Co-authored by Ian H. Morrison, John T. Murray, and Amanda A. Sonneborn

On January 21, 2011, the U.S. Court of Appeals for the Seventh Circuit issued two important decisions for all employers who offer 401(k) plans.  These two decisions could severely undermine plaintiffs’ ability to challenge fiduciary decisions related to 401(k) plans on a class-wide basis. 

In Howell v. Motorola, Inc. (Case No. 07-3837) and Lingis v. Dorazil (Case No. 09-2796) (“Stock Drop Cases”) [link to case], the Court concluded that the“safe harbor” in 29 U.S.C. § 1104(c) of the Employment Retirement Income Security Act (“ERISA”) shielded fiduciaries from claims that the defendants failed to disclose sufficient information about an allegedly bad business transaction and that certain defendants failed to monitor the conduct of fiduciaries they had appointed.  The Seventh Circuit also determined that the fiduciaries did not violate ERISA’s duty of prudence by including the Motorola Stock Fund as an investment option in the 401(k) plan, because Motorola stock never performed so poorly as to make it an imprudent investment option.  The Seventh Circuit also ruled that one plaintiff’s release agreement, signed as part of a reduction in force, barred his breach of fiduciary duty claims, despite a carve-out for claims for “benefits” under the company’s plans.

In Spano v. The Boeing Co. (Case No. 09-3001) and Beesley v. International Paper Co. (Case No. 09-3018) ( “401(k) Fees Cases”) [link to case], the Seventh Circuit vacated largely identical orders certifying classes of virtually all plan participants, raising claims that challenged the appropriateness of certain 401(k) plan fees and the prudence of plan investment options.  The Seventh Circuit found that the certified classes did not meet the adequacy and typicality requirements of Rule 23(a) of the Federal Rules of Civil Procedure. 

The Seventh Circuit’s opinion in the Stock Drop Cases reaffirms the importance of compliance with § 404 (c) of ERISA.  This safe harbor provision can provide 401(k) plan sponsors with protection if their fiduciary decisions are later challenged, although the Seventh Circuit declined to apply the safe harbor to the initial decision to include particular funds in a plan.  The Seventh Circuit’s ruling on the applicability of the release agreement is also significant because it enhances the value of a well-drafted severance agreement.  Moreover, the ultimate holding on the imprudent investment claim sets a high bar for plaintiffs.  Essentially, the Seventh Circuit has said that to recover on an imprudence theory, a plaintiff in a stock drop case must show that the employer has to be on the verge of collapse and that only worthless or extremely risky stocks will be deemed imprudent.  This is significant limitation on stock drop cases, as well as other cases challenging the prudence of particular investment options in 401(k) plans.

The Seventh Circuit’s class certification rulings in the 401(k) Fees Cases call into question the future viability of any 401(k) plan class actions.  The Seventh Circuit mandated that classes share a genuine common interest.  Thus, the opinion certainly suggests that a class that encompasses all participants in a 401(k) is too broad, given the wide-variety of investment practices and dates of participants’ entry and exit from the plan.