The Courts Differ on Vicarious Liability

When advising plan sponsors about their fiduciary responsibilities, we often discuss their ongoing duty to prudently select and consistently monitor outside service providers—viz., by attending to their fees and performance. This discussion typically occurs with respect to external service providers, such as retirement plan advisers, recordkeepers, investment advisers, third-party administrators (TPAs), investment managers, etc.

However, the same principle is equally applicable internally, that is, with respect to employees of the plan sponsor whose duties pertain to the plan. For example, if a board of directors appoints the members of a plan’s oversight committee, not only does the board have the responsibility to prudently select the committee members, but must also monitor each member’s ongoing performance.

Similarly, if a financial institution is required to satisfy the conditions of the best interest contract exemption (BICE) in order to receive variable compensation and avoid a prohibited transaction (PT), the “BICE officer”—i.e., the individual(s) designated by the financial institution to ensure that the exemption’s requirements are met—is responsible to take care that members of the work force adhere to all elements of the prohibited transaction class exemption (PTCE).

However, consider the result when a work force member turns “rogue” and breaches his fiduciary responsibility. Is the fiduciary who appointed, hired or oversees the employee responsible for his actions—i.e., vicariously liable—under the Employee Retirement Income Security Act (ERISA)? Or, as a court of law might phrase the issue, is respondeat superior part of ERISA’s definition of “fiduciary”?

The doctrine of respondeat superior is from the Latin, literally meaning “let the master answer” and is defined as follows: “The employer is subject to liability for torts committed by employees while acting within the scope of their employment.” In other words, federal case law and judicial precedent where one person, an agent, is authorized by another, a principle, to act on that person’s behalf with respect to a third party produces the principles by which vicarious liability is applied. Therefore, it stands to reason that the imposition of vicarious liability should be part of the federal common law of ERISA.

Federal court rulings have been inconsistent, however, in applying vicarious liability in the ERISA context. Here is the dilemma: ERISA is a comprehensive federal statute that spells out exactly who should be responsible for what; to layer atop that system common law remedies is a step that concerns some courts. The Supreme Court has cautioned, in cases such as Great-West Life & Annuity Insurance, that engrafting common law remedies is not a step that should be taken lightly.

Courts have also stated that, while the common law may be a starting point for analyzing ERISA, it is not the stopping point, and the common law must yield and defer to ERISA if it is inconsistent with the act’s language, structure or purpose. There are court actions such as AOL Time Warner, Inc. Securities and ERISA Litigation, a 2005 case from the Southern District of New York, in which the court refused to find respondeat superior liability because ERISA limits liability to named and de facto fiduciaries and expresses no intent to hold a nonfiduciary liable for a fiduciary’s breach.

Courts’ Inconsistent Approach
Not surprisingly, the courts have failed to take a consistent approach on whether a nonfiduciary is liable either. The Court of Appeals for the 7th Circuit has implicitly recognized respondeat superior liability in ERISA cases, but has not decided how far this doctrine should reach. The Court of Appeals for the 5th Circuit has held, without applying respondeat superior principles, that a company might be liable under ERISA Section 409 for “breach of fiduciary duty,” but only when the principal actively and knowingly participated in the fiduciary’s breach.

In contrast, the Court of Appeals for the 6th Circuit permits vicarious liability claims under ERISA, even without their showing that the principal played an active and knowing part in the breach. Other circuits have simply assumed vicarious liability is applicable to ERISA but with little analysis. Investment advisers in particular should be aware of cases such as Stanton v. Shearson Lehman/American Express, a 1986 case in which a district court held a brokerage firm liable for the fiduciary acts of its broker’s employees because making brand-name brokerage firms responsible for their employees’ violations of fiduciary duty served ERISA’s protective purposes.

Because courts are divided, if a vicarious liability claim is made against a financial institution and the individual investment adviser, it will be necessary to review the current state of the law in that circuit.

Marcia Wagner is an expert in a variety of employee benefits and executive compensation areas, including qualified and nonqualified retirement plans, and welfare benefit arrangements. She is a summa cum laude graduate of Cornell University and Harvard Law School and has practiced law for 30 years. Wagner is a frequent lecturer and has authored numerous books and articles.