RICHMOND, Va. -- A lawsuit brought by participants in First Union Corp.'s 401(k) plan is expected to define a plan sponsor's fiduciary responsibility for choosing the funds it offers.
The participants' suit alleges First Union steered the employees' 401(k) contributions into its own funds to boost the bank's profits.
Experts believe the federal court judge hearing the case may go beyond the factual situation in the case and spell out how an employer must go about selecting investment options to satisfy its fiduciary obligations.
While the Department of Labor has provided, in section 404(c), guidance and a safe harbor in selecting investment options, it has not specified criteria for choosing the funds providing those options.
The suit, filed Sept. 7 in U.S. District Court in Richmond, asks for damages of more than $300 million of First Union earnings made from the allegedly illegal practices.
The complaint asserts First Union, based in Charlotte, N.C., restricted the investment options in the 401(k) plan in order to boost fee income and create mass and scale in its proprietary funds. It contends that in the early 1990s, in order to "jump-start what is today a lucrative commercial 401(k) business," First Union made its wholly owned subsidiary, First Union National Bank, trustee of its $3 billion in-house employee plan and Capital Management Group, a bank division, the investment manager and record keeper.
Among other things, the lawsuit also contends First Union:
* charged illegal plan-related expenses and hid that fact from employees;
* chose funds for the plan to benefit itself, not employees;
* misrepresented the fees charged for investing in the stable value fund;
* added more proprietary options to the plan for its own gain and profit;
* misrepresented the fees charged for investing in the enhanced stock market fund;
* used participants' balanced fund holdings as "seed money" to start another balanced fund; and
* failed to evaluate performance of the plan options.
The lawsuit also might signal the beginning of a flood of lawsuits involving defined contribution plans.
"I think there are so few definitions of what it means to be an ERISA fiduciary in the defined contribution world that anyone will look at any case like this with a high degree of anxiety," said William Arnone, partner and national director of employee financial education at Ernst & Young LLP, New York. He was referring to the Employee Retirement Income Security Act.
Since neither the Labor Department nor any federal court has given much direction to plan sponsors on selecting 401(k) investment vehicles, there is a "high likelihood" the federal court hearing the First Union case will go beyond the narrow issues raised by the case, Mr. Arnone said.
This case "will allow a court to fill in the blanks and go beyond the particular facts in this case," Mr. Arnone said. "When a court looks at this issue of fiduciary responsibility, it will probably get into things a fiduciary must do in general to construct a prudent approach to selecting investments."
Among the gray areas are such basics as the plan sponsor's fiduciary responsibility for selecting funds, evaluating fees charged and informing participants, said Mr. Arnone.
While some plan sponsors might wait until an appellate court rules on the issue, Mr. Arnone said, if the district court's conclusions are clear enough, plan sponsors probably will make myriad changes to the way they select investment choices.
As long as the process spelled out is rational and not burdensome, plan sponsors will most likely jump to comply, he predicted.
Other consultants say this case is the first of a flood of defined contribution cases expected to hit the courts soon.
"ERISA litigation cases are on the rise," said Thomas Schenk, president of Harbor Advisors Inc., a Spokane, Wash., consulting firm. "The baby boomers are aging, the amounts of money involved are growing and the subject of a dignified retirement is packed with emotion. Especially of interest should be decisions . . . where the courts are holding plan sponsors to rigid interpretations of fiduciary duties."
For example, last year in Farr vs. U S WEST, the courts held U S WEST liable for what executives didn't tell participants about the tax implications of rollovers, he said.
"It doesn't take a rocket scientist to extrapolate that logic into sponsor liability for some of the poor decisions participants make in their own 401(k) accounts," he said.
"While the specific facts of the First Union case may seem far removed from the everyday world of the typical plan sponsor, the lessons should be: Ignore these trends at your own peril because the stakes are rising every day the boomers approach their retirement."
Pension lawyers say their telephones have been ringing off the hooks with calls from clients concerned about what effect the First Union case could have on the way they run their 401(k) plans.
"People who run 401(k) plans do not do it with the same vigor as they do defined benefit plans," said Ron Richman, partner with Schulte, Roth & Zable, New York. "In defined contribution, it is the participant's money."
Still, most plan sponsors with a "relatively small amount of effort," could assemble a package of funds that would be hard for anyone to challenge, said Mr. Richman, who specializes in cases brought under ERISA.
Even if the court sticks to the narrow situation in the First Union case, the bank is not alone in its use of exclusively in-house funds for its own 401(k) plan. The practice is "pretty widespread," Mr. Richman said.
"The use of your own funds creates a prohibited transaction for which there is a class exemption," he said.
Exemption no inoculation
But the class exemption that was granted by the Department of Labor does not inoculate service providers for the fiduciary responsibility of selecting and monitoring investment vehicles, he added.
"We are getting calls from lawyers in big law firms because their clients (mutual fund companies, banks and insurers) are calling them," said Eli Gottesdiener, a partner at Sprenger & Lang, the Washington law firm representing the First Union employees.
"What we want from the suit -- aside from making the plaintiffs whole -- is to stop the widespread practice of the financial services industry of unthinkingly restricting employees to the company store," he said.
First Union has declined to comment on the case except to release a statement that says: "Our plan provides participants with a broad range of investment options, which are prudently and appropriately selected."
This is not the first lawsuit brought by disgruntled 401(k) participants against First Union. In May, employees sued the bank over the way their 401(k) assets were handled after the 1997 merger of First Union and Signet Banking Corp.
That case seeks $150 million for money management fees paid and profits plan participants allegedly lost when First Union transferred money out of the Signet 401(k) plan and into First Union's 401(k) plan, which includes only proprietary funds.
Motions by First Union challenging the complaint are expected to be heard within the next couple of months.