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Conflicts of interest, bitter ex-employees, fuzzy lines of authority -- how many ways can a CFO leave her company 401(k) open to a lawsuit?
David M. Katz, CFO.com | US
April 1, 2003
Let's look in on a business lunch with an imaginary CFO, who we'll refer to simply as "X."
In the normal course of events, X has lunch with one of her company's bankers, as she has several times before. On several previous occasions, she has asked the banker about a new loan for X's company, and today, after some pleasantries, the banker proposes terms for the loan. As far as X is concerned, the interest rate and maturation date are not to her taste; perhaps they seem just a little "off."
X expresses her dismay at the terms, but then raises an issue that the banker hadn't considered: the bank in question is also her company's 401(k) services provider. X suggests, ever so subtly, that there are other 401(k) providers out there — and that her plan just might choose a new one.
Granting that his employer would very much like to hold on to the company's 401(k) account, the banker shaves a half-point off the loan's proposed interest rate and extends its maturation date.
A coup for X? In these cost-cutting times, you'd think so. But our imaginary CFO could be setting herself up for a day in court by using her company's retirement plan as a bargaining chip, says Ann Longmore, an insurance broker who offered up the hypothetical case. "Tacitly threatening to move [a 401(k) plan] elsewhere if we don't get good rates on a loan," is a prohibited transaction under the Employee Retirement Income Security Act of 1974 (ERISA), says Longmore, a senior vice president with Willis Group in New York City.
The act bars 401(k) plan decision-makers from doing deals on behalf of someone "whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries." In X's case, her negotiations on behalf of her company to get the best terms for the loan may have undermined the interests of her 401(k) constituency. Had she put the plan services up for bid, she might have done a good deal better for the plan.
But such practices have been barred since ERISA's 1974 enactment. Why worry now about a wink and a nod over lunch? Answer: 401(k) plans and their fiduciaries have lately become prime targets for lawsuits. And conflicts of interest like X's might prove particularly alluring to plaintiffs' lawyers, say some experts.
To avoid showing favor either to the corporation or its 401(k), a senior executive might well give the plan as wide a berth as possible. Grant Seeger, the chief executive officer of Security Trust Company in Phoenix, decided recently to do just that when he removed himself from the company's four-member retirement plan committee.
Granted, Seeger's case might not be run of the mill. As a supplier of back-office services to retirement plans, Security Trust forms alliances with such folks as investment consultants and 401(k) recordkeepers. Seeger feels his heavy business involvement with such providers might make him especially prone to divided loyalties. "I don't want to influence who we hire as a provider," he says, explaining his decision to steer clear of retirement-plan deliberations.
On the other hand, Security Trust CFO Loretta Griffin is a member of the 401(k) committee. Since most finance chiefs have at least some say in how the plan is run — or responsibility for naming someone who does — they tend to bear fiduciary liability, and sitting on a retirement committee is likely to boost their exposure. But Griffin minimizes that risk, notes CEO Seeger, by being a strategist rather a bean counter. Decisions based solely on cost, he adds, might not be in the best interests of plan participants.
Among retirement-related fiduciary risks, potential conflicts of interest might be the most common cause of dyspepsia for CFOs, since they arise from the very nature of the finance chief's job. In today's litigious environment, however, many kinds of administrative and structural missteps might put plan participants in a suing frame of mind. Let's let Madame X get her own bromo, while we look into some other potential causes of legal distress — and what you might do for relief.
If a 401(k)'s investment alternatives perform poorly, participants who are no longer with the company — including those who have been fired — might be more likely to sue than those who are, says Ed Goldfinger, CFO of Empirix, a Waltham, Massachusetts-based Web applications provider.
To minimize the risk, the company's plan sponsors "encourage people as they leave to roll [their funds] into either their next 401(k) or an IRA, and we do send out annual reminders urging people to move the money on," he adds. Many companies make such a move mandatory for ex-employees with less than a certain amount in their accounts. Goldfinger, a member of Empirix's three-person plan-oversight committee, says that they have talked about a threshold of $5,000.
Fuzzy Lines of Authority
In small or private companies, where executives are likely to wear an abundance of hats, responsibilities can become blurred. That can put finance chiefs in a no-win situation when it comes to the 401(k): fiduciary liability without sufficient control. When retirement-plan duties aren't spelled out clearly, says benefits attorney Alden Bianchi, the CFO might discover that HR has hijacked the process. If the human-resources people sign on with a dismal mutual fund, employees hit hard by the its poor performance might sue the plan for not following best practices.
Since CFOs tend to have more investment savvy than other executives and are legally responsible for how the plans are run anyway, thinks Bianchi, they'd be prudent to have a say in how those plans are run. "Best practice is [for CFOs] to have a formal grant of authority from the board that the 401(k) is within their portfolios," he says, noting that such a structure is easy to defend in court.
Fettered Plan Participants
The tales of Enron 401(k) participants unable to access their investments have become almost as iconic as the sight of steerage passengers locked below-decks on the Titanic. "If I had company stock in my plan, I would look at ways to liberalize participants' ability to get out," advises Stephen Saxon, an attorney with the Groom Law Group in Washington, D.C. Plan sponsors, says Saxon, should raise the standards in their plans at least to the level spelled out in HR 1000, the pension reform bill reintroduced by Rep. John Boehner.
Under the bill, employees who invested their own retirement savings contributions in company stock would be free to divest that money and reinvest it in other options. Employers that made contributions in company stock would have the option of allowing workers to sell that stock three years after receiving it in their 401(k) plan or after three years of service.
Too-Rigid Investment Policies
Under ERISA, plan sponsors aren't responsible for the investment performance of participants' accounts. They are, however, liable for following the procedures they set up. That, benefits experts say, makes a well-thought-out investment policy statement a good thing to have on hand in case of a lawsuit. Empirix's Goldfinger, for instance, says that his company's plan adheres to "objective thresholds" when it considers dropping a fund.
But sometimes a downgrade in a mutual fund's rating doesn't tell the whole story, the CFO says, and sponsors can serve participants better by probing deeper into the situation. A "plan has to be specific enough that it's executable, yet leave enough room for creativity," he adds.