant or beneficiary or who manages a look-through investment vehicle in which a participant or beneficiary has invested are not direct and necessary results of the designation of the investment manager or of investment in the look-through investment vehicle. However, this paragraph (d)(2)(iii) shall not be construed to result in liability under section 405 of ERISA with respect to a fiduciary (other than the investment manager) who would otherwise be relieved of liability by reason of section 404(c)(2) of the Act and paragraph (d) of this section. (3) Prohibited Transactions. The relief provided by section 404(c) of the Act and this section applies only to the provisions of part 4 of title I of the Act. Therefore, nothing in this section relieves a disqualified person from the taxes imposed by sections 4975 (a) and (b) of the Internal Revenue Code with respect to the transactions prohibited by section 4975(c)(1) of the Code. (e) Definitions. For purposes of this section: (1) Look-through investment vehicle means: (i) An investment company described in section 3(a) of the Investment Company Act of 1940, or a series investment company described in [57 FR 46936] section 18(f) of the 1940 Act or any of the segregated portfolios of such company; (ii) A common or collective trust fund or a pooled investment fund maintained by a bank or similar institution, a deposit in a bank or similar institution, or a fixed rate investment contract of a bank or similar institution; (iii) A pooled separate account or a fixed rate investment contract of an insurance company qualified to do business in a State; or (iv) Any entity whose assets include plan assets by reason of a plan’s investment in the entity; (2) Adequate consideration has the meaning given it in section 3(18) of the Act and in any regulations under this title; (3) An affiliate of a person includes the following: (i) Any person directly or indirectly controlling, controlled by, or under common control with the person; (ii) Any officer, director, partner, employee, an employee of an affiliated employer, relative (as defined in section 3(15) of ERISA), brother, sister, or spouse of a brother or sister, of the person; and (iii) Any corporation or partnership of which the person is an officer director or partner. For purposes of this paragraph (e)(3), the term "control" means, with respect to a person other than an individual, the power to exercise a controlling influence over the management or policies of such person. (4) A designated investment alternative is a specific investment identified by a plan fiduciary as an available investment alternative under the plan. (f) Examples. The provisions of this section are illustrated by the following examples. Examples (5) through (11) assume that the participant has exercised independent control with respect to his individual account under an ERISA section 404(c) plan described in paragraph (b) and has not directed a transaction described in paragraph (d)(2)(ii). (1) Plan A is an individual account plan described in section 3(34) of the Act. The plan states that a plan participant or beneficiary may direct the plan administrator to invest any portion of his individual account in a particular diversified equity fund managed by an entity which is not affiliated with the plan sponsor, or any other asset administratively feasible for the plan to hold. However, the plan provides that the plan administrator will not implement certain listed instructions for which plan fiduciaries would not be relieved of liability under section 404(c) (see paragraph (d)(2)(ii)). Plan participants and beneficiaries are permitted to give investment instructions during the first week of each month with respect to the equity fund and at any time with respect to other investments. The plan provides for the pass-through of voting, tender and similar rights incidental to the holding in the account of a participant or beneficiary of an ownership interest in the equity fund or any other investment alternative available under the plan. The plan administrator of plan A provides each participant and beneficiary with the information described in subparagraphs (i), (ii), (iii), (iv), (v), (vi) and (vii) of paragraph (b)(2)(i)(B)(1) upon their entry into the plan, and provides updated information in the event of any material change in the information provided. Immediately following an investment by a participant or beneficiary in the equity fund, the plan administrator provides a copy of the most recent prospectus received from the fund to the investing participant or beneficiary. Immediately following any investment by a participant or beneficiary in any other investment alternative which is subject to the Securities Act of 1933, the plan administrator provides the participant or beneficiary with the most recent prospectus received from that investment alternative (see paragraph (b)(2)(i)(B)(1)(viii)). Finally, subsequent to any investment by a participant or beneficiary, the plan administrator forwards to the investing participant or beneficiary any materials provided to the plan relating to the exercise of voting, tender or similar rights attendant to ownership of an interest in such investment (see paragraph (b)(2)(i)(B)(1)(ix)). Upon request, the plan administrator provides each participant or beneficiary with copies of any prospectuses, financial statements and reports, and any other materials relating to the investment alternatives available under the plan which are received by the plan (see paragraph (b)(2)(i)(B)(2 )(ii)). Also upon request, the plan administrator provides each participant and beneficiary with the other information required by paragraph (b)(2)(i)(B)(2) with respect to the equity fund, which is a designated investment alternative, including information concerning the latest available value of the participant’s or beneficiary’s interest in the equity fund (see paragraph (b)(2)(i)(B)(2)(v)). Plan A meets the requirements of paragraphs (b)(2)(i)(B)(1) and (2) of this section regarding the provision of investment information. Note: The regulation imposes no additional obligation on the administrator to furnish or make available materials relating to the companies in which the equity fund invests (e.g., prospectuses, proxies, etc.). (2) Plan C is an individual account plan described in section 3(34) of the Act under which participants and beneficiaries may choose among three investment alternatives which otherwise meet the requirements of paragraph (b) of this section. The plan permits investment instruction with respect to each investment alternative only on the first 10 days of each calendar quarter, i.e., January 1-10, April 1-10, July 1-10 and October 1-10. Plan C satisfies the condition of paragraph (b)(2)(ii)(C)(1) that instruction be permitted not less frequently than once within any three month period, since there is not any three month period during which control could not be exercised. (3) Assume the same facts as in paragraph (f)(2), except that investment instruction may only be given on January 1, April 4, July 1 and October 1. Plan C is not an ERISA section 404(c) plan because it does not satisfy the condition of paragraph (b)(2)(ii)(C)(1) that instruction be permitted not less frequently than once within any three month period. Under these facts, there is a three month period, e.g., January 2 through April 1, during which control could not be exercised by participants and beneficiaries. (4) Plan D is an individual account plan described in section 3(34) of the Act under which participants and beneficiaries may choose among three diversified investment alternatives which constitute a broad range of investment alternatives. The plan also permits investment instruction with respect to an employer securities alternative but provides that a participant or beneficiary can invest no more than 25% of his account balance in this alternative. This restriction does not affect the availability of relief under section 404(c) inasmuch as it does not relate to the three diversified investment alternatives and, therefore, does not cause the plan to fail to provide an opportunity to choose from a broad range of investment alternatives. (5) A participant, P, independently exercises control over assets in his individual account plan by directing a plan fiduciary, F, to invest 100% of his account balance in a single stock. P is not a fiduciary with respect to the plan by reason of his exercise of control and F will not be liable for any losses that necessarily result form P’s investment instruction. (6) Assume the same facts as in paragraph (f)(5), except that P directs F to purchase the stock from B, who is a party in interest with respect to the plan. Neither P nor F has engaged in a transaction prohibited under section 406 of the Act: P because he is not a fiduciary with respect to the plan by reason of his exercise of control and F because he is not liable for any breach of part 4 of Title I that is the direct and necessary consequence of P’s exercise of control. However, a prohibited transaction under section 4975(c) of the Internal Revenue Code may have occurred, and, in the absence of an exemption, tax liability may be imposed pursuant to sections 495 (a) and (b) of the Code. (7) Assume the same facts as in paragraph (f)(5), except that P does not specify that the stock be purchased from B, and F chooses to purchase the stock from B. In the absence of an exemption, F has engaged in a prohibited transaction described in 406(a) of ERISA because the decision to purchase the stock from B is not a direct or necessary result of P’s exercise of control. (8) Pursuant to the terms of the plan, plan fiduciary F designates three reputable investment managers whom participants may appoint to manage assets in their individual accounts. Participant P selects M, one of the designated managers, to manage the assets in his account. M prudently manages P’s account for 6 months after which he incurs [57 FR 46937] losses in managing the account through his imprudence. M has engaged in a breach of fiduciary duty because M’s imprudent management of P’s account is not a direct or necessary result of P’s exercise of control (the choice of M as manager). F has no fiduciary liability for M’s imprudence because he has no affirmative duty to advise P (see paragraph (c)(4)) and because F is relieved of co-fiduciary liability by reason of section 404(c)(2) (see paragraph (d)(2)(iii)). F does have a duty to monitor M’s performance to determine the suitability of continuing M as an investment manager, however, and M’s imprudence would be a factor which F must consider in periodically reevaluating its decision to designate M. (9) Participant P instructs plan fiduciary F to appoint G as his investment manager pursuant to the terms of the plan which provide P total discretion in choosing an investment manager. Through G’s imprudence, G incurs losses in managing P’s account. G has engaged in a breach of fiduciary duty because G’s imprudent management of P’s account is not a direct or necessary result of P’s exercise of control (the choice of G as manager). Plan fiduciary F has no fiduciary liability for G’s imprudence because F has no obligation to advise P (see paragraph (c)(4)) and because F is relieved of co-fiduciary liability for G’s actions by reason of section 404(c)(2) (see paragraph (d)(2)(iii)). In addition, F also has no duty to determine the suitability of G as an investment manager because the plan does not designate G as an investment manager. (10) Participant P directs a plan fiduciary, F, a bank, to invest all of the assets in his individual account in a collective trust fund managed by F that is designed to be invested solely in a diversified portfolio of common stocks. Due to economic conditions, the value of the common stocks in the bank collective trust fund declines while the value of publicly-offered fixed income obligations remains relatively stable. F is not liable for any losses incurred by P solely because his individual account was not diversified to include fixed income obligations. Such losses are the direct result of P’s exercise of control; moreover, under paragraph (c)(4) of this section F has no obligation to advise P regarding his investment decisions. (11) Assume the same facts as in paragraph (f)(10) except that F, in managing the collective trust fund, invests the assets of the fund solely in a few highly speculative stocks. F is liable for losses resulting from its imprudent investment in the speculative stocks and for its failure to diversify the assets of the account. This conduct involves a separate breach of F’s fiduciary duty that is not a direct or necessary result of P’s exercise of control (see paragraph (d)(2)(iii)). (g) Effective date. (1) In general. Except as provided in paragraph (g)(2), this section is effective with respect to transactions occurring on or after the first day of the second plan year beginning on or after October 13, 1992. (2) This section is effective with respect to transactions occurring under a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified before October 13, 1992 after the later of the date determined under paragraph (g)(1) or the date on which the last collective bargaining agreement terminates. For purposes of this paragraph (g)(2), any extension or renegotiation of a collective bargaining agreement which is ratified on or after October 13, 1992 is to be disregarded in determining the date on which the agreement terminates. (3) Transactions occurring before the date determined under subparagraph (g) (1) or (2) of this section, as applicable, are governed by section 404(c) of the Act without regard to the regulation. Signed at Washington, DC, this 2d day of October 1992. David George Ball, Assistant Secretary for Pension and Welfare Benefits, U.S. Department of Labor. [FR Doc. 92-24357 Filed 10-9-92; 8:45 am] BILLING CODE 4510-29-M 129 U.S.C. 1104(c). 2See Donovan v. Cunningham, 716 F.2d 1455, 1465, 1467-68 (5th Cir. 1983) in which it was held that a fiduciary of an employee stock ownership plan had the burden of proof to show that the conditions to the availability of the statutory exemption found in section 408(e) of ERISA were met. As support, the court cited SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953): "As the Supreme Court has observed in a different context, it seems 'fair and reasonable' to place the burden of proof upon a party who seeks to bring his conduct within a statutory exception to a broad remedial scheme. SEC v. Ralston Purina Co., 346 U.S. 119, 126, 73 S.Ct. 981, 97 L.Ed. 1494 (1953)." Id. at 1467-68, n.27. 3Section 404(c) refers to a pension plan that "provides for individual accounts." However, the regulation limits coverage of section 404(c) to "individual account plans" described in section 3(34) of ERISA because the Conference Report accompanying ERISA, H.R. Rep. No. 1280, 93d Cong., 2d Sess., 305 (1974) (hereafter, the Conference Report accompanying ERISA, H.R. Rep. No. 1280, 93d Cong., 2d Sess., 305 (1974) (hereafter, the Conference Report), refers to individual account plans that provide for participant control and because control and because section 404(c) contemplates separate individual accounting so that each participant or beneficiary will bear the sole risk of loss attributable to his investment decision. 4This discussion deals only with the effect of such classifications on a plan's status as an ERISA section 404(c) plan; in certain circumstances such classifications may violate other provisions of law, including conditions to qualification of a pension plan under section 401(a) of the Internal Revenue Code (the Code). 5ERISA also imposes certain requirements which are not affected by a participant's or beneficiary's exercise of control over the assets in his individual account; those requirements, of course, continue to apply to plan fiduciaries even though a plan is an ERISA section 404(c) plan. For example, the bonding requirements of section 412 of ERISA would apply to all persons (other than the participant or beneficiary) who handle plan funds under an ERISA section 404(c) plan. 6 Under an arrangement pursuant to which the defined benefit portion provides the floor or minimum benefit, adverse investment experience in the individual account portion could negatively impact on the ultimate liability of the defined benefit portion to provide the promised benefits. 7See ERISA section 206(d)(3)(J). 8Paragraph (e)(4) defines "designated investment alternative" as a specific investment identified by a plan fiduciary as an available investment alternative under the plan. For example, if a 404(c) plan permitted its participants and beneficiaries to invest in any investment which it was administratively feasible for the plan to hold and specifically described an equity fund which was managed by the plan sponsor, the equity fund would be a "designated investment alternative" within the meaning of paragraph (e)(4) of this section. 9The Department notes that, for purposes of the Securities Exchange Act of 1934, participants in an employee benefit plan are considered to be beneficial owners entitled to receive proxy materials if they have the right under the plan or otherwise to vote the securities held on their behalf. See Shareholder Communications Facilitation, Securities Exchange Act Release No. 23847 (Nov. 25, 1986), 51 FR 44267. 10When referring to the proposal, the final regulation uses the term "category" rather than "alternative" where "category" was used therein. Otherwise, in order to be consistent in usage, the final regulation uses the term "alternative" rather than "category" throughout. 11Whether any given penalty or adjustment is unreasonable or otherwise limits a participant's or beneficiary's ability to give investment instructions in accordance with the general volatility or three-month minimum rule is a factual determination which must be made on an investment by investment basis, taking into account factors such as the nature of the investment alternative, its rate of return, market forces, etc. 12See n.29 13See ERISA section 408(b)(2) relating to the provision of services by a party in interest to the plan, and 29 CFR 2550.408b-2. 14Although a plan may impose other reasonable limitations, the totality of such restrictions must not so restrict a participant's or beneficiary's opportunity to exercise control so as to in effect cause the plan to fail to provide participants and beneficiaries an opportunity to exercise control within the meaning of paragraph (b)(2) of this section. 15Paragraph (d)(2)(ii) of the final regulation was designated paragraph (e)(2)(ii) in the proposal. 16Even if a plan offers a diverse portfolio of investments in each of the investment alternatives, it may not meet the general diversification standard of the final regulation. For example, a plan may fail to provide a participant or beneficiary an opportunity to diversify his account if all of the available investment alternatives relate to one industry. 17The language in paragraph (b)(3)(i)(B)(3) of the proposal stated: "[e]ach of which when combined with investments in either of the other categories tends to minimize the overall risk of a participant's or beneficiary's portfolio". This language implied that a play may have only three core investment alternatives. The words "either of" were deleted to indicate that three is the minimum number of alternatives required by paragraph (b)(3)(i)(B). 18As is further explained below, the concept of a "pooled investment fund" contained in the 1987 proposal was expanded in the proposal to include investments which do not permit the investors to share in the gains or losses of the underlying assets of the investment vehicle. Thus, the investment vehicles defined in paragraph (e)(1) are referred to in the final regulation as "look-through investment vehicles" because of the treatment provided these vehicles under paragraph (b)(3)(ii). That provision permits consideration of the underlying investments of these vehicles in determining whether the diversification requirements of paragraph (b)(3)(i) are met. Such designation is relevant to this regulation only and should not be read to imply that the underlying assets of such entities include plan assets. (See 29 CFR @ 2510.3-101 for plan asset rules regarding investment vehicles). 19In this regard, a plan which is designed to be an ERISA 404(c) plan for all plan participants may fail to meet the "broad range of investment alternatives" requirement because the investment alternatives offered by the plan would not permit those participants with small account balances to diversify their investments. In such circumstances, the plan would be considered an ERISA section 404(c) plan solely with regard to those transactions which are directed by a participant or beneficiary who may direct investment of an amount in his account which is large enough to permit broad diversification through the investment alternatives offered by that plan, and only to the extent that all other requirements of this regulation were met. 20 17 CFR section 270.18F-2. 21 This concept is described and clarified in the Department's regulation at 29 CFR 2510.3-101. 51 FR 41262 (November 13, 1968). 22ERISA section 404(c) does not provide relief with respect to any section 406 violation which may occur based on a fiduciary's choice of itself or a person or entity in whom it has an interest to provide services for the plan for a fee or other compensation, or based on a fiduciary's limitation of investment alternatives to include those managed by itself or its affiliates. 23Conference Report at 305. 24With respect to the third factor, the Department did not intend to impose an affirmative duty on the implementing fiduciary to evaluate a participant's or beneficiary's competence. However, the Department is of the opinion that the implementing fiduciary should not be able to invoke section 404(c) to avoid liability for losses resulting from the imprudent instructions of a participant where the fiduciary has actual knowledge of such incompetence. 25Restatement (Second) of Trusts section 216 (1959) provides: Section 216. Consent of Beneficiary (1) Except as stated in Subsections (2) and (3), a beneficiary cannot hold the trustee liable for omission of the trustee as a breach of trust if the beneficiary prior to or at the time of the act or omission consented to it. (2) The consent of the beneficiary does not preclude him from holding the trustee liable for a breach of trust, if -- (a) The beneficiary was under an incapacity at the time of such consent or of such act or omission; or (b) The beneficiary, when he gave his consent, did not know of his rights and of the material facts which the trustee did not reasonably believe that the beneficiary knew; or (c) The consent of the beneficiary was induced by improper conduct of the trustee. (3) Where the trustee has an adverse interest in the transaction, the consent of the beneficiary does not preclude him from holding the trustee liable for a breach of trust not only under the circumstances stated in Subsection (2), but also if the transaction to which the beneficiary consented involved a bargain which was not fair and reasonable. See also III Scott, Trusts section 216 (3rd ed. 1967); Bogert, Trusts section 941 (2d ed. 1960). 26Commentators explained that the issuer of a fixed rate investment contract would view the described alternatives as competing vehicles, and that the availability of such a vehicle in a plan would result in a lowering of the return on the fixed rate investment contract. 27In this regard, the Department points out that the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function which, whether achieved through fiduciary designation or express plan language, is not a direct or necessary result of any participant direction of such plan. Thus, for example, in the case of look-through investment vehicles, the plan fiduciary has a fiduciary obligation to prudently select such vehicles, as well as a residual fiduciary obligation to periodically evaluate the performance of such vehicles to determine, based on that evaluation, whether the vehicles should continue to be available as participant investment options. Similar fiduciary obligations would exist in the case of an investment universe consisting of investment alternatives which are not look-through investment vehicles but which are specifically designated by plan fiduciaries. In those situations where the ERISA section 404(c) plan by its own provisions limits the investment universe by designating specific investment alternatives which are not look-through investment vehicles, the plan fiduciary must comply with the requirements of ERISA section 404(a)(1)(D). 28This provision, dealing with the individual investment decisions of an investment manager relates only to the scope of the relief provided by section 404(c)(2), and is not intended to create fiduciary duties which would not otherwise exist. Thus, even though the individual decisions of the investment manager of an investment company registered under the Investment Company Act of 1940 would not be considered to "result" from a participant's decision to invest in the investment company, the manager would have no liability under ERISA for any losses experienced by the mutual fund because mutual fund assets are not plan assets and, therefore, mutual fund investment advisers are excluded from the statutory definition of "fiduciary" in ERISA (see sections 3(21)(B) and 401(b)(1) of ERISA). 29Of course, if the instruction is one which is listed in paragraph (d)(2)(ii) of the final regulation, the limitation on fiduciary liability provided by section 404(c) contained in paragraph (d)(2)(i) of the regulation would be unavailable to the plan fiduciary pursuant to the provisions of that paragraph. 30The relevant passage of the Conference Report states: "The conferees expect that the (section 404(c)) regulations will provide for stringent standards with respect to determining whether there is an independent exercise of control where the investments may inure to the direct or indirect benefit of the plan sponsor since in this case participants might be subject to pressure with respect to investment decisions. (Because of the difficulty of ensuring that there is independence of choice in an employer established individual retirement account, it is expected that the regulations will generally provide that sufficient individual control will not exist with respect to the acquisition of employer securities by participants and beneficiaries under this type of plan)." Conference Report at 305. 31As stated above, paragraph (c)(1)(ii) of the final regulation requires that the participant or beneficiary not file to exercise control with respect to incidents of ownership by reason of the circumstances described in paragraph (c)(2). Thus, for example, a participant or beneficiary will not be deemed to have exercised control with regard to a proxy where he is subjected to improper influence by a plan fiduciary or the plan sponsor with respect to the proxy. See paragraph (c)(2)(i). The trustee may have an obligation to vote in this situation.