Lawsuits involving investment selection and monitoring under 401(k) Plans are proliferating around the country against companies and their respective directors, officers and plan committees. The allegations asserted in the cases center around the investment options made available to plan participants, attendant costs associated with such investment options, and correlating duties of plan fiduciaries. Most recently, a national financial services company was hit with a class action alleging such claims in Minneapolis. However, potential exposure is not limited to financial institutions and any company that maintains a 401(k) may be a target.

The Claims Generally

ERISA is intended to “promote the interests of employees and their beneficiaries in employee benefit plans.” ERISA imposes the highest fiduciary responsibility known to law upon individuals responsible for administering 401(k) plans. Basically, the duties owed by ERISA fiduciaries to plan participants are loyalty and prudence. Although the duties of loyalty and prudence are simply stated, the claims being filed around the nation place at issue the process necessary for a fiduciary to satisfy those duties:

  • May a plan fiduciary simply adopt the recommendations of the 401(k) trustee or advisor?
  • Does a plan fiduciary have an obligation to affirmatively negotiate better investment terms?
  • Does the plan fiduciary have an obligation to independently investigate the investment options presented? If so, to what degree and how can this be accomplished?

The general legal landscape, as presented by Federal Courts and the U.S. Department of Labor, is often not favorable to plan sponsors and other fiduciaries on these issues.

A Split of Authority in the Federal Courts—The Eighth Circuit and DOL Increase Exposure

The Seventh Circuit is the friendliest to employers under these cases. The Seventh Circuit has held that plan fiduciaries may generally rely upon competition in the investment market to satisfy their duties of loyalty and prudence relative to its process of selecting investments offered under a 401(k) Plan. In the Hecker case, the court found that the investment options offered to plan participants satisfied the obligations of the plan fiduciaries even if other investment options may have been less costly to the plan beneficiaries. Hecker found that ERISA’s safe harbor under 29 U.S.C. § 1104(c) offered protection to the plan fiduciaries because the plan included a sufficient range of options so that the participants had control over the risk of loss. Based on the foregoing, Hecker affirmed dismissal of the action pursuant to a motion to dismiss under 12(b)(6).

The Eighth Circuit, however, has declined to follow the Seventh Circuit’s approach on the same motion presented in Hecker. In the Braden case, a class action was filed asserting violations of ERISA based upon a large retailer’s alleged failure to properly evaluate investment options included in its 401(k) plan and consider the trustee’s interest in including funds in the plan. The plaintiffs alleged that this misconduct constituted violations of the fiduciary duties of prudence and loyalty imposed by ERISA. Although the trial court dismissed the case based upon the Seventh Circuit’s rationale, the Eighth Circuit rejected this analysis and reversed the dismissal of the action. The Eighth Circuit held that plaintiff’s allegations were sufficient to state a claim for violation of ERISA.

In further contrast to Hecker, a California District Court imposed liability against a utility under a similar fact pattern. In the Tibble case, the plaintiffs alleged that the company had violated ERISA by failing to conduct sufficient due diligence with regard to the investments approved for inclusion in the 401(k) portfolio. Despite a formal investment policy that identified a number of different criteria for evaluating investments combined with the recommendations of the plan administrator, the Tibble court imposed liability against the company based upon the purported lack of any evidence that the company considered or evaluated different share classes within the various funds. Tibble also concluded that the plan fiduciaries had an affirmative obligation to attempt to negotiate better terms than arguably offered by the investment funds. Based upon the failure to engage in these acts, the court held the utility liable for significant damages to the class.

The U.S. Department of Labor remains firm in its position that the 404(c) protection (often thought of as an absolute defense by plan sponsors) does not extend to fiduciaries’ process in selecting and monitoring its fund platform under the Plan. As a result, the DOL is filing amicus briefs in many of these actions brought against plan sponsors, and has promulgated new regulations on the issue.