EDS--The End of Fiduciary Responsibiilty

Every week it seems the courts find some new way to cabin participant rights and remedies.  In Langbecker v. Electronic Data Systems, 39 EBCases 2352, 2007 U.S. App. LEXIS 1125 (January 18, 2007) the Fifth Circuit, in a split decision found a doozy.  Since the DOL issued its 404(c) regulation in 1992, it has been generally understood that section 404(c) did not relieve fiduciaries from liability for limiting or designating investment options in a 404(c) plan.  This view was contained in the preeamble to the regulation as a gloss on regulatory language limiting 404(c)s relief to losses which are "the direct and necessary result of that participant's or beneficiary's exercise of control."  29 C.F.R. sec. 2550.404c-1(d)(2)(1).  In fairness, this view also informs examples included in the regulation itself. See examples 8 and 9 of the regulation.

The debate over whether the DOL had the authority to adopt the position in the preamble turns on whether the language in the statute and the regulation itself are sufficiently ambiguous to permit the DOL's interpretation.  The DOL is entitled to Chevron or Auer deference if there is ambiguity.  Ambiguity is in the eye of the beholder, it seems--and this opinion itself cannot seem to make up its mind about the statute, saying in one place that the statutory language leaves the question open, and in another that neither the regulation nor the statute are ambiguous. 

But what about common sense.  Should plans be able to offer just 3 options or four with employer stock, one or more of which are imprudent, and then argue that 404(c) means there is no liability simply because the participant chose that imprudent option, even without knowledge of its imprudence. 

I think the reasoning of EDS is deeply flawed, and consequently the petition for rehearing en banc supported by AARP, NELA, the Pension Rights Center, and the DOL itself has a good chance of being granted.  But it is the court's lack of sensitivity to the consequences of its decision that troubles me the most.  Assuming the majority felt that it had no choice but to issue the decision that it did, it could have acknowledged rather than denied the extraordinarily harsh results its decision could produce.  Instead, the reader is left wondering whether the court is actually pleased by its vision of an Act that provides participants with no protection against the selection of unacceptable investment alternatives.   If  Congress really meant  to have ERISA work this way, Congress should be asked to think again.  I prefer to think that Congress was not so foolish, but that's hardly a surprise coming from someone who helped write the 404(c) regulation.

Comments

[Carl Johnson]

Mr. Machiz is correct, of course. Langbecker v. EDS, following on the heels of Jenkins v. Yager, 444 F.3d 916 (7th Cir. 2006), pretty much writes fiduciary responsibility and the 404(c) regulations right off the books, at least in a couple of circuits. Here's how I see it.

ERISA defined - a statute enacted September 2, 1974, with fiduciary provisions generally effective January 1, 1975, and generally thought of as remedial legislation intended to protect the interests of plan participants.

With reference to Section 404(c), following a discussion of the basic rules of fiduciary responsibility, Conference Report 93-1280, at page 305, states: "[A] special rule is provided for individual account plans where the participant is permitted to, and in fact does, exercise independent control over the assets in his account. In this case . . . other persons who are fiduciaries with respect to the plan are not to be liable for any loss that results from the exercise and control by the participant . . . . The conferees recognize that there may be difficulties in determining whether the participant in fact exercises independent control over his account. Consequently, whether participants . . . exercise independent control is to be determined pursuant to regulations prescribed by the Secretary of Labor."

When back in 1974 I first read ERISA and the legislative history all of this seemed fairly straightforward to me. Simply put, a plan fiduciary must invest the assets of the plan prudently, in the interests of the plan's participants, unless (and only unless) such investment responsibility is shifted to participants pursuant to Section 404(c) regulations that the Department of Labor would shortly issue. Was I ever wrong!

Although I do not have the data at hand, in my experience participant direction pre-ERISA was included mostly in the profit-sharing plans of small, usually professional, employers. When the 401(k) phenomenon began to take off in the 1980s, that changed.

Oh, yes, the regulations. On September 3, 1987, 13 years and one day after ERISA was enacted, the DOL first published proposed regulations under Section 404(c). After public hearings, the DOL re-proposed the 404(c) regulations on March 13, 1991 (that would be roughly 16-1/2 years after ERISA was enacted, if you're counting). Not until October 13, 1992, approximately 18 years, one month after ERISA's inception are we given final regulations, generally effective for transactions occurring on or after the first day of the second plan year beginning after publication (for calendar year plans, that would be January 1, 1994, approximately 19 years, three months after ERISA). Given that the conferees recognized that there may be difficulties in determining whether the participant in fact exercises independent control over his account, and therefore required the DOL to issue regulations to determine whether such independent control existed, 19-plus years seems like a long wait -- but, maybe not.

Analysis and commentary ensued (even I got in on the act in 1997). The December 1992 issue of the ERISA Litigation Reporter, beginning at page 15, led with the headline: "Now That the 404(c) Regulations are Final, Who Cares?" Among other things, the author reaches the rather odd conclusion that a participant may have no remedy for his impudent investment decision if the plan fails to comply with 404(c) because he himself is the plan fiduciary for his own account.

Although few (if any) would take that position today, the article points out that, "The DOL also seems reluctant to tell us what happens if [section] 404(c) is not met . . . ." Apparently that reluctance continues. In 2003 the DOL's staff informally (unofficially) responded to a question on the result of a plan's failure to comply with 404(c) regulations as follows: " . . . [W]hen any of the requirements of 29 CFR 2550.404c have not been met, the defense to liability under section 404(c) is not available. Whether the plan fiduciaries are liable under section 409 of ERISA for losses to a participant based on a participant’s allocation decisions would then be determined by application of the fiduciary principles in part 4 of Title I of ERISA." ABA JCEB Federal Agency Q&As, Labor Department Q&A-31 (2003). Interestingly, the author of the ELR article also notes that the DOL's take on the issue that's now popped up in Langdecker v. EDS is covered in footnote 27 to the preamble to the final regulations (that's right -- beyond the examples in the regulations to which Mr. Machiz refers, our best authority on this critical issue, other than by inference, is a footnote to the preamble).

Another telling early article was cast in the form of a debate between Joan McDonagh, corporate counsel with Emjay Corporation, and Lloyd Dickinson, an attorney with the Foley & Lardner law firm. Journal of Pension Benefits, p.70ff, (Autumn 1993). Ms. McDonagh asks, "Where's the Fiduciary Relief?" She takes the often (subsequently) expressed position that the 404(c) regulations are so vague and uncertain that the "protection offered by 404(c) is extremely limited and unreliable." One conclusion she reaches is that when plan sponsors take a look at the costs and benefits of 404(c) protection, "the most sensible solution may be to eliminate the feature of participant direction from the plan." I believe that Ms. McDonagh was right for the wrong reason, but her crystal ball turned out to be a little cloudy.

Mine was just as cloudy. I expected plan providers to jump all over 404(c) and use it as a marketing opportunity -- "our products and services offer superior features to protect the plan's fiduciaries under the 404(c) regulations." Instead, the pitch has more often been, "You cannot comply with 404(c), it's too uncertain, so why worry about it -- no one else does."

So, here we are in 2007, ERISA's 32nd year. Much of what's left of our tax-favored "retirement system" rests in "profit-sharing plans" that rely largely on the participant's own contributions for funding, and the participant's own uninformed investment decisions for investment income and growth. Congress in 1974 gave us a fiduciary framework, including section 404(c), within which participant-directed plans could have evolved in a responsible manner. Today we have no idea if 404(c) means anything. Yet, on top of that, we're pushing safe-harbor default investment options and advice and education programs, and Congress has even seen fit to declare by law that the 20 percent level is somehow the right point to become concerned about a portfolio's diversity. Why not simply legislate a 10 percent real rate of return for individual account plans (I'd happily settle for 7 or 8 myself right now)? [Sarcasm intended.] What a mess.

My fix would be to start over. By this point the DOL has probably lost control of the possibilities presented by Section 404(c). Congress needs to get back in the picture and make several things clear. First, every participant needs a meaningful remedy under ERISA where the fiduciary breach affects the value of the participant's individual account. Second, a fiduciary other than the participant must be responsible for the prudent investment of the participant's account unless (and only unless) the requirements of the 404(c) regulations are satisfied to their letter in all respects (and in connection with which the 404(c) disclosure regulations are quickly clarified). Third, the law should make clear that fiduciaries are not required to invest the account of any participant by taking into account the individual participant's situation, but are rather are obligated only to invest the assets of the plan as a whole in light of the plan's principal purposes.

[Tom Geer]

First, 404(c) is a safe harbor, not an exclusive rule.

Second, 404(c) itself permits the DOL to interpret the words "exercises control."

Third, all these decisions are made in a real world where sponsors assume they will fail to jump through all the technical hoops of the regulation, and the regulation does not authorize substantial or good faith compliance. Heaven help us if the courts decide that the regulation is the sole way to fiduciary duty compliance for plans with directed investments, because most plans don't in fact comply.

Are you suffering from the problem of the man with a hammer, who thinks every problem is a nail? We all understand the tendency to pride of authorship, but this regulation is really nothing to be proud of.

[Michael Sladky]

Marc,
RE: EDS-End of Fiduciary Responsibility.
First I see nothing wrong with three investment otions. Second, whether EDS is an unacceptable investment; only time will tell. Third, a match in EDS stock was probably better than no match at all. Fourth, employers have begun to seriously rethink whether offering a 401k savings plan is worth the hassle.
Regards.
Mike

[Marc Machiz]

I was just informed that the Fifth Circuit denied rehearing en banc on February 14 in the EDS case discussed in this post.