Financial advisors who provide services to businesses with 401(k) plans and other arrangements governed by the Employee Retirement Income Security Act (ERISA) have a new reason to review fiduciary practices and double-check professional liability insurance. Earlier this year, the U.S. Supreme Court ruled in the case of LaRue v. DeWolff, Boberg & Associates that James LaRue, who lost approximately $150,000 when the administrator of his 401(k) plan failed to carry out investment instructions he gave, could sue the administrator for a breach of fiduciary duty. The ruling made clear for the first time that an individual plan participant could sue a plan administrator to recover losses that did not affect all or a large number of plan participants.

The case adds to the litigation concerns that threaten to chill growth of advisor-sold 401(k) plans to small- and mid-sized businesses, an increasingly productive area for many financial advisors. At Fidelity alone, total record-kept assets in such plans stood at $21.2 billion at the end of 2007, an increase of 26% from the previous year. Several factors are helping to drive the growth in advisor-sold 401(k) plans, including the Pension Protection Act of 2006, which provided guidelines necessary to encourage plan sponsors to retain qualified fiduciary advisors and to define safe harbor procedures to insulate them from the liability associated with the advice.

The ruling comes as growth in the 401(k) advisory business pulls ahead of awareness or acknowledgement of the fiduciary status that many say is an inherent part of working with ERISA plans. But that is slowly changing as an increasing number of financial institutions acknowledge and in some cases support the fiduciary role. Recently, for example, LPL Financial began requiring that all LPL advisors wishing to offer consulting services to retirement plan sponsors enroll in a Fiduciary 360 training program to receive the Accredited Investment Fiduciary (AIF) designation. At Fidelity, spokesperson Stephen Austin notes "an uptick in registered investment advisors acting as co-fiduciaries since the Pension Protection Act."
The potential fallout from the case for advisors is unclear since LaRue must establish in District Court misconduct on the part of the plan administrator and the extent of the resulting damages. It also involves an administrative misstep, not investment advice or investment results. And lawsuits involving individuals are likely to be less attractive to attorneys than bigger class action cases.

But attorneys appear ready to roll should even a small percentage of the 50 million or so employees of companies that offer 401(k) plans decide to sue financial advisors, employers and other plan fiduciaries for losses in individual plans.

Soon after the Supreme Court announced its ruling, the law firm of Shepherd Smith & Edwards posted a blog titled "U.S. Supreme Court Decides That 401(k) Retirement Participants Can Sue For Losses Under ERISA." After explaining the ruling and its implications for individuals, the blog advises readers, "If you or someone you know may be a victim of misconduct, contact Shepherd Smith and Edwards for a free case evaluation by one of our attorneys."

Andrew Stoltmann, a plaintiff's attorney and partner at Stoltmann Law Offices in Chicago, believes the decision "opens financial advisors to a wave of lawsuits. This is an extraordinarily significant decision that opens the floodgates on litigation, and it will be difficult to close them. With the subprime meltdown it is possible that cases are forming at this point."

Those who work with plan sponsors and advisors are less dramatic, but urge caution nonetheless. "There has been a lot of media attention paid to this case, so many people are going to be aware that they can sue plan sponsors and those associated with them, including financial advisors, for fiduciary breaches," says Ken Raskin, head of the employment law practices group at White & Case in New York City. "I think there will be an initial short-term spike in lawsuits, frivolous or otherwise, from some of the millions of plan participants out there."

The ruling also underscores the contention that even those who do not acknowledge a fiduciary role are not necessarily protected, says Richard Lynch, chief operating officer of fi360.com, which runs a fiduciary accreditation program. "Advisors who do not acknowledge fiduciary responsibility are just sticking their heads in the sand," he maintains.  

Plaintiffs' attorneys agree. "If someone sues you, it's almost immaterial whether or not you believe you are a fiduciary. The judge will look at your relationship with the plan sponsor and participants as evidence," Stoltmann concurs. "It doesn't matter what you call yourself. When you are handling a 401(k) plan you are a per se fiduciary."  

Lynch observes that many vendors do little or nothing about educating advisors with regard to their role as fiduciaries, and the majority of broker-dealers still do not acknowledge fiduciary status. Despite the uncertainty surrounding the ruling and its potential impact, those who have carved a niche in the 401(k) market say that with careful planning and safeguards, the benefits of acting as advisor to such plans outweigh the risks.

"Legal liability has always been a concern to advisors, and this just adds one more aspect of it," says Libby Dubick, president of Dubick & Associates, a financial services and advisor marketing consulting firm. "If anything, it provides another reason for businesses with retirement savings plans to bring in an outside expert."

Steven Kaye, president of American Economic Planning Group in Watchung, N.J., views the ruling as "a positive development for my business because it makes employers more aware of fiduciary issues and what I bring to the table, and I think it will prompt more plan sponsors to hire 401(k) consultants."  Many of the businesses he works with are former clients of brokerage firms who are looking for better processes and safeguards to protect themselves. When meeting with prospects, Kaye explains potential liabilities and how a registered investment advisor can put practices into place, such as having an investment committee and offering appropriate investments addressing fiduciary risk. To protect himself, he carries pension fiduciary errors and omission insurance costing him about $2,000 a year and speaks several times a week with an attorney conversant in ERISA matters.

    Experts say other areas advisors working with 401(k) plans might review include:
Service agreements. Attorney Ken Raskin says the ruling should prompt advisors working with 401(k) plans to look into their professional insurance coverages and to review service agreements with clients, particularly with regard to avenues a plan sponsor, or employer, has in recovering losses. "Financial advisors should consider having service agreements in place that limit liability to issues involving fees rather than to investment losses," he advises.
A conflict-of-interest policy that discloses issues such as the fact that an advisor is paid based on asset growth should also be in place, advises Ron Hagan, CEO at Roland Criss, a firm that audits and certifies pension plans. "I've seen plan sponsors repeatedly trapped in lawsuits over this issue."  If documents need to be changed to add more protections, he says, "it's better to do it now rather than later. The ruling provides an opening for advisors to meet with 401(k) clients and talk about how to handle governance issues."  
Vendor relationships and fees. Kaye views acting as a go-between between his employer clients and their vendors as an important part of his role. "The interests of vendors are often at odds with those of the plan sponsor, or employer," he explains. "The vendor wants to get the most revenue possible and do education maybe once a year, rather than quarterly. The employer wants to get the maximum amount of service for the money." Kaye says he will often challenge vendors about fees, the appropriateness and scope of fund lineups, educational services and other issues.
Documentation. "You can't just suggest a group of lifestyle funds and think your fiduciary obligations are being met," says Stephen Ferszt, an attorney with Wolff & Samson in New York City who works with financial advisors on ERISA-related issues. "To be protected, advisors need to show that participants are receiving the information and education they need to make decisions."
One way fiduciaries can demonstrate that they have carried out their responsibilities is by documenting the processes involved, and experts say a detailed record of participant education and governance procedures can mean the difference between winning and losing a lawsuit. "The fiduciary standard is a process standard, not a performance standard, and the best protection from liability is to have a good investment process in place," says Lynch.
Education and training. A number of guides are available to advisors to better understand and carry out fiduciary obligations and expand 401(k) plan business:
- The Department of Labor Web site includes a sample fee disclosure form at (http://dol.gov/ebsa/pdf/401kfefm.pdf ) and a booklet titled Meeting Your Fiduciary Responsibilities (http://dol.gov/ebsa/publications/fiduciaryresponsibility.html).
- 401kexchange.com has a Provider Ratings & Market Share Report that ranks plan service providers based on nearly 50,000 plan sponsor satisfaction surveys, as well as marketing and prospecting tools.
- The Center for Fiduciary Studies at fi360.com sells Prudent Practices for Investment Advisors and other fiduciary handbooks and has information on its fiduciary training programs.
- Information on obtaining a plan audit and CEFEX certification is available at www.rolandcriss.com.