Suppose an employer discovers that some of its employees are market-timing* in the employer’s 401(k) plan and rightly decides that such practices are detrimental to the rest of the participants. Suppose the employer asks the employees to cease the market-timing and all employees heed the request, except one. Could the employer terminate the rebellious employee who fails to comply with its request? Or how about just warning the employee that his employment and career at the company could be impacted if the employee doesn’t stop? Wouldn’t such action on its face appear necessary in light of recent mutual fund scandals? Does an employee have a right to engage in market-timing in a 401(k) plan?

A federal district court in Iowa grappled with these very issues in a fascinating case decided last year. The case was Borneman v. Principal Life Ins. Co., 291 F. Supp. 2d 935 (S.D. Iowa Nov. 25, 2003) [pdf (62 pages)]. According to the court in Borneman, if the plan document allows market-timing, i.e. does not contain any restrictions on market-timing, the employer could be held to violate section 510 of ERISA if it takes adverse action against an employee in order to hinder the employee from exercising his or her rights under the plan. In other words, the court reasoned that, if the plan document allows market-timing, the participant then would have a supposed right to engage in market-timing, and any adverse action taken against the employee to prevent his or her exercise of such right could violate Section 510 of ERISA. (That section provides that “It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan, this subchapter . . . or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan [or] this subchapter.”)

The court in Borneman stated:

An integral part of Plaintiff’s § 1140 claim for retaliation is a showing that he exercised a right to which he was entitled under the terms of his employee benefit plan or under ERISA itself: There is no dispute in this case that throughout the time period relevant to this lawsuit, the market timing trading that Mr. Borneman was engaging in was permitted under the terms of his Plan. Mr. Borneman freely engaged in market timing trading until approximately June 14, 2001. Until that time, there had been no market timing trading restriction in place. Principal had requested that Plaintiff voluntarily limit his trading, but such request does not constitute a limitation under the Plan. Plaintiff’s trading to that point was a protected activity. After June 14, 2001, it is undisputed that Mr. Borneman did not trade in excess of the $30,000 limit imposed by Principal, which this Court has found that Principal had the right to impose. Thus, any trading after June 14, 2001 was a protected activity as well. Consequently, any retaliation by Principal on the basis of Plaintiff’s market timing trading throughout the duration of his employment would have been prohibited under § 1140. At all times, market timing trading in the amounts engaged in by Plaintiff was a right to which he was entitled under his employee benefit plan.

The court went on the analyze the different actions taken by the employer, and determined whether or not they were actions which could constitute “adverse employment actions” interfering with plaintiff’s right to engage in market-timing under ERISA. The court made the following interesting determinations:

(1) Amazingly, terminating the employee did not interfere with his right to engage in market-timing, said the court, since the “[p]aintiff retained his employee benefit plan after termination” and would have been “able to continue market timing trading even after his employment was terminated.”

(2) However, the court held that the adverse performance reviews and even “threats” about the employee’s future at the company could interfere with the employee’s exercise of his “right” of market-timing and section 510 claims should be allowed to survive a Motion for Summary Judgment on those issues:

Although these threats do not immediately affect the terms and conditions of a claimant’s employment, they do materially affect whether or not such employee can freely exercise his ERISA rights. By prohibiting retaliation and interference, § 1140 creates a seamless web of protection for participants and beneficiaries. Participants and beneficiaries are protected from attempts to discourage them from exercising rights under ERISA or their employee benefit plans, and they are protected if exercise of these rights actually results in an adverse employment action. If interference did not encompass protection against threats of discrimination, employers would be free to threaten employees with severe adverse employment actions, including termination, for exercising their rights.

While many plan documents now contain such market-timing restrictions or give discretion to impose market-timing restrictions, many still do not address the issue. Putting the restrictions in the plan document may protect the employer from liability under section 510 of ERISA. In addition, the DOL has indicated (in guidance issued last February on the subject of fiduciary response to the mutual fund scandals) that plan documentation is important with respect to the market-timing issue:

The imposition of trading restrictions that are not contemplated under the terms of the plan raises issues concerning the application of section 404(c), as well as issues as to whether such restrictions constitute the imposition of a “blackout period” requiring advance notice to affected participants and beneficiaries.

*”Market-timing” is a trading strategy that involves frequent purchases and sales of securities (with the securities being held for short periods) in an effort to anticipate changes in market prices.