High court ruling opens 401(k) can of worms
In its ruling in LaRue v. DeWolff, Boberg & Associates Inc., the U.S. Supreme Court held that an employee could sue his employer for investment losses that the employee claimed were caused by the employer’s failure to make requested changes to the investments in his 401(k) account. This decision serves as a wake-up call to many employers who sponsor 401(k) plans and comparable defined contribution plans that give participants individual investment accounts.
The 401(k) plan sponsored by DeWolff, Boberg & Associates allowed participants to direct the investment of their 401(k) accounts. The plaintiff claimed that his employer breached its fiduciary duty to him by not making changes to the investments in his individual account after being directed by him to do so. He claimed that this omission caused his account a loss of approximately $150,000.
A prior U.S. Supreme Court case, Massachusetts Mutual Life Insurance Company v. Russell, held that individual plan participants were not permitted to recover damages if the plan sponsor breached its fiduciary duty. Damages for breach of fiduciary duty were recoverable only for the benefit of the plan as a whole, and could not be recovered by any individual plan participant.
But the court said that the decision in the earlier case was inapplicable because Russell dealt with a defined benefit plan, and not a defined contribution plan. In a traditional defined benefit pension plan, participants do not have individual investment accounts and the benefit paid under the plan is fixed in advance. Thus, the employee is not responsible for investment decisions, and need worry only about whether the plan as a whole is sufficiently solvent to pay the agreed benefit.
In contrast, in a defined contribution plan, participants have individual investment accounts that can go up or down based on the employer’s and employee’s contributions to the account, and the performance of the investments held in the account. There is no fixed benefit. Thus, the employee must be concerned with how his individual investment account performs over time.
Not surprisingly, the performance of an employee’s defined benefit plan account can be significantly affected by whether the employer promptly implements changes requested by the employee. Thus, the court concluded that a breach of fiduciary duty that affected only one participant’s account was significant in the context of a defined benefit plan.
The court’s comments in this regard suggests that it now has a heightened concern that workers whose retirement savings are tied up in 401(k) and similar plans be adequately protected. Thus, while the DeWolff case leaves many issues unclear, one thing that is clear is that the Supreme Court has evidenced an intent to protect employees who must depend on their 401(k) and similar defined contribution plans for their retirement income.
What employers can do
It is important to note that the Supreme Court did not determine whether the employer violated its fiduciary duty by failing to make the investment changes requested. The court merely stated that the claimed failure on the part of the employer was sufficient grounds for a damage claim. There are a few simple measures that an employer can take today in order to try to avoid a claim of the type brought in the LaRue case, and to best ensure the likelihood of success if sued. These include:
• Employers should review the terms of plans to make sure it’s understood what the plans require and determine whether the procedures required by the plans are actually being followed. Employers also should ensure that the people in their organization that are in charge of administering the plans are following the procedures, and that the procedures actually work in a reasonable fashion.
• Employers should keep an eye out for areas where they may need to amend procedures in order to minimize risk and be vigilant about minimizing potential errors or misunderstandings. In addition, documentation should appropriately and sufficiently track any changes made to a participant’s account.
• Employers who use third-party providers should review the agreements they have with those providers, paying specific attention to the extent of the employer’s own responsibility (and the responsibility of the third party provider) if the provider were negligent. Employers also should be familiar with any right they may have to indemnification from the third-party provider, and any indemnification they are required to give to the third-party provider. Likewise, employers should determine whether provider agreements cap or otherwise limit damages that can be recovered by the employer in the case of negligence or other breach on the part of the provider. nhbr
Dodd Griffith, a shareholder and director of the law firm of Gallagher, Callahan & Gartrell, serves as the practice group leader for its Corporate, Finance and Tax Practice. Laurel Van Buskirk is an associate in the firm practicing in the areas of employment law and litigation.