In LaRue v. DeWolff, the Supreme Court reversed a long-standing rule of law that prohibited participants of 401(k) and other retirement plans from seeking individual relief for fiduciary duty breaches. The decision ushers in a new era in which participants will have the upper hand in seeking recovery for alleged breaches of fiduciary duty. As a result, plan sponsors, fiduciaries and administrators should proactively review their procedures and plans in preparation for the litigation environment created by the LaRue decision.
Based on the U.S. Supreme Court’s 1985 decision in Massachusetts Mutual Life Ins. Co. v. Russell, participants of retirement and savings plans subject to the Employee Retirement Income Security Act of 1974 ("ERISA") have been precluded from seeking relief for individual losses caused by breaches of fiduciary duty. However, since Massachusetts Mutual was decided, the retirement vehicle of choice in the United States has shifted from defined benefit pension plans to 401(k) plans. Recognizing this change in the landscape, on February 20, 2008 in LaRue v. DeWolff, the Supreme Court held that Massachusetts Mutual no longer had relevance for 401(k) plans and that individual participants in a 401(k) plan can sue under ERISA to recover the losses alleged to have been caused by a breach of fiduciary duty.
In LaRue, plan participant James LaRue, of Southlake, Texas, had made contributions into his employer’s 401(k) plan. Like most 401(k) plans, the plan in LaRue allowed participants to direct how their accounts are invested. LaRue alleged that the plan administrator (which was the employer that maintained the plan) failed to promptly follow his investment instructions, causing LaRue to lose approximately $150,000. LaRue sought recovery of his investment losses on the basis that that the plan administrator had breached a fiduciary duty. The lower courts, following Massachusetts Mutual, had dismissed LaRue’s claim on the basis that ERISA only allows recovery for losses sustained by a plan as a whole, while LaRue sought relief that would benefit only his account. Without deciding whether there had in fact been a breach of fiduciary duty that was the cause of LaRue’s losses, the Supreme Court reversed the decisions of the lower courts, holding that LaRue could seek individual relief on his claim.
Consequences of the Court’s Decision
LaRue has far-reaching implications for sponsors, fiduciaries and administrators of 401(k) plans, as well as many other individual account balance plans. By permitting individual plan participants the right to bring suit under ERISA for individual losses due to alleged mismanagement of individual plan accounts, the Supreme Court has opened the door, and opened it wide, to a variety of participant claims. In addition to claims like that presented in LaRue where the participant alleged that investment directions were not promptly implemented, it is easy to envision participant claims for many other reasons. For example, a participant might claim a breach of fiduciary duty due to a failure to promptly make a distribution, or due to a failure to properly monitor investment funds offered under the plan, or due to the failure to disclose fees charged against participant’s accounts or even a failure to make sure that fees are as low as possible. There is a strong likelihood that every dispute over a benefit will now be framed as a breach of fiduciary duty. In many instances, claims for breach of fiduciary duty may affect many, if not all, participants of a plan. The growing ERISA plaintiffs’ bar will no doubt seek to take advantage of the opening created by LaRue through a proliferation of ERISA class actions.
Review Policies and Procedures
In light of LaRue, and the potential exposure to liability that stems from it, plan sponsors should take a very careful look at many facets of their defined contribution plan investment and administrative procedures. While ERISA obligates fiduciaries to act in accordance with the highest standards of care, courts often are reluctant to substitute their judgment for that of a fiduciary. Instead, courts often are more concerned with how a fiduciary made a decision, rather than whether the fiduciary made the correct decision. Accordingly, it will be more important than ever for fiduciaries to establish and follow prudent procedures in making decisions that affect the value of participants’ accounts.
Following LaRue, the procedures used by plan fiduciaries and administrators to process participant directions as to the investment of their accounts can be expected to become the subject of intense scrutiny. What may have been innocent mistakes prior to LaRue could now have huge implications for plan fiduciaries. Accordingly, fiduciaries, administrators and plan sponsors should review investment procedures and make efforts to eliminate, to the extent possible, the possibility of delays in the processing of employeedirected transactions. It would be wise for plan sponsors to review the lines of authority with respect to plan operations and make sure that they and the plan’s fiduciaries and administrators understand who has responsibility for various plan functions, and how plan functions and transactions are to be performed or processed. These relatively simple steps should go a long way towards avoiding mistakes that could lead to breach of fiduciary duty claims. To the extent that plan terms require that investment transactions be made within a very short timeframe, it may be prudent to extend the period of time to effect a particular transaction to afford more room for error.
Although plan sponsors may not be fiduciaries for many plan functions, plan sponsors will typically have indemnity obligations to fiduciaries and administrators. Liability under ERISA can result merely if the fiduciary is found to have acted imprudently or in a manner that is contrary to the best interests of participants. In contrast, third-party administrators and investment managers typically will have agreements that require a plan sponsor to indemnify them unless they have acted with gross negligence or willful misconduct. Since this makes plan sponsors ultimately responsible for bearing the expense of a fiduciary breach, it is incumbent upon plan sponsors to make sure that plan transactions and procedures are being properly followed. While it also would be beneficial to negotiate terms that hold third parties responsible for errors and omissions, most plan sponsors will not have the bargaining muscle needed to obtain those terms from vendors.
For the same reason, it also is critical to maintain adequate fiduciary liability insurance. In light of LaRue, plan sponsors and fiduciaries should review their fiduciary liability policies to make sure that coverage is satisfactory. They also should familiarize themselves with the notice requirements of these policies. Often, fiduciary liability policies require that a plan fiduciary notify the carrier when it is aware that claims "may" be brought. If a plan sponsor or fiduciary becomes aware of any specific instances when an individual participant's account may have been mishandled - and this could include failing to follow a participant's investment direction or a delay in processing a distribution request - the plan sponsor should evaluate the need to provide notice to its fiduciary liability carrier of the possibility of a claim being brought by the affected participant.
As indicated above, LaRue may open the door to lawsuits that claim a breach of fiduciary duty based on allegations that fees imposed on participants for the administration of the plan are hidden or excessive. As a result, plan sponsors should undertake a review to ensure that any fees imposed on various 401(k) investment alternatives are reasonable and that all fees borne by participants are adequately disclosed.
While 401(k) sponsors might consider eliminating participant-directed investments in order to minimize claims like those raised in LaRue, the ability of participants to direct their investments has become a staple of 401(k) plans. Also, plans in which assets are invested in the discretion of one or more trustees are by no means immune from breach of fiduciary duty claims. Assuming that participantdirected investments are likely to remain a central feature of 401(k) plans, plan sponsors, fiduciaries and administrators should:
- Review plan and investment procedures to minimize opportunities for losses caused by delays and similar errors.
- Build new administrative steps that place more responsibility on participants to confirm that investment directions have been followed and to promptly notify a responsible plan representative if and when directions are not timely followed.
- Review the indemnification provisions of vendor agreements with third-party administrators and investment managers/brokers. Consider replacing vendors that are inflexible about taking responsibility for their own errors.
- Review fiduciary liability policies to make sure coverage is adequate and that responsible representatives are aware of the notice requirements for claims.
- Undertake regular reviews of procedures to make sure that the plan is operating as desired and, to the extent that they discover errors, correct and follow up on them to ensure that they are not repeated.