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CCH® PENSION — 07/31/12

Bank that failed to detect TPA mismanagement of 401(k) account funds not subject to suit under ERISA

The custody of plan funds and the receipt of fees pursuant to a depository agreement with a third-party administrator (TPA) did not confer fiduciary status on a bank sufficient to allow for suit under ERISA, the U.S. Court of Appeals in Cincinnati (CA-6) has ruled. In addition, because the claims against the bank for failing to monitor the fraudulent actions of the TPA derived from ERISA violations, state law claims of unjust enrichment were preempted, effectively leaving the plan participants without a remedy.

TPA misconduct in managing plan funds

A TPA managed various employee benefit and 401(k) retirement plans. Going beyond the traditional administrative services, however, the TPA directed clients to send funds to accounts that he opened in his company’s name at a bank. The bank advised the TPA to open the account in his name and provided titles referencing the accounts’ corresponding clients. Because the accounts bore the name of the TPA’s company, the TPA, as the sole owner and operator of the company, was able to transfer money among and out of the accounts, thereby allowing for the subsequent embezzlement of customer funds.

The TPA briefly moved accounts to another bank, but that bank closed the accounts for improper activity. Unfortunately, the original depository bank failed to exercise the same vigilance. In fact, the bank facilitated the TPA’s withdrawals and transfers, receiving over $50 million in deposits from plan accounts and plan assets. The bank also collected fees and analysis charges from the TPA accounts, totaling more than $500,000 over the course of the relationship.

As a consequence of the bank’s failure to comply with requirements under the Bank Secrecy Act to report large currency transactions and suspicious activity, the U.S. Financial Crimes Enforcement Network, assessed a fine of $10 million. The failure to monitor the accounts and the TPA’s unusual account activity further raised the suspicion that the bank knew or should have known about the TPA’s misconduct.

When the TPA declared bankruptcy in 2006, the pervasive theft and fraud was discovered. The bankruptcy trustee filed suit against the bank on behalf of the victimized plans for which he assumed fiduciary status on behalf of the TPA. The trustee asserted ERISA claims against the bank, both as a fiduciary and as a nonfiduciary, as well as state law claims based on negligence and aiding and abetting.

A federal district court ruled that ERISA provided the trustee with standing to sue on behalf of the defrauded plans, but that the bank was not an ERISA fiduciary, subject to suit. The court also dismissed the nonfiduciary claims against the bank and ruled that ERISA preempted the state law aiding and abetting claim. However, the court allowed the trustee’s state law negligence claim to proceed.

Subsequent to the ruling, former clients of the TPA also brought suit. In a consolidated complaint, the clients and the trustee further charged the bank with recklessness and unjust enrichment under state consumer protection laws. The court again found, however, that ERISA preempted the remaining state law claims against the bank.

Bank as fiduciary

In order to recover damages (as opposed to equitable relief), the trustee needed to persuade the appellate court that the bank was an ERISA fiduciary. The trustee charged that the bank exercised authority or control over the ERISA plan accounts by maintaining accounts for the TPA, receiving deposits to the accounts, and permitting the TPA to transfer and withdraw money from the accounts. However, the court found that the TPA maintained the accounts and directed account activity, while the bank merely held the funds on deposit. Custody of the plan assets alone, the court stressed, cannot establish control sufficient to confer fiduciary status.

Similarly, the fact that bank advised the TPA on how to structure its accounts did not create fiduciary status. Control of the accounts remained with the TPA, the court explained.

The trustee’s strongest argument supporting control by the bank over plan assets was the fact that the bank withdrew over $500,000 in fees from the TPA’s plan accounts. Precedent in the Sixth Circuit holds that the unilateral disposition of funds incident to the termination of a contractual relationship with plans could create discretionary control necessary for fiduciary status. However, the court noted that the bank merely collected routine fees contractually owed under the depository agreement, and did not unilaterally exercise any power to pay itself fees. The mere collection of fees, the court stressed, did not subject the bank to liability as an ERISA fiduciary.

ERISA preemption of state law claims

The trustee and the TPA’s former clients alleged that the bank’s breach of the duty to monitor the accounts of the TPA and failure to comply with banking oversight rules effectively enabled the fraud. In dismissing the claim, the district court explained that state law limited plaintiff claims to allegations of knowing or bad faith conduct and, thus, did not recognize claims based on negligence. In addition, the court ruled that ERISA preempted any allegation that survived such a threshold, effectively leaving the participants without a remedy.

In affirming the district court, the appellate court noted that the claims against the bank did not arise from an independent legal duty, but derived from ERISA violations committed by the TPA. By seeking to impose liability on the bank for knowingly permitting the TPA to breach its fiduciary duties, the state law claims sought an "alternative enforcement mechanism" for the legal duties imposed under ERISA. Having concluded that the bank was not an ERISA fiduciary, the court would not subject a nonfiduciary to damages under state law when such damages are not recognized under ERISA.

Source: McLemore v. Regions Bank (CA-6).

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For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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