Suit Reversal Clarifies 401(k) “Participant”

An appeals court has revived an ERISA lawsuit, giving the plaintiff the right to sue his former employer for alleged mismanagement of its 401(k) plan even though he had cashed out.

Executives at Conexant Systems accused of breaching their fiduciary duty in guarding the company’s 401(k) plan likely breathed a sigh of relief when the case was thrown out last year. But an appeals court has given it new life by affirming that even if a former employee has cashed out of a plan, he can still be considered a participant under the Employee Retirement Income Security Act (ERISA).

The case involves Howard Graden, a Conexant employee who cashed out his 401(k) plan in October 2004, when the semiconductor manufacturer’s stock — which made up the bulk of the retirement plan — was at $1.70 a share. Graden, who had left the company two years before, in 2002, blamed the low stock price — which was significantly lower than March 2004′s 52-week high of $7.42 — on a risky merger. He claims Conexant, its officers, and the plan’s administrators breached their fiduciary duty by offering a Conexant stock fund even though it wasn’t prudent, and making false and misleading statements about the merger that led him to invest in the fund. In 2004 Conexant merged with GlobespanVirata in a deal that didn’t turn out to be profitable for the company.

Three judges for the U.S. Court of Appeals for the Third Circuit hinged their unanimous decision on whether Graden asserted that his payout was deficient based on the plan’s terms as mandated by ERISA. By agreeing that that was indeed the case, the appeals court vacated a March 2006 decision to dismiss Graden’s lawsuit, which was handed down by the U.S. District Court of New Jersey.

The higher court’s ruling clarifies that a participant is entitled to a benefit that “encompasses both miscalculations of a person’s entitlement and reductions traceable to fiduciary malfeasance.” To be sure, the judges did not opine on whether Conexant and its employees did anything wrong: the opinion merely bolsters Graden’s case to move forward. For its part, Conexant has said the case is without merit. The company did not respond to CFO.com’s request for comment on this latest development.

ERISA defines a participant as a current or former employee “who is or may become eligible to receive a benefit of any type from an employee benefit plan.” Anyone falling under that category can use ERISA to bring a lawsuit against a company. Graden argued that he qualifies, saying that if Conexant compensated participants for the loss created by what he alleged were fiduciary-duty breaches, then he would have been eligible for those eventual benefits.

The appeals court judges explored the definitions of what a “benefit” entails and determined it clearly includes the 401(k) participants’ vested benefits (their contributions and any investment gains). But it could also include an amount that’s missing from a 401(k) statement if improprieties have occurred. Indeed, ERISA entitles a participant to “the value of his account unencumbered by any fiduciary impropriety,” Judge Thomas Ambro wrote in his opinion. “In other words, 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.”

Graden’s case garnered the attention of retiree activists the AARP and the Department of Labor, which oversees the implementation of ERISA. Both groups weighed in in favor of Graden’s case through amicus briefs.

On the other hand, an amicus brief filed on behalf of Conexant by the National Association of Manufacturers expressed worries about the repercussions of a ruling in Graden’s favor. Extending the definition of a “participant” to someone who has cashed out could mean companies would need to continue spending money on sending information about the plan to those people, the group wrote. But Ambro said he sees no reason to make a plan holder responsible for providing information to someone that is no longer in the plan and has started withdrawing benefits. “It seems within the fiduciary’s discretion to send reports only to those participants known to the fiduciary,” he wrote.

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