Losses on 401(k) Investments due to Fiduciary Breaches & Scams - Employee Retirement Income Security Act (ERISA)

(June 28th, 2009)

The US Supreme court ruled on February 20th, 2008 that those individuals who have 401(k) plans and have been subject to financial scams, fiduciary breaches that have resulted in investment losses have the right to recover their losses. This was considered a landmark ruling in favour of the 50 million Americans who have 401(k) plans and who are at high risk of abuse by mutual fund administrators & managers. In this article, we explore the rulings of the Supreme Court and how these rulings differ from past rulings, and if your 401(k) loss is protected under these new laws.

In November 2007, the US Supreme court heard the case of LaRue v. DeWolff, Boberg & Associates where the lawyers of Mr. James LaRue argued that his 401(k) plan administrator did not following directions specified by him and lost $150,000, and that he should be allowed to recover this money. In the past, the Supreme Court ruled that cases of this nature of fiduciary breach of duty could only be taken to court if they affected the well being of an entire organization’s 401k plan, thus limiting individual lawsuits. However after February 20th, 2008, the Supreme Court ruled that individual lawsuits will be allowed based on the Employee Retirement Income Security Act of 1974 (ERISA).
Employee Retirement Income Security Act of 1974 (ERISA)

It is stated in Section 502(a)(2) of ERISA that any fiduciary breach of conduct is subject to remedies and litigation in courts for the entire 401(k) plan – not an individual’s plan. In defined benefit plans that provide a fixed annuity to investors upon retirement (pension plan), any misconduct by the mutual fund administrator would result in a loss to the entire plan and all of the people participating in it. Thus, the entire group of people would be allowed to file a lawsuit against the mutual fund administrator, not individual investors. In the case of LaRue v. DeWolff, Boberg & Associates, it was a matter of breach of conduct in a defined contribution plan where the participant was not guaranteed a fixed annuity monthly payment but rather their investment gains over lifetime of the plan would determine their monthly payments upon retirement.

The Supreme Court found this clause under Section 409 of ERISA:
"...statutory provision authorizes a participant in a defined contribution pension plan to sue a fiduciary whose alleged misconduct impaired the value of plan assets in the participant's individual account."

In the case of LaRue, court action was taken against the employer DeWolff, Boberg & Associates as well as the 401k retirement plan administered by DeWolff. DeWolff’s 401(k) retirement plan allowed participants to make investment decisions based on their own research and guidance, and to direct their investment choices to the plan administrator for execution. LaRue claimed that in the years 2001 and 2002, he specified to his plan administrator to make changes to his stock investments, but his specifications were not followed. He claimed that due to this ignorance, the value of his 401(k) plan was reduced by $150,000. Thus, LaRue was seeking compensation for this $150,000 loss and won! This landmark ruling now allows those people who have been faced with wilful negligence or breach of conduct to go to courts to seek reimbursement for their losses.

What does the future hold? Many 401(k) plan administrators now realize they could be faced with lawsuits if they do not follow the specifications of their investors. Cases of lawsuits may arise from underperformance of plans, charge of excessive fees and lack of choices of investments. Below are some precautions that 401k administrators can follow to avoid being faced with lawsuits.

i) Allow 401(k) investors to make changes to their account and their investment choices on their own, so as to hold them accountable for their actions.

ii) Have contracts with 3rd party providers that include compensation for mistakes resulting in financial losses.

iii) Buy fiduciary liability insurance to protect themselves from lawsuits of breach of fiduciary duty or negligence.

iv) Review their 401(k) plan procedures to make sure they comply with the Pension Protection Act of 2006 as well as Employee Retirement Income Security Act of 1974 (ERISA).