“How did you go bankrupt? Two ways. Gradually, then suddenly.” – Ernest Hemingway

In September 2023, former employees of Bed Bath & Beyond sued members of the company’s 401(k) committee, the committee responsible for the prudent management of the company’s 401(k) plan. The former employees allege they lost more than $5 million following the company’s bankruptcy filing in April 2023, a loss the committee could have avoided.

The company had teetered on the brink of bankruptcy for months prior to the April filing. In January 2023, the company had warned its investors about a potential bankruptcy as it burned through cash, but the company was nevertheless able to leverage its popularity with meme stock traders to raise $400 million. The company also began shuttering stores and laying off employees without severance pay in hopes of buying time to turn around its operations. Unfortunately, these moves were not enough to keep this “old school” retail chain out of bankruptcy.

In June 2023, the bankruptcy court approved Overstock.com Inc.’s acquisition of Bed Bath & Beyond’s intellectual property assets, and Overstock.com relaunched the brand online. The shareholders who had attempted to capitalize on Bed Bath & Beyond’s meme stock status were wiped out when the court-approved bankruptcy plan went into effect at the end of September. The bankruptcy court has ordered the proceeds from the liquidation of the company’s assets be used to pay back the company’s debtors.

Sharing the Pain—Creditors, Shareholders, and Plan Participants?

Litigation by shareholders and debtors against the directors and officers of bankrupt companies, while not common, is certainly not rare. These cases often allege the directors and officers failed to disclose their true financial situation, take steps to avoid bankruptcy, or protect corporate assets.

While shareholder claims often receive the most attention, it’s also not uncommon to see litigation from employees who had invested in company stock through a company-sponsored benefit plan. Readers may recall this situation at Enron, where executives encouraged employees to buy company stock just days prior to the company’s collapse.

The lawsuit against Bed Bath & Beyond is different. The former employees are not alleging that the company stock was wiped out by the company misrepresenting its financial condition. The employees allege that the loss they suffered was avoidable. That may or may not be true. Regardless, analyzing the lawsuit provides an opportunity to highlight some best practices.

The Lawsuit and Guaranteed Investment Account Background

The former employees allege that they lost more than $5 million when a guaranteed investment account (GIA) suffered a loss due to rising interest rates. A GIA guarantees a fixed rate of return from the day you invest your money until maturity. At maturity, your original investment and interest earned are paid out or reinvested.

In a GIA, employee contributions are invested in stocks and bonds to achieve a fixed rate over a specified period. Large life insurance companies offer GIAs, and they back up, or guarantee, the fixed rate of return with the insurance carrier’s corporate assets as long as the contract stays in place for the requisite amount of time.

Bed Bath & Beyond’s former employees alleged that their account was invested primarily in long-term bonds that lost value as interest rates rose. Filing for corporate bankruptcy resulted in the premature termination of the contract with the insurer. As explained by the retirement plan’s record keeper in a New York Times article, this:

set off a requirement to transfer money out of the guaranteed interest accounts. Because of the timing, they said, bonds that serve as the underlying investments for the accounts—a type of “group annuity contract”—had to be sold at a loss.

The former employees allege the 401(k) committee breached its fiduciary duties by failing to replace the GIA with less risky options, something that would have avoided the $5 million in losses suffered by the employees. According to the complaint, the company knew as early as 2019 that its business was not viable and had opportunities in 2020 and 2021 to replace the GIA, but the committee did not. The committee even certified in 2020, 2021, and 2022, that it did not believe any event that would subject the GIA to a market value adjustment, including bankruptcy of the plan sponsor, was likely to occur.

Should We Expect Similar Lawsuits to Follow?

The bankruptcy-related litigation against Bed Bath & Beyond’s 401(k) committee may be a sign of the times as companies face the impact of higher interest rates and a challenging economy on their operations and customers. According to S&P Global, the total corporate bankruptcy filings is 516 through September 2023. This is more than the annual filings in 2021 and 2022 and nearly more than the 518 filings in the first three quarters of 2020, when the pandemic shut down the economy.

What does this mean for plan fiduciaries and plan committees? Do they now need a crystal ball to tell them if their company will go bankrupt? No. Even the Bed Bath & Beyond plaintiffs didn’t expect plan fiduciaries and committees to predict the future. They did, however, expect them to have a process for evaluating the risks a declining business had on their 401(k) plan assets:

Defendant Committee was required to monitor the risk of loss to the Plan if BBB’s reinvention campaign failed and the company declared bankruptcy[.]…This did not require prescience regarding the ultimate fate of BBB’s effort to reinvent itself after years of decline; rather, it required a prudent process for investigating risks and alternatives for the Plan.

Establishing a Prudent Process

As the case against Bed Bath & Beyond illustrates, the failure to monitor risk in these uncertain times can expose your plan fiduciaries to litigation. Should the litigation not go their way, plan fiduciaries could be personally exposed, a particularly serious situation since the company cannot indemnify the individual fiduciaries if the company is in bankruptcy.

The mission of a 401(k) committee is to manage the plan in accordance with the highest standards of fiduciary responsibility and in the best interests of plan participants, as required by the Employee Retirement Income Security Act (ERISA). Best practices in forming and running a 401(k) committee include:

1. Diverse Members. The committee should be composed of individuals across the organization including HR, finance, and senior management, with each member having a clearly defined role. This includes designating who will serve as the named fiduciary, who has discretion over investment options, and who oversees administrative tasks.
2. Training. Committee members should receive proper training to understand their fiduciary responsibilities under ERISA, so they act prudently and make informed decisions regarding the plan.
3. Documentation. Proper documentation is crucial. The committee must maintain records of meetings, decisions, and any actions taken regarding the plan. This documentation serves as evidence of the committee’s fiduciary diligence.
4. Investment Due Diligence. The committee should conduct thorough due diligence to ensure investment options are diverse, well-managed, and suitable for plan participants.
5. Monitor Service Providers and Their Fees and Expenses. The committee should regularly review the performance and services of third-party providers, such as recordkeepers and investment managers. This includes reviewing plan fees and expenses to ensure they are reasonable and in the best interest of participants.
6. Engage a 401(k) Plan Advisor. Hiring a 401(k) plan fiduciary advisor can offer several benefits to a company and its employees.
7. Work with Legal and Financial Professionals. Committee members will want to receive updates from experts in the field to stay informed about legal changes and evolving best practices in retirement plan management.

By following a prudent process, 401(k) committees can fulfill their responsibilities to plan participants and help ensure that the retirement plan is managed transparently and in the participants’ best interests.

A Solid Backup: Fiduciary Liability Insurance

Unfortunately, a prudent process does not completely shield the plan fiduciaries or committees from litigation by disgruntled plan participants. You will want to have a solid fiduciary liability insurance program in place as it may be the only source of protection if a lawsuit is filed while the company sponsor is in bankruptcy.

When it comes to placing your fiduciary liability insurance, consider these best practices:

1. Work with an expert. ERISA is a complex, nuanced field. Insolvency and bankruptcy further complicate matters. The consequences of binding a poorly brokered policy can be enormous. You want to work with a broker who is aware of the issues and places a significant amount of this business directly with the insurance market.
2. Start early. The fiduciary liability insurance placement is application driven. Completing the application early and having your broker reach out to the broader insurance market may generate competition.
3. Plan to meet with your insurance carriers if bankruptcy is imminent. Insurance underwriters will have questions about the impact of bankruptcy on the plans. Have your bankruptcy counsel and/or 401(k) plan advisor attend this meeting. Your counsel and/or 401(k) plan advisor will be able to address the underwriters’ questions.
4. Seek options. Insolvency and bankruptcy will impact insurers’ appetite for your risk, but there still may be other insurance carriers willing to take on the risk. When placing your insurance, try to bind with insurance carriers that have significant underwriting and claims-handling expertise when it comes to fiduciary programs.
5. Coverage terms matter. Fiduciary liability policies are not one-size-fits-all. The failure to customize coverage to your specific issues could result in uncovered loss, leaving 401(k) committee members paying out of pocket.

When economic times are hard, some bankruptcies cannot be avoided. However, having a prudent process in place along with a well-placed fiduciary liability insurance policy will go a long way to protecting your 401(k) committee members from being exposed to personal liability.