401(k) Participants May Sue for Breach of Fiduciary Duty

In a closely watched case arising under the Employee Retirement Income Security Act of 1974, as amended ('ERISA'), the U.S. Supreme Court recently clarified the right of employees to sue plan fiduciaries for mismanaging their individual 401(k) accounts. Prior to the Supreme Court's clarification, the lower courts were divided as to whether certain remedies under Sections 502(a)(2) and 409 of ERISA (29 U.S.C. ' 1132(a)(2) and 29 U.S.C. ' 1109 respectively) allowed recovery for breaches by fiduciaries that affected only individual accounts, rather than the plan as a whole. In LaRue v. DeWolff, Boberg & Associates, Inc., 128 S. Ct. 467, 42 EBC 2857 (2008), the Supreme Court has now settled the issue, holding that ERISA authorizes a plan participant to recover for fiduciary breaches even if those breaches affect only the participant's individual account.

The Facts and Holding of LaRue

While employed at the management consulting firm DeWolff, Boberg & Associates ('DeWolff'), James LaRue ('LaRue') participated in the firm's ERISA-regulated 401(k) retirement savings plan (the 'Plan'). Under the Plan, participants had the option of instructing DeWolff on how to invest their money. According to LaRue's complaint, in 2001 and 2002 DeWolff failed to invest LaRue's money as he directed, causing an estimated loss of $150,000. In June 2004, LaRue filed suit against DeWolff and the plan, alleging breach of fiduciary duty.

Rather than seek money damages, which would generally be prohibited under ERISA unless the relief sought was for 'the plan as a whole,' LaRue requested make-whole or 'equitable' relief under ERISA Section 502(a)(3). This section authorizes plan participants to bring a civil action for 'appropriate equitable relief' to redress violations of a plan, to enforce ERISA's provisions, or to enforce the plan's terms. The trial court dismissed LaRue's claim on the pleadings, finding that his claim was essentially one for money damages because 'the court would have to transfer money from defendants to plaintiff,' and, therefore, was not appropriate for relief under ERISA Section 502(a)(3).

On appeal, LaRue made a broader argument. In addition to raising Section 502(a)(3), LaRue also argued that his suit was proper under Section ERISA 502(a)(2). This section permits a participant to bring a civil action 'for appropriate relief' for breach of certain fiduciary duties. The Court of Appeals for the Fourth Circuit rejected both arguments and affirmed the district court's decision. Curiously, although the court found that LaRue had waived the Section 502(a)(2) claim, it nonetheless addressed the argument and held that under the Supreme Court's precedent in Mass Mutual Life Insurance Co. v. Russell, 473 U.S. 134 (1985), recovery under Section 502(a)(2) must inure to the 'benefit of the plan as a whole,' not a particular person who participated in the plan. As to LaRue's Section 502(a)(3) claim, the court agreed with the district court that LaRue sought money damages, not equitable relief.

In a unanimous decision, the Supreme Court reversed the Court of Appeals. The Court held that it did not need to reach the issue of whether LaRue's claim under ERISA Section 502(a)(3) was cognizable, because its interpretation of LaRue's Section 502(a)(2) claim was dispositive in favor of LaRue.

Writing for the Court, Justice Stevens ' who wrote the decision in Russell 23 years earlier ' distinguished Russell, which dealt with a defined benefit plan, on the ground that the 'landscape' of employee benefit plans has changed. Noting that 'defined contribution plans dominate the retirement plan scene today,' the Court found that a breach of fiduciary duty that harms a single participant 'creates the kind of harm that concerned the draftsmen of [ERISA Section] 409,' because the duties imposed by Section 409(a) 'relate to the proper management, administration, and investment of fund assets with an eye toward ensuring that the benefits authorized by the plan are ultimately paid to participants' (internal quotation marks omitted). To that end, the Court held that Section 502(a)(2) authorizes 'recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account.'

Although LaRue leaves the reach of ERISA Section 502(a)(3) for another day, it clarifies that individual participants can bring breach of fiduciary duty claims against their employers to have their individual accounts made whole. And while LaRue highlights that Section 502(a)(2) only encompasses 'appropriate claims for 'lost profits,” it leaves to the lower courts to determine the type of 'lost profits' claims that may be recovered. It is important to note that the Court assumed that DeWolff breached fiduciary duties and that these breaches had an adverse impact on LaRue's individual account. It is now up to LaRue to prove these allegations are true.

The Likely Impact of LaRue

Like most experienced practitioners, we expect that the decision in LaRue will lead to more ERISA litigation in the future. However, our expectation is not based on the substance of the LaRue decision. In fact, we had believed that ERISA provided a remedy for losses suffered by an individual plan participant, not just losses suffered by the plan as a whole, before the LaRue decision.

Our expectation that LaRue will lead to an increase in ERISA litigation is based on the following factors:

First and foremost, as pointed out by Chief Justice Roberts' concurring opinion, the LaRue decision seems to make it easier for participants to characterize an ordinary administrative mistake as a breach of fiduciary duty under ERISA.

Second, some individual participants (and their lawyers) who may have been deterred from bring individual claims by the minority view holding that ERISA only authorized claims and relief for damages to the plan as a whole, will now be undeterred.

Finally, as a practical matter, the wide publicity being accorded the Supreme Court's decision in LaRue, is likely to open the eyes of many plaintiffs' lawyers (and remind others) of the viability of lawsuits under ERISA. The latter is one of the few statutes that allows the plaintiff to recover legal fees, in addition to other alleged damages.

Strategies to Protect Fiduciaries in Light of the Holding in LaRue

Many corporate officers, employees and board members serve as ERISA fiduciaries. For a fiduciary accused of breaching its duties under ERISA, the stakes are high. ERISA Section 409 imposes personal liability on a fiduciary that breaches its duty. ERISA authorizes lawsuits against fiduciaries by participants, beneficiaries, the plan administrator, other fiduciaries and the U.S. Department of Labor. The federal courts have uniformly held that ERISA's fiduciary duty is 'the highest duty known to the law.'

It gets worse. ERISA Section 206(d) provides for the forfeiture of a participant's account balance or benefit by the amount the participant is required or ordered to pay to the plan in connection with a lawsuit relating to a breach of fiduciary duty, including pursuant to a settlement agreement. Did we mention that ERISA imposes personal liability?

While the precise implications of LaRue are not yet clear, we believe that companies should act now to protect their officers, employees, board members and others who serve as ERISA fiduciaries. We have developed a series of strategies to help protect clients and the persons they employ as fiduciaries in light of the LaRue (and previous court decisions).

Companies should determine who is a fiduciary with respect to each of their benefit plans. This includes any person who: 1) exercises discretionary authority or control over management of the plan; 2) exercises discretionary authority or control over plan assets; 3) renders investment advice to the plan for a fee; 4) has discretionary authority or responsibility for plan administration; and 5) selects, appoints or supervises other fiduciaries.

A corporation's board of directors generally is the initial fiduciary with respect to all benefit plans subject to ERISA. However, ERISA explicitly permits fiduciaries to delegate their duties and responsibilities ' and liability. We strongly recommend delegation. Most companies will want to make certain that the line of delegation of authority (and liability) flows clearly and unambiguously away from the board of directors, senior executives, and the company.

Companies need to review their benefit plans, policies and procedures from top to bottom to improve documentation and compliance in light of the deficiencies in benefit plan committee procedures pointed out by recent court decisions. Among the most common deficiencies are: 1) the failure to properly constitute a benefit committee; 2) the failure of that committee to hold meetings; or 3) the failure of committee members to attend meetings.

Companies need to review the plan, trust, SPD and investment policy statement and any other applicable documents to eliminate all language that arguably give the fiduciaries discretion over areas they really do not control. For example, if the plan or board resolution designates a committee as the named fiduciary, but that committee controls selection of the investment funds to offer but not administrative issues, the designation/delegation needs to be narrowed.

We suggest that companies consider creating a separate investment committee for plan investments (including company stock, for which we maintain a separate list of protective measures) and an administrative committee for other plan matters. The committee members must take care not to mix up the duties and actions of either committee between settlor functions and fiduciary functions. If the company uses a single committee, clarify its responsibilities (see point 2 above). Where a committee has been delegated some settlor functions, take great care to ensure that the members understand and the minutes reflect when the committee is acting as a fiduciary and when it is acting as a settlor.

To enhance the argument that the company's board of directors is acting only as a settlor, not as a fiduciary, some companies will create the fiduciary committee, designate it as the plan's named fiduciary, and appoint the committee members (by title, not name) in the plan document, rather than by board resolution. Alternatively, if a company believes it is desirable to shift fiduciary responsibility and liability from the board to the CEO, it can draft the plan documents so that the CEO appoints the fiduciary committee.

Companies should evaluate the overall composition of the investment committee. A company should appoint responsible individuals with experience in financial and/or retirement plan matters. When consistent with best practices, including the company's culture, the company should avoid placing the CEO, CFO or the General Counsel on the fiduciary committee, as these individuals may be perceived to have access to too much non-public information. It may also make sense for the General Counsel and members of the legal department to serve as counsel to the committee and not as fiduciaries, for reasons of privilege, etc.

Companies and fiduciary committee members should review the Committee Charters and other governance documents related to the Plan. Companies and fiduciary committee members should ensure that all documents are consistent. For example, make certain the Notes to Financial Statements of the Plan do not provide that 'the company selects the investment funds' when this authority has been delegated to a committee.

Companies and fiduciaries should verify that indemnification provisions in the plan documents and fiduciary liability insurance protect committee members and other potential fiduciaries.

Companies and fiduciaries should review plan investment and administrative contracts to confirm they are consistent with the plan's governance structure and do not inappropriately limit the liability of plan fiduciaries and service providers (such as through indemnification or exculpation provisions).

Companies and fiduciaries should ensure the plan's compliance with the QDIA rules to the maximum extent practicable. If you cannot meet all of the requirements at this time, as a best practice, at least try to meet those requirements that you can. Companies and fiduciaries should understand that default investment options can hold, over time, a substantial percentage of the assets of the plan. Fiduciaries should investigate, understand and give appropriate consideration to the default investment option (including, for example, any target or lifecycle investment funds offered by the Plan).

Fiduciaries should be certain to understand the plan's investment fees and expenses, and attempt to reduce those fees where appropriate to do so.

Committee members must create records and keep minutes of the Committee's meetings, review and analysis of fiduciary issues to demonstrate procedural prudence.

Companies and fiduciaries should consider training for the plan's fiduciaries, to assist them in understanding and implementing the foregoing. We routinely perform fiduciary training for our clients.

Conclusion

This is not an exhaustive list, and none of these strategies can guarantee that someone will not sue the fiduciaries or that a court will not rule against them. However, under the current case law, these strategies could improve the fiduciaries' chances of prevailing. We are continuously refining this strategy list as new court decisions are rendered so check in with us for future developments and ideas.

Michael S. Melbinger is a partner and Steve Flores is an associate in the Employee Benefits and Executive Compensation Department of Winston & Strawn LLP, Chicago.

In a closely watched case arising under the Employee Retirement Income Security Act of 1974, as amended ('ERISA'), the U.S. Supreme Court recently clarified the right of employees to sue plan fiduciaries for mismanaging their individual 401(k) accounts. Prior to the Supreme Court's clarification, the lower courts were divided as to whether certain remedies under Sections 502(a)(2) and 409 of ERISA (29 U.S.C. ' 1132(a)(2) and 29 U.S.C. ' 1109 respectively) allowed recovery for breaches by fiduciaries that affected only individual accounts, rather than the plan as a whole. In LaRue v. DeWolff, Boberg & Associates, Inc. , 128 S. Ct. 467, 42 EBC 2857 (2008), the Supreme Court has now settled the issue, holding that ERISA authorizes a plan participant to recover for fiduciary breaches even if those breaches affect only the participant's individual account.

The Facts and Holding of LaRue

While employed at the management consulting firm DeWolff, Boberg & Associates ('DeWolff'), James LaRue ('LaRue') participated in the firm's ERISA-regulated 401(k) retirement savings plan (the 'Plan'). Under the Plan, participants had the option of instructing DeWolff on how to invest their money. According to LaRue's complaint, in 2001 and 2002 DeWolff failed to invest LaRue's money as he directed, causing an estimated loss of $150,000. In June 2004, LaRue filed suit against DeWolff and the plan, alleging breach of fiduciary duty.

Rather than seek money damages, which would generally be prohibited under ERISA unless the relief sought was for 'the plan as a whole,' LaRue requested make-whole or 'equitable' relief under ERISA Section 502(a)(3). This section authorizes plan participants to bring a civil action for 'appropriate equitable relief' to redress violations of a plan, to enforce ERISA's provisions, or to enforce the plan's terms. The trial court dismissed LaRue's claim on the pleadings, finding that his claim was essentially one for money damages because 'the court would have to transfer money from defendants to plaintiff,' and, therefore, was not appropriate for relief under ERISA Section 502(a)(3).

On appeal, LaRue made a broader argument. In addition to raising Section 502(a)(3), LaRue also argued that his suit was proper under Section ERISA 502(a)(2). This section permits a participant to bring a civil action 'for appropriate relief' for breach of certain fiduciary duties. The Court of Appeals for the Fourth Circuit rejected both arguments and affirmed the district court's decision. Curiously, although the court found that LaRue had waived the Section 502(a)(2) claim, it nonetheless addressed the argument and held that under the Supreme Court's precedent in Mass Mutual Life Insurance Co. v. Russell , 473 U.S. 134 (1985), recovery under Section 502(a)(2) must inure to the 'benefit of the plan as a whole,' not a particular person who participated in the plan. As to LaRue's Section 502(a)(3) claim, the court agreed with the district court that LaRue sought money damages, not equitable relief.

In a unanimous decision, the Supreme Court reversed the Court of Appeals. The Court held that it did not need to reach the issue of whether LaRue's claim under ERISA Section 502(a)(3) was cognizable, because its interpretation of LaRue's Section 502(a)(2) claim was dispositive in favor of LaRue.

Writing for the Court, Justice Stevens ' who wrote the decision in Russell 23 years earlier ' distinguished Russell, which dealt with a defined benefit plan, on the ground that the 'landscape' of employee benefit plans has changed. Noting that 'defined contribution plans dominate the retirement plan scene today,' the Court found that a breach of fiduciary duty that harms a single participant 'creates the kind of harm that concerned the draftsmen of [ERISA Section] 409,' because the duties imposed by Section 409(a) 'relate to the proper management, administration, and investment of fund assets with an eye toward ensuring that the benefits authorized by the plan are ultimately paid to participants' (internal quotation marks omitted). To that end, the Court held that Section 502(a)(2) authorizes 'recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account.'

Although LaRue leaves the reach of ERISA Section 502(a)(3) for another day, it clarifies that individual participants can bring breach of fiduciary duty claims against their employers to have their individual accounts made whole. And while LaRue highlights that Section 502(a)(2) only encompasses 'appropriate claims for 'lost profits,” it leaves to the lower courts to determine the type of 'lost profits' claims that may be recovered. It is important to note that the Court assumed that DeWolff breached fiduciary duties and that these breaches had an adverse impact on LaRue's individual account. It is now up to LaRue to prove these allegations are true.

The Likely Impact of LaRue

Like most experienced practitioners, we expect that the decision in LaRue will lead to more ERISA litigation in the future. However, our expectation is not based on the substance of the LaRue decision. In fact, we had believed that ERISA provided a remedy for losses suffered by an individual plan participant, not just losses suffered by the plan as a whole, before the LaRue decision.

Our expectation that LaRue will lead to an increase in ERISA litigation is based on the following factors:

First and foremost, as pointed out by Chief Justice Roberts' concurring opinion, the LaRue decision seems to make it easier for participants to characterize an ordinary administrative mistake as a breach of fiduciary duty under ERISA.

Second, some individual participants (and their lawyers) who may have been deterred from bring individual claims by the minority view holding that ERISA only authorized claims and relief for damages to the plan as a whole, will now be undeterred.

Finally, as a practical matter, the wide publicity being accorded the Supreme Court's decision in LaRue, is likely to open the eyes of many plaintiffs' lawyers (and remind others) of the viability of lawsuits under ERISA. The latter is one of the few statutes that allows the plaintiff to recover legal fees, in addition to other alleged damages.

Strategies to Protect Fiduciaries in Light of the Holding in LaRue

Many corporate officers, employees and board members serve as ERISA fiduciaries. For a fiduciary accused of breaching its duties under ERISA, the stakes are high. ERISA Section 409 imposes personal liability on a fiduciary that breaches its duty. ERISA authorizes lawsuits against fiduciaries by participants, beneficiaries, the plan administrator, other fiduciaries and the U.S. Department of Labor. The federal courts have uniformly held that ERISA's fiduciary duty is 'the highest duty known to the law.'

It gets worse. ERISA Section 206(d) provides for the forfeiture of a participant's account balance or benefit by the amount the participant is required or ordered to pay to the plan in connection with a lawsuit relating to a breach of fiduciary duty, including pursuant to a settlement agreement. Did we mention that ERISA imposes personal liability?

While the precise implications of LaRue are not yet clear, we believe that companies should act now to protect their officers, employees, board members and others who serve as ERISA fiduciaries. We have developed a series of strategies to help protect clients and the persons they employ as fiduciaries in light of the LaRue (and previous court decisions).

Companies should determine who is a fiduciary with respect to each of their benefit plans. This includes any person who: 1) exercises discretionary authority or control over management of the plan; 2) exercises discretionary authority or control over plan assets; 3) renders investment advice to the plan for a fee; 4) has discretionary authority or responsibility for plan administration; and 5) selects, appoints or supervises other fiduciaries.

A corporation's board of directors generally is the initial fiduciary with respect to all benefit plans subject to ERISA. However, ERISA explicitly permits fiduciaries to delegate their duties and responsibilities ' and liability. We strongly recommend delegation. Most companies will want to make certain that the line of delegation of authority (and liability) flows clearly and unambiguously away from the board of directors, senior executives, and the company.

Companies need to review their benefit plans, policies and procedures from top to bottom to improve documentation and compliance in light of the deficiencies in benefit plan committee procedures pointed out by recent court decisions. Among the most common deficiencies are: 1) the failure to properly constitute a benefit committee; 2) the failure of that committee to hold meetings; or 3) the failure of committee members to attend meetings.

Companies need to review the plan, trust, SPD and investment policy statement and any other applicable documents to eliminate all language that arguably give the fiduciaries discretion over areas they really do not control. For example, if the plan or board resolution designates a committee as the named fiduciary, but that committee controls selection of the investment funds to offer but not administrative issues, the designation/delegation needs to be narrowed.

We suggest that companies consider creating a separate investment committee for plan investments (including company stock, for which we maintain a separate list of protective measures) and an administrative committee for other plan matters. The committee members must take care not to mix up the duties and actions of either committee between settlor functions and fiduciary functions. If the company uses a single committee, clarify its responsibilities (see point 2 above). Where a committee has been delegated some settlor functions, take great care to ensure that the members understand and the minutes reflect when the committee is acting as a fiduciary and when it is acting as a settlor.

To enhance the argument that the company's board of directors is acting only as a settlor, not as a fiduciary, some companies will create the fiduciary committee, designate it as the plan's named fiduciary, and appoint the committee members (by title, not name) in the plan document, rather than by board resolution. Alternatively, if a company believes it is desirable to shift fiduciary responsibility and liability from the board to the CEO, it can draft the plan documents so that the CEO appoints the fiduciary committee.

Companies should evaluate the overall composition of the investment committee. A company should appoint responsible individuals with experience in financial and/or retirement plan matters. When consistent with best practices, including the company's culture, the company should avoid placing the CEO, CFO or the General Counsel on the fiduciary committee, as these individuals may be perceived to have access to too much non-public information. It may also make sense for the General Counsel and members of the legal department to serve as counsel to the committee and not as fiduciaries, for reasons of privilege, etc.

Companies and fiduciary committee members should review the Committee Charters and other governance documents related to the Plan. Companies and fiduciary committee members should ensure that all documents are consistent. For example, make certain the Notes to Financial Statements of the Plan do not provide that 'the company selects the investment funds' when this authority has been delegated to a committee.

Companies and fiduciaries should verify that indemnification provisions in the plan documents and fiduciary liability insurance protect committee members and other potential fiduciaries.

Companies and fiduciaries should review plan investment and administrative contracts to confirm they are consistent with the plan's governance structure and do not inappropriately limit the liability of plan fiduciaries and service providers (such as through indemnification or exculpation provisions).

Companies and fiduciaries should ensure the plan's compliance with the QDIA rules to the maximum extent practicable. If you cannot meet all of the requirements at this time, as a best practice, at least try to meet those requirements that you can. Companies and fiduciaries should understand that default investment options can hold, over time, a substantial percentage of the assets of the plan. Fiduciaries should investigate, understand and give appropriate consideration to the default investment option (including, for example, any target or lifecycle investment funds offered by the Plan).

Fiduciaries should be certain to understand the plan's investment fees and expenses, and attempt to reduce those fees where appropriate to do so.

Committee members must create records and keep minutes of the Committee's meetings, review and analysis of fiduciary issues to demonstrate procedural prudence.

Companies and fiduciaries should consider training for the plan's fiduciaries, to assist them in understanding and implementing the foregoing. We routinely perform fiduciary training for our clients.

Conclusion

This is not an exhaustive list, and none of these strategies can guarantee that someone will not sue the fiduciaries or that a court will not rule against them. However, under the current case law, these strategies could improve the fiduciaries' chances of prevailing. We are continuously refining this strategy list as new court decisions are rendered so check in with us for future developments and ideas.

Michael S. Melbinger is a partner and Steve Flores is an associate in the Employee Benefits and Executive Compensation Department of Winston & Strawn LLP, Chicago.