February 28, 2008

The U.S. Supreme Court unanimously ruled on February 20th, 2008 in LaRue v. DeWolff, Boberg & Associates that an individual participant may bring suit for fiduciary breaches under the Employee Retirement Income Security Act (ERISA) to recover losses in an individual defined contribution account. Press accounts have predicted tidal waves of litigation against plan fiduciaries based on this new theory of liability. But while this is certainly the most significant fiduciary liability decision under ERISA in over a decade, ultimate exposure to plan fiduciaries is likely to be much more limited. And here at ULLICO Casualty Company, we care not only whether our policyholders will be sued, but whether they are protected by our fiduciary liability insurance.

The LaRue Facts

The plantiff James LaRue is a former employee of plan administrator DeWolff, Boberg & Associates who participated in DeWolff's 401k plan. He claimed that in 2001 and 2002 he directed DeWolff to, "make certain changes to the investments in his individual account," apparently changing his investment elections out of funds with stock exposure during the market decline. But he claimed that DeWolff never made the changes and this omission "depleted" interest in the plan by $150,000. LaRue sued the DeWolff firm and the DeWolff's 401k plan seeking "make whole" or other equitable relief under section 502(a)(3) of ERISA, codified as 29 U.S.C. 1132(a)(3).

The district court dismissed LaRue's complaint on the grounds that LaRue sought money damages, which are not permitted under section 502(a)(3).

LaRue appealed to the Fourth Circuit relying on both Section 502(a)(2) and 502(a)(3). The Fourth Circuit affirmed the section 502(a)(3) dismissal on the same grounds as the district court. The appelate court rejected LaRue's Section 502(a)(2) claim on the ground that the Supreme Court's 1985 opinion in Massachusetts Life Ins. Co. v. Russell permitted Section 502(a)(2) claims only on behalf of the entire plan rather than on behalf of any one participant's individual interest.

Ruling in favor of LaRue, the Supreme Court  reversed the lower courts and held that an individual plan participant like LaRue has the right to pursue an individual action, notwithstanding the court's prior holding in Russell. The Court expressly noted that, in contrast to the 1970's era of ERISA's founding when defined benefit plans predominated, "defined contribution plans dominate the retirement scene today." The circumstances for an individual participant in a defined benefit plan, according to the Court, are quite different than under a defined contribution plan, because misconduct relating to a defined benefit plan would not affect any one individual's plan interest unless the misconduct caused a default of the defined benefit plan itself:

Accordingly, the Court held that 502(a)(2) "does authorize recovery for fiduciary breaches that impair the value plan asstes in a participant's individual account." The court thus vacated the Fourth Circuit's judgment and remanded the case for further proceedings.

Key Points from the LaRue Decision

Commentators have predicted that the floodgates for claims by individual participants have been unleashed. But the following factors demonstrate that the LaRue decision may not bring an unwelcome increase in potential liability for plan fiduciaries:

1. LaRue Likely Does Not Apply to Defined Benefit Plans: In reversing the lower court, the justices distinguished defined benefit plans from defined contribution plans, noting that the "retirement plan scene today" is dominated by 401k-type defined contribution plans. In the LaRue decision, the Court held that the alleged employer misconduct falls squarely within the enforcement mechanism of ERISA section 409, which relates to the proper management, administration and investment of plan assets. According to the Court, fiduciary misconduct in defined contribution plans does not necessarily threaten the entire plan's solvency so as to reduce participants' benefits, and thus a participant does not have to plead recovery for the "entire plan." Consequently, the LaRue decision likely leaves Russell intact and participants will not have claims against defined benefit plans unless the solvency of the entire plan is at risk. And since most defined contribution claims will relate only to losses in individual accounts, the potential liability is much more limited.

2.LaRue did not win anything yet - he only gained the right to continue his lawsuit: This is a potentially pyrrhic victory for LaRue, as he must go back to the trial court and substantiate his claim. The Court specifically noted that "we do not decide whether [LeRue] made the alleged declarations in accordance with the requirements specified in the plan." He likely has to exhaust his plan administrative remedies. Indeed, the Court noted that it did not decide whether LaRue is "required to exhaust remedies set fourth in the Plan before seeking relief in federal court pursuant to Section 502(a)(2)." And the court did not resolve the question of whether or not LaRue asserted his rights in a timely fashion, a sticking point that limits many fiduciary claims. In other words, LaRue on remand will face steep defenses and evidentiary challenges. LaRue does not change the fundamental principle: just because an individual has the right to pursue an individual claim does not mean that they have a meritorious claim.

3. Are LaRue's Claims Covered under Fiduciary Liability Insurance Policies?: The Key questions for our policyholders is whether individual 401k claims trigger the "benefits due" exclusion found in the typical fiduciary liability policy. A fairly typical "benefits due" exclusion provide that the insurance company "shall not be liabile for that part of Loss, other than Defense Costs that constitutes benefits due or to become due under the terms of a Benefit Program unless, and to the extent that, (i) the Insured is a natural person and the benefits are payable by such Insured as a personal obligation, and (ii) recovery of the benefits is based on a covered Wrongful Act."

The initial consideration is whether the "benefits due" exclusion would even apply to this kind of claim. LaRue filed his claim for breach of fiduciary duty based on Section502(a)(2), and did not assert traditional claims for "benefits due" under Section502(a)(1)(B). but in his concurring opinion, Chief Justice John G. Roberts (joined by Justice Anthony M. Kennedy) questioned whether LaRue's claim was more properly a claim for benefits under ERISA Section502(a)(1)(B), which would have more clearly required exhaustion of administrative remedies, rather than a claim for fiduciary breach under Section502(a)(2). A benefits claims provides fewer remedies and requires that participants first exhaust administrative remedies under the plan before seeking relief in federal court. but for insurance coverage purposes, the question is whether that "benefits due" exclusion is irrelevant to an individual's breach of fiduciary claim under Section502(a)(2). In other words, can you turn a benefits claim, by creative pleading, into a generic breach of fiduciary duty claim just by avoiding the more appropriate benefits due claim under the statue?

While unclear, most benefits due exclusions, and certainly the policies by our company, do not apply to defense expenses. Thus, we would defend any fiduciary in a LaRue-type claim.  Additionally, for plan fiduciaries with personal liability under ERISA section 409(a), the benefit exclusion's coverage carve back preserves coverage for natural person insureds with a "personal obligation" to pay benefits due. Surprisingly, LaRue did not name any natural person defendants in his lawsuit. If both natural persons and entity defendants were involved, potentially difficult allocation issues for indemnity amounts could arise if the personal obligation section of the exclusion were triggered.

4. Most LaRue Liability Will Fall on Administrators: Most 401k plans are administered by third-party service providers. Plan fiduciaries retain their fiduciary responsibilities even if the plan retains a third-party administrator, but insurers will retain the right to subrogate against the TPAs to the extent they pay any losses. This is another reminder to plan trustees to outsource fiduciary functions to competent service providers with expertise on fiduciary functions.

5. While Common, Most LaRue-type Claims Will Be resolved Before Litigation: The premise behind most predictions of a flood of litigation is that this type of claim of failing to execute investment elections is very common. The issue involves a participant who submits an investment directive to the plan administrator, the administrator fails to follow or correctly implement the directive, and the participant suffers an investment loss. But while this type of loss is common, in most circumstances, the plan fiduciary/vendor pays the claim, known as a surcharge, without dispute. In fact, in the reverse situation when the participant's directive is not followed and the participant actually benefits, the participant is typically permitted to retain the mistaken gain. Thus, most LaRue claims will never make it to litigation.

For further information about our products and programs, contact John O'Brien, Assistant Vice President of Marketing, toll free at 888.315.3352 or jobrien@ullico.com

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