The outcome of a legal battle between First Union Corp. and participants in its 401(k) plan could alter the way financial services firms run their own employee retirement programs.
The case arose from the 1997 merger of Signet Banking Corp., Richmond, Va., and First Union, Charlotte, N.C. It seeks $150 million in profits plan participants allegedly lost when First Union transferred money from the $250 million Signet 401(k) plan to First Union's nearly $3 billion 401(k) plan, which uses only proprietary funds.
Didn't explore options
The complaint filed in the federal district court in Richmond, Va., also asks First Union return all of the fees it made for managing the money in its own plan.
The former Signet employees, who, following the merger, are now First Union employees, also contend First Union inadequately explored investment options other than its own mutual funds.
Most investment management firms would rather use their own mutual funds in their own company plans, observers note.
If, following the lower court's decision, an appellate court adopts the former Signet employees' argument that First Union failed to fulfill its fiduciary responsibility by using only its own investment options, financial institutions could be faced with an ERISA dilemma:
How can financial institutions prove they satisfied their fiduciary responsibilities because their funds are the best when, depending on the benchmark used, there is always going to be a better performing fund?
The Department of Labor apparently acknowledged the situation because it has given a class prohibited transaction exemption to banks, insurance companies and financial service providers -- allowing them to use their own investment products without incurring the penalties of a prohibited transaction.
But the former Signet employees are arguing this does not exempt First Union from its basic fiduciary responsibility.
'It's done every day'
"It's very typical in an acquiring situation for the plan of the acquired company to be merged into the plan of the acquiring company," explained Ian S. Kopelman, who chairs the employee benefits and executive compensation practice of the Chicago-based law firm Rudnick & Wolfe.
Usually, the acquired plan assets then are deposited into the investment options of the acquiring company, Mr. Kopelman said.
"It's done every day in an acquiring situation."
"It is irrational to argue that although that's done every day by hundreds of acquiring companies, it can't be done if the acquiring company is a financial institution and the plan uses its own funds," he said.
Not everyone agrees with Mr. Kopelman.
"Observers should pay careful attention to the 'lack of a gain' issue in the First Union suit," said Tom Schenk, a principal with Harbor Advisors, a consulting and participant advisory firm in Spokane, Wash. A lot of mutual funds in 401(k) plans have had a "lack of gain," and are underperforming their benchmarks next to comparable index funds.
Plan sponsors should not dismiss the First Union lawsuit by saying it is an isolated case. When baby boomers realize they don't have enough money to retire, they might start suing their employers over the returns of the funds in their 401(k) plans, Mr. Schenk said.
"The business of saving and investing for retirement takes so many years to unfold," Mr. Schenk said. "I believe it will eventually dwarf tobacco, firearms and other product liability litigation."
Mapping an issue
Apart from the legal issues raised by the lawsuit, the complaint also alleges problems with the way First Union executives "mapped" or directed assets from investment options in the old plan into the new plan.
"The mapping did not make any sense," said Shlomo Benartzi, assistant professor of accounting at the Anderson School at the University of California, Los Angeles.
Even though the First Union plan has seven investment options, Signet's seven old options were mapped to only three First Union proprietary funds, the complaint said. Those three funds are First Union's Stable Fund, Enhanced Stock Market Fund and Evergreen U.S. Government Securities Fund.
For example, Signet participants who invested in the Twentieth Century/American Century Ultra Investors Fund saw their money transferred to First Union's Enhanced Stock Market Fund. Ultra is an actively managed fund that invests in stocks of medium to large companies with accelerating earnings and revenue trends. First Union's enhanced fund is a bank collective index fund.
Some $50 million in assets from the Signet plan's Capital One Financial Corp. Stock Fund, a portfolio of stock from a spun-off Signet subsidiary, were mapped to First Union's Stable Fund, which is a money market fund.
While the Capital One stock was being liquidated and the assets transferred, the stock tripled in value, the complaint alleges. Meanwhile, the First Union Stable Fund returned 5% per annum during the same period, according to the suit.
Plan sponsors are supposed to treat the plan assets as if it is their own money, but that might be hard to do when directing plan dollars into proprietary funds makes the funds more attractive to clients by increasing the assets under management, said Eli Gottesdiener, a partner in the Washington firm of Sprenger & Lang, who represents the former Signet employees.
When the plan sponsor decides to administer the plan in-house and that plan sponsor also has its own family of mutual funds, that company has to be "especially careful," Mr. Gottesdiener said.
"They wanted the funds so they could collect fees and make their commercial vendor practice more attractive to other plan sponsors," he said.
Moreover, First Union offers a few of the funds that were in the old Signet plan to plan sponsors it services, Mr. Gottesdiener said.
"They offer them to customers. Why wipe it out for your own employees?"
Paying more attention
But he is not predicting this case will open the floodgates to more lawsuits. Instead, he expects plan sponsors will pay closer attention to their fiduciary duties and participants will keep more careful watch over their retirement savings.
"We're hoping people will become more educated and pay more attention to what's going on with their nest egg and make sure no possum is raiding their nest egg," Mr. Gottesdiener said.
First Union has a policy not to comment on pending litigation for the record, according to Sarah Holden, a company spokeswoman. First Union is not expected to respond to the complaint for a couple of month.
