The DOL's Enron Brief: What it Means for 401(k) Investments
While the Enron case primarily involves participant investments in employer stock, the fiduciary principles raised in the case broadly apply to the selection and monitoring of all investments in 401(k) plans. Rather than focus on the employer stock aspects, this article highlights how the issues raised in the Enron litigation generally apply to fiduciaries and investment options for 401(k) plans.
The Department of Labor (DOL) filed a brief, as a “friend of the court” (amicus curae), in Tittle v. Enron. The case is a class action lawsuit by the participants in Enron’s retirement plans. The defendants include Enron, former Enron CEO Kenneth Lay, members of the plans’ Administrative Committee and members of Enron’s Compensation Committee. The DOL filed its brief in response to the defendants’ attempt to have the case dismissed.1 While the positions taken by the DOL in its brief are not new, they have not been well publicized and are not known by many sponsors of 401(k) plans.
People’s Actions as Well as Their Titles Dictate Whether They Are Fiduciaries
Cindy Olson argued that she should not be liable because she was only acting on behalf of the corporation (Enron). Ms. Olson was both a member of the Administrative Committee and an officer of Enron. In its brief, the DOL responds that Ms. Olson would have been a fiduciary even if her involvement had been limited to fiduciary acts as an agent or officer of the plan sponsor. That is, she would have been a “functional” fiduciary because she was making fiduciary decisions [e.g., selecting the investment options for the 401(k) plan].
However, the DOL asserts that the court does not need to conclude that Ms. Olson was a functional fiduciary because she was a named fiduciary as a member of the Administrative Committee. (The Enron plan document identified the Administrative Committee as a plan fiduciary.)
There have been conflicting court decisions on whether a corporate officer who does not serve in an official (i.e., named or appointed) fiduciary capacity runs the risk of becoming a fiduciary by making fiduciary decisions on behalf of the corporate plan sponsor. The DOL and most of the courts have concluded that it does result in fiduciary status.
There is no dispute that service as an appointed or named fiduciary (e.g., a plan committee member) results in fiduciary status.
Since fiduciary status means potential personal liability under ERISA, while acting as an agent for the corporation does not, the determination of fiduciary status is significant – particularly to Ms. Olson and the other members of the Administrative Committee who, under the DOL analysis, have their personal net worths exposed to the claims of the 401(k) participants.
Persons Who Have the Power to Appoint Other Fiduciaries Are Themselves Fiduciaries
The DOL stated in its brief that Enron, Kenneth Lay and the members of the Compensation Committee were fiduciaries because they had the power to appoint, retain and remove the members of the Administrative Committee.
The DOL’s position is not new. Shortly after the enactment of ERISA in September 1974, the DOL expressed its position that the persons who appoint fiduciaries are themselves fiduciaries in Interpretive Bulletin 75-8. It is the DOL’s position that fiduciaries must prudently select and regularly monitor their appointees as well as terminate them when they are not properly performing their duties. The plaintiffs claim that the Compensation Committee failed to monitor the performance of the Administrative Committee. As a result, they say, the failure of the Administrative Committee to perform its duties was not identified and corrected. Assuming the Compensation Committee members were fiduciaries (which appears to be the case), and that the allegations are correct, the members of the Compensation Committee are exposed to potential personal liability.
In our experience, in most cases the plan committee members are appointed by the board of directors or a key officer (e.g., the CEO). In those cases, the directors or the appointing officers would be fiduciaries under this principle.
The board of directors or whoever appoints the plan committee members should review and discuss the qualifications of the candidates – and only qualified people should be appointed to the plan committee. After all, the selection and monitoring of the investment options will have a profound effect on the retirement benefits and post-retirement standard of living for the employees. They should provide the appointees with adequate resources to do their jobs. The appointees should report to them at least once a year as to their activities. The appointing fiduciaries (i.e., the board or the officers) should review that report and approve it, once they are satisfied with its contents. If the appointees are not fulfilling their duties, they should be removed. Finally, all of these activities should be documented and kept in a due diligence file.
Fiduciaries Must Override the Terms of the Plan if They Would Require the Fiduciary to Act Imprudently
The defendants argue that they did not violate their fiduciary duties as the terms of the plan required them to include Enron stock in the plans.
The DOL indicates in its brief that ERISA §404(a) forbids fiduciaries from following the terms of the plan document where it would be imprudent to do so or would otherwise violate ERISA. The DOL asserts that the defendants should not have allowed participants to invest in Enron stock when they knew it was not a prudent investment. The DOL concludes that, if the stock was no longer a prudent option, the defendants were required to remove it from the plan, even if the plan document provided for it.
Fiduciaries must act prudently and in accordance with ERISA, even if the terms of the plan document require otherwise. Where the terms of the plan conflict with ERISA, fiduciaries are required to ignore those terms. This concept conflicts with the IRS position that the qualification rules require that a plan be administered according to its terms. While it is, from an academic perspective, possible for the two agencies to enforce those conflicting interpretations, as a practical matter it is inconceivable that they would. The likely outcome is that the IRS would defer to the DOL by acknowledging that fiduciaries may override the terms of a plan where it would be imprudent to follow them.
Fiduciaries May Be Liable for Losses Resulting from Participants’ Imprudent Investment Options if the Requirements of §404(c) Are Not Satisfied
In its brief, the DOL interprets ERISA to say that fiduciaries are not liable for losses sustained by participants resulting from participants’ imprudent selection of investments only if the requirements of ERISA §404(c) are satisfied. This position is consistent with the language in the preamble to the regulations for ERISA §404(c). The preamble indicates that the DOL considered and rejected the idea of a safe harbor where fiduciaries could either comply with the requirements of the regulation or, alternatively, satisfy the statute by other means. As a result, it appears as though the only way fiduciaries may be relieved of liability for losses resulting from participants’ imprudent investment selections is if all of the requirements of ERISA §404(c) are complied with. There are over 20 requirements specified in the regulations to ERISA §404(c).2
The DOL brief asserts that the fiduciaries (i.e., the defendants) did not demonstrate that they satisfied the following requirements of ERISA §404(c): (1) participants and beneficiaries were provided with an explanation that the plan intends to qualify as a 404(c) plan; (2) participants and beneficiaries were provided with an explanation that fiduciaries will be relieved of liability for losses; and (3) the requirements for employer stock were satisfied.
While the DOL highlighted those examples, we have seen several other common failures to satisfy ERISA §404(c), including: (1) the failure to appoint a 404(c) fiduciary; (2) the failure to notify participants as to the identity of and contact information for the appointed fiduciary; (3) the failure to provide participants with prospectuses immediately before or after their initial investment in a particular option; and (4) the failure to notify participants of the additional information they may request.
The consequences of failing to comply with ERISA §404(c) is that fiduciaries may be personally liable for losses sustained by participants as a result of their imprudent investment decisions.
Trustees May Be Required to Override a Fiduciary’s Instructions if the Trustee Knows or Should Know that a Breach Will Occur if it Follows the Instructions
In its brief, the DOL states that if the facts are true as alleged, Northern Trust was required to stop the lockdown. (Prior to Enron, lockdowns were called blackouts. However, politicians, reporters and plaintiff’s attorneys have added this colorful and dramatic language to our vocabulary.) Northern Trust was a directed trustee and the recordkeeper for the plans. The DOL states that, as a directed trustee, Northern Trust was a fiduciary. Pursuant to the DOL brief, if Northern Trust “knew or should have known” the truth about the volatility of Enron’s stock and the instability of the company, then Northern Trust should have stopped or delayed the lockdown.
The American Bankers Association (ABA) and the SPARK Institute (also known as the Society of Professional Administrators and Recordkeepers) have filed “friend of the court” briefs in the Enron matter arguing against the positions taken in the DOL’s brief.3 The ABA argues that ERISA requires a trustee who is directed by a named fiduciary, i.e. a directed trustee, to refuse to comply with the fiduciary’s instructions “unless it is clear on its face” that the directions violate the terms of the plan or ERISA. The SPARK Institute argues that the DOL implies that recordkeepers (as opposed to directed trustees) are required to prevent lockdowns if they would be imprudent. This DOL position is only relevant for directed trustees who have the ability to intercede. Northern Trust was in a unique position in that it was a directed trustee as well as a recordkeeper. As a result, it was a fiduciary who, as a recordkeeper, had the ability to stop the lockdown. In most cases, the DOL’s position would not be relevant for third party administrators, recordkeepers and investment providers as they are not fiduciaries.
Service Providers May Be Liable if They Participate in a Breach of Fiduciary Duty
Service providers may be liable under ERISA if they have actual or constructive knowledge of the circumstances that make a fiduciary’s actions a breach of fiduciary duty and if they participate in the breach. The DOL brief states that Arthur Andersen may be liable to the plaintiffs for participating in the fiduciaries’ breach of fiduciary duty. It cites the Supreme Court’s holding in Harris Trust v. Salomon Smith Barney as authority for its position.
If a service provider (e.g., a third party administrator, consultant or broker) becomes aware of actions that may be a breach of fiduciary duty, the service provider should consult with an ERISA attorney to determine if it has any exposure. As a general comment, be particularly cautious about advising, documenting or reporting any such activities. For example, if the service provider falsely completes a Form 5500 by failing to disclose a prohibited transaction, there may be exposure. Similar issues exist for documenting transactions like plan loans or other transfers of money or assets that are imprudent or prohibited.
Conclusion
The DOL’s Enron brief provides a unique opportunity to understand the DOL’s positions on ERISA’s requirements for 401(k) fiduciaries. ERISA requires fiduciaries to act prudently in all of the aspects of their fiduciary duties. Fiduciaries should be cognizant of those requirements, should perform their duties in a thoughtful and thorough manner, and should carefully document their activities in order to avoid potential problems.
ENDNOTES
© 2003
Article was reprinted, with permission, from The ASPA Journal, Vol. 33, No. 2 (Mar-Apr 2003). Copyright 2003 ASPA. All rights reserved.
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