SOLUTIONS IN A FLASH – RETIREMENT PLAN CORRECTION SOLUTION:
PLAN C — “C” IS FOR CATASTROPHE

By: Alison J. Cohen, Esq.

Sonny and Ruben met for their usual quarterly lunch. Friends since college, Sonny is a successful entrepreneur and Ruben is the investment advisor for Sonny’s personal assets and the retirement plans. This time, Sonny told Ruben that he wanted to pick Ruben’s brain about some “brilliant investment ideas” (loose translation: Sonny, as always, was looking for free advice). Ruben usually reluctantly gives in and gives Sonny his thoughts, but didn’t think that Sonny really respected his opinion. He also worried about Sonny’s reckless streak.

“Ruben, great to see you, man! How have you been? How’s the family?”

“Doing pretty well, Sonny. Kathy and the kids – “

Sonny cut him off, “Terrific. So, I have these big ideas on how to invest my money.”

“Oh. Ok. What are you looking at?”

“Cryptocurrency, man. That’s where it’s at. And some private equity opportunities that I found. They are looking fabulous.”

“Well, within your IRA and other investment accounts that could be … “

Sonny interrupted again, “No. No. Not that money. I want to use the funds in my company’s Profit Sharing Plan and the Defined Benefit Plan. That’s where the big bucks are.”

“What? That’s not just your money. That’s the money for your employees, too.”

“As the owner of the company, I’m giving it to my employees, so basically it’s mine. I’ve had you manage the plan money historically, but I think we need to get more aggressive and really bring in some big bucks for everyone.”

“There are risks involved with that, Sonny. Let’s review what you’re actually looking at.”

“That’s the best part. Plan C! It’s already done. You can watch the growth of the money with me. I bet we have a 50% rate of return by the end of the year.”

“How much did you transfer over to these new investments, Sonny?”

“All of it.”

“All of it? Are you nuts?”

“Ruben – relax. I’m going to show you how it’s done.”

No matter what Ruben said during that lunch hour, Sonny just talked over him and insisted that he had done the right thing. Ruben got back to his office, wrote Sonny a letter to resign as his investment advisor, and warned him in writing that his actions could be both a personal disaster and a fiduciary breach for the plan. He encouraged him to re-diversify the plan assets, including a substantial amount of traditional investments to offset the risk of his new purchases. Sonny never responded to the letter.

Sure enough, though, six months later, the cryptocurrency that Sonny invested in turned out to be worthless, losing a significant portion of the value in both retirement plans. And the magical private equity opportunity that was going to make everything better? Couldn’t get a valuation for it and the Form K-1 that Sonny got showed a value lower than his initial investments. It was a disaster for the participants’ accounts.

Several participants had either terminated service (you can imagine how Sonny ran his company) or retired, and they were asking for their distributions. There aren’t enough liquid assets to pay them out after this fabulous “Plan C.” With Ruben out of the picture, Sonny was left holding the bag – and rightfully so!

Was this a real scenario? Yep.

What was Sonny’s Liability?

As is always the case, the employer is responsible for ensuring that the assets in the defined benefit plan are sufficient to cover the benefits owed. When the Adjusted Funding Target Attainment Percentage (AFTAP) (which is roughly the amount of assets needed to fund earned benefits) drops below 60%, the law dictates that the amount of pension plan benefits is frozen automatically, with no new benefits earned by employees until the assets go up.  What also happens is that the plan sponsor likely has a larger minimum required contribution under Internal Revenue Code (IRC) section 430. Failure to meet this contribution requirement leads to a 10% excise tax under IRC 4971(a), which can convert to a 100% excise tax if the deficiency is not quickly remedied.

The profit-sharing plan has no funding obligation that is affected by the losses, but Sonny is in deep doo-doo in that plan, too. The Supreme Court stated in Hughes v. Northwestern University that “plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.” If investing in the alternative assets and failing to diversify the investments is determined to be imprudent, Sonny would be personally liable for losses to his participants’ accounts.  Even if the initial investment was found to be prudent, the failure to monitor the investment and stem the bleeding when the values were plummeting would make Sonny liable.

But Didn’t the President and the U.S. Department of Labor Profess New Love for these Alternative Investments?

Yes and no. Executive Order 14330, dated August 5, 2025, did not protect plan sponsors from liability for losses experienced from alternative assets, despite the wording in Section 1 of the Order.  The Order instructed the Secretary of Labor to clarify its position on alternative assets (which it did by rescinding Biden era guidance discouraging such investments) and the fiduciary process in relation to investments in those assets. It asked the DOL to clarify the rules about fiduciary duties and to consider some safe harbors for the investments. It asked the DOL to coordinate with the Securities and Exchange Commission (SEC). Period.

No matter what investments are considered, all fiduciaries still have a duty under ERISA to exercise the best judgment and hold the participants’ interests first and foremost in their minds as decisions are made. There has been no action that would change the duties under ERISA in relation to the investment of plan assets. Sonny still must exercise “care, skill, prudence and diligence under the same circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters” would use. So, would a prudent person acting in like capacity and familiar with fiduciary rules invest solely in alternative assets with so little diversification?

What are the Key Considerations that a Fiduciary Should Consider?

Beyond just the rate of return, a fiduciary has to look at the needs of the plan, which include liquidity needs. Liquidity needs are based on the demographics and typical withdrawal patterns. It is also important to determine the risk tolerance of the group as a whole, which is also based on demographics. Finally, a fiduciary is required to diversify investments so as to minimize the risk of large losses, unless under the circumstances, it is clearly prudent not to do so. Likely, this is what Ruben was trying to do for the plan before Sonny took over with his “Plan C.”

How Should Sonny Move Forward from Here?

Hopefully, Sonny will have a solid cash flow and will be able to meet his minimum required contributions to the defined benefit plan. For the profit-sharing plan, Sonny needs to consult with an ERISA attorney to determine how to minimize his liability. Profit-sharing plans commonly permit the participants to direct their own investments, which generally reduces some of the liability for the employer. Sonny needs to consider permitting participant investment direction in the profit-sharing plan, and enjoying the benefits of ERISA section 404(c) and its liability reduction. Sonny could also consider providing participants with the option to use a self-directed brokerage account (SDBA) within the plan to access additional investment opportunities, such as alternate investments, for their own accounts.

Conclusion

Allowing sophisticated investors to direct the investment of their own accounts into alternative investments may be the wave of the future in some profit-sharing plans. But investing for a defined benefit plan is a whole other animal. A fiduciary needs to be informed about how a defined benefit plan works so as to understand how investment return can affect the funding obligations. Investments with high volatility can threaten both the employer’s contribution requirements and the benefit security of the participants. Investing in alternative investments, like cryptocurrency and private equity alternatives, may not always be appropriate for all plans.

Before a plan sponsor dives into “Plan C,” they should consult with a financial advisor and listen to their advice.

If you or a client need assistance correcting a fiduciary issue like the one Sonny faced, please contact us. After all, we are your ERISA solution!