Enron, 404(c) and the Personal Liability of Corporate Officers

By Fred Reish and Joe Faucher

Corporate officers who serve as 401(k) investment fiduciaries are legally responsible for participants’ investment decisions—not just for the investment options, but also for the directions given by the participants. Is that statement a radical idea or a legal reality?

In our last column, we discussed the significance of ERISA’s 404(c) protections—or, more accurately, the consequences of failing to satisfy the requirements in the 404(c) regulation. For a copy of the regulation, see www.reish.com/pa/benefits/404cregs.cfm. The conclusion was that unless participant-directed plans satisfied the Section 404(c) conditions, the investment fiduciaries—usually the members of the plan committee—were legally responsible for participants’ investment decisions. Since in our experience, few plans satisfy the 20-plus requirements in the regulation, most of the investment fiduciaries for the over 300,000 401(k) plans are – probably unknowingly – legally responsible for the prudence of participant investment decisions. (For a list of those requirements, see www.reish.com/pa/benefits/20steps.cfm.)

In the days since we wrote that column, the Department of Labor (DOL) has filed its “Amended Brief of the Secretary of Labor as Amicus Curiae Opposing the Motion to Dismiss” in the Enron 401(k) litigation [Tittle v. Enron Corp., Civil Action No. H-01-3913 (S.D. Tex.)]. We have posted a copy of the brief on our website at: www.reish.com/publications/pdf/dol_enron.pdf.

The DOL brief was filed in opposition to motions by the defendants (including Enron, Kenneth Lay, the Plan Administrative Committee members and Enron’s Compensation Committee members) to dismiss the class action lawsuit filed against them by Enron’s 401(k) plan participants. The brief lays out the DOL’s thinking on a host of important fiduciary issues, including the following:

• Who has fiduciary status for investments [see e.g., ERISA §3(21)(a) and 29 C.F.R. §2509.75-8 at D-4].
• The personal liability of the fiduciaries [see ERISA §409(a)];
• The duty to prudently select and monitor (and remove) a company stock option (under the general fiduciary responsibility rules of ERISA §404(a));
• The duty to override the terms of a plan document where prudence so requires [see ERISA §404(a)(1)(D)]; and
• The liability of directed trustees [as a result of either the general fiduciary rules in ERISA §404(a) or their co-fiduciary responsibilities under ERISA §405(a)].

We will write about most of those issues in future columns. For purposes of this column, though, the brief explains the DOL’s interpretation of 404(c) and the consequences of failing to satisfy the conditions of the Section 404(c) regulation.

The DOL begins its 404(c) discussion with this conclusion:

The only circumstances in which ERISA relieves the fiduciary of responsibility for a participant-directed investment is when the plan qualifies as a 404(c) plan.

The brief goes on to explain that a fiduciary “is not liable for losses to the plan resulting from the participant’s selection of investments in his own account, provided that the participant exercised control over the investments and the plan met the detailed requirements of a Department of Labor regulation.” [Emphasis added.]

The brief points out that the Section 404(c) regulation sets out the detailed conditions for qualifying as a Section 404(c) plan. Because the statute gives the DOL broad authority for determining, through the issuance of a regulation, the criteria for qualifying for 404(c) protection, there is little, if any, chance that fiduciaries could prevail in a claim that they did not comply with the specific requirements of the regulation, but nonetheless provided the participants with adequate information. Expressed in a different way, it will not be sufficient to argue that the fiduciaries satisfied the “spirit” of the law. Further, in drafting the regulation, the DOL considered—and rejected—the concept of a safe harbor where the fiduciaries could either literally comply with the specific requirements of the regulation (i.e., the safe harbor) or, alternatively, satisfy the statute on other grounds [See the preamble to the final regulation, 57 Fed. Reg. 46906, 46907 (Oct. 13, 1992)].

In response to the defendants’ (Enron, Lay, et al.) argument that the plaintiffs (the participants) failed to explain how the plan did not comply with the requirements in the 404(c) regulation, the DOL posited that the fiduciaries had the burden of showing compliance, and not vice versa:

...Enron, and not the Plaintiffs, bear the burden of showing that §404(c) applies (In re Unisys, 74 F.3d at 446; Allison v. Bank One-Denver, 289 F.3d 1223, 1238 (10th Cir. 2002). Here, Enron has not established that ERISA §404(c) applies to the Savings Plan in general or to the choice of Enron stock as an investment option within the Savings Plan in particular.

That conclusion is supported by the preamble to the final Section 404(c) regulation, which states:

It is the Department’s view that section 404(c) is similar to a statutory exception to the general fiduciary provisions of ERISA and, accordingly, the person asserting applicability of the exception will have the burden of proving that the conditions of section 404(c) and any regulation thereunder have been met. [57 F.R. 46906, October 13, 1992]

The brief describes several 404(c) conditions that Enron had not demonstrated that it satisfied, including the following:

• Whether the participants and beneficiaries were provided with an explanation that the plan intended to qualify as a Section 404(c) plan. [DOL Reg. §2550.404c-1(b)(2)(i)(B)(1)(i)]
• Whether the participants and beneficiaries were given an explanation that, if the plan qualified as a Section 404(c) plan, the fiduciaries would be relieved of liability for losses under the circumstances described in the 404(c) regulation. [Id.]
• Whether the plan satisfies the specific regulatory requirements for employer stock. [DOL Reg. §§2550.404c-1(b)(2)(i)(B)(1)(vii), -1(b)(2)(i)(B)(2)(vi)(C)(3), and -1(d)(2)(ii)(E)]

The DOL concluded:

Absent a showing that the plan qualifies as a 404(c) plan, the fiduciaries retained full fiduciary responsibility for all of the plan’s investments, including the Enron stock that the participants directed the Trustee to purchase with their employee contributions. In re Unisys, 74 F.3d at 443-47.

While the DOL picked those examples of the Section 404(c) requirements, in our practice we have seen several other common failures to satisfy the Section 404(c) regulation, for example:

• Failure to appoint a 404(c) fiduciary and to inform the participants of the identity of, and contact information for, that fiduciary. [DOL Reg. §2550.404c-1(b)(2)(i)(A) and -1(b)(2)(i)(B)(1)(vi)]
• Failure to provide participants with prospectuses immediately before or after their initial investment in a particular option. [DOL Reg. 2550.404c-1(b)(2)(i)(B)(1)(viii)]
• Failure to notify participants of the additional information they may request under the regulation. [DOL Reg. §2550.404c-1(b)(2)(i)(B)(1)(vi) and (B)(2)]

If 401(k) investment fiduciaries are legally responsible for participant investments unless the plan satisfies the Section 404(c) conditions, why aren’t fiduciaries taking the steps necessary to be protected by the Section 404(c) shield?

The answer is not clear. Why would a fiduciary unnecessarily expose him- or herself to claims from the widow of a 65-year-old participant who invested entirely in employer stock or entirely in a technology fund? What about the 25-year-old who is invested entirely in cash—year after year? Most people would agree that those are imprudent decisions—and, unless the plan complies with Section 404(c) requirements, they are the legal responsibility of the plan’s investment fiduciaries (i.e., of the officers or committee members who oversee the plan’s investments).

By complying with the 20 to 25 conditions in the Section 404(c) regulation, which are not overly burdensome, fiduciaries can “insure”—or protect themselves against—the imprudent investment, or asset allocation, decisions of participants.

It is inconceivable that a responsible officer or committee member would accept that potential liability if they understood the risk and if they knew that Section 404(c) protection was available. The likely problem is that the attorneys, consultants and investment providers have not done an adequate job of explaining ERISA Section 404(c), and its value, to plan sponsors. The clear statement of the DOL’s interpretation of the law in the Enron litigation may change that.

As an aside, the cost of fiduciary breach insurance is increasing, particularly for plans that hold employer stock. If the trend of increased 401(k) fiduciary litigation continues—and if it expands to cover other, more common, 401(k) investments (such as mutual funds)—it is almost certain that the premium costs for fiduciary insurance will increase significantly.

Conclusion
The DOL’s explanation of the consequences of failing to satisfy the conditions for Section 404(c) protection is a wake-up call for plan sponsors, fiduciaries and advisors. Without that protection, 401(k) investment fiduciaries are needlessly exposing their personal estates to risk—and their advisors may be called upon to share in that risk if they have not adequately explained the importance of Section 404(c) protection.

Learn more about R&R related practice areas:
Employee Benefits
ERISA Litigation