The decision “cleared up an area where there was some ambiguity,” said John Nixon, vice chairman of the employment services group in the Philadelphia office of law firm Wolf Block.

The 3rd Circuit reversed a lower court’s dismissal of Howard Graden’s lawsuit against Conexant Inc. on the grounds that Graden’s cashing out of the plan meant he had no standing to sue.

“The lower court followed what everyone understood the law to be,” Nixon said. “You had to have an [401(k)] account balance to have standing.”

Graden participated in Conexant’s 401(k) until October 2004, investing only in the company stock fund. At the time he cashed out, Conexant’s stock had fallen to $1.70 from a 52-week high of $7.42 in March 2004.

He sued, alleging that Conexant’s pursuit of a risky merger was to blame for the stock drop. Conexant argued that since Graden had cashed out of the plan, he was no longer a participant and did not have standing to sue.

But the 3rd Circuit’s decision notes that ERISA entitles 401(k) plan participants “not only to what is in their accounts, but also to what should be there given the terms of the plan and ERISA’s fiduciary obligations.”

“From this, it is not difficult to conclude that Graden has standing as a plan participant,” the court said, noting that if his lawsuit succeeds, it “will restore assets to the plan that are allocable to Graden’s account, and he will then get a distribution from that restored account.”

“When determining participant standing under ERISA, the relevant inquiry is whether the plaintiff alleges that his benefit payment was deficient on the day it was paid under the terms of the plan and the statute,” said the panel’s decision. “If so, he states a claim for benefits, which, if colorable, makes him a participant with standing to sue.”

Both the Department of Labor and AARP filed amicus briefs supporting Graden, while the National Association of Manufacturers filed an amicus brief supporting Conexant.

Nixon said the decision will create some challenges for companies that sponsor 401(k) plans. When working with plan sponsors, “We try to always draw as small a circle as possible around possible claimants,” he said. “Now, even if you encourage them to take their money out, they’re still a possible claimant.”

The decision also raises issues with regard to the administration of 401(k) plans, and especially record keeping, Nixon said. “If in fact this case becomes the rule of the day, people are going to have to re-examine their service provider agreements to see, post-termination, to what degree the service provider has to retain records for them.”

But he noted that the Supreme Court is due to consider a case, LaRue v. DeWolff, that raises the same issue about the standing of plan participants after they cash out of 401(k) plans. Nixon predicted that if the Supreme Court rules on this issue, “they will read the term ‘participant’ literally and basically restore the status quo.”

Filed by Susan Kelly of Financial Week, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.