In a major ruling, the First U.S. Circuit Court of Appeals held that employees who retire and receive lump-sum distributions from their company’s defined-contribution plan, such as a 401(k), have the right to sue the administrators of the plan if they don’t believe their moneys were managed wisely. As our population ages and our economy sputters, the handling of retirement moneys faces strict scrutiny. This important decision makes plain that fiscal prudence is in the eye of the beholder — especially when what the beholder is left holding, after years of hard work, feels a little light.
Keeping the money in good Grace
When Keri Evans and Timothy Whipps, employees of the large manufacturing company W.R. Grace & Co., retired in 2001 and 2002, they received lump-sum distributions from the company’s defined-contribution plan. This kind of plan creates an individual account for each employee, into which both the employee and the employer make contributions over the years the employee works. Upon retirement, the employee receives the money from his or her account in the form of a distribution. The amount of the distribution depends on the long-term performance of the investments made with the joint contributions.
The plan offered by Grace included an option to invest in the company’s own stocks, called the “Grace Common Stock Fund.” Grace itself put its bets on the fund: It not only invested all employer contributions in the fund but also barred employees from moving the contributions out of the fund and into an alternative investment until reaching the age of 50.
Fall from Grace
Unfortunately, neither Grace nor the fund did well. Grace stock became a risky investment because of financial pressures from asbestos-related product-liability litigation. By January 2001, plan administrators had stopped putting employer contributions into the fund. A few months later, Grace filed for bankruptcy. Evans retired within weeks of the bankruptcy filing, and Whipps retired one year later.
Evans and Whipps believed their retirement moneys had been eroded by the administrators’ decision to continue offering Grace stock as an investment option and putting all employer contributions in the fund, even when it became clear the company’s stock was declining in value. Essentially, they claimed they received less money on the day they “cashed out” of the plan than they would have received in the absence of mismanagement by those entrusted with investing on their behalf.
It’s one thing to feel the financial pinch while still on the job, but it’s quite another to feel it after working for many years and expecting to retire with a comfortable pension. Evans and Whipps (with others) sued various plan fiduciaries in their personal capacities, including those at Grace.
Breaking the fall
The federal district court in Boston dismissed the lawsuit, saying that neither Evans nor Whipps met the Employee Retirement Income Security Act (ERISA) definition of a plan “participant” because they weren’t suing for “benefits” but rather were suing for “damages.” The decision operated as a bit of a “gotcha” — although a current employee could go to court and claim mismanagement, he or she was out of luck once retired. That was true even if the very same mismanagement might have caused the retiree to receive a lesser distribution than would have been the case with sound investing.
The First Circuit rejected the lower court’s “gotcha” approach. The claim for additional benefits is really the same as a claim for damages: In either instance, the person wants a sum of money to make him or her whole for losses caused by the fiduciary’s breach. And a retiree can’t obtain damages for everything that might go wrong. For example, ERISA doesn’t permit lawsuits for damages from the emotional distress caused by the plan’s failure to honor its obligations, its failure to advise on tax consequences, or for any delay in processing a benefit claim.
But the law does require fiduciaries who fail to manage retirement funds prudently to “make good” to the plan and those who depend on it when they fail to carry out their fiscal duties properly. Experts, the appellate court advised, can help those harmed calculate the loss to the plan by comparing performance of imprudent investments with the performance of a better portfolio.
The appellate court refused to draw what it called an “arbitrary distinction” between current and former employees. All should be able to recover. The lower court’s view, the appellate court sardonically noted, would encourage an employer to defeat an employee who has a legitimate claim by keeping the mismanagement of the plan a “well guarded secret” until the employee “cashes out” and receives benefits.
Prudence trumps Grace
Unlike defined-benefit plans, in which employees get a fixed amount irrespective of the plan managers’ investment strategy, defined-contribution plans depend on administrators doing the best job possible because the amount distributed will rise or fall with the managers’ fiscal acumen. This decision puts an increased burden on plan administrators and employers to handle retirement moneys wisely. And it gives aging baby boomers, not inclined to sit quietly on the sidelines, the right to sue if they’re delivered too little for their golden years.