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PHILADELPHIAA former employee who has cashed out of his 401(k) plan can still sue the plan's administrator for mismanaging the plan's assets, says a federal appellate court, in a decision that observers says significantly increases the number of plan participants who can file suit against their plan sponsors.
The former employee is still considered a participant under the Employee Retirement Security Act, which governs the plan, says the 3rd U.S. Circuit Court of Appeals in its July 31 opinion in Howard Graden vs. Conexant Systems Inc. The unanimous three-judge panel's opinion reverses a lower court decision dismissing the case.
The lawsuit, which seeks class action status, has attracted significant attention, with the Washington-based National Manufacturers Assn. submitting an amicus brief supporting Newport Beach, Calif.-based Conexant, while briefs supporting the plaintiff were filed by the Washington-based AARP and the U.S. Department of Labor.
According to the decision, Mr. Graden, who was a Conexant employee until 2002, and a participant in the company's 401(k) plan until 2004, had directed his money into a fund composed entirely of the stock of Conexant, which develops semiconductor devices for the telecommunications industry.
Between March 2004 and October 2004, when Mr. Graden cashed out, the company's stock dropped from $7.42 to $1.70 per share. Mr. Graden charged the drop "was the result of a risky and ultimately failed merger," says the opinion. He said Conexant had breached its fiduciary duty by offering the stock fund as an investment option and making false and misleading statements about the merger.
The question presented "is one of statutory standing," says the opinion. "ERISA defines a participant as 'any employee or former employee...who is or may become eligible to receive a benefit of any type from an employee benefit plan."'
ERISA "entitles individual account plan participants not only to what is in their accounts, but also to what should be there given the terms of the plan and ERISA's fiduciary obligations," says the decision. "From this, it is not difficult to conclude that Graden has standing as a plan participant. As an account holder in the Conexant plan, he was entitled to the net value of his account as it should have been in the absence of any fiduciary mismanagement."
The decision notes that NAM's amicus brief said finding Mr. Graden to be a participant would require employers to make costly disclosures to people who have cashed out. But the appellate decision said "inclusion of ostensibly cashed-out employees derives from the text of the definition" and a 1989 U.S. Supreme Court decision in Firestone Tire & Rubber Co. vs. Bruch.
"We cannot imagine holding a plan fiduciary liable for failing to provide information to someone who, as far as the fiduciary knows, is cashed out," the ruling stated.
Defense attorney Robyn F. Tarnofsky, of New York-based Paul, Weiss, Rifkind, Wharton & Garrison L.L.P., which represented Conexant, said, "We're still studying the decision."
"It's obviously a huge decision because many district courts have been going the other way on this particular issue," said plaintiff attorney Jeffrey M. Norton, of Harwood Feffer L.L.P. in New York.
Stephen D. Rosenberg, an attorney with McCormack Firm L.L.C. of Boston, said, however, the decision "is consistent with a trend we're seeing in deciding how to interpret this language. Many courts are...giving plaintiffs in these cases standing."
Attorneys say the decision means more plaintiffs will file suit against plan administrators. "It means untold numbers of retirees and employees and former employees" who had lacked standing to pursue losses because of fiduciary breaches "now have a cause of action where they didn't before, where that right was more or less in limbo for the last couple of years," Mr. Norton said. Even so, he said he does not think there will be an a significant increase in ERISA litigation.
Mr. Rosenberg said if there are layoffs, "people are going to cash out," and these will be people "who aren't too happy with their former employer and may be more willing to file suit than someone still with the company."
"And at the same time, you have what's clearly a developing wave of litigation" over the issue of fiduciary breaches in managing 401(k) assets, Mr. Rosenberg said.
Mr. Rosenberg said the case is also significant because the "first wave of defense in all fiduciary cases is always procedural," and a court may not have been allowed to proceed to a lawsuit's merits. A decision like Graden "is saying the court can get to the merits," said Mr. Rosenberg.
Howard Graden, appellant, vs. Conexant Systems Inc., et al., 3rd U.S. Circuit Court of Appeals No. 06-2337, July 31, 2007.