Two recent events have combined to further heighten the risk of litigation. One is a recent Supreme Court decision making it easier for participants in 401(k) and similar plans to sue plan fiduciaries for alleged fiduciary breaches. The other is the sheer anger and frustration felt by countless numbers of plan participants as they watch the value of their retirement savings plummet and see that they will have to work far longer than they had planned.
Now is the time for plan sponsors and fiduciaries to review their retirement and health plans, as well as the plans’ administrative practices, to determine whether there are steps that can be taken to reduce the potential for litigation—or at the very least, to increase their chances of prevailing in court in the event that litigation cannot be avoided. Here are some areas that should be reviewed:
Plan-imposed limits on filing suit in court
Federal law governing plans sets forth a statute of limitations—that is, the date by which suit must be filed or forever barred—only with respect to claims of breach of fiduciary duty. It does not specify, however, how long participants have to file in court alleging that they have been wrongly denied benefits. Federal courts have filled this void by imposing the limitations period of the most analogous state-law claim, which, in the case of a claim for benefits, is the state’s statute of limitations for filing suit in a contract dispute.
Plans may find this approach far from appealing for two reasons. First, where the plan sponsor operates nationally, the plan will be burdened with 50 different statutes of limitations. Secondly, the underlying state-law limitations period may be unreasonably long—as long as 10 years in some states. The longer the period between the actual event that gave rise to the litigation and the suit itself, the greater the chances that evidence in support of the plan’s position, such as plan documents and summary plan descriptions, may be destroyed. And there’s a greater chance that those who might have been in the best position to defend the plan are no longer employed by the company. They might not even be alive.
A plan may escape this fate by adopting its own plan-based period of limitations. This step establishes a deadline by which a participant who has completed the plan’s administrative procedures but who nevertheless believes that his claim has been wrongly denied by the plan must file a claim in court—or be forever barred from doing so.
Courts have long recognized that parties to a contract can agree to a shorter limitations period than that prescribed by state law. Virtually every court that has reviewed the issue as applied to employee benefit plans (including two federal courts of appeal) has applied the same rationale to plans. Courts have almost uniformly been willing to enforce such provisions, provided that the plan-imposed limitation meets four requirements:
(1) It must be included in the plan document.
(2) It must be fully disclosed to participants in the plan’s summary plan description.
(3) It must be reasonable in time and drafted to begin running after the completion of all of the plan’s administrative appeals. A typical provision might bar the suit if it is filed beyond one year after the plan’s final administrative denial.
(4) It must be fully communicated to participants in the plan’s claim denial letter.
Company stock as a plan design rather than a fiduciary decision
Where participants are allowed to invest in company stock, events that negatively affect the share price may also give rise to participant litigation. Participants will often allege that although company stock may have been only one of a myriad of investment options, the fact that plan officials knew or should have known of these events means that at some point the retention of company stock as an option became imprudent and therefore a breach of fiduciary duty.
Employers as the plan sponsors will likely be fiduciaries of the plans they maintain and therefore will be liable for any fiduciary breach in which they engage. But employers wear two hats—plan sponsor and plan fiduciary. Some things are done by an employer in its capacity as a plan sponsor, such as deciding whether to even adopt a plan, and if so, what type of plan and how it will be designed. Those plan-sponsor actions are not actionable as a breach of fiduciary duty.
In an area of the law just developing, two courts have now held that in a properly designed provision, the decision to retain company stock as an investment option can be viewed as a plan-sponsor action. It is not properly actionable as a breach of fiduciary duty. In both cases where this defense was upheld, the plans contained express language mandating the inclusion of company stock as an investment option and expressly stating that plan fiduciaries did not have the discretion to remove the company stock as an investment option.
Defending other investment options under the plan—including the use of target-date funds
It is inescapable that there will be some investments made available under a plan that fiduciaries do have the requisite discretion to retain or remove. Where this discretion exists—including the discretion to add new funds—it is clear that the resulting decision is a fiduciary one, and as such it is subject to review and potential liability.
As a result of guidance issued by the Department of Labor, many plans last year added target-date funds to their plans’ menu of investment options. As a result of that guidance, target-date funds became the premier vehicle available to serve as a safe-harbor default investment option for accounts for which the plan does not receive investment instructions. Unfortunately, many plans have now realized that target-date funds lack any real uniform guidelines as to the appropriate mix of equity and other investments. Nor do they have a uniform rate at which such funds should become more conservative as investors get closer to their targeted retirement date. Since the plummet in the stock market, target-date funds have come under significant criticism in the media and have now been the subject of a congressional hearing.
Many plan fiduciaries will find themselves having to justify not only the particular target-date fund selected, but other investment options under the plan as well.
The appropriateness of any investment is to be judged not on the basis of how well it performed, but rather, whether the fiduciaries were prudent in its selection. Under this standard, commonly known as the "prudent man" rule, the selection will be deemed prudent if the process used to select the investment was itself prudent. That determination relieves the selecting fiduciary from liability for bad results.
Procedural prudence requires that fiduciaries establish and document that a prudent process was used to select the investments. This requires that the records be sufficient to show: (1) what options were considered; (2) why particular investments were selected; (3) why others were discarded or not selected; (4) proper consideration of the risk and return history of the investment, its cost and whether that history reflects current management and, if not, the impact of the management change; and (5) how the investments as a whole mix, match and further the plan’s goals. Moreover, procedural prudence requires that if at any turn the selecting fiduciary is not competent to make a particular evaluation or does not understand all or any aspect of an investment, that the fiduciary consult an appropriate expert.
Making sure plan fiduciaries are not liable for participants’ investment decisions
Most plans that allow participants to make their own investment decisions under the plan do so hoping to comply with a special safe harbor. If the plan complies, the participants—not the plan’s fiduciaries—will be responsible for the results that flow from those investment decisions.
Plans must disclose to participants that the fiduciaries are attempting to meet this safe harbor and that if they are successful, fiduciaries will not be responsible for participants’ investment decisions
There are a number of provisions that a plan must satisfy in order for fiduciaries to get this protection. However, one of the simplest requirements is one that is often overlooked: Plans must disclose to participants that the fiduciaries are attempting to meet this safe harbor and that if they are successful, fiduciaries will not be responsible for the participants’ investment decisions. The failure to satisfy this disclosure requirement is one of the reasons why the Department of Labor argued in the Enron case that the company’s plan fiduciaries were not eligible for the safe-harbor relief. Plans should make sure that this disclosure is included in the summary plan description.
Conclusion The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.
If history is any indicator, plan sponsors and fiduciaries can expect more litigation in the future. This is particularly the case in the face of the significant losses realized by plans in the past several months. Plan sponsors and fiduciaries should undertake a litigation audit now of their retirement and health plans to determine where vulnerabilities exist. Once this determination is made, steps should be taken to close any holes and to ensure that all plan decisions, particularly investment-related decisions, are properly documented and records retained in the event of litigation.
The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.