Corporate America is definitely not losing a lot of sleep over the 3rd Circuit's July 2007 decision in Graden v. Conexant Systems Inc. But those in charge of ERISA compliance may be facing some restless nights.
The ruling--which gives individuals who pull their money from an ERISA plan a continuing right to sue plan administrators under the statute--does not increase the overall liability of plan sponsors. However, by broadening the circle of ERISA claimants, it makes record-keeping considerably more complicated for employers.
"The advice law firms were giving to clients was that they had no responsibility for former participants in the plan, and people who had cashed out were off the rolls from a liability and a record-keeping perspective," says John Nixon, vice chair of the employment services group in Wolf Block's Philadelphia office.
Howard Graden's lawsuit changed all that.
Graden was an employee of Conexant, a semi-conductor developer, who participated in the company's retirement 401(k) savings plan. The plan allowed participants to invest their money in various predetermined investment packages.
Graden directed his money into a package composed entirely of Conexant common stock, which traded on the Nasdaq. Between March 5 and Oct. 4, 2004, Conexant's stock plummeted from $7.42 to $1.70. On Oct. 4 Graden pulled all his money out of the plan.
Graden maintained that a risky and ultimately unsuccessful merger with GlobespanVirata Inc. caused the stock drop. In February 2005, he sued Conexant, alleging the company, its officers and individual members of the committee that administered the plan had breached their fiduciary duty to plan participants by offering the stock fund as an investment option, knowing it was not a prudent investment. Graden also accused the defendants of making false and misleading statements about the merger that caused him to invest in the fund.
The U.S. District Court of New Jersey dismissed Graden's suit in March 2006 for lack of standing. Judge Stanley Chesler concluded that Graden was not a "participant" for ERISA purposes because he had cashed out of the plan before suing.
"The District Court's decision was in accord with what everyone understood the law to be," Nixon says.
Graden appealed. The Department of Labor and AARP filed briefs supporting him. The National Association of Manufacturers countered with a brief in support of Conexant.
As the Court of Appeals saw it, Judge Chesler had erred. ERISA, the 3rd Circuit noted, defined a participant as "any employee or former employee ... who is or may become eligible to receive a benefit of any type" from an employee benefits plan.
"In other words, ERISA entitles individual account-plan participants not only to what is in their accounts but what should be there given the terms of the plan and ERISA's fiduciary obligations," the Court of Appeals reasoned.
As an account holder in the Conexant plan, Graden was entitled to the net value of his account in the absence of fiduciary mismanagement. If his suit succeeded, some of the assets restored to the plan would have to be allocated to his account.
"When determining participant standing under ERISA, the relevant inquiry is whether the plaintiff alleges that his benefit payment was deficient on the day it was paid under the terms of the plan and the statute," the court concluded. "If so, he states a claim for benefits, which, if colorable, makes him a participant with standing to sue."
Graden, then, increases the potential claimants under ERISA. And that creates challenges for companies that sponsor 401(k) plans.
"The difficulty arising from Graden is that even if plan sponsors encourage participants to take their money out, they remain as possible claimants," Nixon says. "Sponsors will have to review their service provider agreements to ensure proper post-termination records are being kept."
Nixon says his firm hasn't yet arrived at a definitive recommendation as to how long those records should be maintained, but suspects it will be six years, the standard limitation period.
The silver lining is that Graden doesn't change the overall extent of plan sponsors' liability.
"The plan is the entity that's entitled to recover all of its loss under ERISA, and the total of the loss will be the same, regardless of the number of claimants," says Jeffrey Norton, a member of Harwood Feffer, and Graden's attorney. "It boils down to allocation."
The judgment in Graden supports Norton's reasoning.
"The loss to the plan would necessarily include losses suffered by former employees who were invested in the Conexant Stock Fund, and the amount of recovery would have to make good on those losses," the court stated. "Otherwise, the plan would not recover all of its loss."
If the plan recovered money that could only be allocated to people no longer in the plan, the court pointed out, it would be unclear what the plan was entitled to do with that money.
In the end the bigger concern for corporations is whether Graden will fuel an increase in ERISA lawsuits.
"Historically, it's much less likely that current employees will sue their employer, whereas former employees tend to be bolder about it," Norton says. "So despite the fact that Graden doesn't change the overall amount of the liability, I can see why employers fought it so hard."