On February 20, 2008 the Supreme Court ruled that a participant in a 401(k) plan can sue the plan sponsor for mismanaging his account. That seems pretty logical, but until that decision, any suit brought against a 401(k) plan sponsor had to be on behalf of the plan (i.e. ALL the participants).

In this instance, (LaRue v. DeWolff), only one participant was harmed when the plan sponsor did not follow his investment instructions. Under the old law, the “plan” was not materially harmed so there would not have been an event to cause a lawsuit. The Supreme Court said what most of us would have said, “This man lost $150,000 and should be allowed to sue for restitution.”

Plan Sponsors Beware: the door is now open for many lawsuits against the plan and the plan fiduciaries. The LaRue case was one example of negligence, but this ruling could allow any of the following scenarios:

“The plan paid allowable expenses (for recordkeeping, etc.) that were too high which reduced the overall growth of my account by ½% every year. I was in the plan for 15 years and that ½% cost my account $147,000.”

“The plan forced me to choose from 15 mutual funds. At any given time over my 10 year participation in the plan, at least a third of those funds performed below the category average. During one period, 11 of the 15 funds were underperforming. As a result I could only achieve a return of 5.5% when my allocation should have earned 9.7% based on market averages. Failure to offer competitive funds cost me $140,000.”

“I worked my entire career for this company and have been in the plan for 28 years. I have been putting in the 6% needed to get the full 3% match. But nobody ever told me that I needed to invest my money in stock funds. I always thought that the guaranteed account was the safest way to get to retirement. If only the company would have told me to use the other funds, I would have listened. My total account is less than $100,000. If I had been taught about how to invest or even told that 6% wasn’t going to be enough, I would have done more. If I had contributed 8% with reasonable investments, I would have had twice as much savings. Lack of employee education cost me over $100,000.”

These are all hypotheticals, but the issues are very real and can get very expensive if participants get litigious. Even if some of the lawsuits ultimately do not have merit, plan sponsors will need to look at every nuisance complaint and make a judgment about whether it would be worth the expense of fighting it in court. With claims for a few hundred or a thousand dollars, it would be cheaper to reimburse the participant than to hire an attorney to fight them.

What should Plan Sponsors do to protect themselves?

Unfortunately, there is no way to completely insulate oneself from lawsuits. Now that it is clear that a participant can file suit for monitory damages against the plan sponsor, it is likely that some frivolous suits will be filed. By creating sound practices for governing their retirement plans, sponsors will reduce the number of legitimate claims while putting themselves in a better position to defend the frivolous suits.

• Create and empower a committee (or a few committees) to address administrative, operational and investment issues related to the retirement plan.
• Conduct a thorough operational review of the plan that includes all plan documents and policies, vendor contracts and investment analysis. Then address any shortcomings of the plan that are identified in the review.
• Hold regular (quarterly) meetings to review the plan investments, administration and compliance issues and operational efficiencies.
• Conduct periodic (at least every three years) due diligence reviews for all services provided to the plan to ensure that the plan is getting the proper level of service at competitive prices.

Regardless of the specific actions taken, it is most important that the plan sponsor follow a well defined process and document every action and decision made on behalf of the plan. This is worth repeating: It is not enough to have a process; the plan sponsor must diligently follow that process and when the first lawsuit against the sponsor is filed, it will be the consistent documentation that will provide the evidence that will help to avoid adverse consequences.