The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that should be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.
In earlier posts, I covered the first two factors—Performance and Fees, and their examples. In my last two posts, Alternative Assets (15) and Alternative Assets (16), I covered the Complexity factor and the first example of its application.
This article looks at the second example under the Complexity factor. As a refresher, here’s how the proposal describes that factor:
(l) Complexity. The plan fiduciary must appropriately consider the complexity of the designated investment alternative and determine that it has the skills, knowledge, experience, and capacity to comprehend it sufficiently to discharge its obligations under ERISA and the governing plan documents or whether it must seek assistance from a qualified investment advice fiduciary, investment manager, or other individual.
(The bolding in this article is mine…just to emphasize the points that I consider the most important.)
The proposal gives two examples about the application of the Complexity factor. The second one is:
(2) Example. Complexity; Participant needs—
(i) Facts. The plan document for a participant-directed individual account plan specifies that the plan sponsor’s chief financial officer is the named fiduciary of the plan and responsible for the establishment of the plan investment menu and selection and monitoring of designated investment alternatives. The named fiduciary does not enlist the services of an investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA, an investment manager within the meaning of section 3(38) of ERISA, or any other type of professional consultant. The named fiduciary adds a managed account service to create a customized portfolio tailored to each participant’s unique financial circumstances as the plan’s qualified default investment alternative. But, because the named fiduciary does not understand the design of the managed account service, the named fiduciary provides only the age of each participant to the managed account service, instead of providing, or allowing the participants to provide, information about the participants’ unique financial circumstances. Based on each participant’s age, the managed account service creates a portfolio for each participant that is materially similar in terms of strategies, historical performance, and liquidity to the portfolio that each participant would have been exposed to in the plan’s target date fund—another designated investment alternative in the plan. The target date fund has substantially lower fees than the managed account service.
Comment: In my view, this fact scenario is unlikely. The providers of managed accounts usually receive 7 or 8 data points from the recordkeeper, for example, age, gender, compensation, account balance, etc. In addition, the managed account programs that I have worked on allow participants to add another 5 or so datapoints of personal information (even though most don’t). So, I don’t think the example is realistic from a practical perspective. However, the DOL’s point is a good one, that is, if plan fiduciaries don’t understand how a service works and, as a result, they use it in a way that adds cost, but little value, that is a breach due to the failure of the fiduciaries to understand the complexity of the service and therefore the failure to provide value that matches the additional cost.
(ii) Analysis. A plan fiduciary must, including with the help of professional investment advisers like third-party investment advice fiduciaries within the meaning of section 3(21)(A)(ii) of ERISA, when appropriate, determine that it has the skills, knowledge, experience, and capacity to understand each designated investment alternative sufficiently to discharge its obligations under ERISA and the governing plan documents.
Comment: This analysis seems obvious. If a fiduciary lacks the “skills, knowledge, experience, and capacity” to understand the investment or service, then the fiduciary has to get competent help. If fiduciaries hire a 3(21) “recommending” adviser, that is evidence of a prudent process. However, the question remains… will the adviser provide the enough support and education so that the fiduciaries then have the “skills, knowledge, experience, and capacity”? To explain why I ask that question, several court decisions have said that fiduciaries cannot rely blindly on advisers and cannot accept an adviser’s recommendation without more. (More specifically, the courts say that fiduciaries cannot rely “blindly” on their advisers.) Instead, fiduciaries must ask questions and gain the information and understanding needed to adopt the adviser’s recommendation as their own. On the other hand, if fiduciaries use a 3(38) “deciding” adviser, they are not subject to that requirement, since the adviser is making the decisions. In both cases, plan fiduciaries must prudently select and monitor the advisers, but the primary fiduciary responsibility for investments in shifted only where the adviser is making the decisions—a so-called 3(38) investment manager.
One thing that may not be obvious, though, is that this could be seen as creating a new requirement, which is that fiduciaries must go through a self-evaluation to determine if they are competent to make decisions about plan investments and services. For example, do they understand the concepts behind target date funds and why and how the allocations change over time? Maybe, but maybe not.
(iii) Conclusion. The facts in this example do not establish that the named fiduciary satisfied section 404(a)(1)(B) of ERISA and paragraph (l) of this section in selecting the management account service as a designated investment alternative. The selection and implementation process appears to be flawed because the named fiduciary failed to comprehend the features, values, and fees of the designated investment alternative. After an appropriate due diligence process, a plan fiduciary would ordinarily be expected to understand how a designated investment alternative functions and delivers value to plan participants and operationalize it accordingly.
Comment: The DOL’s discussion and my comments previewed this conclusion. Plan fiduciaries need to understand the investments and services they are evaluating. No confusion about that conclusion.
The preamble discusses the example as follows:
Proposed paragraph (l)(2) relates to complexity in the area of participant needs and illustrates an example that would not satisfy paragraph (l) and section 404(a)(1)(B) of ERISA. In the example, the named fiduciary selects as the plan’s qualified default investment alternative a managed account service designed to create a customized portfolio targeted to each participant’s unique financial circumstances. The named fiduciary, that does not understand the design of the service and does not seek professional advice, provides only the age of each participant to the service and does not provide, or permit participants to provide, additional information about their unique financial circumstances. As a result, the service creates a portfolio for each participant that is materially similar to the portfolio that the participant would obtain through the plan’s target date fund, which has substantially lower fees. This example demonstrates a flawed selection process in which the named fiduciary appears to not understand how the designated investment alternative delivered value to the plan and therefore failed to operationalize it accordingly.
Comment: I imagine that plaintiffs’ attorneys will have a field day with the expectation that fiduciaries are “expected to understand how a designated investment alternative functions and delivers value to plan participants and operationalize it accordingly”. I can imagine the questions that committee members will be asked about the more complex investments such as target date funds and stable value funds. For example, do committee members understand the differences between different target date fund families and why one might be better than another for a particular plan and its participants? Do they know how to make that comparison? And so on.
Concluding Thoughts
The Complexity factor is a marketing piece for investment advisers. If plan fiduciaries engage in the process of evaluating their competency for understanding the more complex plan investments, they will—at least in my view—decide to work with advisers who will serve as plan fiduciaries and particularly for 3(38) investment managers who select and monitor the investments in the menu for participant directed plans.
