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Observations on Employee Ownership

Implications of the LaRue Decision for ESOPs

Corey Rosen

February 2008

(Corey Rosen)Since a seminal case in 1985 (Massachusetts Mutual Life Insurance Company v. Russell, 473 U.S. 134), courts have largely, if not unanimously, concluded that individuals cannot sue ERISA plan fiduciaries for individual losses to the plan. Internal Revenue Code Section 409(a), which governs such suits, states that fiduciaries are liable to make good any losses to a plan resulting from a breach of their duties. The plan in question was a disability plan that failed to pay Russell out in a timely manner. The court concluded that Russell could not sue for monetary damages under Section 502(a)(2) of ERISA, which allows employees to seek damages under Section 409(a), because the breach did not affect the benefits that other participants would receive under the plan. The argument was that monetary damages could be provided only for the plan as a whole, so employees could sue only on behalf of the plan, not themselves. That same logic applied equally well to defined benefit plans because they assure that participants will get whatever they are promised, even if the fiduciaries had to make up losses to one or more individual participants. Only possible plan insolvency or fiduciary errors that threaten the plan's benefits could override these issues. Individuals could generally sue only under a different section of ERISA, Section 502(a)(3), which provides for equitable relief (here, that would mean changes in plan operations), not individual monetary damages.

In a defined contribution plan, however, losses to individuals represent a more difficult problem. Under Section 502(a)(3), a typical decision (as has happened in a number of "stock-drop" suits) has been for the plan to be changed so that assets become more diversified. Under Section 502(a)(2), assets to the plan overall might also be restored, such as by making an additional corporate contribution and restoring benefits to a class of former employees affected by the fiduciary breach. But what if the problem concerns not all the participants, but just one or a few? If they cannot sue for monetary damages individually, but only on behalf of the plan, what good would that do them? How could their losses be restored, especially if they no longer worked for the company?

On the other hand, many attorneys feared that if individuals could sue for financial damages personally under Section 502(a)(2), there could be a flood of lawsuits, even if the allegations were not well-grounded. Fiduciaries, it was argued, have enough of a responsibility just making sure the plan overall is not damaged; if any individual could sue for damages for any violation, companies might decide not to set up plans at all, leaving employees worse off.

On February 20, 2008, in LaRue v. DeWolff, Boberg & Associates (No 06-856), the Supreme Court unanimously concluded that individuals do have the right to sue for individual monetary damages under Section 502(a)(2), although a concurring opinion by Chief Justice Roberts leaves some room for doubt as to just how such suits should proceed. The case has now been remanded to a lower court to determine whether a fiduciary breach actually occurred and what the damages, if any, should be.

LaRue was a 401(k) plan participant who alleged that failure to make changes in his investments that he requested just before the 2001-2002 stock market plunge cost him $150,000. Lower courts denied the suit, saying that participants can sue only on behalf of the entire plan.

The Supreme Court reversed these rulings. During oral argument, judges wondered how the problem could have been resolved if LaRue had to sue on behalf of the plan instead of as an individual. Would assets have to be moved from other accounts to restore his balances? That was clearly not an option. The majority opinion, written by Justice Stevens, said that the Russell opinion and similar cases reflect a benefits "landscape that has changed." Now that individual account plans dominate, it is often impractical to sue for the entire plan when the problems rest with individual accounts. The Court ruled that fiduciary misconduct that affects either the assets of one or more individuals, or the whole plan, is exactly what the law was meant to cover for these kinds of plans.

In their concurring opinion, Justices Thomas and Scalia went even farther, saying that the "the allocation of a plan's assets to individual accounts for bookkeeping purposes does not change the fact that all the assets in the plan remain plan assets." So, they said, the plain language of the law makes it clear that a Section 502(a)(2) argument is appropriate.

However, Chief Justice Roberts and Justice Kennedy, in their concurring opinion, took a somewhat narrower view. While agreeing that individuals could sue under Section 502(a)(2), they also wrote that individuals should exhaust administrative remedies first. Some attorneys have commented this would become a common line of defense because many plaintiffs do not exhaust these remedies.

So what does this mean for ESOPs? The decision specifically includes all form of defined contribution plans, so ESOPs are covered. Generally, ESOP experts believe it will have much more impact on 401(k) plans than on ESOPs, particularly for fiduciary errors and omissions and for excessive plan charges. How much the decision will allow employees to sue over choices or performance of investments in plans is hard to say given the facts of this case and that the Court did not specifically comment on this matter. Still, the large majority of ESOPs are funded by the company with no individual choices or directions, so losses to one participant's account are likely to be mirrored in accounts of other participants. ESOP lawsuits, in other words, could already usually proceed under Section 502(a)(2). Of course, that does not mean some aggressive attorneys will not try this tack anyway or that there could not be situations where there are specific individual issues, particularly regarding errors and omissions for individual accounts (failing to offer a diversification election, for instance). A very broad reading of the case, however, could include a decline in stock value after an employee leaves but before payout.

On the other hand, some attorneys have concluded (but others disagree) that LaRue may make it more difficult for participants to file class-action lawsuits against any kind of plan if courts conclude they could instead have sued as individuals. In that case, it is likely that only individuals with large account balances and a tolerance for legal wrangling will proceed.

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