Every day business professionals operate with the real threat that a claim and/or lawsuit could be filed against them for actual or alleged errors or negligence in professional services. The purpose of this newsletter is to give you, the reader, a relatively painless way to think about the risks inherent in doing business as an employee benefits professional, and ideas on how to limit those risks. In this article, Joe Faucher of Reish & Luftman summarizes a recent Federal Court of Appeal decision in which plan participants tried to label a TPA as a plan fiduciary, and discusses the concept of co-fiduciary liability. I hope you find the article helpful in navigating your way safely through related liability issues. Ultimately, it is prudent to invest in comprehensive professional liability insurance coverage to protect your business, and personal assets, when threatened and in need of defense.
Anyone who has ever done business with someone suspected of shady dealings knows the meaning of the phrase "if you lie with dogs, you wake up with fleas." Fortunately for third party administrators (TPAs), the Ninth Circuit Court of Appeals recently decided a case in favor of a TPA who suspected its client's CEO of embezzling 401(k) plan monies. The case is CSA 401(k) Plan v. Pension Professionals, Inc., 195 F.3d 1135 (9th Cir. 1999).
Shortly after it began providing plan administrative services for Computer Software Analysts, Inc. (CSA), Pension Professionals, Inc. (PPI) noticed discrepancies between amounts withheld from participant paychecks, and amounts deposited in the 401(k) plan trust. It suspected CSA's CEO of embezzlement.
At that point, PPI had several paths it could have chosen. It could have done nothing, crossed its fingers, and hoped that no court would ever hold it to be liable to the plan or its participants because of its suspicions of the embezzlement. Or, it could have chosen to stay on board, and attempt to pressure the CEO to return the embezzled assets to the plan. Finally, it could have simply "fired" CSA as a client, and walked away from this problem in the making.
What PPI did was to retain an attorney to advise it on the appropriate course. After consulting with the attorney, PPI agreed to continue providing its services for CSA on the conditions that (1) the CEO adhere to a repayment schedule that he proposed in a letter to PPI, (2) PPI would include language in participant account statements indicating that 401(k) assets had not been deposited in the trust account, in violation of IRS and DOL mandates.
The CEO followed the repayment schedule - for a short time - but then presented PPI with what appeared to be falsified financial statements. PPI finally resigned, and the CEO eventually pleaded guilty to embezzling plan assets. Plan participants then sued PPI, seeking to recover the funds that the CEO embezzled.
The theory that the participants sued under was that PPI had become a plan fiduciary under ERISA. Since fiduciary status depends either upon (1) a finding that the plan documents identify the person as a fiduciary, or (2) a finding that the person has performed one of the functions described as fiduciary functions by ERISA and its regulations, and PPI was not designated as a fiduciary by the plan documents, the Plaintiffs alleged that PPI was a "functional fiduciary." Specifically, they argued that in imposing conditions regarding repayment of plan assets as a condition of its continued agreement to provide administrative services, PPI became a plan fiduciary, since it exercised discretionary authority or control over plan administration.
The Court of Appeal disagreed. It held that "the conditions that PPI proposed were designed to assert control over its own engagement, and not to exercise discretionary authority or control over the Plan's management or administration."
The holding is very significant for TPAs and other benefits professionals. It clearly establishes that their primary responsibility runs to the plan sponsor, and not directly to the participants, and distinguishes between the responsibilities of the plan trustees and those of the plan service providers. It also gives guidance to benefits professionals who are put in the difficult position of having to choose between (1) turning a blind eye to negligent (or as in this case, criminal) activities by plan fiduciaries, and (2) risking being perceived as a plan fiduciary.
In the PPI case, the TPA was able to take an approach which allowed it to exert some control over the unethical plan trustee, without becoming a plan fiduciary in the eyes of the court. It just happened to do the right thing in the process - a fact which almost certainly was not lost on the Court.
You might wonder why it would have mattered in the PPI case if the Court had found PPI to be a plan fiduciary. After all, no one ever accused PPI of embezzling any money from the plan. PPI had no access whatsoever to plan assets. The answer lies in the ERISA concept of co-fiduciary liability.
ERISA §405(a) provides as follows:In addition to any liability which he may have under any other provisions of this part, a fiduciary with respect to a plan shall be liable for a breach of fiduciary responsibility of another fiduciary with respect to the same plan in the following circumstances:
(1) if he participates knowingly in, or knowingly undertakes to conceal, an act or omission of such other fiduciary, knowing such act or omission is a breach;
(2) if, by his failure to comply with section 1104(a)(1) of this title in the administration of his specific responsibilities which give rise to his status as a fiduciary, he has enabled such other fiduciary to commit a breach; or
(3) if he has knowledge of a breach by such other fiduciary, unless he makes reasonable efforts under the circumstances to remedy the breach.
In the PPI case, therefore, had the Court determined that PPI was a fiduciary, it could have imposed liability upon PPI under either subsections (2) or (3) above for the losses the plan suffered by virtue of the CEO's embezzlement. Presumably, since PPI insisted that the plan sponsor disclose the fact that 401(k) deferrals had not been deposited into the plan trust, it would not have been held liable under subsection (1) (since it could not have been accused of "concealing" the breach of fiduciary duty).
Of course, in the PPI case, the Court could also have found that PPI had made "reasonable efforts under the circumstances to remedy the breach" under subsection (3). Since the Court found that PPI was not a plan fiduciary, the questions of whether it could be liable as a co-fiduciary, and whether its efforts were "reasonable" within the meaning of the statute, were moot.
There are two additional points that warrant mention. First, the same Court that decided the PPI case has not always been so reluctant to find that a traditional "service provider" or "vendor" crossed the line into fiduciary status. Several years ago, in Thomas, Head & Griesen v. Buster, 24 F.3d 1114 (9th Cir. 1994), the Ninth Circuit concluded that a salesman of notes secured by junior trust deeds rendered investment advice for a fee, and thus, became a plan fiduciary - notwithstanding the fact that he was clearly a salesman who sold only one type of investment to the plan. So, before any service provider or investment vendor gets too complacent about trends in ERISA fiduciary liability law, they should remember cases like Buster.
Second, there are other theories - theories that do not depend upon a finding of fiduciary status under ERISA - that plan participants may pursue. To the best of our knowledge, those theories have not been pursued (or at least successfully pursued) by Plaintiffs in these types of cases. We are probably only a downturn in the market away from seeing those theories advanced.
Since our goal in this newsletter is to protect employee benefit plan service providers, and not to provide good ideas to plaintiff's attorneys, we'll say nothing more, for now, on those theories. Until the next issue, however, I welcome your questions.
Copyright 2000 by Professional Practice Insurance Brokers, Inc., a Hilb, Rogal & Hamilton Company. Reprinted with permission from The Benefits Professional Update, First Quarter Update.