Best Practices to Prevent 401(k) Litigation

Richard Unser, AIF, QPFC, CRPSERISA Risk Management Consultant213-689-2392runser@lockton.com

www.401k-fraud-lawyers.com

The 401(k) lawyers at our firm are currently offering free consultations to individuals who suffered financial damages as a result of mismanagement or fraud involving 401(k) retirement plans. We are committed to making sure that plan sponsors, administrators and fiduciaries are held responsible for 401(k) fraud and mismanagement when it occurs. Employees in 401(k) lawsuits who saw their retirement funds diminished because:

– Plan sponsors failed to fulfill their fiduciary duties by allowing 401(k) administrators to charge excessive fees for their services.

– Plan administrator failed to follow their directions regarding investments.

– 401K plan sponsors do not take steps to eliminate imprudent investments from a plan, or intentionally fail to warn 401(k) participants that an investment or investments had become risky.

If you or someone you know lost money as a result of 401(k) mismanagement or fraud, we urge you to contact one of our 401(k) lawsuit lawyers right away to discuss your case.

Who is Getting Sued?

• Stage 1 – Vendors– Haddock v. Nationwide– Ruppert v. Principal– Phones Plus v. Hartford

• Stage 2 – Plan Sponsors– Braden v. Walmart– Tribble v. Edison– Will v. General Dynamics

• Stage 3 – Plan Sponsors and Vendors

Why Are They Being Sued?

Claims by participants allege:• Service arrangements with “unreasonable”

“hidden” and/or “excessive” fees.• Plan fiduciaries do not understand or recognize

revenue sharing arrangements.• Plan investments “underperformed.”• Plan administration.• Benefit payments amounts or denial of benefits.

Case StudiesConversion Gone Wrong

Attached at the Hip The Russian Bride

401(k) Lawsuit Turns DeadlyDot Your “i’s” and Cross Your “t’s”

The Billion Dollar Typo

Conversion Gone Wrong

Facts of the case• Participants claimed:

– Plan was systemically neglected. – Investments underperformed. – Market value adjustment (MVA).– Improper mapping.– Service providers engaged in prohibited transactions.

Results of the case• Company settled for $6.25 million in April 2010.• Estimated Defense costs over $1 million.• Class included participants and beneficiaries from 1996-2006.

Conversion Gone Wrong - Best Practices

• Plan Investments:– Review– Benchmark– Document– Replace (as needed)

• Strong Fiduciary Governance:– Document, Document, and Document

Attached at the Hip

Facts of the case • CFO is sole trustee of the 401(k) plan and decides to work primarily from a home in Northern

CA. • Operations manager is co-trustee for the sole purpose of signing distribution.• CFO terminated for fraud against the company.• Lawsuits are filed in state court:

– CFO claims wrongful termination– Company files suit for fraud against the company. – Law firm for company adds allegations regarding breach of fiduciary duty to the plan

• Parties are about to settle and release the CFO from liability re the plan and pay him his distribution until ERISA Council is hired.

Results of the case• Plan ordered to independent fiduciary. • CFO files for personal bankruptcy. • CFO forfeits his 401(k) account balance of $250,000 back to the Plan, but this amount is not

enough to restore the losses. • DOL is now suing both the CFO and the operations manager for the $600,000 in remaining

damages.

Attached at the Hip - Best Practices

• If you agree to be a Plan Fiduciary, take that role very seriously, you can’t just be a check signer;

• Know if you have a Conflict of Interest and recuse yourself;

• Hire competent advisors with experience in ERISA claims;

• In the event of a dispute, hire independent counsel for the plan.

Are you a Fiduciary?

According to the Department of Labor Website:o Using discretion in administering and managing a plan or

controlling the plan’s assets makes that person a fiduciary to the extent of that discretion or control.

o Fiduciary status is based on the functions performed for the plan, not just a person’s title.

o List includes:o Plan trustee.o All individuals exercising discretion in the administration of the

plan.o All members of a plan’s administrative committee. o And those who select committee officials.

Are you a Fiduciary?

• If you sign your 5500?• If you are named the “Plan Administrator”?• If you decide what your company matching/profit

sharing contribution is?• Is their a difference between a trustee and

fiduciary?• Other questions?

Indentifying Conflicts of Interest

Exclusive Purpose Rule• Acting solely in the interest of plan participants and their beneficiaries and with the exclusive

purpose of providing benefits to them.

Potential Internal Conflicts• Know when the “fiduciary hat” or the “employer hat” fits.• Employer hat:

– Settlor Functions• Fiduciary hat:

– plan administration– plan investments– management of plan assets

Potential External Conflicts• Identify and manage when there is the potential for a conflict.• Examples:

– A bank offers favorable business banking terms if the company transfers their 401(k) plan– Your stock broker offers you discounted commission or fees if the company transfers the 401(k) plan– Selection of Stable Value/Money Market funds/Target Date Funds– Opportunities for non-level compensation

Managing Conflicts of Interest

1. Identify conflicts (or potential conflicts) that may impact the management of a plan;

2. Evaluate those conflicts and the impact they may have on the plan and its participants;

3. Determine whether the conflicts will adversely impact the plan; 4. Consider protections that would protect the plan and participants;5. If the conflict adversely impacts the plan and its participants,

change service providers, investments or other circumstances related to the conflict.

The Russian Bride

Facts of the case• 55 year old Participant is in hospital on deathbed.• Participant’s elderly mother is the designated beneficiary. • Participant passes away shortly thereafter. • Participant’s Russian bride of less than 1 year files claim for her 401(k)

benefit. • Mom also files claim for benefit and alleges fraud. • Company files interpleader action with court.

Results of the case• Company settles by paying 401(k) Plan benefit to bride. • Company also paid an equivalent amount of $125,000 from company funds

to Mom. • Defense costs were approximately $30,000.

The Russian Bride - Best Practices

• Have clear procedures for handling claims inquiries, especially on beneficiary issues.

• Be aware of interpleader as an option.• “Pure heart and empty head” is no defense to

fiduciary breach claim.

Claims Management

• Be sensitive to whether you have a claim or not:– Wrongful Benefits Denial Claim– Fiduciary Breach

• Be proactive.• Work with your ERISA council and insurer immediately.• Follow ERISA claims management process (located in

plan document and SPD).• Document denial or acceptance of claims in accordance

with ERISA and your claims procedures.

401(k) Lawsuit Turns Deadly

Facts of the case• 4 employees filed a class action lawsuit in 2006 against plan sponsor, its pension review

committee and Fidelity Management Trust Co.• Participants claimed:

– Plan included investment options with “unreasonable and excessive” fees– “Secretly” charging and retaining revenue sharing payments

• Motion to dismiss denied in February 2008.• Trial began January 5th 2010.• January 7th 2010 a plaintiff in the case fatally shot three co-workers and injured five more

before killing himself.• Trial concluded January 2010.

Results of the case• If participants do not have knowledge of revenue sharing arrangements plan sponsor may

not qualify for ERISA Section 404(c) protection.• Fidelity Trust could qualify as a fiduciary because it did the first-cut screening of investment

options, and has veto authority over the inclusion of investment options.• Final judgment pending.

Similar Cases

Date Plan Sponsor Judgment/Settlement Amount

October 2010 Bechtel $18.5 Million

August 2010 General Dynamics $15.5 Million

July 2010 Edison Amount Pending

November 2009 Caterpillar $16.5 Million

401(k) Lawsuit Turns Deadly- Best Practices

• Strong Fiduciary Governance: – Document, Document, Document

• Plan Fees – Review – Benchmark – Document – Disclose

What is ERISA 404(c)

• ERISA 404(c) provides relief for a fiduciary with respect to participant directed accounts.

• You must elect this protection!– Disclosure requirements:

• Summary Plan Description• Form 5500

– Participant or beneficiary must have control over investments.

• Best practices checklist included in Lockton tab.

408(b)2 Overview

• General Rule: It is a Prohibited Transaction for the plan to enter into an agreement with a service provider.

• Exception under 408(b)2—if the arrangement and compensation with the service provider are “reasonable and necessary” then it is an NOT a Prohibited Transaction and is an acceptable arrangement.

• Became a final interim rule in July 2010. • In order for the arrangement with a service provider to be “reasonable” certain disclosures must

be made to the plan sponsor and they must take this information and make a determination of “reasonableness”.

• Required Disclosures:– Compensation—all compensation regardless of its classification as: direct, indirect, termination

compensation, etc. must be fully disclosed in writing, prior to the arrangement being entered into.– Services—all the services the “covered service provider” is rendering must be disclosed in as much detail

as necessary in order to prove these service are “reasonable” and “necessary” in light of the fee being charged.

– Fiduciary Status—if the service provider is a fiduciary to the plan they must disclose that detail.

Effective Plan Benchmarking

• Build an “apples-to-apples” comparison group.

• Collect ALL fees.

• Examine participant success measures.

• Examine plan complexity.

• Examine fiduciary oversight and best practice services.

• Examine plan-driven and participant-driven services.

• Examine service standards.

Dot your “i’s” and cross your “t’s”

Facts of the case • CFO and COO are co-trustees of the retirement plan. • Company goes into receivership.• COO (who had breached his duties, but this was not yet known) terminates

and withdraws his 401(k) balance. • DOL investigates and finds there are late deposits to the plan. • DOL then writes a short letter to the CFO:

– You were a fiduciary, you have the necessary $200,000 in your 401(k) account to cover the late deposits, so pay up.

Results of the case• Claim for fiduciary insurance.• CFO had not actually breached any duties.• Cost to defend DOL allegations ~$25,000.• Cost to CFO defend himself ~$20,000.

Dot your “i’s” and cross your “t’s” - Best Practices

• Recognize that if you get a phone call from the DOL or IRS, you are “under investigation.”

• Immediately disclose to your insurance provider. and include on future applications.

• Consider including a strong indemnity for plan fiduciaries in the plan.

The Billion Dollar Typo: (you can win the case and still owe attorneys’ fees)

Facts of the case• Verizon’s in house counsel made a small drafting error in its cash balance plan (one phrase in the benefit

formula was accidentally repeated twice). • Potential cost to Verizon = 1.6 billion dollars.• Participant filed claim for benefit based on literal plan language.• Plan denied claim – based on fact that document was not correct (scrivener’s error) – they

“reinterpreted” the plan.

Results of the case • Participant sued and won – 7th Circuit: held - only a court can “reform” a document, similar holding in

Cross v. Bragg (IRS had approved retroactive amendment). • Verizon then sued to reform the document and won; Participant then sued for fees for the initial lawsuit

and won; parties ordered to meet and confer re amount of fees. • Fiduciary insurance with defense coverage will cover this type of situation.

Best Practices• Read the plan carefully. Unambiguous drafting errors likely need to be corrected through a court filing

and an IRS filing. • Verizon won because it has clear and substantial evidence of intent and because of the large windfall

that would have been paid to participants – but most cases are not this big or this clear.

Innocent Error in Restated Adoption Agreement

Facts of the case • Company restated their 401(k) plan for a change in the law – requiring a new adoption

agreement. • Plan provider accidentally inserted a 2 year vesting schedule in place of the prior 5 year

vesting schedule. • The Company did not have counsel review and no one at the Company caught this for 10

years. • Cost to correct = $1,000,000 in additional vesting.

Results of the case • Company applied for and obtained IRS approval to retroactively amend the plan in 2009, no

additional vesting required by IRS. Good evidence of intent, i.e. SPD, notices.

Best Practices • Read the document. • Following the Verizon case, this would have required court action to fix.

Bad timing…

Facts of the case• Surviving spouse of a former partner was granted a Qualified Domestic Relations Order

(QDRO).• The QDRO was served to the plan sponsor.• Unfortunately, the spouse was never notified or provided any documentation that she was

responsible for directing the investments in the account.• That notice was required by Section 404(c) of ERISA pertaining to participant directed Plans. • Notice to liquidate was given.• However, the shares were not liquidated until 30 days later (Plan Manager was on an

extended vacation). • Value of the spouses mutual fund shares declined $209,840.40 from the original date the

QDRO was served.• Spouses sues for the lost funds.

Results of the case• Damages were limited to the difference in account value had they been placed in the pool

fund properly and the share price when the shares were sold plus any interest and attorney fees.

• Matter resolved for $130,000.

Future of ERISA Litigation

• Economic and demographic pressures of the Baby Boom Generation.

• LaRue v. DeWolff impact.• Blood in the water…• Legislative and regulatory environment drawing

more scrutiny to retirement plans.

Best Practices

1. Properly Identify and Appoint Plan Fiduciaries.2. Strong Fiduciary Governance: Document, Document,

Document.3. Consider ERISA Safe Harbors: 404(c), QDIA, etc.4. Ensure Plan Administration Matches Plan Document.5. Plan Fees: Review, Benchmark, Document, Disclose.6. Plan Investments: Review, Benchmark, Document, Replace

(as needed).7. Maintain Beneficiary Designations.8. Recognize and Respond to Potential ERISA Claims.9. Employee Education.10. Hire Qualified and Competent Advisors.

Action Items

1. Obtain indemnification from your employer specific to ERISA liability.

2. Identify plan fiduciaries and their duties.3. Review/consider your fiduciary insurance policy.4. Review plan document, fees, investments, and

operations. 5. Create a written plan and timeline to remedy any

deficiencies you find.6. Lastly…

Hire Qualified and Competent Advisors

The DOL stated “Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert.”

Liss v. Smith, the court said: “where the trustees lack the requisite knowledge, experience and expertise to make the necessary decisions with respect to investments, their fiduciary obligations require them to hire independent professional advisors.”

The End

• Questions? • Comments?