Sued By Your Own Employee?

Being sued by an employee doesn’t sound like fun, especially if that employee is an Attorney. But why would an Attorney do this? Surely they are well educated and understand the inner workings of law office operations.

What circumstances could provoke an Attorney to sue their employer? Sexual Harassment? Maybe. Failure to compensate as agreed? Not likely, as these complaints are usually settled internally quickly and amicably. Failure to make Partner? Age Discrimination? What else?

Some of the most overlooked and under-estimated liabilities are those associated with the management of an employee benefit plan. Specifically, a qualified retirement plan that is subject to ERISA (Employee Retirement Income Security Act) and Internal Revenue Code § 401(a). The pitfalls are difficult to identify, yet the liabilities are very real.

Never has retirement been such an important issue to Americans as it is today. The irony of this is that most don’t pay close enough attention to their retirement plans until they realize they are grossly deficient in necessary funds to retire. Surely most of these cases are not the fault of the Plan Sponsor, the Trustees or the Plan Administrator, yet some are. Many Trustees and others who had responsibilities to cautiously manage their retirement plans will find themselves in serious trouble due to their casual approach to a critically important responsibility.

Bruce’s Story - A Hypothetical Example

Bruce was hired right out of law school in 1968 by a successful, but relatively small Law firm. He was one of 18 Attorneys who were regular full time employees. In 1989, the Partners adopted a 401(k) plan. The Partners, who were also the Trustees, hired a professional investment advisory and management firm for the first four years to invest the 401(k) contributions. In the fifth year, the employees, including Bruce, begged the Trustees to allow them to "self-direct" the investment of their accounts. The Trustees succumbed to the pleadings of the plan participants, and they hired a long time friend of one of the Trustees, who worked as an investment salesperson. The Trustees were told by the new investment representative that as long as they had at least three investment choices and participants were allowed to change their investments quarterly, then the Fiduciaries would not be liable for the poor investment decisions the employees made, which is only partially correct.

All of the employees attended an enrollment meeting where they were enrolled in the new investments, given some information about each individual investment including past fund performance and other data that would soon be filed and forgotten. Bruce listened to the thirty minutes worth of "investment education", and feeling "educated" made his investment choices. Over the next five years, the world and domestic economies would fluctuate wildly, and the style of the investments drifted away from what they were intended to do. Surely an educated man like Bruce knew that he should monitor his portfolio to ensure he was still on the right track yet he didn’t. The next time he saw the investment representative was three years after the initial enrollment and did not know that he needed to be "re-educated". He assumed that the investment rep would tell him whether he needed a change, and since no such information came, he was lulled into a false sense of security about his progress.

It is now the year 2000, and Bruce is now 56 years old. He begins to assess his financial position and begins to see that he will not have enough money to retire when he wanted. In fact, he will have to work until he is 71 before he can fully retire. How could this have happened? His father died at age 73! He decided to take all of his data to his CPA to try to figure out what went wrong. His CPA concluded that had he allocated his 401(k) portfolio differently, he would have been able to retire at age 66, and his funds would have lasted well past his life expectancy. Only if he had known!

Bruce consults with a friend, who is an ERISA Attorney and learns that the Fiduciaries who were charged to protect the participants had failed in their responsibility. When the Plan strategy was changed to allow participants direct their own investments, the Fiduciaries assumed a greater responsibility. Bruce filed a lawsuit against the Fiduciaries of his 401(k) plan to recover the accumulated deficiencies in his account. The Fiduciaries defense was that since their plan was intended to be a 404(c) plan, their liability was limited and that they would be protected from a lawsuit arising from a participant who has invested unwisely.

The Fiduciaries were surprised to find out that their plan, when examined in a court of law, was found not to comply fully with 404(c) and therefore were not protected from Bruce’s lawsuit. How could this have happened? How could this have been prevented? Allowing participants to choose their own investments is only a small part of the equation, and this is not where the Fiduciaries failed. The failure occurred, in part, because Bruce was not given solid ongoing advice, education, communication and monitoring to ensure he has headed in the right direction. Still there is more.

So what should you do?

Being pro-active in analyzing your plan will make a huge difference. In gathering information for your plans’ Trustees and Fiduciaries, consider the following:

Is your plan intended to comply with 404(c)? Does your plan document state this?

Are your participants getting all of the education, information and communications required?

Have the Trustees retained a Registered Investment Adviser and delegated fund management to him/her?

Complying with 404(c) is a "all or none" proposition. This means that a plan must comply with ALL aspects of 404(c) to access the Fiduciary protection desired.

What To Look For

Here are the main items you should be looking for:

1. Does the plan allow participants to choose from a broad range of investment alternatives that meet certain criteria? At a minimum, your plan should have at least three different investment choices with materially different risk and return characteristics.

2. Does the plan allow participants the opportunity for participants to exercise control over assets in their accounts, and are they educated on a routine basis to ensure they know how to exercise control over their accounts. Further,

a. Participants must be permitted to make transfers among investment alternatives with a frequency commensurate with the volatility of the investments, but not less than quarterly.

b. Participants must be able to give their investment instructions to an identified plan fiduciary who is obligated to comply with those instructions. (Registered Investment Adviser, Trustee, Administrator etc.)

3. Making sure the participants understand what they are trying to accomplish, and how their chosen funds are going to help attain their goals is critical. Allowing participants to wander aimlessly, even if you have had educational meetings is dangerous. You may not know who "gets it" and who does not, so a good follow-up system should be implemented. It is important to proactively communicate, ask the right questions and keep on it until the participants understand. This ensures that your employees have interpreted and internalized the educational and investment data into something that it is useful and meaningful. Problems occur when expectations and reality don’t match.

4. Complying with 404(c) can be a lot of work. The key is consistency, proactivity, ongoing communications and participant reassessment. If this seems like a hassle or too much work, the Trustees can delegate these responsibilities to a Registered Investment Adviser (RIA) and none else. Many insurance agents and mutual fund sales people are licensed to sell the right investments, but because they are not Registered Investment Advisers, they can not have certain duties officially delegated to them. This means under these scenarios that the Trustees would retain 100% of the responsibility for educating participants, selecting funds, investing funds and continually staying on top of things. The value of a good Investment Adviser, like that of a good Attorney, should never be underestimated.

Conclusion

Complying with 404(c) should not be a casual thing. It was intended to require rigorous and diligent Fiduciary efforts to ensure participants are being taken care of. If complying with 404(c) is too much work, either hire a Registered Investment Adviser to assume the 404(c) compliance responsibilities, or hire the Adviser to develop a non-participant directed, yet solid investment portfolio that is designed to accomplish specific goals. Don’t assume your participants understand their investments, or where their current portfolio will take them because most Fiduciaries don’t. Closely examine the retirement plan at least quarterly. Make sure participants understand their rights and where they "could be" in the future by exercising t hose rights. Lastly, like all Human Beings, no one likes to admit that they don’t understand, especially when they think their friends in the office do. You should assume that at least half of your employees don’t fully understa nd their plan and investments. Be proactive and let them know help or information is always available, and not to be embarrassed to ask for it -- like Bruce was.