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Managing Your DC Plan Can Get You Sued

There are a multitude of ways employers can be sued for their fiduciary responsibilities related to employee retirement plans. Here are some ways they can protect themselves.

Monday, February 20, 2012
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Defined-contribution plans were intended to free employers from the risk of making large pension promises at uncertain cost. With 401(k)s and similar plans, employers no longer have to worry about investing funds to make specific benefit payouts years down the road.

But today's employers are hardly out of the woods. Many potential pension-related liabilities remain, especially for those who manage their employees' retirement investments or choose participant investment options.

In fact, the investment of retirement funds exposes even the most conscientious employers to legal challenges which can be just as onerous -- and financially damaging -- as the old fixed-benefit burdens.

Much of the exposure for employers comes from "failure to disclose" claims. Given that the relationship between employees and employers in disputes is adversarial, the law intentionally provides a wide range of legal remedies to employees claiming to have been wronged or incompletely advised as to fees, rights and risks.

Moreover, there is no shortage of lawyers ready to pounce on employers when the law, or even the vagaries of the market, can help establish a colorable argument that an employer fiduciary has been negligent or self-serving.

The Employee Retirement Income Security Act of 1974, the federal law that governs most private employee-benefit plans, includes detailed and specific disclosure requirements. In theory, if certain disclosure requirements are met, employers have a "safe harbor" from frivolous lawsuits. But what constitutes adequate disclosure is open to interpretation, and safe-harbor immunity remains under continuous assault from aggressive legal teams.

So how can employers protect themselves?

A recent regulation issued by the U.S. Department of Labor, the federal agency that regulates ERISA, spells out the steps plan administrators must take to make sure that participants are fully informed and establishes "safe-harbor" protection from liability if they take them. 

The scope of this protection is unclear, however, and recent court decisions have emphasized that plan administrators and other fiduciaries have an affirmative duty to provide information, particularly in the context of defined-contribution plans like 401(k)s.

What if a plan participant makes an investment that, for whatever reason, performs poorly? Can the employer ever inform the plan participant of the totality of market risk? Yet poor investment performance and the explanation of plan fees -- costs against quality -- have become two extensively litigated matters.

Failure to understand the tax implications of benefit decisions is another. Participants can face potentially severe tax consequences -- of which they can later claim ignorance -- in handling their own 401(k) nest eggs.

For example, a premature withdrawal from a 401(k) plan -- generally one occurring before age 59-1/2 -- can expose participants to a 10-percent penalty, as well as liability for taxes, on the amount withdrawn. Furthermore, when a participant fails to repay and defaults on a plan loan secured by his or her individual plan account, a significant portion -- if not all -- of the remaining account balance is treated as a distribution to cover tax liability.

Thus, the participant stands not only to lose his or her retirement savings, but must also pay taxes on "phantom income" as well. 

Participants hit with such an "unanticipated" tax bill -- even when such consequences are fully laid out in a plan prospectus -- may claim the sponsor was negligent in his affirmative duty to disclose such risks. Plan fiduciaries become especially vulnerable to this liability as effective protective measures, for example participant loan life and disability coverage, become more widely available.

Investments in employer stock -- however attractive -- can also open the door to legal complications. Whatever attractions employer stock has for employees, an opportunity to invest can be used against the employer if a plan participant can claim that he or she was not fully informed about the employer's present and even future financial condition.

Indeed, plaintiffs' lawyers have brought actions alleging that fiduciaries have breached their duties by failing to disclose information about important corporate events -- privileged information that under regular securities law might lead to charges of insider trading.

It remains unclear whether the Department of Labor contemplated this contradiction. But in any case, lawsuits testing safe-harbor provisions will certainly continue.

Benefit-rights disclosure is another area of potential exposure for fiduciaries.

Some fiduciaries and their advisers take comfort in the fact that ERISA ordinarily provides only for "equitable" relief for breaches of fiduciary duty that affect a single or limited group of plan participants and does not extend across the entire plan. 

Such relief is often thought of as limited -- resulting in tolerable penalties like the issuance of an injunction or the imposition of a "constructive trust" on profits realized by a fiduciary as a result of an individual breach. The fiduciary (or its insurer) would then not be exposed to large monetary damages.

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This view of ERISA remedies may be too rosy. A fiduciary found liable for a breach of duty may not be required to write a check to the individual plan participant who suffered. But such relief may require that the plan write a check, in which case all plan participants can claim to have been wronged.

Court decisions dealing with "open window" options under a defined-benefit plan provide a good example of how this can happen. An open-window option involves an offer of enhanced benefits to participants who choose to retire during a specified period.

By using open-window packages, employers can reduce their workforce without the costs and disruptions of actual layoffs. When initial benefit enhancements do not attract sufficient early retirees to satisfy the employer's business objectives, it is often necessary to provide additional incentives, much as airlines provide ever-greater incentives for volunteers on overbooked flights.

However, "early takers" of open-window packages may then turn around and claim that employers breached their ERISA fiduciary duties by failing to disclose the possibility of further enhancements to the program.

In general, the courts have found that employers do have a fiduciary duty to disclose such possible enhancements to participants as soon as they are under "serious consideration."

Courts have held that the plans were "estopped," or prohibited, from providing the unenhanced benefits by reason of the employers' failure to disclose. This results in an additional burden to the plan, which someone -- presumably the employer -- must make up.

In short, under today's law, there is no certain safe harbor when it comes to fiduciary disclosure obligations in retirement-plan management. What constitutes proper disclosure remains a matter of interpretation -- and litigation. 

Despite the recent detailed standards laid out by the DOL, employers should follow court decisions closely and consider possible financial liabilities that may emerge from new disclosure rulings and solutions to mitigate the associated risk.

William A. Schmidt is a partner in K&L Gates LLP. He was formerly counsel for regulation in the Plan Benefits Security Division of the Office of the Solicitor of the U.S. Department of Labor, where he was responsible for providing legal advice with respect to the Department's regulatory, interpretive and legislative activities under ERISA. He also serves as an adjunct professor of law at Georgetown University Law Center. Some information in this article was provided by Custodia Financial.

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