Last June I blogged about the trend of participant fee class actions moving down to smaller 401(k) Plans. http://benefitsnotes.com/2016/06/inside-trustees-for-small-minnesota-401k-plan-face-class-action-over-excessive-fees/ Occasionally, class actions are brought based on other breaches of fiduciary duties, particularly those involving significant drops in value of concentrated Plan investments such as employer stock referred to as “Stock Drop Cases”. A similar class action complaint was recently filed against the owner of the Emerald Coast Eye Institute, LLC by former employees Linda McLain and Colleen Gamer (the “Complaint”). The two nominal class plaintiffs allege that they were terminated as a result of complaining to the owner and Plan Trustee, Samuel Poppell, about breaches of fiduciary duty with respect to the 401(k) Plan resulting in losses and damages over $1 million.

The Complaint alleges that Poppell served as the Plan’s investment manager, investment advisor and Plan fiduciary even though he had no formal training for any of these responsibilities. In carrying out those duties, Poppell reportedly invested over 50% of the 401(k) Plan’s assets in a single stock – VirnetX, a publically traded patent troll. The remainder of the Plan assets was reportedly in cash equivalents (money market funds). The Complaint alleges that on numerous occasions the Plan’s third party administrator and the named Plaintiffs encouraged Poppell to get professional advice and diversify the Plan’s portfolio. These pleas were ignored. Further, participants were not allowed to direct their investments and all contributions (both employer and employee) were invested in Poppell’s selections.

The Plan was terminated in October of 2015. The class action complaint alleges the following violations:

1. Breach of fiduciary duty by the Trustee to prudently invest the Plan assets of the 401(k) Plan, failing to diversify Plan investments, and by failing to properly monitor and remove inappropriate holdings. The VirnetX stock continued to decline but remained as the Plan’s primary holding. Over the time held, the VirnetX stock declined in value by $543,235.91

2. Violations of The Employee Retirement Income Security Act of 1974 (ERISA) § 510 (retaliation) for the employment terminations of Plaintiffs McLain and Gamer as a result of expressing concerns about Plan losses and management. Plaintiffs also included a state law wrongful termination action under Florida’s Whistleblower Act.

ERISA requires that all Plan fiduciaries act in the best interest of the Plan participants. ERISA § 404 provides that the duty of prudence includes a duty to diversify the Plan’s assets so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so. ERISA Plan Fiduciaries are subject to the “prudent expert rule” which means that a fiduciary who does not have the skills and knowledge necessary to perform the required statutory duties is compelled to engage outside experts to do so. This typically entails the hiring of an investment advisor, investment manager or institutional trustee to manage Plan investments.

The Department of Labor issued regulations many years ago for participant directed plans under ERISA § 404(c). These rules relieve plan fiduciaries of liability for plan losses resulting solely from a participant’s direction into a particular investment option. Under the Emerald Coast Eye Institute Plan, participants were not allowed to direct the investments of their contributions nor the company’s contributions. As a result, the Plan fiduciary (the owner) retained full responsibility for selection, monitoring and diversification of the Trust assets.

This case was filed on September 30, 2016 in the U.S. District Court for the Northern District of Florida. Discovery and further proceedings will determine the final outcome. However, regardless of the outcome, Plan Sponsors should take notice of the allegations in the Complaint to avoid potential liability. Best practices would include:

1. Engaging a qualified investment advisor familiar with 401(k) or other defined contribution plans;

2. Regularly reviewing and monitoring all of the selected investments under the Plan;

3. Benchmarking fund managers against their peer group and common indexes;

4. Allowing participant direction of investments to minimize potential liability for in-house fiduciaries; and

5. Making sure that the investment array is properly diversified. On that point, note that even if plan fiduciaries have selected different equity fund managers for separate asset classes in the Plan’s fund array, the individual stock holdings of the various funds should be reviewed to determine the amount of overlap and exposure to single plan investments or sectors (i.e., multiple funds all holding large amounts of Apple, Google, Facebook, etc. as an example). What appears to be a widely diversified portfolio sometimes is not so diversified when individual stock holdings are examined.