The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

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August 2007

401(k) Liability: Lessons From The American Experience

By: Hugh Wright & Jasmine Walsh

In the past decade, there has been an unprecedented volume of litigation in the pension and benefits industry. Shifting demographics have led members of group retirement savings plans to more closely scrutinize all aspects of their financial futures. Even the most routine activities of plan sponsors, administrators, and trustees are being called into question as members seek to ensure the integrity of their ‘pension promise.’

In Canada, the vast majority of pension litigation to date has been in the context of Defined Benefit plans. To a large extent, this reflects the pension industry in Canada which has traditionally favoured DB models, particularly in the public and quasipublic sectors.

Less Common

In the past decades in the United States, the DB model has become far less common. Participation in Defined Contribution plans – called 401(k) plans for the section of the Employee Retirement Income Security Act (ERISA) that permits them – have grown exponentially.

A definitive trend is emerging south of the border in 401(k) litigation. A common feature in most of these actions is the allegation that plan sponsors and service providers have breached their fiduciary duties by charging inappropriate and excessive fees against the pension fund.

401K Liability

This trend raises definite questions for DC stakeholders in Canada. Are the policy and statutory contexts in which DC plans operate sufficiently similar to warn of litigation ahead in the Canadian DC world? Further, if the answer to that question is ‘yes,’ what can Canadian plan sponsors learn from their counterparts south of the border to avoid liability?

Until recently, very little active litigation had been undertaken by DC plan members in the U.S. claiming breach of fiduciary responsibilities in relation to administrative fees. The litigation to date can be divided into two categories – the early cases and the post – 2006 cases.

Early Cases

In Whitfield v. Tomasso in 1988, the plaintiff successfully claimed for breach of fiduciary duty by showing, among other things, that the trustees of the 401(k) plan allowed the administrative expenses to climb to 50 per cent of the plan’s annual income over a seven-year period. The conduct of the trustees in Whitfield was clearly beyond the expectations of a fiduciary under the common law or under ERISA.

ERISA requires trustees to discharge all duties solely in the interest of the participants and beneficiaries for the exclusive purpose of providing benefits with the “care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

In Whitfield, the Eastern District Court of New York found that the trustees were unaware of the costs of their administrative expenses, that they were not properly documented, and that they had been advised by an accountant that the expenses were too high and did nothing to remedy the situation. Each trustee was required to account to the fund for all expenses in excess of 10 per cent of the fund’s income.

In Brock v. Robbins et al, the Seventh Circuit Court of Appeals heard an appeal from a decision of the Northern District Court of Illinois dealing with administrative expenses. The same provisions of ERISA were considered. There, the trustees had agreed to continue a service agreement with an external insurer without concrete knowledge of the insurer’s rates. Payment of the insurer’s fees was charged against the fund.

The Court of Appeals held that this was a breach of fiduciary duty within the meaning of ERISA. The fees were not unreasonable, however, and no actual loss to the fund occurred. Despite this, the court held that non-monetary equitable relief was appropriate against the trustees, such as an order that they should never act in a fiduciary capacity in relation to a 401(k) plan in the future.

2006 And Forward

In 2006, litigation concerning high administrative fees in the U.S. gained sudden momentum. This was no surprise to stakeholders who had been paying close attention to the 401(k) market.

In the late 1990s, the U.S. Department of Labour commissioned a study. The ‘Study of 410(k) Plan Fees and Expenses (DOL Study)’ examined “the incidence, structure, and magnitude of fees and expenses charged to sponsors of and/or participants in 401(k) plans.”

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