Notes on DRI's Upcoming Data Breach & Privacy Law Conference
It’s not possible to ignore data breach and cyber security issues anymore, even if you want to and even if, as a lawyer, you think it is outside your practice area and instead the responsibility of some other group of lawyers in your firm. I have written before on this blog about the significant importance of these issues to benefit plans and their vendors, as they control more personal financial and identifying data than almost any other entities operating in the United States economy. At this point, you cannot even open up the Wall Street Journal without coming across news of a major data breach or related legislative or industry activity. A couple of years ago I spoke nationally to a major financial and insurance company on the risks and the nature of insurance coverage for them, including under cyber policies (you can find my slides here), and things have simply ratcheted up exponentially since then.
Colleagues of mine at the DRI are hosting DRI's inaugural Data Breach & Privacy Law conference in Chicago on Sept. 11-12, 2014. The conference will cover everything from the Anatomy of a Cyber Attack to the Theories of Civil Liability for a Data Security Breach to the Insurance Coverage Issues Implicated in Data Breach Claims. You can find the brochure and registration materials here.
Of interest to me is the focus on insurance coverage issues, which was also the focus of my earlier talk on the issue of data breaches. It’s interesting to me because, as some of you may know from previous posts and articles or from hearing me speak, my view of insurance coverage law is animated by my more than quarter century experience working with it, going back to the tail end (that’s an insurance coverage pun, get it?) of the asbestos coverage wars and the start up of the environmental coverage wars. When you look back over the history of the field, coverage lawyers – especially on the policyholder side - were able to build huge practices in the ‘80s and ‘90s on the back of those types of big ticket exposures, and many have spent the decades since looking for the next big ticket coverage disputes that could sustain such practices, generally without finding anything comparable. Do you remember Y2K? Policyholder-side coverage lawyers were bulking up – at least in their marketing – in anticipation of a big boom in losses and related coverage disputes, but that boom went bust almost as soon as the calendar flipped. Some, incidentally, who had a long enough history in the industry anticipated that, as I can remember Jerry Oshinksy, who built one of the largest policyholder side practices of the asbestos/environmental coverage era, commenting in 1999 that Y2K would not generate the work driven by that earlier era. Data breach, though, may finally be that new area of liability that generates large amounts of coverage work that coverage lawyers have been waiting for since the Wellington Agreement came into being, the California Coordinated Asbestos Coverage trial ended, and Superfund prosecution wound down, given the scale of the breaches we now see on a regular basis.
Did the First Circuit Just Change its Test for Preemption?
Or did it just use a clever turn of phrase? More likely the latter, I think, but even if that is the case, it is absolutely a turn of phrase that is useful and important to know for anyone litigating an ERISA preemption issue in the First Circuit.
Historically, courts in the First Circuit have focused on two concepts in deciding whether a state law claim is preempted: (1) whether the state law cause of action seeks to supplement the causes of action available under ERISA itself; and (2) whether the state law claim requires consideration of the ERISA plan to decide the claim or would dictate specific terms or operational procedures for the plan. Two weeks ago, the First Circuit, in the case of Merit Construction Alliance v. City of Quincy, discussed the second concept by, in essence, applying a sliding scale analysis that considered how much impact the state law in question actually had on the ERISA governed plan, finding that too much equals preempted, while too little equals not preempted.
In addressing whether a city ordinance requiring bidders to establish an apprenticeship program was preempted, the First Circuit explained:
ERISA “supersede[s] any and all State laws insofar as they may now or hereafter relate to any employee benefit plan.” 29 U.S.C. § 1144(a). The Supreme Court has distilled the statute's “relate to” language into two independently sufficient alternatives: “a connection with or reference to” an ERISA plan will result in preemption. Shaw, 463 U.S. at 97. . . The battle here, as waged by the parties, focuses on the “connection with” component of the two-sided ERISA preemption calculus. . . .[N]ot every conceivable connection will support preemption. For example, state laws that merely exert an “indirect economic influence” on a plan do “not bind plan administrators to any particular choice” and, thus, do not come within ERISA's preemptive reach. Cal. Div. of Labor Standards Enforcement v. Dillingham Constr., Inc., 519 U.S. 316, 329, 117 S.Ct. 832, 136 L.Ed.2d 791 (1997) (internal quotation marks omitted). On the other hand, “state statutes that ‘mandate[ ] employee benefit structures or their administration’ ... amount[ ] to ‘connection[s] with’ ERISA plans” and are therefore preempted. Id. at 328 (final alteration in original) (quoting Travelers, 514 U.S. at 658). The path from influence to coercion amounts to a continuum and it is not always a simple task to determine where along this continuum a particular state law falls.
The Court then proceeded to analyze where on that continuum the city ordinance fell, for purposes of determining whether or not it was preempted.
I don’t believe this discussion of the continuum was intended to create a new test for preemption or to establish a new standard for analyzing the issue. There has always been an element, in First Circuit preemption analysis, of considering how closely a state law acts upon the operation or terms of an ERISA governed plan, and this discussion of the continuum seems to fit easily within that tradition. Nonetheless, looking at the question of whether a particular claim is preempted by analyzing where it falls on such a continuum is a handy and potentially persuasive manner of addressing the question. Anyone advocating for or against preemption in the First Circuit would be well-served by structuring the argument around where on that continuum the claim in question falls. It is an easy framework for the audience to grasp, while sufficiently malleable to allow a party to argue for a favorable placement on that continuum.
Changing Firms, and a Brief Note on the Right of Service Providers to Make a Profit
So, some of you may have noticed a change on the masthead at the top of this blog, which notes that I am now at the Wagner Law Group , in its Boston office. It has been a pleasure litigating ERISA and business disputes for the past nearly quarter century at the McCormack Firm, but every now and then an old dog needs to do a new trick. More seriously, for the past several years, I have been increasingly called on by clients to assist with DOL investigations and to handle plan deficiencies and other problems, all outside of the litigation context. The Wagner Law Group, with its deep bench and broad expertise in all areas of ERISA governed benefit plans, gives me the opportunity to provide those services more extensively to my clients, while continuing my litigation practice, which is heavily oriented towards breach of fiduciary duty and other ERISA disputes. So not only was the timing right, but so is the fit.
If you want more information on my changing firms, you can find the press release on my joining the Wagner Law Firm here. When I read it myself for the first time, I immediately thought of a line a U.S. Senator I once heard speak liked to use immediately after being glowingly introduced, which was: “thanks for the kind introduction, which my father would have appreciated and my mother would have believed.”
With that out of the way, I wanted to turn to one brief, substantive discussion. Eric Berkman has a fine article out in Massachusetts Lawyers Weekly, in which he quotes me on the First Circuit’s decision in Merriman v. Unum Life, which rejected claims that a retained asset account structure for paying life insurance benefits under an ERISA governed plan violated ERISA. In one of my quotes, I explained that:
"The plaintiffs' bar is looking for ways defendants are making money or making these services profitable and calling them prohibited transactions or breaches of fiduciary duty," Rosenberg said. "But this case, which falls in line with cases in other contexts, is saying that as long as the plan beneficiary is getting everything he or she is supposed to be getting under the plan, it's OK that the insurance company or other service provider is also making a profit."
While there are a lot of technical issues to Merriman, I think this is the important takeaway if one is looking at the forest rather than the trees. Across the benefit industry, service providers have to turn a profit; if they don’t, we will quickly not have a benefit industry. The holdings in cases like Merriman, which found the payment structure appropriate even though it could create some additional profit for the insurer, drive home the point that, so long as there is no prohibited transaction or misuse of plan assets or other illegal behavior, its okay for service providers and insurers to turn a profit.
Just Finished Speaking to ASPPA on ERISA Litigation, Soon to Speak at ACI's National ERISA Litigation Forum
So I had a great deal of fun speaking on current events in ERISA litigation to the ASPPA regional conference here in Boston this past Thursday, and my great thanks both to the organizers who invited me and everyone who attended. I am especially grateful to those in the audience, more knowledgeable about the wizarding world of Harry Potter than I, who did not point out that, in trying to compare a malicious (but hypothetical) plan sponsor to an evil but all powerful wizard, I mixed up Dumbledore and Voldemort. Oh well – much better than mixing up the prohibited transaction rules, I suppose.
One of the more interesting discussions that came up during my presentation had to do with recent case law revolving around what are, and what are not, plan assets, and how that issue influences the outcomes of cases (including ones I have litigated over the years). It is worth noting that the First Circuit just issued a very important decision validating certain employee life insurance benefit structures on the basis of just that consideration, in Merrimon v. Unum Life. One of the points I touched on in my talk is that the question of when funds are and are not plan assets for purposes of ERISA is almost certain to be a central aspect of both future litigation and future efforts by plan service providers to insulate themselves from fiduciary liability, given very recent developments in the case law. The new First Circuit decision, Merrimon v. Unum Life, is very noteworthy in this regard, as one can see in it how years of litigation and the appropriateness of a relatively common form of benefit payment structure can come down to, at root, the very basic question of what constitutes plan assets for purposes of ERISA litigation.
With that said, I wanted to turn to another speaking engagement on my calendar, which is the American Conference Institute’s 8th National Forum on ERISA Litigation, on October 27-28 in New York. I will be speaking on “Ethical Issues in ERISA Litigation,” including on one of my favorite issues, the fiduciary exception to the attorney-client privilege, along with Mirick O’Connell’s Joseph Hamilton. The reason I wanted to mention it today is that, through July 24th, a special rate is available for anyone who registers, mentioning my name and this blog. To take advantage of the special rate, you should contact Mr. Joseph Gallagher at the American Conference Institute, at 212-352-3220, extension 5511.
I hate to sound like an infomercial, but if you are planning to attend anyway (or weren’t aware of the conference before but now are interested in attending), it would be silly of me not to pass along this information.
What Should Employees Do in Response to Fifth Third Bancorp?
The Supreme Court’s decision in Fifth Third Bancorp, concerning the standards for prosecuting stock drop claims involving employer stock held in ERISA governed plans, certainly increased the attention paid to the question of the obligations of plan fiduciaries when it came to the risky holding of employer stock in a plan. But there is a flip side to that focus on the roles and obligations of corporate officers and plan fiduciaries with regard to the propriety of excessive holdings, in risky conditions, of employer stock. You see, I have often written, and I think many others have recognized it as well, that despite the protections granted to plan participants by the fiduciary obligations imposed on those running a plan and by the requirement that the plan be operated consistent with the plan documents, ERISA does not render the plan and its administrators In loco parentis, at least outside of pensions (and even then only to a certain extent), with regard to plan investments, nor does ERISA otherwise absolve participants of having to understand the plan and make sure their accounts hold suitable investments.
I was reminded of this over the weekend, when the Wall Street Journal ran this article (subscription required) about the importance of participants in plans that hold employer stock taking the time to reduce those holdings as a proportion of their investment mix. Sure, the new stock drop rules under Fifth Third make it somewhat more likely that a group of employees in a particular company who lose a large percentage of the value of their holding of employer stock under circumstances where that could have been avoided by better decision making by fiduciaries can sue for, and possibly recover for, losses in employer stock holdings. But the reality is that such recoveries will be few and far between, as the pleadings standards are still strict and only the largest plans with such losses are likely to draw the interest and ire of the class action bar. This means that, for all other plan participants who hold employer stock in their accounts, it is incumbent upon them to remember the doctrine of caveat emptor (two Latin phrases in one Monday morning after only one cup of coffee – pretty good, don’t you think?) and to reduce their exposure to a level commensurate with their tolerance for risk.
Why the Supreme Court Got It Right in Fifth Third Bancorp v. Dudenhoeffer
So, where do we even begin with Fifth Third Bancorp v. Dudenhoeffer, which is, first, a fascinating decision and, second, one that has already inspired countless stories in both the legal and financial media? I thought I would begin by passing along some of the better commentary I have come across in the wake of the decision, along with a few thoughts of my own.
First of all, the best substantive piece explaining what in the world the decision actually says is this one, from Thomas Clark on the Fiduciary Matters Blog. He does a nice job of explaining what the opinion really held. One of the things that grabbed me right off the bat about his post is that he opened by pointing out that, by the Court’s opinion, “the ‘Moench Presumption’ which has been adopted nearly unanimously by every Circuit Court in the country has been unequivocally rejected.” I appreciated the fact that he pointed out that the presumption had been adopted “nearly universally” by the circuits that have considered it, rather than calling it universally accepted, as I have long been the nitpicker on this, pointing out that the First Circuit has passed on opportunities to adopt the presumption, even though most authors writing on the subject have consistently but wrongly stated that the presumption had been universally accepted by those courts presented with it. Now, though, it turns out to have been universally accepted by all but two courts to have considered it, the First Circuit (as I have written before) and the Supreme Court, but obviously the decision of one of those two not to adopt it matters more than that of the other, by some significant degree of magnitude.
Second, I liked this brief piece by Squire Patton Boggs’ Larisa Vaysman in the Sixth Circuit Appellate Blog, comparing some of the conduct that the opinion could be construed to approve of by a fiduciary to conduct that one might have otherwise slurred as a Ponzi scheme. Substantively, she emphasizes that, under the Court’s holding, to plead an ERISA stock drop claim, “a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary . . . would not have viewed as more likely to harm the fund than help it.” What is interesting about this to me is that I have long considered the Moench presumption, no matter the complex doctrinal discussions that have grown up around it, to reflect a judicial need to find some way to balance fiduciary obligations under ERISA with securities obligations imposed on insiders by the securities laws. The Moench presumption always struck me as too blunt an instrument for those purposes, but that didn’t change the fact that, to me, some way of balancing those sometimes competing interests was necessary. Vaysman’s post highlights the fact that the Supreme Court did not abandon this need to balance the competing interests, but instead imposed a different means of balancing those interests. I think the Supreme Court did a nice job in Fifth Third of imposing that balancing by means of a factual evaluation of the conduct in question, rather than by a presumption, unsupported in ERISA itself, that simply, for all intents and purposes, had effectively barred such claims.
I also liked this financial trade press article, from Pensions & Investments, on the decision, as much as anything for its recognition that the decision drove home the point that “courts should evaluate stock-drop cases ‘through careful, context-sensitive scrutiny of a complaint's allegations,’” rather than by means of a judicially created presumption that cannot be located in the ERISA statute itself. This is, of course, a drum I have always beaten about ERISA litigation and the Moench presumption in particular, which is that it is much more appropriate to delve into the facts to decide whether a case has merit, because the world – and a particular case - can look entirely different on its actual facts than it looks based on judicial assumptions made at the outset of a case, including when judicially created presumptions are applied without first examining the truth of the events at issue. I also liked the author’s emphasis on the fact that the opinion recognizes that the presumption simply had no basis under the statutory language itself.
Blogger - and friend - Susan Mangiero has called me on my promise, made in a prior post about predictions on the outcome of this case, to detail my views, once the decision was in, on whether the Court got it right. As my comments about the articles above probably made clear, I am fond of the decision and think the Court got it just right. They solved a troublesome riddle, which is how to balance the securities law obligations of corporate officers with ERISA’s fiduciary obligations, in a manner that neither distorted the statute – as was the case with the Moench presumption – nor encouraged the filing of stock drop suits against fiduciaries that lacked any basis other than the fact that a stock price had declined.
ERISA, the Wisdom of Crowds and the First Hundred Names in the Phonebook
The wisdom of the crowd, or something else maybe? Susan Mangiero has a wonderful post on something that I probably should have known existed, but did not: an internet site where lawyers and other voyeurs vote on the outcome of pending Supreme Court cases. As Susan notes, the site includes a prediction on a key ERISA case, Fifth Third Bancorp v. Dudenhoeffer, pending before the Supreme Court. It will be interesting to see whether the wisdom of the crowd can accurately predict the outcome of that case.
But there might be a more interesting question to explore, which stems from William Buckley’s famous line that he would rather be governed by the first 100 people in the phone book than the faculty of Harvard. If the Supreme Court rules in a case like Fifth Third Bancorp to the opposite of that predicted in advance by the crowd, the more interesting question may not concern the accuracy of the crowd’s prediction, but instead who reached the better result: the crowd or the Court? I will tell you what. After the Court issues its decision in Fifth Third Bancorp, if the crowd came down on the other side, I will write a blog post on which one I thought was right: the stand-in for the faculty of Harvard (i.e., the sitting justices) or the stand-in for the first hundred folks in the phone book (i.e. the voting public).
How to Trigger Insurance Coverage for an ERISA Claim
Well, how can I not comment on this, given the focus of both this blog and my practice? The Second Circuit was just presented with the question of whether an insurer has to provide a defense to a company and its officer, under the employee benefits liability portion of a policy, for an ERISA claim related to a retaliatory discharge/reclassification claim brought by an employee of the insured. The employee claimed, in essence, that she had been retaliated against for complaining of sexual harassment.
Now, coverage by insurers for complaints alleging sexual harassment or similar claims under standard CGL policies have their own complicated backstory, revolving around the question of whether, no matter what is actually alleged in the complaint by the employee, the acts in question are intentional, dishonest or otherwise harmful in a manner that precludes coverage. Some of this history goes back to at least the 1980s, and, having been involved with a client’s rollout of the coverage, it played a role to some degree in the creation and eventual acceptance of EPLI – or employment practices liability insurance – coverage.
The insurer here took the same tack with regard to the ERISA claim at issue, and, given the history noted above and the nature of the claim, understandably so. The issue, though, as the Second Circuit found, is that the ERISA claim itself did not require any type of intentional misconduct, which is basically true across the board with most types of ERISA claims, and held that the insurer therefore could not deny coverage for the ERISA claim based on an exclusion for dishonest or malicious acts. The Court found that the ERISA claim could, in essence, simply be a claim for negligent conduct – at least as pled in the complaint – and thus the insurer could not deny a defense to the insured based on such an exclusion, which would not reach a claim of negligence.
There are a number of lessons here for both insured companies (and their officers) who are sued in ERISA cases and for their insurers. First, don’t assume that principles related to coverage of employment related claims will transfer to an ERISA claim; they may very well not do so. Second, you have to pay close attention to the true nature of an ERISA claim (including its key legal elements) before deciding whether or not there is coverage, and not simply to the surrounding factual allegations relating to the insured’s conduct (which in most harassment and similar claims are usually pretty egregious, at least as alleged by the plaintiff).
Anyway, here is the decision, which is Euchner-USA, Inc. v. Hartford Casualty Insurance Company, and here is an article providing a nice summary, for those of you who don’t want to read the full decision.
Copyright Infringement and Architects (Software and Otherwise)
Riddle me this, Riddler: what does the design of a center entrance colonial house have to do with complex computer software?
A lot, it turns out, if you are interested in the borders that should attach to IP rights so as to best balance the need to encourage the creation of new products against the risk of stifling innovation. Anytime one renders a design or technical development exclusive to one owner, such as when an inventor obtains exclusivity by means of a patent or an author obtains it by means of holding the copyright, we encourage the original owner to exploit that product, but preclude others from doing the same. When we do that, it is important to create a structure that gives enough protection to the original inventor to motivate people to create new products, but not so much protection that it discourages others from creating related advancements; if we get that balance wrong, we impede the technological advancement that is the original purpose of granting exclusivity in the first place.
I was thinking of this today because of an odd correlation that popped up in my reading. I have litigated copyright infringement cases both over plans for commercial architecture and over very complex computer code, each time defending someone who had created and sold a new product but was charged with allegedly having infringed upon the prior copyright protected work of a prior author (in one case another architect, in the other a different software company). While I effectively won both cases – to the extent that very favorable settlements count as wins in a world in which 99% of cases never see a trial – the more interesting point is that I prevailed on both cases on essentially the same theory, which was that the similarities between my client’s work (whether the design for the building or the code for the software) and that of the holder of the copyright on the prior work concerned aspects of the prior author’s work that copyright law does not protect. Copyright law, through various means – such as the merger doctrine and others – does not protect common or universal design elements, nor does it protect substance that, in essence, cannot be designed around, such as certain problems in software coding that can only be solved in very limited ways. Copyright law allows later-in-time creators to make use of those types of elements in their work (whether that be the design of a house or the design of high value software) even if they were also used in previous, otherwise copyrightable work. In this way, copyright law successfully draws the line between encouraging innovation through the grant of exclusive ownership and corresponding rights of exploitation, on the one hand, and the risk, on the other, of stifling innovation through that grant of exclusivity; these doctrines keep open for other innovators the use of certain elements, whether lines of software code or aspects of building design or other forms of expression, without which further advancement of the art in question is not possible.
This is one of the great, somewhat hidden achievements of American copyright law, one that is worth bearing in mind, and perhaps emulating to some extent, in the world of patent law, as we try to come to grips with the patent troll phenomenon and the runaway nature of patent infringement litigation in this day and age. The trick to solving those problems in that area of the law right now is figuring out how to find that sweet spot – the one that copyright law has, to a large extent, already found – between granting enough exclusivity to drive innovation but not so much that it simply generates excessive patent infringement litigation and gives rise to mills full of patent trolls.
So the answer to the riddle that commenced this discourse lies in this excellent article on the manner in which doctrines limiting the scope of copyright protection just defeated an architect’s claim of copyright infringement based on the architect’s use of certain historical and consumer driven elements in a design for a classic New England colonial home. These same doctrines were, as I mentioned before, the basis for my prior representations of both architects and computer software programmers, with the doctrines generating good results in both circumstances. I liked how clearly the article articulated the use and role of these doctrines in the context of home design, and was immediately struck by the fact that you could replace the references to architect and houses with references to programmers and software and have an equally accurate article. The same copyright doctrines, in my experience, control the outcome of both litigation over building plans and over computer software. That consistency across the board is one of the things that makes American copyright law great, both intellectually and as a practitioner, and is what makes it possible for competitors to plan ahead and understand when they can, and when they cannot, touch on prior work.
What Happens to Company Owners Who Get Overaggressive When Selling Out to an ESOP?
Just what is it about Chicago and ESOPs? Is it something in the water, redolent of gangsters and Al Capone? First, there was the Sam Zell/Tribune ESOP transaction, which, as I wrote before, was such a complex transaction that, building it around the ownership interests of the employees could not help but raise fiduciary flags, and eventually resulted in a substantial settlement of a breach of fiduciary duty lawsuit. Now, there is Fish v. GreatBanc, decided last month by the Seventh Circuit, which involved an ESOP transaction that, not only went south, but went south after the financial advisor to the independent trustee evaluating the proposed transaction on behalf of the participants called it “the most aggressive deal structure in the history of ESOPs.”
I have said it before and I will say it again (and I am sure I will say it many times after today too): ESOPs are financial stakes of employees, not mere financial tools for private company owners. Those who forget that lesson are, if not doomed to repeat the past lessons of earlier fiduciaries, at least doomed to sitting at the defendants’ table in a courtroom.
Leaving that lesson aside, the decision itself is instructive on two major points of ERISA litigation. The first is the proper interpretation and application of ERISA’s fiduciary duty statute of limitations to ESOP disputes and the second is as an excellent overview of the rules governing fiduciaries with regard to private company ESOPs. The opinion itself is so informative and, happily, well-written that I strongly recommend reading it, despite its relative length. For those who would prefer the Cliff Notes, Mark Thomas and Robert Shaw of Williams Mullen provide an excellent summary in this article from last week.