Bombshell 401(k) lawsuit ruling sends Principal back to court

An appeals court this week revived a class-action lawsuit against Principal Life Insurance Co. that alleges the insurer breached its fiduciary duty to plan participants.

The development “is a stunner,” said Greg Ash, a partner at the law firm Spencer Fane, who is not involved in the case.

In an opinion issued Monday, a three-judge panel of the Court of Appeals for the 8th Circuit wrote that the lower District Court erred when it found that Principal was not a fiduciary to an employer-sponsored plan that used the Principal Fixed Income Option.

The opinion contrasts with earlier decisions in the 10th Circuit in a similar case against Great-West Life & Annuity Co., though the 8th Circuit extensively cited that case law in its order.

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In finding that Principal was a fiduciary to the plan, the appellate court sent the case back to District Court. In 2018, the lower court had granted summary judgment for Principal in the case, which was filed in 2014.

At issue is the company’s role in administering the 401(k) plan option. Every six months, Principal sets the guaranteed rate of return that participants receive, and it has liquidity and surrender charge constraints in the contracts for the product.

For that plan option, Principal notifies its plan sponsors clients a month ahead of any change to the crediting rate, according to court records. Plan sponsors can reject the rate, though they must withdraw funds to do so. And if they do withdraw funds, they must either pay a 5% surrender charge or provide notice 12 month ahead of the withdrawal, the court noted in its opinion.

“If [an individual] plan participant wishes to exit, he or she faces an ‘equity wash,’” the judges wrote. “They can immediately withdraw their funds, but not reinvest in plans like the PFIO for three months.”

The plaintiff, Frederick Rozo, alleged that Principal breached its fiduciary duty by engaging in prohibited transactions.

“This is a major decision upholding one of [the Employee Retirement Income Security Act’s] fundamental principles — that those with control over plan assets must abide by ERISA’s fiduciary duties,” law firm Stris & Maher, which represents the plaintiffs, said in a statement. “The decision will help ensure that people whose retirement savings are in the hands of insurance companies like Principal are not taken advantage of.”

Principal issued a statement saying that it disagrees with the allegations and that the firm will continue to defend itself in court.

“Many of our clients rely upon guaranteed products that provide capital preservation benefits and a guaranteed return,” the company wrote. “It is a more conservative investment for those nearing retirement or looking for less volatility and risk in the marketplace.”

Such plans are often used by small employers, particularly those who averse to investment risks, said Spencer Fane's Mr. Ash. A drawback of that plan design is that the contracts are notoriously dense and the crediting rates tend to be low, he said.

The appellate court’s ruling is “an outlier, and a potential game-changer for financial services companies that offer investment products like this one,” Mr. Ash said. It leaves “any provider of an investment vehicle like this one in quandary.”

Class-action suits involving similar products were more common several years ago, but the volume of litigation declined following the Great-West decision, he said.

“The outcomes in those cases have been the opposite,” Mr. Ash said. “I would imagine that this [Principal] case surprised the defendants a lot.”

In December, the Supreme Court declined to hear an appeal from the plaintiffs in the Teets vs. Great-West case. In that case, plaintiffs alleged that the company breached its fiduciary duty in connection with the guaranteed-rate fund in part because of the spread the company retained.

The Great-West case found that a plan service provider acted as a fiduciary if it “did not merely follow a specific contractual term set in an arm’s-length negotiation” and “took a unilateral action respecting plan management or assets without the plan or its participants having an opportunity to reject its decision,” court records state.

A key difference between the Principal and Great-West cases is that Principal imposed the liquidity restriction in its contracts, while Great-West did not, the judges wrote.

“When Principal notifies a plan sponsor of the proposed [crediting rate change], the sponsor has not agreed to it,” the opinion stated. “A service provider may be a fiduciary when it exercises discretionary authority, even if the contract authorizes it to take the discretionary act.”