High Court Case May Have Big Effect on 401(k)s

While the case may not have the cachet of an O.J. trial, the stakes are much higher. In 2004, James LaRue sued his former employer, Dallas consulting firm DeWolff Boberg, in federal court in South Carolina for failing to follow investment instructions in his 401(k) plan. On two occasions he wanted to sell stocks and move to cash during the tech-stock boom. LaRue claims the negligence ultimately cost his 401(k) $150,000. The federal court dismissed the case, ruling that what he was asking for wasn't covered under the Employee Retirement Security Act of 1974, says Paul Secunda, a law professor at the University of Mississippi and one of the 11 law professors who signed an amicus brief supporting LaRue.

LaRue appealed to the Fourth Circuit Court of Appeals in Virginia, which affirmed the earlier decision. The court's view was that Erisa allows lawsuits only when they seek to enforce the rights of everyone in the plan, not just of an individual account holder. (DeWolff Boberg denies mishandling LaRue's account.)

So at issue for the Supreme Court now is whether a loss in a single 401(k) account can be considered as a general "loss to the plan." In that instance, an Erisa provision allows employees to sue for recovery.

After reading through the arguments presented to the Supreme Court on Monday, Secunda says there's a good chance enough justices will vote in favor of LaRue. Either way the high court rules, the case will better define the scope of relief available to employees under Erisa law. But, he says, don't expect a ruling until next spring.

If the Supreme Court does side with LaRue, the case returns to federal court for many more months of legal tussle. But DeWolff and other companies fear that a LaRue victory would spark a wave of meritless lawsuits. Secunda's response to such concerns: "Just because you might have some frivolous lawsuits in this area doesn't mean you should take away the meritorious lawsuits."

We asked Secunda how far federal law should go in protecting employees' retirement benefits and how a win for LaRue would affect employers' 401(k) offerings.

SmartMoney.com: Why do you think LaRue is entitled to redress?

Paul Secunda: I think Erisa provides a remedy. He claims the administrators of the 401(k) plan didn't follow his instructions. He wanted to get out of risky stocks and move into less risky ones. If you lose money because of someone else's negligence, you should have recovery for that. The federal law protects employee benefits. The problem is that Erisa sets up a limited remedial scheme. What I mean by that is you have to identify a specific provision under Erisa which you're bringing your claim under. The problem is that this type of claim by a person who has lost money in a 401(k) by what we call a fiduciary duty — and in Erisa law fiduciary duty is put on the plan administrators to act on the best interests of the plan's participants — they have to identify a section under Erisa by which to make their claim.

The section they want to come under is 502(a)(2); the classic 502(a)(2) claim is when the plan as a whole loses money because of a "breach of fiduciary duty." Let's say you invest too much in one stock, so you didn't diversify enough. This particularly happens when you're in a non-401(k) plan, or a defined-benefit plan. In an individual account, just because LaRue lost money in his 401(k) doesn't mean other employees lost money. Is it considered a loss to the plan if only a single person loses money in their 401(k) as a result of a breach of fiduciary duty?

DeWolff argues no, it does not come under the remedial scheme of Erisa. It needs to be a collective loss. It's not enough for the individual to lose money. The other side says no, there's no logical distinction between loss to the whole plan and loss to the individual. The whole plan is a collection of individual accounts.

SM: What do you think about that distinction?

PS: I think it's logical to say the plan is nothing more than made up of individual accounts, so if there's a loss to individual accounts, there's loss to the plan. It's about whether there's loss to the plan under this section of Erisa.

SM: What's the significance of the amicus brief you signed on behalf of LaRue's opposition to his former employer's motion to dismiss the case?

PS: While this case already was granted review by the Supreme Court, DeWolff filed a motion to dismiss with the Supreme Court, saying LaRue already cashed out of his 401(k), so the case was moot. I filed an amicus with other law professors, saying that even if he cashed out, he still would have had more to cash out had the company followed his investment directions.

SM: Do you think the Supreme Court is likely to side with LaRue in this case?

PS: I think there are enough votes on the Court to go with LaRue. He can bring this type of case and sue to recover what he lost in his 401(k) plan.

SM: How does the outcome of this case affect other 401(k) plan participants?

PS: The take-home point is that if you're a 401(k) account holder, you will be able to seek recovery for money lost in your account if that money is lost because of some kind of wrongdoing or negligence by the person in charge of your account. Like in LaRue, if you give investment instructions to do something, and they're ignored and you lose money, you can recover on that.

SM: Would workers be more inclined to take legal action when they think their plan's administrator erred in their retirement portfolio?

PS: Employers and third-party administrators are worried about this. They say it will open the floodgates of litigation and that every case of malfeasance will lead to a lawsuit. I don't see that. Hopefully, it would lead to more communications between account holders and their administrators. And it would make it less likely that people like LaRue will be ignored. Even if someone does make a mistake, generally the parties can knock their heads together short of instigating litigation. Litigation is time consuming and expensive. This case started five years ago, and it's still not over. It could be another two years before there's a result. I think this rule will give more incentive for plan administrators to work out the problems between 401(k) holders and employers.

I think also that historically, over the last 20 years, Erisa has been interpreted as employer friendly. That seems to be a grand irony, because this was a law passed in 1974 to protect employee benefits.... Most Supreme Court cases interpreted Erisa in an employer-friendly way, strictly construing what the law provides [in terms of] monetary relief for employees. It says you can get the value of the benefits you were denied, say, hospital services under your health plan. But let's say you were denied hospital services and you had a miscarriage because of it. You can't sue for damages for that.... Also, Erisa has been found by the Supreme Court to trump inconsistent state laws that try to give more relief back to employees. I'm suggesting that giving people like LaRue a remedy is pushing back now in the other direction to align more closely with what Erisa was supposed to be about.

SM: How do you determine if there was a "breach in fiduciary duty" by the plan administrator?

PS: They never actually got to the question of whether there was a breach [in the lower courts]. They had ruled there's no remedy under Erisa. Now, assuming there has been a breach of fiduciary duty, the question is: Is there a claim? Has there been a wrong that can be remedied under Erisa?

SM: The Chamber of Commerce, representing the business world, says allowing cases like LaRue's could lead to a wave of lawsuits and would be very costly.

PS: If you're worried about frivolous lawsuits, the courts have gate-keeping functions to keep these kinds of lawsuits out.... My thought would be just because you might have some frivolous lawsuits in this area doesn't mean you should take away the meritorious lawsuits. You just can't say people are going to take advantage of this, so then no one can get any kind of remedy.... People like LaRue should have this claim.

SM: Even though you don't think a LaRue win necessarily would "open the floodgates of litigation" for every 401(k) plan breach, might it still be a concern for employers? Would they be more inclined to offer less in the way of retirement or defined-contribution plans in an effort to avoid liability?

PS: A LaRue win is certainly a concern for employers. Just the fact that more of these breach-of-fiduciary suits will be filed — whether meritorious or not — will make running these 401(k) plans more expensive for employers. So, yes, one of the possibilities is that employers may cut back on offering these types of plans as a result. Alternatively, employers may shift back to defined-benefit plans [i.e., pensions] because they may see defined-contribution plans as having fewer advantages if they become more expensive to operate. I don't believe there will be a large amount of employers abandoning their 401(k)s because offering such a retirement plan is a competitive must when vying for the services of employees in the job market.