The U.S. Supreme Court in February issued a landmark ruling that clarifies a basic and important distinction between defined benefit and defined contribution plans under the Employee Retirement Income Security Act of 1974.
Fiduciaries to 401(k) and other defined contribution plans should be aware of the implications of the ruling, which clearly suggests they will be held to different standards from fiduciaries to defined benefit plans.
The distinction between DB and DC plans seems obvious. Until the ruling in February it was legally unrecognized in the courts, so in practice it did not have to be recognized by plan sponsors and investment advisers.
In part, that ambiguity was because in both types of plans all the assets are held in a single collective trust. Over the years, lower courts had applied DB thinking to the modern world of individual accounts of 401(k) plans, which were not envisioned when ERISA was enacted, and which have slowly evolved their own legal standards.
That confusion possibly contributed to a general complacency on fiduciary issues including transparency, fee levels and conflicts of interest that many 401(k) plan executives, managers and consultants have been confronting in recent years, often in court.
A U.S. District Court and the 4th U.S. Circuit Court of Appeals both failed to recognize the differences between a DB plan and DC plan in terms of losses stemming from a fiduciary breach and their effect on individual participants. They applied DB plan standards to modern DC plans.
The rulings by the two lower courts closed off any remedy for an individual 401(k) participant to recover from a breach of fiduciary duty that led to investment losses. In the particular case that went through the courts LaRue vs. DeWolff, Boberg & Associates Inc., et al. the investment loss was $150,000. The two lower courts ruled a participant had no grounds to sue over a loss stemming from a fiduciary breach unless it harmed the entire plan and the other participants. Both the lower courts held ERISA provides remedies only for entire plans, not for individuals, the Supreme Court decision noted.
The appellate court ruled against a 401(k) participant recovering an investment loss from a fiduciary breach. It held that the law provides remedies only for entire plans, not for individuals. ... Recovery under this subsection must "inure to the benefit of the plan as a whole,' not to particular persons with rights under the plan.
In the LaRue case that eventually went to the Supreme Court, a participant alleged that the plan administrator's failure to follow his investment directions depleted his interest in the plan.
The Supreme Court cleared up the uncertainty in ERISA, ruling it does authorize recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account.
In a defined benefit plan, the Supreme Court ruled, the impact of fiduciary misconduct 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 defined contribution plans, however, fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive.
The decision spent a lot of words clarifying the legal distinction in the impact of a fiduciary loss in a DB plan compared with a DC plan.
The kind of thinking of the lower courts likely has been part of the mind-set of some plan executives, money managers and consultants over the years, giving them a sense of protection from complaints. And the ambiguity in 401(k) fiduciary duty might have contributed to the host of lawsuits filed by 401(k) participants alleging breaches of fiduciary responsibility on transparency and fees, including some cases alleging losses affecting the entire plan.
The Supreme Court ruling settles the matter of losses involving an individual participant. But the courts still have a number of other key issues to settle in regard to fiduciary oversight of DC plans arising from the lawsuits filed against 401(k) plan sponsors alleging lack of transparency and excessive fees.
Clearly, case law interpreting ERISA in terms of defined contribution plans will continue to evolve, and plan sponsors and other fiduciaries will have to pay careful attention to be sure their actions meet the new standards.