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Supreme Court Permits Employees to Sue Fiduciaries for 401(K) Losses

Labor and Employment Update

March 6, 2008

In a decision that may greatly expand liability for employers and other defined contribution plan fiduciaries, LaRue v. DeWolff, Boberg & Associates, Inc., No. 06-856 (February 20, 2008), the Supreme Court has ruled that the Employee Retirement Income Security Act (ERISA) permits an employee to bring a breach of fiduciary duty action to recover his or her individual 401(k) plan losses.

The plaintiff in that case, James LaRue, participated in a 401(k) plan sponsored and administered by his employer DeWolff, Boberg & Associates. LaRue alleged that two requests to DeWolff to make changes to his 401(k) plan went unheeded, resulting in a loss of $150,000 to the value of his plan.

DeWolff successfully argued to the U.S. Court of Appeals for the Fourth Circuit that the case should be dismissed under the Supreme Court’s 1985 ruling in Massachusetts Mut. Life Ins. Co. v. Russell. In Russell, the Court held that ERISA does not permit challenges to defined benefit plans to recover individual losses. Relying on Russell, the Fourth Circuit reasoned that actions to recover for individual losses under a defined contribution plan, such as a 401(k), were similarly barred by ERISA.

In a unanimous decision (as to the result but not as to the reasoning), the Supreme Court reversed. The majority, in an opinion written by Justice Stevens, who also authored the Russell decision, held that the difference in the types of benefit plans at issue is in fact a critical distinction warranting different treatment of defined contribution plans under ERISA.

The majority explained that a defined benefit plan, such as the disability plan at issue in Russell, provides a fixed benefit. Under such plans, misconduct by a plan’s administrators will not affect an individual’s entitlement to a defined benefit without posing harm to the entire plan. Thus, it is appropriate in such cases to bar challenges based on individual claims of fiduciary misconduct.

In contrast, the majority reasoned, fiduciary misconduct with respect to a defined contribution plan, such as the 401(k) plan at issue in LaRue, “need not threaten the entire plan’s solvency to reduce benefits below the amount that participants would otherwise receive.” Under these circumstances, and mindful of the current popularity of 401(k) plans, the majority concluded that ERISA intended to provide participants in defined contribution plans with a right to sue for individual losses allegedly due to fiduciary misconduct.

Notably, Chief Justice Roberts, in a concurring opinion joined in by Justice Kennedy, argued that LaRue’s claim is properly viewed as a claim for benefits against the retirement plan, rather than as a breach of fiduciary duty action. If the matter were treated as a claim for benefits, the employee would be required first to exhaust the plan’s administrative remedies before bringing a lawsuit. Further, a claim for benefits would be brought against the plan and not against individual fiduciaries.

Under the approach taken by the majority, which now allows a suit against fiduciaries and thus exposes them to personal liability, the employee arguably is not required first to exhaust administrative remedies. In a somewhat cryptic footnote, however, the majority expressly stated that it was not addressing whether in fact LaRue “was required to exhaust” any administrative remedies prior to seeking relief in court.

Accordingly, it appears that the lower court to which the case is remanded could determine that LaRue is free to seek judicial redress on a claim of fiduciary misconduct, or the court could decide that it has the leeway under the majority opinion to find that LaRue’s claim is a claim for benefits, and as such, is subject to the plan’s administrative remedies. If the La Rue court and subsequent courts take the latter approach, the potential impact of the majority’s opinion may be significantly limited.

Bottom Line

Regardless of the eventual outcome in LaRue, the case promises to spawn a great deal of litigation. Not only does it portend an increase in employee suits alleging fiduciary misconduct with respect to their individual 401(k) plans, but there also is likely to be a significant increase in litigation at the appellate level as a result of the questions left unanswered by the various opinions rendered in the case.

In any event, employers with defined contribution plans should review their plan procedures to ensure that they comply with the Department of Labor’s regulations, as well as with any applicable provisions of the Pension Protection Act of 2006. While it may be difficult to totally prevent individual mistakes such as the one alleged in LaRue, employers can minimize their risk by developing and implementing effective auditing procedures.

Further, employers should ensure that they have maximized their protection against potential fiduciary liability. Toward this end, they should review indemnification provisions in service agreements with third party administrators, as well as any fiduciary liability insurance they may carry, to make certain that these agreements cover a LaRue-type lawsuit.