SAN FRANCISCO - A third-party administrator had no responsibility to blow the whistle on a 401(k) plan sponsor suspected of embezzling money from the plan, the 9th Circuit Court of Appeals has ruled.
The administrator, Pension Professionals Inc., had forced Software Analysts Inc. to disclose the problem on participant statements, but because the firm lacked discretionary authority over plan management and administration, it was not a fiduciary under the Employee Retirement Security Income Act, the court ruled.
About 50 plan participants sued to recover the money from Pension Professionals, attempting to hold the firm responsible for re-paying the missing assets because it had not warned participants or notified governmental authorities of discrepancies between the company's withholding from paychecks and the amounts deposited in employees' 401(k) accounts, according to the appellate opinion filed Nov. 23. Attorneys, in a published report, estimated total losses to be close to $1 million.
"In the real world, it is hard to know whether a judge or a jury will find a service provider a fiduciary," said Fred Reish, partner of Reish & Luftman, a Los Angeles-based ERISA law firm. He is not connected to the case.
ERISA attorneys "are always afraid that the participants will find some fact so your client will have fiduciary responsibility under the plan," he said.
The theft, he said, "is not what the participants were complaining about, but they were complaining that the third-party administrator did not take fiduciary-type steps."
If a service provider is not a fiduciary, it can document its conduct, encourage the plan sponsor to do the right thing and quit without informing the Department of Labor or plan participants, Mr. Reish said. A fiduciary, on the other hand, must take steps to protect plan participants, including notifying participants and federal authorities, he said.
The tricky issue for 401(k) service providers is that almost anything done mechanically could be considered a fiduciary act, Mr. Reish added. Even if a service provider is not characterized as a fiduciary by the plan or in its contract with a plan sponsor, the provider could be found to be one if it exercises some control and authority over the plan.
For example, if a plan sponsor's investment policy guidelines are unclear and the service provider fills in the gaps, the service provider could be held to be a fiduciary, he said.
Attorneys for Pension Professionals, Aliso Viejo, Calif., said that this had been a "gray area" of the law and that the case cleared some of the confusion.
"There is not a lot of case law in this area where it's not talking about investment advice and discussing obvious acts that would render one a fiduciary," said Cynthia A. Goodman of Los Angeles-based Robinson, Di Lando & Whitaker, attorneys for Pension Professionals.
The court opinion also limits the liability exposure of third-party administrators, said Michael C. Robinson, a partner with the law firm.
"Another important thing that came out of the case is that third-party administrators do not have a watch-dog duty," Mr. Robinson said. "They do not have to go run to the Department of Labor or the police or the FBI on every circumstance that comes up."
In this case, Pension Professionals discovered discrepancies between the withholdings and deposits about six months after it was hired by Computer Software Analysts.
Pension Professionals notified the plan's co-trustee and company Chief Executive Officer Levi Carey - whom it suspected of embezzling the money - and Louis King, co-trustee, that failure to deposit the money violated Internal Revenue Service and Department of Labor regulations, the opinion states. Mr. Carey agreed to a repayment schedule and to include a notice of the problem on participants' account statements.
In July 1998, Mr. Carey pleaded guilty to embezzling the missing funds, the opinion states. Participants first sued Aetna Inc., Hartford, Conn., the plan custodian, but the case was thrown out with a summary judgment motion in Aetna's favor, Mr. Robinson said. They then sued Pension Professionals to recover the about $700,000 shortages, he said.
The court opinion indicated that in order to become a fiduciary, a person or firm must have control over management of the plan, get paid for investment advice or have discretionary responsibility over plan administration.
Pension Professionals had no power over managing the 100-participant plan's assets and did not make eligibility or claims decisions. Therefore, it had no fiduciary responsibility, the court held.
