Fiduciaries at added risk of court action

Class action litigation in the US is not unusual and more likely than not, the majority of class action litigation deals with pensions or other shareholder activism issues.

However, in light of a recent ruling by the US Supreme Court in the action entitled LaRue v. DeWolff, Boberg & Associates, Inc., No. 06-0856 (2008), it is anticipated that pension litigation in the US will further increase.

At issue in the LaRue case was whether a loss to a participant's individual account in a defined contribution (DC) plan is a loss "to the plan" or a loss to the individual. In this closely watched decision, the US Supreme Court held that the Employee Retirement and Income Security Act of 1974 ("ERISA"), which is the federal law that protects pensions and other employee benefits, affords a remedy to an individual participant in a DC plan that suffered investment losses to his plan account due to a breach by the plan's fiduciaries.

Breach of fiduciary duty under ERISA

In the US, ERISA sets the minimum standards for pension plans in the private sector and provides a comprehensive overview for the regulation of these plans. The provisions of ERISA were enacted to address public concern that the funds of private pension plans were being mismanaged. Since its enactment in 1974, ERISA has been amended to meet the changing retirement and healthcare needs of employees and their beneficiaries. An integral part of ERISA subjects both DB and DC plans to a number of requirements, including requirements for fiduciary responsibility.

Section 502(a)(2) of ERISA permits a plan participant to file a lawsuit for appropriate relief under Section 409 of ERISA. ERISA Section 409 imposes personal liability on plan fiduciaries for breaches that result in "losses to the plan" and a breaching fiduciary must then provide restitution for "any losses to the plan resulting from a breach" and restore to the plan any profits made from using the assets of the plan in improper ways.

Background to the LaRue decision

In LaRue, the plaintiff, James LaRue, a participant in a 401(k) plan administered by his former employer, requested the plan administrators change his investment options for his individual account in 2001 and 2002. The plan administrators failed to make these changes, and his individual account allegedly suffered losses of approximately US$150,000. LaRue then sued in 2004 for the resulting loss, alleging the respondents, acting in a fiduciary capacity, failed to properly invest the assets allocated to his 401(k) plan account, thereby causing it to diminish in value.

In the underlying decision, the US District Court for the District of South Carolina held that LaRue was not entitled to relief under ERISA, noting that Section 502(a)(2) does not permit a participant to sue for losses to his individual account, because under that section, recovery must be for the benefit of the plan as a whole, not to an individual participant (LaRue v. DeWolff, Boberg & Associates, Civil Action No. 2:04-1747-18(D.S.C. 2005)). LaRue appealed this decision and the US Court of Appeals for the Fourth Circuit affirmed the lower court decision holding that ERISA ¤ 502(a)(2) allows participants to recover losses only on behalf of the entire retirement plan (LaRue v. DeWolff, Boberg & Associates, 450 F.3d 570 (4th Cir. 2006)). The Court of Appeals relied on the Supreme Court's earlier decision in Massachusetts Mutual Life Insurance Co. vs. Russell, 473 U.S. 134 (1985), in which the Supreme Court held that a participant in a disability plan that paid a fixed level of benefits could not bring a suit under ERISA to recover consequential damages arising from a delay in the processing of her claim.

On 18 June 2007, a writ of certiorari was granted by the US Supreme Court to specifically decide: (1) whether ERISA ¤ 502(a)(2) authorises a participant in a DC plan to sue to recover losses to the plan caused by a fiduciary breach when the losses are attributed to the participant's individual plan account; and (2) whether an action by a plan participant against a fiduciary to recover losses caused by a fiduciary breach seeks "equitable relief" within the meaning of ERISA ¤ 502(a)(2).

The Supreme Court decision

The Supreme Court reversed the lower court decision and held that damage to the participant's account was in fact damage to the plan. Chief Justice Stevens in the decision for the Court stated specifically that "although ¤ 502(a)(2) does not provide a remedy for individual injuries distinct from plan injuries, that provision does authorise recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account".

This decision marks a significant expansion of the liability faced by plan fiduciaries in the US.

The Supreme Court noted while the Russell decision accurately reflected ERISA's operation in the DB context, it was "beside the point in the DC context…..Misconduct by such a plan's administrators will not affect an individual's entitlement to a defined benefit unless it creates or enhances the risk of default by the entire plan. For DC plans, however, fiduciary misconduct need not threaten the entire plan's solvency to reduce benefits below the amount that participants would otherwise receive."

Although all of the Chief Justices agreed on the outcome of the LaRue case, they disagreed as to the reasoning behind it. A concurrence by Chief Justice John G. Roberts Jr. provides that the wording of the 401(k) plan may require the plaintiff in LaRue to pursue a narrower "denial of benefits" remedy that would in fact require LaRue to exhaust administrative remedies before filing suit. Chief Justice Roberts asserted that LaRue's claim was really a claim for benefits and therefore arguably could only be brought under a different provision of ERISA, Section 502(a)(1)(B), and not under Section 502(a)(2). This would also raise the possibility that LaRue would first have to exhaust administrative remedies before filing suit in court and the administrator's decision would be reviewed only for an abuse of discretion. Chief Justice Roberts' opinion was joined by Justice Anthony M. Kennedy.

The LaRue action will now return to the lower court, which may have to sort out whether LaRue should have followed administrative remedies or whether he gave proper instructions to plan administrators.

Fiduciary issues in the UK

In the UK, trustees are faced with a number of statutory duties brought into force by the Pensions Act 1995. A duty of care was also placed on trustees under the Trustee Act 2000. The Pensions Act 2004 introduced a number of changes to the duties and obligations of trustees including a new statutory requirement for 'knowledge and understanding'. In addition, the Pensions Regulator has issued a Code of Practice on Internal Controls in September 2005 and Code of Practice for Trustees dealing with DC arrangements.

Plan fiduciaries in the US and the UK face many of the same important issues. In an environment where legislation and litigation continue to increase, due diligence is key.

Points to note in both jurisdictions

As a result of the LaRue decision, plan sponsors and employers in the US are anticipating an increase in pension litigation and are encouraged to review their DC plans to make sure there are sufficient oversight guidelines in place and that they are compliant with ERISA ¤404(c), which provides that fiduciaries are not liable for investment losses in a self-directed individual account plan, provided that certain requirements are met.

It is important for plan fiduciaries to know their duties. It is recommended plan fiduciaries review their personal and the plan's insurance coverage. This is also good advice for plan fiduciaries in the UK. Employers, trustees and other responsible fiduciaries in the UK, as in the US, likewise have individual accountability for decisions affecting the financial and operational conduct of pension schemes. However, although pension trustee liability insurance should be considered, it is definitely not an alternative for training and for diligently carrying out duties in accordance with the requirement of trust law and legislation.

As reported in a recent Global Pensions news story ('Trustees ask for help', 21 January 2008), significant pressures are being placed on trustees in the UK and pension schemes are coming under increased scrutiny from the Pensions Regulator and shareholders alike. Due to the increasing interest in and heightened awareness of pension and governance related issues, and with the increased risk of litigation (in both the US and the UK), pension due diligence is crucial. It is prudent for pension fiduciaries in either jurisdiction to evaluate their personal and professional risk in this current litigious environment.