Should Employers Rue LaRue?

In a recent decision, the United States Supreme Court unanimously held that a participant in a 401(k) plan could bring a lawsuit for breach of fiduciary duty—even though the alleged breach affected only the participant's own account and not the accounts of any other plan participants. That decision may have serious implications for employers who sponsor retirement and other benefit plans, and for the fiduciaries of such plans. Employers and fiduciaries alike may want to take a fresh look at their plans and procedures in light of that decision.

Background of the Case

In LaRue v. DeWolff, Boberg & Associates, Inc., plaintiff James LaRue sued his former employer, DeWolff, Boberg & Associates, which administered its own 401(k) retirement savings plan. That plan allowed participants to make choices about how their contributions were invested, within certain guidelines and procedures. LaRue claimed that his retirement account suffered a loss of approximately $150,000 because the company failed to follow his investment instructions in 2001 and 2002, when the stock market performed poorly.

The 401(k) plan at issue was governed by the Employee Retirement Income Security Act of 1974 (ERISA), which, among other things, makes those who have fiduciary responsibility for the plan liable for losses to the plan that are caused by a breach of fiduciary duty. LaRue sued DeWolff in 2004, claiming, in the Supreme Court's words, that DeWolff's failure to adhere to his instructions "amounted to a breach of fiduciary duty under ERISA."

Relying on a 1985 Supreme Court decision, the U.S. Court of Appeals for the 4th Circuit dismissed LaRue's claim, holding that damages for breach of fiduciary duty could only be recovered on behalf of the plan as a whole, and that an individual could not recover for personal losses.

The Supreme Court Decision

The Supreme Court reversed the appeals court, holding that the damage to LaRue's 401(k) account was a loss to the plan.

Writing for the majority, Justice John Paul Stevens first pointed out that at the time the 1985 case was decided, the defined benefit plan was the most common type of retirement plan. He noted that in that type of plan, the individual beneficiary generally receives the same, defined amount of money, and that "[m]isconduct by the administrators of a defined benefit plan will not affect an individual's entitlement to a defined benefit unless it creates or enhances the risk of default by the entire plan."

Twenty-three years later, Justice Stevens noted, the "landscape" of employee benefit plans has changed dramatically. "Defined contribution plans dominate the retirement plan scene today," he wrote. In this context, while the plan holds assets collectively, individuals have their own (often self-directed) accounts. Misconduct might thus easily affect only one individual's account without harming another's.

The Supreme Court clarified that although the section of ERISA at issue "does not provide a remedy for individual injuries distinct from plan injuries, that provision does authorize recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account." That would be true, the court noted, whether the participant's account "includes 1% or 99% of the total assets in the plan."

What does the decision mean for employers who sponsor employee benefit plans?

When the LaRue decision was released in February, it generated a substantial amount of media attention, with National Public Radio and seemingly every major newspaper in the country covering and analyzing the story. U.S. Secretary of Labor Elaine Chao called LaRue "a huge victory for workers and retirees." Critics, on the other hand, predicted that it would lead to a rash of lawsuits by employees, and might even discourage employers from sponsoring employee benefit plans. What actually happens remains to be seen, but the likely result is probably somewhere between those two extremes.

LaRue is a huge victory for employees in the sense that a contrary decision would have been a significant loss. In that case, participants in 401(k) plans might not have had any remedy for misconduct by plan fiduciaries that caused them substantial losses (at least if that misconduct affected less than all of the plan's participants).

And while employers acting as plan administrators might have preferred a holding that they were immune from liability, such a result probably would have come as a surprise to most employers, who have assumed that they could be held liable for investment mistakes in 401(k) plans. Furthermore, such a result might have been short-lived, as Congress might have stepped in to impose liability by amending ERISA. Finally, it is important to point out that LaRue is not all bad news for employers, because it reaffirms the important rule that damages suffered by an individual participant outside the plan are not recoverable—such as damages for emotional distress or lost opportunities outside the plan.

It remains to be seen how LaRue's "injury to the plan" concept will be applied in the context of unfunded plans (such as many health and welfare plans).

What does the LaRue decision mean for individual employees of the plan sponsor who perform fiduciary functions?

Since some courts hold that employees who perform fiduciary functions can be held personally liable for a breach of fiduciary duty, LaRue increases the exposure of those employees to suits seeking to recover alleged damages out of their personal assets.

LaRue provides a good opportunity for both the employer and the employees to review the terms of any fiduciary liability insurance and any applicable indemnification provisions to make sure the best available protections are in place. For plans that offer participant-directed investments, it might also be appropriate to review processes and procedures to ensure that all participants' directions are actually followed. If a third-party administrator is responsible for processing investment changes, it may make sense to review the applicable contracts to make sure that the third-party administrator is accepting responsibility for any errors made by its employees.

Would a plan amendment be helpful?

Although the Supreme Court voted 9-0 to overturn the lower court's decision against LaRue, four of the justices signed off on concurring opinions that take a slightly different approach to the case. Of particular interest was Chief Justice John Roberts' concurring opinion, which suggested that the type of claim asserted in LaRue should properly be characterized as a "claim for benefits that turns on the application and interpretation of plan terms, specifically those governing investment options," rather than a claim for breach of fiduciary duty. He went on to note that, if this were so, the claim presumably would be subject to the requirement that the participant first exhaust the plan's administrative remedies before bringing suit, and that the plan administrator's decision be given appropriate deference by a reviewing court.

It remains to be seen whether courts will follow the path suggested by Chief Justice Roberts—he noted it was only a theory, and there are arguments to the contrary not addressed in his concurrence. However, plan sponsors interested in this approach may want to consider amending their plans to state clearly that exhaustion of administrative remedies is required for any dispute that involves the interpretation of plan terms, no matter what legal label is attached to that dispute. Doing so would put the plan sponsor in the best position to argue that exhaustion of LaRue-type claims is required, and that the plan administrator's decision must be given deference by any reviewing court.