Court Keeps 404(c) Shield in Place for Trustee

A retirement plan trustee was protected by Employee Retirement Income Security Act's (ERISA) 404(c) safe harbor shield against a lawsuit by two 401(k) participants in connection with wrongdoing charges against the plan’s investment adviser.

The plaintiffs filed the suit after finding out that their accounts had been hit with a significant asset loss because of the activities of the adviser, whom both had appointed to manage their accounts.

The court noted that plaintiffs David Tullis and Michael Mack were two physicians who maintained pension funds through the Toledo Clinic Employees’ 401(k) Profit Sharing Plan, and that in the early 1990s, they chose William Davis of Continental Capital Corporation as their investment adviser.

In this case the plaintiffs alleged that Defendant UMB Bank:

  1. breached its fiduciary duty;
  2. violated ERISA;
  3. was negligent in failing to warn;
  4. made “bogus” investments;
  5. engaged in misrepresentation and fraud; and
  6. violated security laws.

The Facts

In October 1999, the U.S. Securities and Exchange Commission (SEC) entered a Temporary Restraining Order against Capital because two of its brokers were engaged in fraudulent activities, and the court noted that the plaintiffs contend that the defendant, UMB Bank, which served as the Trustee for the plan, knew of this fraud – but failed to inform them.  Subsequently, in April 2001, UMB Bank filed suit against Davis and a subsidiary of Capital on behalf of the Toledo Clinic Employees’ 401(k) Profit Sharing Plan, alleging that several investments were improper, that they had severely declined in value immediately after being purchased, or that the investments simply never took place.

However, the plaintiff’s allege that the defendant again failed to inform them of either Davis’ or Capital’s fraudulent activities.  Additionally, the court noted that the defendant UMB Bank “continued to accept and honor allegedly forged investment directives from Davis without consulting or warning the plaintiffs.”   Consequently, the plaintiffs continued to maintain their investment account with Davis.

Motion for Summary Judgment

Then in the spring of 2003, a court order ended Capital's ability to conduct business and appointed the Security Investor Protection Program as Trustee.  During the ensuing bankruptcy proceedings, it was discovered that a number of Davis' investments were nonexistent, and it was at this point the plaintiffs discovered "the full extent of the losses to the value of their pension plans."  According to the court’s summary Tullis alleges as of February 28, 2003, UMB Bank represented the value of his retirement assets to be $724,561.29, while the actual value was just $142,269.41.  Moreover, Mack contends that on July 1, 2001, the defendant represented the value of his retirement assets to be $1,613,407.87, but when Mack attempted to withdraw those monies he discovered that they were only worth $420,793.57 - a difference of $1,192,614.30.

Suits Filed

The plaintiffs initially filed suit against Davis, Capital, UMB Bank, and "others" in the Lucas County Court of Common Pleas, cases that the court notes were stayed pending the outcome of the bankruptcy proceedings. The plaintiffs then requested the Toledo Pension Plan, which administered the 401(k) program, bring suit against the defendant for the bank’s alleged breach of fiduciary duties as an ERISA trustee.  However, the plan declined to do so, according to the court, citing a Master Trust Agreement (“MTA”) that includes an indemnification clause holding the bank harmless from claims. Consequently, the plaintiffs filed this action in the Northern District of Ohio on January 24, 2006.

In considering the motion for summary judgment, the court noted that the defendant UMB Bank argued that no liability exists as a fiduciary for losses resulting from plaintiffs’ exercise of control over their own assets.  Additionally, the defendant asserted that, even if it were liable for such activities, the applicable statute of limitations limits recovery to losses incurred within the last six years.  Plaintiffs, on the other hand, claimed that those affirmative defenses were procedurally barred, and that even if they were permitted, UMB retained responsibility as a “directed trustee.”

ERISA 404(c) Applied

U.S. District Judge David A. Katz of the U.S. District Court for the Northern District of Ohio ruled that UMB Bank had met the legal requirements for Section 404(c) under the Employee Retirement Income Security Act (ERISA), specifically noting that:

  • the plan documents clearly indicated the plan's intent to be a Section 404(c) plan;
  • the participants had independent control over their accounts and were provided sufficient information to establish the opportunity to exercise that control; and
  • those participants could invest in any asset that was legally permitted and administratively feasible (complying with the "broad range" of investment alternatives requirement).

Here the court rules that, “between the manual and plan documents, Defendant provided Plaintiffs “sufficient information” within the meaning of ERISA in order to properly establish the opportunity to exercise control.”

As for the statute of limitations, the court held that since the 404(c) safe harbor defense was applicable, and sufficient to dismiss the claim, there was no reason to consider that objection.

Prohibited Transactions

The plaintiffs also argued that UMB Bank followed several investment directives that were prohibited under ERISA, and therefore breached its fiduciary duty.  However, Judge Katz noted that, “In the instant case, although several prohibited transactions may have occurred, Defendant simply did not cause the plan to engage in those transactions.”  He went on to note that, as agent for the plaintiffs, Davis caused the plan to engage in transactions used for the benefit of a party-in-interest (himself), but that since “plaintiffs exercised individualized control over their own assets and selected Mr. Davis as their agent, and therefore, as aforementioned, the Defendant Bank cannot be held liable for breach that occurs as a result of such individualized control.”  Judge Katz noted that, “section 406 of ERISA clearly prohibits fiduciaries from causing the plan to engage in prohibited transactions, rather than simply allowing such transactions to occur.”

Moreover, he observed that “Plaintiffs concede that Defendant performed no review of the investment directives in question, but indicate that Defendant was under an obligation as a fiduciary to do so.”  Judge Katz dispensed with this claim, noting that “as Defendant was relieved of fiduciary obligations under 404(c), and Defendant did not cause the prohibited transaction and therefore did not engage in a prohibited transaction within the meaning of ERISA.”

Trump Card

Plaintiffs had also argued that UMB Bank had an obligation to provide them with an accurate valuation of their assets - but Judge Katz once again invoked the "trump card" of ERISA 404(c ), noting, “Because the Court has established that Plaintiffs exercised independent control over their plans, Defendant cannot be held responsible for the valuation breach in question that resulted from Plaintiffs' exercise of independent control.”

Finally, regarding UMB Bank’s status and obligation as a directed trustee to the plan, the court noted that once again, “…section 404(c) shields Defendant from liability. Section 404(c) provides Defendant with insulation from fiduciary duties that would otherwise ordinarily be imposed,” Judge Katz noted in rejecting the notion of fiduciary liability in this case.  As for the accuracy of the account valuations, Judge Katz said that “This provision of the regulations accompanying section 404(c) of ERISA does not require a fiduciary to guarantee that all material facts are conveyed to participants; the regulations prohibit fiduciaries from concealing facts,” and that while “A plan fiduciary may have an affirmative duty to disclose material non-public facts to a beneficiary in certain circumstances,” that “…in all of the cases in which a fiduciary was found to have an affirmative obligation to disclose information first involved an inquiry initiated by a plan participant.”

Judge Katz went on to note that “In the absence of an inquiry, fiduciaries need not disclose changes made to a benefit plan to the beneficiary,” and ”because Plaintiffs made no timely inquiry into the plan changes, Defendant was under no affirmative duty to disclose changes.”

The ruling is available here.