Supreme Court Ruling on 401(k) |

Supreme Court Ruling on 401(k)

STEVEN SMITHspecial to the daily

On February 20th of this year, the U.S. Supreme Court declared open season on 401(k) plan sponsors and administrators. Its ruling in LaRue vs. DeWolff, Boberg & Associates should have the notice of employers, administrators, and participants meaning most of us should pay attention.When Participants Go IgnoredJames LaRue claims his instructions in 2001 and 2002to move investments out of equities and into conservative vehicleswere ignored by plan administrators. LaRue calculates that his account lost $150,000 compared to what its value would have been under his instructions.The 4th U.S. Circuit Court of Appeals in Richmond, Virginia ruled in 2006 thatparticipants may seek relief for such fiduciary breaches, but only on behalf of the plannot for injury to their own account. The Supreme Court, therefore, was to decide who is entitled, underERISA, to obtain relief from employers when they fail in their fiduciary capacities: individualsor plans alone?The high Courts opinion was unanimous: an individually injured participant is entitled to relief under ERISA. This decision marches in time with the current national drumbeat of the importance of fiduciary duties for those managing money on behalf of others.A Wrong Without a Remedy?Legislatures create laws to establish standards of conduct in industries and professions. But many laws bear toothless legal remedies for breach of those standards, making them essentially unenforceable.For better or worse, the strong remedy in the U.S. is to file suit. Occasionally, even in the absence of a statutory remedy, the Supreme Court has found an implied right of individual action, as in its 1971 ruling on securities fraud under Section 10 (b) (5) of the Securities Act.With changes in doctrinal philosophy, however, the Court has been more deferential to Congress and curtailed the implication of remedies. Thus, fiduciary liability has existed practically only in theory.Pension Plans and Their EvolutionWhen ERISA was passed in 1974, defined benefit pension plans were the norm, in which participants share a contractual interest in a fund. ERISA contains strict fiduciary standards governing the establishment and administration of pension plans and its remedial provisions were drafted with injuries only to the plan in mind. At the time, defined contribution plans inwhich participants own their individual accountswere virtually nonexistent.In a 1985 defined benefit case, the Court narrowly interpreted the provision as rejecting individual claims for consequential damages in connection with a group disability policy. But Justice Stevens states emphatically in his LaRue opinion that the earlier cases emphasis: on protecting the entire plan from fiduciary misconduct reflects the former landscape of employee benefit plans. That landscape has changed.The Court has acted on the evolution of ERISA through defined contribution plans, such as 401(k)s. The opinion bulldozes ERISA statutory impediments to individual claims by applying a lost profits approachbased on trust lawto participants separate interests in the plan assets. Interestingly, all nine Justices agreed unanimously on this point.A Ticking Time Bomb For Sponsors?Larue involved injury to a single account. Our current fiduciary spotlight, however, focuses on plan design, affecting all accounts in a plan. As the ruling has not changed fiduciary responsibilities, lets remind ourselves what ERISA really says. Section 404 (a) requires employers to select, monitor, remove, and replace a prudent menu of diverse investment choices that permits participants to create portfolios consistent with their individual risk and return goals. As Justice Stevens points out, Section 404 (c) immunizes employers from fiduciary liability for the participants investment decisions when the plan meets 404 (a). The plan must exclusively be designed to benefit participantsnot vendors.Nonetheless, insurance companies and proprietary mutual fund firms have been selling 401(k) plans to sponsorsoften with a closed architecture, limited mutual fund choices, and expensive, poorly performing offerings.Class action lawyers are frothing at the mouth. Imagine a claim seeking lost profits of 50 basis points on behalf of 2,500 plan participants over five, 10, or 20 years for fund choices containing excessive fees. Or a claim against an improperly selected Qualified Default Investment Alternative (QDIA) option under the Pension Protection Act (PPA) of 2006. Do the math.The Best DefenseFor sponsors, the conclusion is simple: know your plan. Although there remain impediments to participants winning cases (some of the Justices said yes, but not so fast in LaRue), taking your fiduciary responsibility seriously is the best defense against claims.Sit down with your advisors and third-party administrators. Take a hard look at your offerings and implement regular reviews and adjustments to choices and processes. Be prepared to change vendors if your current administrators offerings are too limited or too expensive.Getting InvolvedFor participants, this ruling is a reminder that investors are best served by their own well, participation. Participants should understand their plans and how they meet their financial goals and risk tolerance. If you dont understand, ask questions. This ruling should make everyone at your plan very willing to respond.Steven R. Smith, JD, CFP is the principal of RightPath Investments & Financial Planning, Inc. a fee-only Registered Investment Advisory firm in Frisco, Colorado. If you have any questions or comments about the information provided in this article please contact Steve at (970) 668-5525 or

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