Employees May Sue Plan Fiduciaries After Company Stock Tanks 

(Published June 12, 2008)

In February, the U.S. Supreme Court ruled in LaRue v. DeWolff, Boberg, & Associates, Inc. (U.S. Sup. Ct., No. 06–856) that 401(k) plan fiduciaries may be liable to employees for losses to their individual accounts that occur when the fiduciaries fail to execute employees' investment selections. A federal appeals court is relying on  LaRue  to allow employees to bring a class action lawsuit against 401(k) plan fiduciaries who chose company stock as one of the investment options. (Rogers v. Baxter International, Inc., 7th Cir., No. 06-3141, 2008)

Overvalued And They Knew It

Employees could exercise some control over their 401(k) investments, though the plan and its trustees could limit the assets individual accounts could contain and when trading could occur. Crux of employees' case: Plan trustees, as fiduciaries, knew the company's stock was overvalued and yet permitted employees to continue to invest in it, thus making the investment a bad deal. Two incidents backed up the employees' claim. First, they alleged that the stock dropped from $43 to $32 a share after quarterly results fell short of the company's projections; then they alleged that the stock dropped $1.48 after earnings had to be restated due to a foreign subsidiary's fraud.

The appeals court, which had been waiting for the U.S. Supreme Court to rule in LaRue, issued its decision in response to the company's motion to dismiss the case. Court: Under LaRue, the case can't be dismissed. To prove their allegations, employees must establish that the plan fiduciaries knew about the two incidents that caused the stock to drop in value and that, as a result, they had a duty under ERISA to prevent employees from investing in the company's stock.

As the case proceeds, one key question, according to this appeals court, will be whether fiduciaries must allow or prevent investments for blocks of weeks or months at a time (when company stock or some other stock is "overpriced"), rather than making decisions based on long-run considerations.

ERISA Section 404(c) — Do Not Pass Go, Do Not Collect $200

Most employers and plan fiduciaries probably think that as long as the 401(k) plan offers participants at least three diverse investment options, provides participants with investment materials, and allows them to change investments at least quarterly, ERISA Section 404(c) lets them off the hook. Nothing is further from the truth. ERISA Section 404(c) isn't a get-out-of-jail-free card; it allows fiduciaries to limit their liability for the investment choices participants make, but not for liability for the investment options available under the plan, or for selecting and monitoring outside service providers of those investment options. To show that fiduciaries acted prudently and in the sole interest of plan participants and beneficiaries, fiduciaries should take these actions.

• Document the processes used to choose investments and service providers, and how those decisions were made.
  
  
• Review contracts with service providers to determine which party is responsible if errors occur that impact participants' accounts. These contract clauses should be flagged for renegotiation when the current contract expires.
  
  
• If an error is attributable to a service provider, contact the provider and insist that the error be fixed expeditiously and at no cost to the plan.
  
  
• Treat employees who have terminated, but who haven't taken a distribution of their plan assets, the same as active participants. Provide them with all required notices, including summary annual reports, summaries of material modifications, and summary plan descriptions.
  

Related Topic(s): Benefits