As employee benefits lawyers, we spend a lot of time telling retirement plan sponsors how to follow the law and not get sued, audited, investigated, complained about, or otherwise be forced to endure unpleasant interactions with people who can get you in trouble.
So we’ve decided to switch things up and give you a step-by-step guide laying out the easiest way to get yourself—and your retirement plan—into hot water.
Fortunately, we were handed a prime example to use for our roadmap:
A recently settled federal court case called McLain v. Poppell involving a Florida eye doctor, a 401k plan, and a company called VirnetX.
Poppell was the founder of Emerald Coast Eye Institute (or ECEI), and was the trustee and fiduciary of ECEI’s 401k plan, which had a few dozen participants.
According to the complaint, Poppell strayed seriously off course when dealing with the ECEI 401k plan. Here’s what he allegedly did—and what plan sponsors should avoid:
1) Keep sole control over your employees’ 401k investments and ignore all recommendations to the contrary
Poppell had sole control over the plan’s investments and did not let participants choose how to invest their own accounts. In other words, he alone made the investment decisions for all of the plan’s money. The participants also claimed he had no specific background or expertise in finance or investing and—on several different occasions—rejected the third-party administrator’s recommendations to hire an independent financial advisor.
2) Invest the majority of the plan’s money in one incredibly speculative company
With Poppell’s complete control over investments, he decided to direct a significant portion of the plan’s assets into a company called VirnetX. Although a publicly traded company, VirnetX is what’s typically (and uncharitably) referred to as a “patent troll,” or a company that has little to no business operations aside from acquiring patents and then suing other companies it believes are violating those patents. At the time, VirnetX’s value depended significantly—arguably almost exclusively—on the outcome of patent litigation against Apple. In other words, investing in VirnetX essentially was a bet on the outcome of a patent-infringement lawsuit.
3) Base decisions on your research from internet message boards
What could have possibly caused such a large, concentrated, and speculative investment? According to the employees, Poppell’s research from internet message boards.
4) Watch as the stock craters in value
According to the complaint, during 2014 over half of the plan’s assets were invested in VirnetX. The rest was invested in cash equivalents. The plan started 2014 with about $985,000 in total assets; by the end of 2014, the plan’s investment in VirnetX had caused a loss of almost $550,000, wiping out about 56 percent of the plan’s value in a year where the S&P 500 returned over 13 percent.
5) When employees complain that they’re losing all their money, threaten to terminate the plan
In mid-2015, several participants started complaining about the large losses in their 401k accounts. Poppell’s response? According to those employees, he got mad and threatened to terminate the 401k plan altogether. (Which he, in fact, did several months later. During 2015, the plan’s investments lost another $142,000, and a little over $300,000 in remaining accounts appears to have been distributed in 2015 and 2016 based on the plan’s filings.)
6) When employees keep complaining that they’re losing all their money, terminate them
After complaining the first time didn’t resolve anything, the employees continued to protest. Shortly afterward, they contend, Poppell fired them.
The story didn’t end well for Poppell. He was sued in a class action lawsuit by plan participants for breaching his fiduciary duties under ERISA and retaliating against employees who asserted their rights under ERISA. He settled for $180,000. The Department of Labor got involved and required the participants to be made whole.
While it’s easy to point out the compounding and collective problems alleged in the Poppell case, the reality is all sponsors are susceptible to similar—but hopefully less obvious—shortcomings on a regular basis.
Many of ERISA’s fiduciary standards are based on the process taken to arrive at a particular outcome, so seek competent professionals to help select and manage investments. Allow them to help you diversify. Don’t take unnecessarily large and concentrated risks, especially if participants have no control over their investment allocations.
If your plan’s investments are underperforming, have a process in place to identify, review, and remove them if necessary. Avoid actions that could be construed as retaliation when employees voice concerns over their retirement plan.
And, whatever you do, don’t use more than half of your plan’s money to gamble on a company you read about on internet message boards.
Robert Q. Johnson is a member of the ESOPs & Employee Benefits practice group of Kaufman & Canoles. He can be reached at rqjohnson@kaufcan.com.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
WHAT HAPPENS WHEN A MULTI NATIONAL CORPORATION SELLS HIGHLY APPRECIATED COMPANY STOCK IN A 401K PLAN AGAINST AN EMPLOYEES SPECIFIC REQUEST AND PREVENTS EMPLOYEES FROM USING THE NET UNREALIZED APPRECIATION RULE TO PULL HIGHLY APPRECIATED COMPANY STOCK OUT OF A 401K AND PAY TAX ON IT AT THE BASIS IT WAS PUT INTO THE PLAN AND DEFER ANY GAIN ON THE STOCK TO WHEN IT IS SOLD OR THE PARTICIPANT DIES AND THEN PAYS AT CAPITAL GAIN RATES. IS THERE ANY RECOURSE AND WHO CAN HELP THE EMPLOYEE