DC plan re-enrollment litigation

July 15, 2013

In this article we review litigation coming out of the 2008 global financial crisis that addresses re-enrollment programs. We begin with a brief discussion of what re-enrollment programs are and the authorization of them under the Department of Labor's Qualified Default Investment Alternatives (QDIA) regulation. We then discuss two cases – Bidwell et al. v. Univ. Med. Ctr. et al. and Falcone v. DLA Piper – that address re-enrollment programs that took place (in connection with QDIA regulation compliance) in 2008.

Background

Let's begin with a definition. Generally, ‘re-enrollment’ refers to a sponsor-initiated program, under a defined contribution plan that allows participants to designate investments, that requires participants with assets in some or all of a plan's current funds to either (1) affirmatively elect to invest those assets in a specific fund (or funds) or (2) be defaulted into a QDIA (typically, a target date fund (TDF)). Thus, unlike a plan default provision that applies to participants who have not designated an investment option, a re-enrollment program applies even where the participant has previously made a designation.

Re-enrollment can come up in a variety of situations, e.g., where a plan fund (or funds) is being eliminated, where the plan's providers are being changed, or as part of a comprehensive initiative to ‘reset’ participant investment choices and ‘nudge’ participants towards investment in, e.g., a TDF.

The QDIA regulation

While re-enrollment programs have (of necessity) been around more or less since the invention of participant choice, the first really massive wave of re-enrollments occurred in 2007-2008, when DOL published the QDIA regulation. That regulation provided that a sponsor/fiduciary can (where certain requirements are met) default a participant into a QDIA, and the participant will be treated as if she had affirmatively elected the default. Generally (and oversimplifying), a QDIA is a TDF, a balanced fund or a managed account.

To get the protection for defaults provided by the QDIA regulation, the following conditions must be met:

(1) The assets must be invested in a QDIA.

(2) The participant must have been given an opportunity to provide investment direction but have not done so.

(3) A notice generally must be furnished in advance of the first investment in the QDIA and annually thereafter.

(4) Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants.

(5) Participants must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments but at least quarterly.

(6) The plan must offer a "broad range of investment alternatives" as defined in ERISA section 404©.

The big question: can you ‘default’ participants who have previously made an election?

The main issue dealt with in the QDIA regulation was, what is an appropriate default fund, especially in the context of, e.g., an automatic enrollment program? It was clear that DOL's position – that the only safe harbor defaults were QDIAs – had consequences for past defaults, which often were directed to capital preservation funds such as money market funds and stable value funds (SVFs).

Many sponsors, however, were unable to tell which investments in, e.g., an SVF had been ‘defaulted there’ and which were in the fund because of an affirmative election. This problem presents the critical issue for re-enrollment programs: where a participant has affirmatively elected to invest in a particular fund, can you move his money out of the SVF and into a QDIA under a re-enrollment program, where the participant makes no affirmative election in connection with the re-enrollment?

The preamble to the final QDIA regulation seems to give a very clear ‘yes’ answer to this question:

It is the view of the Department that any participant or beneficiary, following receipt of a notice in accordance with the requirements of this regulation, may be treated as failing to give investment direction for purposes of [condition (2) above], without regard to whether the participant or beneficiary was defaulted into or elected to invest in the original default investment vehicle of the plan. Under such circumstances, and assuming all other conditions of the regulation are satisfied, fiduciaries would obtain relief with respect to investments on behalf of those participants and beneficiaries in existing or new default investments that constitute qualified default investment alternatives. ... Like the proposal, the final regulation applies to situations beyond automatic enrollment. Examples of such situations include: The failure of a participant or beneficiary to provide investment direction following the elimination of an investment alternative or a change in service provider, the failure of a participant or beneficiary to provide investment instruction following a rollover from another plan, and any other failure of a participant to provide investment instruction. Whenever a participant or beneficiary has the opportunity to direct the investment of assets in his or her account, but does not direct the investment of such assets, plan fiduciaries may avail themselves of the relief provided by this final regulation, so long as all of its conditions have been satisfied. (Emphasis added)

We quote this language at length because it seems to speak so clearly to the ‘big question.’

The worst case

The timing of the finalization of the QDIA regulations, and the implementation of re-enrollment plans in connection with it in 2007-2008, could not have been worse. In many plans, significant numbers of participants were defaulted out of capital preservation vehicles and into QDIAs that included significant equity exposure (and thus capital risk). More or less right after that, the global financial crisis hit, and some major TDFs, for instance, sustained losses in the 25% range.

If any set of facts would test whether re-enrollment was legal, 2007-2008 would. There are (at least) two cases that have come out of that period: Bidwell et al. v. Univ. Med. Ctr. et al.(affirmed by the 6th Circuit in June 2012); and Falcone v. DLA Piper, which was brought in 2009 in the United States District Court For The Northern District Of California, in which plaintiff defeated a motion to dismiss, after which the case appears to have been settled.

Bidwell

We mentioned the lower court decision in Bidwell in a 2012 article. Summarizing the facts: Bidewll involved a 403(b) plan, but the ERISA principles applied by the court are generally the same as for, e.g., 401(k) plans. The plan included an SVF which, until 2007, served as its default investment. Plaintiff participants had, prior to 2007, affirmatively invested all of their plan assets in the SVF.

As part of its compliance with DOL's QDIA regulations, Defendant/plan sponsor UMC: (1) Determined that it could not distinguish between assets that had been ‘defaulted’ into the SVF and those that had been affirmatively invested in it. (2) Sent all participants investing in the SVF a notice that, unless the participant affirmatively elected otherwise, their investment in the SVF would be transferred to a "Life Span time-based Asset Allocation Model" (LSA), which appears to have been a TDF. (3) Receiving no response to this notice from plaintiff participants, transferred their assets to the TDF. It appears that that transfer took place somewhere around July-August 2008.

When plaintiffs received their first post-transfer benefit statement, in October 2008, they directed that their assets be transferred back to the SVF. But, as a result of the 2008 financial crisis, they had already lost money. (There were two plaintiffs in the case; one lost $85,000, the other $16,900.)

The plaintiffs then sued, claiming that UMC and its outside administrator had violated ERISA in making the original transfer from the SVF to the TDF. Two key elements of their claim were that (1) they never received the notice and (2) given their affirmative election to invest in the SVF, the sponsor/fiduciary did not have the authority to transfer them out of it. With respect to the latter claim, plaintiffs asserted (among other things) that the fiduciary violated procedures described in the plan's summary plan description, which said that a participant's original election "shall control until a new election is made."

The lower court held for the defendant/plan sponsor generally and on both of these issues. With respect to the ‘non-received’ notice, the court found that UMC complied with the notice requirements of the QDIA regulation and that therefore non-receipt by the plaintiffs did not trigger an ERISA violation.

Plaintiffs appealed, "contend[ing] that the district court's conclusion was erroneous because the [QDIA safe harbor] can never insulate a fiduciary against claims by plan participants ... who previously elected their investment vehicle rather than having it chosen for them by default." In furtherance of this position, plaintiffs argued that UMC had a duty to keep records identifying money in the SVF that had been "affirmatively elected."

On appeal the Sixth Circuit (like the lower court) found for the defendants, relying largely on the language of the QDIA preamble quoted above.

Plaintiffs did not, on appeal, address the non-receipt of notice issue, but the court nevertheless considered it, holding:

Under ERISA, a fiduciary is obligated to take measures "reasonably calculated to ensure actual receipt of the material by plan participants." ... Here, UMC provided the correct addresses to [the SVF carrier] for distribution of the notice by first-class mail, and there are records indicating that [the SVF carrier] sent out the correct number of letters as directed. Although more proof could be had, perhaps through individual delivery confirmation, UMC’s actions were "reasonably calculated to ensure actual receipt" and it was reasonable for UMC to rely on the dependability of the first-class-mail system and [the SVF carrier's] proof that the correct number of letters were sent out.

Falcone

Falcone involved facts very similar to Bidwell. Plaintiff entered the employer's plan in 2006 and rolled over assets from his previous employer's plan. He claimed to have affirmatively given instructions to invest his assets in the plan's money market fund. As part of a re-enrollment program and in compliance with the QDIA regulation, defendant-employer in July 2008 transferred plaintiff's assets out of the money market fund and into a TDF. In October 2008 plaintiff "discovered" that his assets had been transferred to the TDF (while it's not entirely clear, it appears that as a result of that transfer plaintiff lost $225,000).

There was a dispute about what sorts of notices were sent in connection with the transfer. Plaintiff claimed that he did not receive a May 15, 2008 notice. He claimed that a June 11, 2008 notice said "[i]f you have previously made an affirmative investment election, your contributions will continue to be invested per your investment elections" and included additional language to the same effect.

Defendant employer disputed plaintiff's claims that he actually gave investment instructions and that the June 11 notice read the way he claims it did. But this decision was on a motion to dismiss, so all of plaintiff's allegations were assumed to be true. Defendant moved to dismiss on the grounds that, even assuming Plaintiff's allegations, "they were still entitled under the Plan's terms to make the transfer."

The court held for the plaintiff, finding that he had the "ability, under the plain language of the Plan, to direct the investment of his account assets." Moreover, both the (alleged) June 11 notice and a general notice outlining procedures for directing investments stated "that the administrator will adhere to prior investment instructions or provide written notice of any change …."

Thus, disputes over facts – critically, the terms of the notice plaintiff received – were enough to get plaintiff past a motion to dismiss. The case appears to have then been settled. We caution that the facts in Falcone are relatively undeveloped and its usefulness as precedent is unclear.

Lessons and takeaways

Considering the QDIA regulation and these two cases, the current state of affairs seems to be as follows:

The QDIA regulation by its terms seems to provide a broad authorization for 401(k) investment re-enrollment programs.

This is an emerging area of the law. We may see more litigation and the emergence of judge-made ‘glosses’ on the QDIA authorization.

‘Not getting the notice’ seems to be a basic element in claims. The other element that will be significant is language in the plan and in communications that seem to give participants the unqualified right to ‘invest assets as he or she chooses.’

In light of the last point, sponsors will, in connection with a re-enrollment program, want to (1) document the notice process carefully and (2) review (and, conceivably, revise) plan documents and communications to make clear there is authorization for the program.

DOL notes, in the preamble to the QDIA regulation, that there may be other fiduciary issues not covered by the QDIA safe harbor, e.g., the termination of an SVF investment where there is a significant "market value adjustment."

A final observation: both these cases arose in the context of a ‘perfect storm’ that is unlikely to be repeated -- the coincidence of a mass re-allocation from capital preservation vehicles to TDFs in connection with the QDIA regulation and an extraordinarily large drop in stock prices. We may see a market drop like 2008 again, but the QDIA project was a one-time thing.

Sponsors considering a re-enrollment program, however, will want to think about which asset classes (both QDIAs and non-QDIAs) are vulnerable to significant asset swings. In that regard, company stock funds are particularly significant, and the problem may cut both ways. While the defendant won the case, Tatum v. R.J. Reynolds Tobacco Company illustrates the risk with respect to company (or single) stock funds. In Tatum the plaintiff was ‘involuntarily’ moved out of a stock fund that significantly increased in value relative to the QDIA.

October Three, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

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