Tax Bulletin (March 2008)
Supreme Court Decision May Spur
Individual and Class Actions
Fiduciaries for Defined Contribution Plans
A. Brodie (New York),
P. Serota (New York),
A. Ericson (San Francisco), partners, and
Husa (New York), an associate, all with Pillsbury Winthrop
Shaw Pittman LLP.
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The U.S. Supreme Court has opened the door to more claims by participants in 401(k) plans who allege that the plan fiduciaries' breach of their duties under the Employment Retirement Income Security Act of 1974 ("ERISA") reduced the value of the participants' individual accounts. Without a dissent, the Court held that ERISA allows participants in a defined contribution plan to recover from plan fiduciaries for losses in their individual plan accounts, when those losses are caused by fiduciary misconduct. LaRue v. DeWolff, Boberg, & Assocs., 128 S.Ct. 1020 (Feb. 20, 2008).
Although it did not address such claims directly, the decision will be viewed by plantiffs' lawyers as lending legal foundation to the numerous class actions that have been brought against troubled companies based on the investment of 401(k) plan assets in company stock. As a result of the Supreme Court's decision, therefore, one can anticipate more class actions by 401(k) participants, as well as lawsuits by individual defined contribution plan participants whose enrollment or investment elections were mishandled by the plan administrators.
Recovery Available For Losses to Individual's Account in a
The Supreme Court observed in LaRue that the "landscape of employee benefit plans" has changed over the last two decades. While the typical form of retirement plan used to be the traditional defined benefit plan, in which participants were paid a pension or similar fixed benefit based on a formula, today "[d]efined contribution plans dominate the retirement plan scene." A defined contribution plan provides varying returns based upon how much participants elect to contribute and how participants' contributions are invested.
Defined Contribution Plan
Prior to LaRue, some courts had concluded that defined contribution plan participants could not seek relief under ERISA's fiduciary provisions for losses in their individual accounts. Those courts relied on the text of ERISA § 409, 29 U.S.C. § 1109, which provides that fiduciaries "to a plan," if found liable for breach of their duties, must make good any losses "to such plan" and restore lost profits "to such plan." In Massachusetts Mutual Life Insurance Co. v. Russell, 473 U.S. 134, 142 (1985), the Supreme Court had remarked, in the context of a defined benefit plan, that ERISA's framers "were primarily concerned with the possible misuse of plan assets, and with remedies that would protect the entire plan, rather than with the rights of an individual beneficiary."
In LaRue, a participant in a defined contribution plan claimed that he had directed the plan sponsor to make certain changes to his investments, but that his directions were never carried out. The participant sued his former employer, DeWolff, Boberg, & Associates, Inc. ("DeWolff"), as well as the ERISA-regulated 401(k) defined contribution plan that DeWolff administered, to recover approximately $150,000, which he claimed was the amount by which the omission had "depleted" his interest in the Plan.
The District Court granted DeWolff's motion for judgment on the pleadings and the U.S. Court of Appeals for the Fourth Circuit affirmed. The Fourth Circuit rejected the participant's claim that he had a cognizable claim under ERISA § 502(a)(2)which authorizes "appropriate relief under [ERISA] § 409"because that section "provides remedies only for entire plans, not for individuals." LaRue v. DeWolff, Boberg, & Assocs., 450 F.3d 570, 572 (4th Cir. 2006).
The U.S. Supreme Court reversed. Unanimously, the Justices concluded that a participant in a defined contribution plan could sue under ERISA § 502(a)(2) to recover losses sustained in his individual plan account.
Defined Benefit, Defined Contribution Plan Structures Distinguished
The five-justice majority opinion, written by Justice John Paul Stevens, focused on the distinction between defined benefit and defined contribution plans to support the plaintiff's claim for relief. The majority contrasted the plaintiff's claim with the one in Russell, where a participant in a disability plan had sought consequential damages arising from a delay in processing her contractually-determined benefit. "Unlike the defined contribution plan in this case," the majority explained, "the disability plan at issue in Russell did not have individual accounts; it paid a fixed benefit based on a percentage of the employee's salary." While the petitioner in Russell received the full amount of the fund assets to which she was contractually entitled, the petitioner in LaRue alleged that he had received less than his contractually determined share of the fund assets due to the plan administrators' breach of fiduciary duty.
"For defined contribution plans," the majority reasoned, "fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive. Whether a fiduciary breach diminishes plan assets payable to all participants and beneficiaries, or only to persons tied to particular individual accounts, it creates the kind of harms that concerned the draftsmen of [ERISA] § 409."
In a separate concurrence, Justice Clarence Thomas, joined by Justice Antonin Scalia, explained further that defined contribution plans are composed of a number of individual accounts. "[W]hen a defined contribution plan sustains losses, those losses are reflected in the balances of the plan accounts of the affected participants, and a recovery of those losses would be allocated to one or more individual accounts," Justice Thomas noted. "On their face," he wrote, "[ERISA] §§ 409(a) and 502(a)(2) permit recovery of all plan losses caused by a fiduciary breach," including those felt by the holders of individual accounts.
In another separate concurrence, Chief Justice John G. Roberts, Jr., joined by Justice Anthony Kennedy, observed that ERISA § 502(a)(1)(B), which allows participants to "recover benefits due
under the terms of [the] plan," may also provide relief in this situation. Identifying a possible defense to fiduciary claims for lost benefits, Chief Justice Roberts noted that the LaRue Court had not considered whether the possible availability of relief under § 502(a)(1)(B) might change the result.
Plan Fiduciaries Should Prepare for More Lawsuits
After LaRue, ERISA fiduciaries should anticipate expanded claims for liability under ERISA. Class action plaintiffs will likely argue that LaRue provides a legal basis for recovering losses sustained in individual 401(k) plan accounts due to plan investments in company stock. The complaints in such cases typically allege that the plan fiduciaries, who often include company insiders, knew adverse information about the company's prospects yet breached their fiduciary duties by continuing to allow the purchase of company stock with plan funds. The fiduciary obligations at issue in those cases include the duty to act "solely in the interest of the participants and beneficiaries," the duty to administer the plan with the diligence and care expected of "a prudent man acting in a like capacity and familiar with such matters," and the duty to diversify plan assets so as to minimize the risk of large losses. See ERISA § 404(a)(1), 29 U.S.C. § 1104(a)(1).
Additionally, fiduciaries should expect more individual claims for breach of fiduciary duty based on plan processing errors. LaRue will likely be viewed as providing authority for such claims. The Court, however, noted that it had not decided whether the plaintiff was required to "exhaust" the plan's administrative remedies before suing for breach of fiduciary duty. Chief Justice Roberts' concurrence spoke to the issue at greater length, explaining that courts have disagreed over whether plaintiffs may "recast" as claims for breach of fiduciary duty "what are in essence plan-derived benefit claims that should be brought under [ERISA] § 502(a)(1)(B)." If such a claim were brought under section 502(a)(1)(B), Chief Justice Roberts observed, it would be subject to the "safeguard
recognized by almost all the Courts of Appeals
that a participant exhaust the administrative remedies mandated by ERISA
before filing suit." The plan administrator's decisions on such matters typically are reviewed only for abuse of discretion.
LaRue has also clarified that the pool of potential plaintiffs is not limited to current participants. Previously, some federal courts had precluded former participants, who had liquidated their plan accounts, from suing for earlier losses in those accounts. In a footnote, the Supreme Court observed that LaRue did not become moot just because the plaintiff was no longer a plan participant: a plan "participant" under ERISA may include "a former employee with a colorable claim for benefits."
How Should Plan Participants and Plan Fiduciaries Respond to LaRue?
LaRue recognizes and endorses current theories in ERISA litigation, while leaving the viability of defenses to those theories uncertain. The result may well be more litigation accusing plan fiduciaries of breaching their fiduciary duties.
The ultimate recoveries in 401(k) fiduciary cases may be significant. As the Supreme Court recognized in a footnote, ERISA § 502(a)(2) "encompasses appropriate claims for 'lost profits'" resulting from a fiduciary breach. In other words, the plan fiduciaries may be required to restore a plaintiff to the situation in which he would have been, had no breach of duty occurred.
Consequently, following LaRue, plan sponsors and fiduciaries may wish to consider the following steps, among others:
- Ensure that the plan has a working administrative process that complies with applicable regulations and has been disclosed to plan participants in appropriate detail.
- Ensure that the plan administrative process extends to fiduciary claims (although federal courts may not respect such provisions in some cases).
- Confirm that the plan administrator has been granted discretion in interpreting the plan and in making findings of fact, so that the administrative decisions are protected by the liberal "abuse of discretion" standard.
- Review the plan's compliance with ERISA § 404(c) and related regulations, which protect fiduciaries from liability for the investment choices made by participants in defined contribution plans.
- Review the plan's policy on investments in company stock, and consider whether any changes are appropriate.
- Review the plan's fiduciary insurance, if any, and determine whether the plan and its fiduciaries are adequately covered.
This material is not intended to constitute a complete analysis of all
tax considerations. Internal Revenue Service regulations generally
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