Whitley v. BP, Stock Drops, and the Outer Limits of Fiduciary Responsibility
There is an old political saying that where you stand depends on where you sit, which, roughly translated, means that people tend to assert positions that are beneficial to their own organizations and employers, rather than based upon a consideration of broader issues. The author of the maxim, Rufus Miles, thinks the idea goes all the way back to Plato.
I often think of this maxim, known as Miles’ law, when ERISA litigators comment on prominent court decisions affecting ERISA claims, particularly breach of fiduciary duty actions. Lawyers from firms who primarily or exclusively represent major financial companies or plan sponsors always speak well of defense oriented decisions, and those who represent participants, particularly class action lawyers, always speak poorly of such decisions. The reverse, of course, tends to occur when a court issues a decision that seems to expand liability under ERISA or to favor participants on even a superficial or procedural level.
For me, probably because I represent the full range of actors in the ERISA universe, from participants to plan sponsors to third party administrators to fiduciaries and back again, I tend to be pretty agnostic about prominent decisions issued by courts on key ERISA issues. Some are good, some are bad, some are just plan poorly reasoned and worthy of criticism no matter which side of the “v” you favor.
One I am not particularly critical of is the clear trend line against participants in the so-called stock drop suits, involving claims of breach of fiduciary duty based upon collapse in the stock price of company stock held in employer plans, at least in cases where plan participants always had the option of diversifying out of those holdings but instead voluntarily kept too much of their retirement holdings in company stock. As I have written before, how many economic cycles does one have to live through to know that keeping a large portion of your retirement assets or other wealth, voluntarily, in the stock of your publicly traded employer might just not be the best idea?
But leaving that caveat aside, it is necessary to maintain some strong bars to such claims, because otherwise they simply become a back door avenue for plaintiffs’ firms to prosecute securities litigation, only in this instance, under ERISA, which – for all its reputation as a defense-oriented statute – is a more flexible basis for pursuing such claims than are the securities laws at this point. Stock drop claims more properly belong under the securities laws and its doctrines, and should be evaluated under them. Now don’t get me wrong: I am not saying there cannot be a fiduciary breach for purposes of ERISA related to employer stock that warrants a claim under ERISA under all circumstances, but only that stock collapse, without more, is really simply securities litigation in ERISA clothing.
I have always believed that the Supreme Court’s decision in Dudenhoeffer was a fine piece of line drawing in this regard, allowing such claims in a narrow class of circumstances but limiting them to a degree sufficient to maintain a firm distinction between securities law and ERISA’s fiduciary standards. I believe the post-Dudenhoeffer decisions out of the district courts and federal courts of appeal have demonstrated that this is an accurate view of that decision, including the most recent high profile decision on this issue, the Fifth Circuit’s decision this week in Whitley v. BP, PLC. Whitley was a stock drop claim arising from one of the more notorious environmental disasters in recent years, with the participants claiming that the loss in the value of their company stock holdings that resulted from it was attributable to fiduciary violations by the plan’s fiduciaries. As the Fifth Circuit explained:
On April 20, 2010, the BP-leased Deepwater Horizon offshore drilling rig exploded, causing a massive oil spill in the Gulf of Mexico and a subsequent decline in BP's stock price. The BP Stock Fund lost significant value, and the affected investors filed suit on June 24, 2010, alleging that the plan fiduciaries: (1) breached their duties of prudence and loyalty by allowing the Plans to acquire and hold overvalued BP stock; (2) breached their duty to provide adequate investment information to plan participants; and (3) breached their duty to monitor those responsible for managing the BP Stock Fund.
After much procedural maneuvering by the plaintiffs to try to plead a viable breach of fiduciary duty theory involving this fact pattern, the Fifth Circuit eventually dismissed the action, finding that the plaintiffs could not satisfy the standards for stock drop claims after Dudenhoeffer. Procedurally and doctrinally, it reads to me as a correct ruling. But there is more to it than that. If you step back and think about this case as a whole – and not just based on where you sit in terms of who should bear the losses from a stock drop, the employees or instead the employer – the decision makes even more sense. There is an awful long distance – both literally and metaphorically - between an offshore drilling rig and the plan fiduciaries sitting in an office somewhere deciding to offer company stock in a retirement plan. To borrow a concept from tort law, there is an almost inconceivable number of breaks in the chain of causation between the decision making of the fiduciaries and a loss stemming from this event. Although I fully understand how one can connect the dots, it is really pushing the outer limits of fiduciary responsibility to do so.
Singing the Praises of ESOPs
I do a lot of litigation related to ESOPs, sometimes for them, and sometimes against them. One thing I have learned for sure over the years is that the well-run ESOPs, where everything is aboveboard and the fiduciaries are clearly acting – and want to act – in the interest of the employee participants, are spectacular creatures: they create wealth for employees, give rise to significant employee investment in the company’s success, and seem to at least correlate with growth in key company metrics. Many lawyers who represent ESOPs are almost evangelical in their fervor for the form.
For those of you who don’t spend a lot of time with ESOPs, or are just plain unfamiliar with the world of ESOPs, this article from the Atlantic really paints a good picture of why well-run ESOP companies are so valuable, in so many different senses of the word.
What the Disqualification of an ESOP Illustrates About ESOPs In General
Here’s a great little story by lawyer and blogger Jeffrey Cairns on the IRS disqualifying a professional practice’s ESOP based on significant operational defects, not the least of which was a failure to comply with the plan’s terms concerning eligibility. I like the post because it lays out the nature of the ESOP, the defects, and how those defects led to disqualification clearly and carefully. Often, stories about these types of events tend to speak in broad generalities, or else take the disparate problems in a particular ESOP and the multiple causes of a disqualification and treat them as one undifferentiated mass. Cairns doesn’t do that here, and instead explains exactly what errors were made that led to the disqualification.
The reason the story caught my eye – beyond its clarity – is that it relates to a point of contention I often find myself in with lawyers and financial advisors who tout the wonders of the ESOP form. ESOPs certainly have their place, and can, when used correctly and with the right intentions on the part of a company’s owners or founders, be a very important tool. I have found over the years, however, that some ESOP advocates, and especially lawyers who defend them against suits by participants or regulators, sometimes seem to have a “see no evil” approach to ESOPs and to treat all criticisms of the form as illegitimate. I have always thought that this view goes too far. It has always been my opinion that ESOPs are wonderful in theory, but in practice, they are only as good as both the intentions of those who found them and the competency of those who run them. When ESOPs are put in place properly, run competently, and installed with the interests of the plan participants at heart, they are a wonderful thing. However, as the case of disqualification depicted in Cairn’s post reflects, this isn’t always the case. No matter what promoters of that corporate form argue, ESOPs are not the be all and end all unless they are run right and with the right intent. Cairn’s story of the disqualification of one small firm’s ESOP well illustrates that point.
My Exclusive Interview with Fiduciary News on ERISA Litigation
The good people at Fiduciary News gave me a soapbox, and I was happy to climb up on it. They interviewed me as part of their series of monthly interviews on ERISA and related topics, and I discussed ERISA litigation and a wide range of related issues. You can find the “Exclusive Interview: ERISA Attorney Stephen Rosenberg Says Litigation’s Legacy is Improved Plan Design” here. You will see I went on for a bit, as I am wont to do when anyone wants to talk about ERISA!
Follow the Money: What Happens to the Proceeds of Class Action Settlements
When you read in the paper about a large settlement in an excessive fee case or other claim involving a 401(k), ESOP or other ERISA governed plan, do you think about what happens next, and about how to distribute the money among the plan participants? I do, in cases where I have represented the class, but also in cases where I have defended the plan or its fiduciaries. As this article from Plan Advisor discusses, there are a lot of issues that go into deciding how to distribute the settlement among current plan participants and those who have left the plan. The article gives a good overview, and drives home a key point: there is a lot of complexity behind the scenes in figuring out how to distribute the money, which the media, reporting on the large figures of the settlement itself or on the large award to class counsel (which are both sexy subjects), tend to ignore or simply be unaware of, because it just isn’t that interesting to the public as a whole. But in real life, this part of a settlement is crucially important, and creates a fair amount of work for those who administer class action settlements and those who administer plans themselves.
Here are a few things I have observed and lessons I have learned over the years. First, the class definition in the litigation and which is used by the court in approving the settlement is hugely important. In class action litigation involving these types of plans, the class of affected participants is typically defined by the litigants and eventually approved by the court. If the parties and the court really focus on the definition, its terms can provide a great deal of guidance to the administrator with regard to exactly which current and former plan participants should receive distributions. Often, though, the class may have been superficially defined, in a manner that the lawyers feel will be sufficient to win court approval, but which may not, in fact, be precise enough to guide distribution of the proceeds and provide real guidance in that regard to the plan administrator. A focus on this issue by the lawyers negotiating the terms of a class action settlement can make a real difference when it comes time for the administrator to do the hard work of allocating the settlement proceeds.
Similarly, settlement documents in a class action, negotiated by the parties as part of closing a deal and obtaining court approval of the settlement, are usually replete with detailed explanations of as many facets of the settlement as the lawyers for both sides can think to cover. This is often, I hate to say, more often due to self-interest of the lawyers involved than to any higher motivation, as a detailed, comprehensive explanation of the settlement is often crucial to winning court approval of the settlement and to defeating objectors to the settlement who are part of the settlement class. There is nothing wrong with that per se, in that the class action system, with its awards of attorneys fees out of settlement proceeds and the checks and balances imposed by court oversight, is designed both to be driven by self-interest and to tamp down its unchecked excesses (I should note here that unlike many of its critics but like many of those who, like me, actually toil in the orchards of class action litigation, I find that this aspect of the system works pretty well in the vast majority of cases). A focus in these papers on settlement allocation – perhaps by including a subsection expressly directed at describing allocation of the proceeds in as exquisite of detail as possible - can greatly aid the administrator later on in distributing the settlement proceeds.
Company Stock in Retirement Plans: Where Lies the Line Between Prudent and Imprudent Conduct?
Chris Carosa at Fiduciary News highlighted this New York Times article in his twitter feed the other day, in which the author argued that there is no reason, from the point of view of a participant/employee, to hold large amounts of company stock in a retirement portfolio (as opposed to, say, as part of a bonus plan or other compensation supplement that is external to a 401(k) plan or other retirement account). The author of the article makes a very persuasive case that, as a participant, holding company stock of their employer is a mistake, and violates basic, elementary rules of diversification and investment philosophy that any competent financial advisor would insist their clients live by. So, the author asks, how can it possibly make any sense to have company stock holdings in a 401(k) plan or to have company matches to retirement savings be in the form of company stock? The author’s answer, as you can tell from the summary above, is it doesn’t.
But if it doesn’t make any sense from the perspective of a participant, then how can it ever be a prudent decision for a fiduciary to offer it in the first place? A fiduciary is supposed to be acting as a knowledgeable expert and in the best interest of the participants, so if one accepts the premise that someone knowledgeable about retirement investing would not hold company stock in a 401(k) plan, then it would seem to never be in the interest of participants – and therefore compliant with a fiduciary’s obligations – to offer company stock in a retirement plan. Note that this question concerns general retirement savings of employee participants, and not ESOP holdings, which we know are deliberately and intentionally overweighted to holding company stock.
Now, this analysis needs one qualification. We all know that some companies do so well that employees and participants would be ill-served by not holding employer stock, and the returns on their retirement accounts would be severely reduced absent large holdings of company stock. All have heard the story of Microsoft millionaires (or Apple, or Facebook, or Google, or fill in the name of the tech company) but we also know that sometimes this has been true of employers in less glamorous industries as well (even if not to the same extent with regard to the appreciation of their stock). But these events are outliers in a bell curve, and are not the experience of most participants or of most employers offering company stock, just as the instances of company stock holdings going south, i.e., a stock drop, are outliers as well. For most participants in most plans in most companies, the potential gain certainly doesn’t outweigh the general risk, accepted in investment theory, of the accompanying excessive concentration of stock of any one company, which in this instance is the employer.
So, if this is the case, how can it ever be prudent to offer company stock in a 401(k) plan, and, if the stock falls in value, not have it be a fiduciary breach? Such an analysis would suggest that even holding or offering the company stock as an option is a fiduciary breach, as it is not prudent to offer it at all. But this is where ERISA meets the real world. The statute was not enacted in a vacuum, but was instead created by balancing competing interests. And the answer to the question, and the reason why such an argument would not succeed in a stock drop case, is that ERISA allows, to a certain extent, such holdings, so their very existence alone, without more, cannot constitute a fiduciary breach. The statute allows for it, so doing it can’t breach the statute.
And this, to a certain extent, is what Dudenhoeffer was about – the idea that a plan sponsor gets the protection of being allowed to do, without being accused of imprudent conduct, what the statute specifically allows, but is not insulated anymore than that from scrutiny of its conduct. So here, with regard to company stock, despite the idea that it is probably never prudent, as an individual retirement investor, to hold an excessive concentration of one company’s stock and in particular that of one’s employer, that alone cannot support a breach of fiduciary duty claim against a plan sponsor; instead, to impose fiduciary liability, that plan sponsor must have done something more than just offering that stock to employee participants.
The Wall Street Journal on Increased Oversight of ESOP Transactions
The Wall Street Journal ran an interesting, if superficial, story on tougher scrutiny of ESOP transactions and how that is impacting smaller companies with ESOP programs. As the article pointed out, ESOPs in that context are very much a tool for the owner/founder class to cash out their equity developed by building the business – including for the purpose of transforming the business into a retirement nest egg – without having to go out into the open market to sell it, by instead selling it in an essentially captive transaction to the employees. But the interesting thing about that is that the former – selling the company into the open market – comes with the built in valuation discipline of an open market, with the company having the value that informed buyers are willing to put on it relative to other potential investment options open to those buyers. ESOPs, as a tool for the owner/founder class to cash out their equity, don’t come with the protections and tools for valuing the worth of the company that are inherent in selling into an open market; the pricing, and thus the amount of cash out open to the owner/founders, is instead determined artificially, independent of an open market, by an appraisal process that is supposed to be watched over, on behalf of the employees, by the plan fiduciary.
The Journal article discusses the fact that DOL initiatives in this area are driving up the cost and requiring somewhat more disciplined oversight of the process by companies proceeding with ESOPs. The article, however, references that it is simply driving up the cost of appraisals from an average of $10,000 to $11,000, and that certain legal and related fees are higher for companies that want to ensure that there are no perceived or actual conflicts of interest in the transaction. If that is all the additional cost for ESOPs that are caused by enhancing the protections of employees in such a transaction, then that isn’t much cost at all to give the employees at least some of the protections that the marketplace would give to a third party buyer.
Clearing Out the Attic of My Mind: Notes From ACI's 8th National Forum on ERISA Litigation
With all due apologies to longtime Globe sports columnist Dan Shaugnessy, who would periodically “clean out his desk” by running a column of short bits he had collected, here’s a list, in no particular order, of interesting (to me, anyway) items I took away from ACI’s excellent 8th National Forum on ERISA Litigation in New York City this week, where I spoke on ethical issues in ERISA litigation:
●What a great group of panelists, and thoughtful, educated audience. They reaffirmed my (somewhat narcissistic and self serving) belief that ERISA litigation attracts and holds onto the sharper tools in the bar.
●Day 2 of the conference had an excellent panel on ESOPs, with at least one panelist noting the pervasive problem of conflicted fiduciaries in this area, who may have interests in the outcome of a transaction that are not the same as those of the employee participants in the ESOP. During the course of the day, whether at lunch or by the coffee table outside the meeting room, everyone I spoke to had a horror story about a conflicted ESOP trustee and an ESOP transaction that disserved employees as a result. Isn’t it past time to effectively require the appointment of independent fiduciaries, from outside of the employee owned or soon to be employee owned company, to pass on transactions on behalf of the employee owners?
●I’ve been hearing for years that Broadway is either dead or dying, but you couldn’t tell that from the outdoor advertising at all of the theaters surrounding the conference site. Either all the shows out there right now are the best there’s ever been, or it is truth in advertising, rather than Broadway, that is dead.
●Incidentally, every time I left my hotel I saw a big promo for Bradley Cooper in a new version of Elephant Man on stage. I know everyone’s a critic, but Cooper was the weak link in the American Hustle cast, so I can’t say the promo had me reaching for my wallet.
●Nobody knows nothing, at this point, about what impact Dudenhoeffer will have (I exaggerate slightly, as many panelists and audience members had calculated and well-educated guesses as to the future of stock drop litigation). As I discussed with some members of the audience, one wonders whether the class action bar will go forum shopping with regard to the next round of decision making in this area, looking for the most favorable possible venues for the first of the next round of decisions in this area.
●Speaking of the class action bar, those of its members who were in the audience looked amused when a panelist referenced the class action bar as “sharks.”
●There was an excellent panel on the public pension crisis. It looks to me like the problem will inevitably be left to bankruptcy courts and litigators to sort out, which drives home the extent to which the political will and leadership needed to address the problem is absent.
●One of the most interesting panels to me every year is the insurance industry panel discussing fiduciary liability and other insurance matters related to insuring risks and exposures in the benefit plan industry. It lays the complexity of insurance coverage law (which many lawyers find a very complex area) on top of one of the few areas of the law that exceeds it in complexity, ERISA.
●In the time between the insurance panel’s presentation and getting back to my office, what showed up on my desk but a complicated problem concerning the extent of insurance coverage for an ERISA exposure.
●In the time between my own presentation on ethical issues in litigating ERISA cases and getting back to my office, what showed up on my desk but an ethical conundrum I had never seen nor even thought of before. Grist for the next time I give a presentation on that issue, I suppose.
●The judicial panels on the morning of the second day of the conference are always interesting, and it always catches my attention how many times, and in how many different ways, the judges reference their desire to have the lawyers before them simply act courteously and respectfully to each other in the cases pending before them. One judge commented that, from his seat on the bench, it looks to him that “civil lawyers act criminally to each other and criminal lawyers act civilly to each other.”
●In the time between that judicial panel and my own presentation several hours later, I received at least two emails that documented the judges’ concerns in this regard.
●And I bet so did every other lawyer sitting in the audience.
●There are worse places in the world to watch a World Series game than the West Side Palm in NY.
●I really enjoyed the top hat plan litigation presentation, but that may just be me. There is something I have always found fun about litigating top hat and other executive compensation disputes. Maybe it’s the structure of top hat plan cases, which have a very logical order and composition of issues that can be exploited by a litigator. The presentation matched this, with a focus on the step by step elements of creating top hat status and defending against challenges to it.
●And finally, the panelist who discussed standards of review in ERISA litigation and noted that he may be the only person in the room old enough to remember litigating before Firestone was a treat. Firestone was decided in1989, and, despite nearly 25 years of experience, I never litigated benefit disputes in a pre-Firestone environment, so it was fun to hear, even briefly, how the litigants and the courts addressed the standard of review in the days before Firestone (hint: they typically didn’t).
Tatum v. RJR Pension Investment Committee: What it Teaches About Fiduciary Obligations
Somehow, RJR Nabisco has always been fascinating, from beginning to now. There must be something about combining tobacco and Oreos that gets the imagination flowing; maybe its the combination of the country’s most regulated consumer product with the wonders of possibly the world’s favorite cookie. Heck, its birth even birthed a book and then, in turn, a movie starring James Garner, whose mannerisms, in the guise of Jim Rockford, are imbedded to at least a slight degree in the personality of every male my age. Ever watch a late forties/early fiftyish lawyer try a case in front of a jury? Watch closely, and you will see at least a little Rockford in the persona.
Now, in the guise of a Fourth Circuit decision over breaches of fiduciary duty involving company stock funds, RJR Nabisco has become a touchstone for ERISA litigators as well. There are a number of takeaways and points of interest in the decision, which you can find here, and the decision has generated no small number of thoughtful commentaries over the past few weeks, some of which you can find here, here, here and here. Without repeating the yeoman’s work that others have already done summing up the case, I am going to run a couple of posts with my thoughts on two key aspects of the case.
Today, I wanted to address the question of the finding of a breach of fiduciary obligations, and I will, lord wiling and the creek don’t rise, follow that up with a post on the question of proving loss as a result of the breach. These are two interrelated issues in fiduciary duty litigation, and Tatum v. RJR has some interesting things to say, and to teach, about both.
Initially, as everyone knows, you cannot have a breach of fiduciary duty recovery without a breach of fiduciary duty. Here, the Court found a breach of fiduciary duty on the basis of the defendants’ quick and informal decision concerning whether to continue to offer company stock that was based as much as anything on myths and legends about holding company stock in a plan as it was on any type of a reasoned approach to the question. Concerned about the possible liability exposure under ERISA for holding an undiversified single company stock fund in a plan, a working group decided to eliminate the fund without actual investigation into the legal, factual, potential liability or other aspects of holding the fund. Further, they did so in a short meeting, without ever gathering any of the detailed information that would be relevant to making such a determination.
There is a real and important lesson here with regard to the manner of making any decisions with regard to plan investment options, and an additional one that is of particular significance with regard to a decision to eliminate an investment option, which was the event in RJR Nabisco that triggered potential liability. The general lesson is that the days of fly by the seat of your pants management of plan investment options are over (if they ever existed; people may have been doing it that way, but it was probably never legally appropriate to do so). Instead, a failure to properly investigate investment options, including using outside expertise to do so, has reached the point where it can essentially be considered a per se breach of fiduciary duty. It may not have that posture in the law, in the sense of pleading and proving it simply establishing the existence of a breach, but that fact pattern, at this point in time (and not simply because of the holding in RJR Nabisco, but because of a number of cases and legal developments leading up to the time of that ruling), will consistently lead to a finding of a breach.
The more specific lesson to think carefully about here is something very interesting, and to some extent ironic. The working group felt obliged to eliminate the investment option because of questions related to the liability issues of holding a non-diversified single company stock fund, but that is not the same question as whether it was in the best interests of the plan participants to hold, or to instead eliminate, that fund. It is the latter question, and not the former question which is primarily one that concerns the risks to the plan sponsor and those charged with running the plan, that is supposed to be at the heart of the decision making process when it comes to these types of issues. Fiduciaries must run a plan – subject to many limitations on that general principal – in the best interest of the plan participants, without regard to their own interests. That, in all areas of the law, is the basic premise and obligation of being a fiduciary. Here, the defendants’ fiduciary breach occurred because they failed to do that: they did not investigate or analyze the issue from the perspective of what was best for the participants but instead from the perspective of the risks to the plan sponsor and its designees (i.e., the fiduciaries).
When thought about that way, the irony becomes apparent. By being overly concerned about the liability risks of keeping the investment option, the defendants created liability exposure by getting rid of the investment option.
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).
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.
What Does the Moench Presumption Look Like in the Light of the Real World?
One recurring problem in ERISA litigation is the tendency of courts to address and decide novel and complex issues on motions to dismiss, rather than after allowing full development of the factual record. New and original breach of fiduciary duty theories can look entirely different when considered by courts on the full record than they appear when analyzed solely on the pleadings, at the motion to dismiss stage. The excessive fee cases presented this dynamic perfectly, with early decisions, such as Hecker v. Deere, that were resolved on motions to dismiss appearing, in hindsight, to be incorrect in comparison to later decisions, either made after a full factual record was developed, such as in Tibble, or on motions to dismiss after years of litigation had established a broader and more general understanding of the issues raised by those types of claims. One of the underlying themes of my article, “Retreat from the High Water Mark,” was that the early decision on the excessive fee theory in Hecker was flawed, precisely because the court did not have before it a detailed, factual understanding of the nature of the claim and of the fee structure. As a result, the court, by deciding such a novel theory at the motion to dismiss stage, had to assume facts about the mutual fund marketplace and 401(k) plans that were not necessarily true.
My biggest criticism of the Moench presumption, more than its effort to strike a balance between fiduciary obligations under ERISA and securities law obligations imposed on public companies and their officers, is the creation and application of the presumption at the motion to dismiss stage, rather than waiting to see what the evidence shows as to whether corporate insiders underserved the interests of participants when serving as the fiduciary for company stock plans. Just as the history of excessive fee litigation shows, and as I discussed in “Retreat from the High Water Mark,” it is much easier to more accurately determine whether fiduciary obligations are breached when the facts are all before the court, rather than by means of the assumptions, surmise and allegations that can animate decision making in such complex and novel areas at the motion to dismiss stage. The Moench presumption effectively precludes stock drop claims under ERISA, and effectively establishes the governing rule of law for fiduciaries of employer stock plans. The rule and its application may be right, or it may be wrong, but it would be a lot easier to determine that by considering the obligations as fiduciaries of corporate insiders in light of the true facts of their conduct, which the application of the presumption at the motion to dismiss stage – and in fact even its creation without and before any court has ever fully developed and analyzed the facts of such a claim – precludes.
I was thinking of this because Mitchell Shames, who is now an independent fiduciary at Harrison Fiduciary and before that was the long time general counsel for State Street Global Advisors (including during the time that the First Circuit blessed their structure for handling exactly these types of conflicts, in Bunch v. W.R. Grace), has pointed out that corporate insiders serving as fiduciaries in this context do actually face conflicts, and not just in theory. Mitchell has written an excellent post detailing, from firsthand knowledge, the conflicts faced by corporate insiders who are tasked with making investment decisions of this kind for plan participants.
Mitchell writes that when a CEO appoints insiders to make these types of decisions:
everyone takes notice. While CEO lieutenants may be adept at various technical and managerial skills, often, intense loyalty to the CEO is a common attribute. (Dissidents typically do not rise to the C-suite).
This loyalty often includes a precise understanding of the CEO’s goals and priorities with respect to corporate strategy and is often rewarded by promotions, committee appointments, raises, bonuses, stock options and other assorted perks. The senior managers are properly incentivized to advance the vision of the CEO.
Upon assuming a spot on a fiduciary committee, however, these same senior managers are required to shed the very skills that contributed to their corporate rise. When making decisions on behalf of the plans, they are supposed to set aside any allegiance to the CEO, forget about the stock options they may have patiently accumulated over the years, and make decisions irrespective of an impact on corporate earnings.
The potential for conflicts of interest are real; they are not the abstract musings of lawyers and academics. Many transactions squarely put the corporation and the plan on opposite sides, with competing goals.
I was struck, in regards to my concerns about the limitations imposed by “motion to dismiss decision making” and their relationship to the Moench presumption itself, by Mitch’s conclusion, in which he asked: "So, can these corporate offices so deftly switch hats as ERISA lawyers assume? Are fiduciary committee members so professional, so trustworthy, so ethical, that they are immune to the human impulses which gave rise to [the principle that]: 'No one can serve two masters'?"
One wonders whether the Moench presumption would seem to fairly balance the needs of sponsors and participants if it was considered only after a full factual record was created that might show this type of problem with conflicts faced by the fiduciaries. Would the rule seem to make as much sense in that light as it does when a court is faced with only the allegations of a complaint? Would a court reach a different conclusion than at the motion to dismiss stage on this issue if the judge was considering this type of claim after hearing a senior corporate officer who had served as the fiduciary testify as to his understanding of his obligations, conflicts, and the need to balance them?
We can’t know this definitively. What we do know, though, is that it would certainly be a lot better to decide what the legal rule governing stock drop cases should be by first learning all the relevant facts, and then creating the rule, rather than by doing it in reverse (which is essentially where we are right now, with the Moench presumption applied by courts at the pleading stage).
What if Trust Law Cannot Support the Moench Presumption?
The “stock drop” presumption of Moench, now before the Supreme Court in Fifth Third Bancorp, is best understood as a judicial attempt to balance the sometimes conflicting demands placed on corporate insiders by, on the one hand, the securities laws and, on the other, ERISA, when it comes to employee stock plans in publicly traded companies. It’s not an unreasonable tack to take, even if those perceived conflicts could be easily handled and avoided simply by the use of an outside independent fiduciary, as W.R. Grace did years ago in the situation that became the First Circuit case of Bunch v. W.R. Grace, which I discussed here, rather than using a corporate insider in that role.
The problem though, for those who believe that it is appropriate for the courts to find a way to balance those obligations, is how to get to that result. The terms of the ERISA statute itself don’t easily lend themselves to the creation, justification and imposition of the presumption, leaving the importation of, and reliance upon, doctrines developed under trust law to provide a basis for the creation of the presumption. But what if trust law, properly understood, cannot support the creation of a presumption of that much benefit to plan fiduciaries? Can the presumption stand if that is the case? The extent, nature and degree to which the Supreme Court grapples with these two issues – whether either the terms of the statute or the scope of trust law can support the presumption – will tell a very interesting tale, by illustrating whether the presumption’s status is actually driven by the legal foundation crafted by the statute and trust law or, instead, by an outcome driven need to balance the securities law regime with the dictates of ERISA. If the presumption is found valid, one will need to look closely at whether the Court was able to properly base that conclusion in the historical intricacies of trust law or in the statute’s language. If so, then the presumption can be understood to follow naturally from existing law; if not, then the presumption must be seen, as many have argued it is, as simply a convenient judicial fiction, one not properly founded on either trust law or statutory language, used to balance conflicting legal obligations imposed by distinct statutes.
Into this question rides Professor Peter Weidenbeck, in this absolutely fascinating article, “Trust Variation and ERISA’s ‘Presumption of Prudence’,” in which he details the history of the trust law basis on which the Moench presumption is said to rest, and finds that the trust doctrines relied upon by the courts that have created and applied the presumption do not support the presumption. In a nutshell, Weidenbeck argues "that prevailing state law standards governing trust variation do not impose the extremely restrictive (well-nigh insuperable) barriers that the federal courts following Moench mistakenly assume” and that deciding how to handle stock drop cases requires a more nuanced and comprehensive analysis of statutory history.
You can download his article here, and I highly recommend reading it. Even though it discusses tax issues and trust law, it is very readable, and only 24 pages in any event. At a minimum, the Supreme Court’s eventual opinion in Fifth Third Bancorp will make a lot more sense if you read the article first.
Fifth Third Bancorp and the Lack of a Historical Foundation for the Existence of a "Coach Class Trustee"
This is an interesting point, to me anyway, and a point that, for me, falls in that odd space between too short for a good blog post but too long for a tweet. I have written before that, because I seldom use blog posts to simply pass on others’ work and instead usually post substantive discussions, I created a twitter feed to have somewhere to pass along other people’s work when I am only going to briefly comment on it and not speak in depth on that work. This, of course, has left me in the position of not knowing exactly what to do when I have something to say about someone else’s writing that will take less than a couple of paragraphs to say but more than a hundred and forty characters. (Maybe someone needs to start a new micro-blogging app, say with 280 characters as the limit??).
Anyway, Chris Carosa has a wonderful essay out on the true and historic meaning of the term fiduciary, and the high level of care that its classic meaning imposes on someone serving in that role. The timing of the essay is interesting, coming as it does right after the Supreme Court heard argument on the Fifth Third Bancorp case, concerning whether there are limits on the fiduciary obligations of the trustee of an ESOP that might not exist in other circumstances. As this argument recap by Timothy Simeone of SCOTUS blog points out, at least some of the Justices seemed troubled by the idea that the fiduciary in that circumstance might have a lesser standard of care than he or she would in other circumstances, with Justice Kennedy quipping that the ESOP fiduciary, if that is the case, would then be some sort of a “coach class trustee.” And therein lies the point I wanted to make, one too long to make in my earlier retweeting of Chris’ essay: it is impossible to reconcile the existence of a “coach class trustee” with Chris’ presentation of the historical meaning of the term fiduciary. You just can’t do it.
The First Circuit's Wary Relationship to the Moench Presumption
By the way, speaking of Fifth Third Bancorp, I take exception at the assertion (see here, for instance) that every circuit to consider the issue has effectively adopted the Moench presumption, although with some dispute over how and when to apply it. The First Circuit, which tends to favor fact specific resolutions of complex ERISA disputes over sweeping doctrinal approaches to resolving them, rejected a variation on the presumption in 2009 in Bunch v. W.R.Grace. The Court explained:
Appellants seek to induce us to reject State Street's actions by having us apply a presumption of prudence which is afforded fiduciaries when they decide to retain an employer's stock in falling markets, first articulated in Kuper v. Iovenko, 66 F.3d 1447, 1459 (6th Cir.1995) and Moench, 62 F.3d at 571–72. The presumption favoring retention in a “stock drop” case serves as a shield for a prudent fiduciary. If applied verbatim in a case such as our own, the purpose of the presumption is controverted and the standard transforms into a sword to be used against the prudent fiduciary. This presumption has not been so applied, and we decline to do so here, as it would effectively lead us to judge a fiduciary's actions in hindsight. Although hindsight is 20/20, as we have already stated, that is not the lens by which we view a fiduciary's actions under ERISA. DiFelice, 497 F.3d at 424; Roth, 16 F.3d at 917–18. Rather, given the situation which faced it, based on the facts then known, State Street made an assessment after appropriate and thorough investigation of Grace's condition. Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir.1984). This assessment led it to find that there was a real possibility that this stock could very well become of little value or even worthless to the Plan. It is this prudent assessment, and not a presumption of retention, applicable in another context entirely, which controls the disposition of this case. See also LaLonde v. Textron, Inc., 369 F.3d 1, 6–7 (1st Cir.2004) (expressing hesitance to apply a “hard-and-fast rule” in an ERISA fiduciary duty cases, and instead noting the importance of record development of the facts).
This came five years after the Court refused to accept and apply the Moench presumption in LaLonde v. Textron, where the Court explained:
As an initial matter, we share the parties' concerns about the court's distillation of the breach of fiduciary standard into the more specific decisional principle extracted from Moench, Kuper, and Wright and applied to plaintiffs' pleading. Because the important and complex area of law implicated by plaintiffs' claims is neither mature nor uniform, we believe that we would run a very high risk of error were we to lay down a hard-and-fast rule (or to endorse the district court's rule) based only on the statute's text and history, the sparse pleadings, and the few and discordant judicial decisions discussing the issue we face. Under the circumstances, further record development—and particularly input from those with expertise in the arcane area of the law where ERISA's ESOP provisions intersect with its fiduciary duty requirements—seems to us essential to a reasoned elaboration of that which constitutes a breach of fiduciary duty in this context.
At the end of the day, once the Supreme Court has ruled in Fifth Third Bancorp, these decisions may be rendered little more than a historical oddity and an interesting backdrop to the development of the presumption of prudence in the case law. For now, though, they constitute an interesting footnote to the discussion about how the various circuits have, to date, applied the Moench presumption.
One Judge's Vote on the Likely Outcome of Fifth Third Bancorp
Wow, what a great piece by Rob Hoskins summing up the law throughout the circuits on the Moench presumption, by means of a review of a new decision by the Eastern District of Missouri on the issue. I highly suggest reading at least Rob’s “Moench Presumption for Dummies” if you want to have a solid understanding of the issues raised by the use of the presumption, or the decision itself for more detail. One of the things that is interesting about the decision itself, by the way, is the court’s handling of the pending Supreme Court review of the Moench presumption issues. The Court ruled on the motions pending before it, finding that the Moench “'presumption of prudence' is appropriately applied at the motion to dismiss stage," but noted that:
The Court is cognizant that this issue is currently pending before the United States
Supreme Court. See Fifth Third Bancorp v. Dudenhoeffer, No 12-751, cert. granted December 13, 2013. Consistent with the majority of courts construing the applicability of the presumption, the Court will apply it with respect to the pending Motion. In the event that the Supreme Court determines the presumption is inapplicable in the 12(b)(6) analysis, the Court will entertain a motion to reconsider.
Doesn’t this mean, effectively, that the District Court is making a prediction of where the Supreme Court will end up on this issue? I suspect the judge wouldn’t have ruled right now to the opposite of what the judge believed was likely to be the outcome of the Supreme Court case.
The Lessons of First Data Corp's Suspension of 401(k) Contributions
There is a fascinating story in today’s Wall Street Journal, about First Data Corp. abandoning the practice of making cash contributions to employee 401(k) accounts, as part of cost cutting clearly designed to make the company more profitable (or at least profitable enough) to hold an IPO, which would allow an exit for the leveraged buyout group that had acquired First Data but has so far failed to improve the company’s prospects. As the article explains, First Data is instead going to make stock awards to all employees, but apparently outside of the retirement plan format. As best as one can tell from the article, the stock grants to employees won’t be made as part of an ESOP or some other type of retirement plan account, although the article is not entirely clear on this point.
We have seen for years the abandonment of pensions in favor of 401(k)s and similar plans that remove long term funding and investment risks from the sponsor/employer, and transfer those obligations and risks to employees. That is old news. What is new, however, and both interesting and troubling about the First Data story, is that it takes that transitioning of retirement risk from a company to its employees one step further, by replacing the cash contribution by the plan sponsor with the entirely speculative and risky grant of private stock, for which there is not even a current public market. In so doing, First Data has gone one step beyond simply the transitioning of employee retirement risk to employees by means of 401(k) plans, by removing the certainty – and cost to the company – of cash contributions in favor of paper awards that do not increase the employees’ current retirement assets. There are multiple problems with this step, viewed from the prism of retirement policy. First, we have all long counseled employees against excessive reliance on company stock in retirement planning, and in fact, it is a common refrain in defending against ERISA stock drop cases that employees in many cases could have and should have diversified out of company stock, but did not do so. This change by First Data effectively forces employees to have less cash to use for diverse investments in their 401(k) plans in favor of holding, apparently outside of the retirement plan, a concentrated amount of company stock. Second, and related to this, the company is reducing the cash in employee 401(k) accounts at the same time that the market is doing well as a whole (generally speaking), reducing the employees’ ability to invest broadly and keep up with the market; instead, they get company stock which, according to the article, is becoming less and less valuable each day.
A related and to me, fascinating, note on this is the fact that the stock grants, as noted above, may not be made as part of an ESOP or otherwise within the context and confines of an ERISA governed plan. If this is so, then the plan sponsors will avoid the obligations and potential liabilities that come with fiduciary status, when it comes to the granting of the stock and company decisions that impact the value of the employees’ stock holdings down the line. This is a very interesting and subtle point that should not be overlooked, particularly since the company is basically a creature, at this point, of the leveraged buyout industry and the real purpose of the changes in question are clearly directed at future transactions that would allow the current major investors to cash out. If they keep the employee stock obligations out of any ERISA governed plan, including an ESOP, the fiduciary obligations imposed by ERISA will not be implicated in or by any future transactions designed to unwind the stakes of current ownership. If those stock grants are instead placed in ERISA protected plans, in contrast, ERISA’s fiduciary obligations will serve as a check on any future complex transaction involving the company’s stock that might negatively impact the value of stock held by employees, in circumstances where those same events might positively impact those with control over the company and the majority of its stock. Those of you who recall the tortured history of theChicago Tribune’s ESOP and its role in a complex corporate transaction will recognize this point, and the risks and benefits incumbent in the decision to keep, or not, the stock grants within an ERISA governed plan.
Why the Complexity of Plan Valuation Argues Against Turning Appraisers into Fiduciaries by Regulatory Pronouncement
I have written before, both in short form on this blog and long form for the Journal of Pension Benefits, on my view that it is not necessary to alter the regulatory definition of fiduciary to transform appraisers into fiduciaries. Simply put, there are so many parties who already bear the title of fiduciary and are therefore legally responsible for the impact on a plan of a deficient appraisal that transforming appraisers into fiduciaries is likely to do little more – when it comes to plan performance and governance – than create another party to name as a defendant in ERISA litigation, namely the plan’s appraisers. Moving the risk of fiduciary liability for a poor appraisal from the fiduciaries who run the plan – and selected the appraiser and accepted the appraiser’s findings – to the appraiser itself is unlikely to change the incentives and disincentives that impact the quality of a plan’s appraisal; it will simply move some of those incentives and disincentives from those who operate the plan to the appraisers they hire, or else will simply multiply those same incentives and disincentives so they are borne both by those who run a plan and by the appraisers they hire.
When it comes to the general opposition by the appraisal industry to such a change, however, I have to admit that I nonetheless have generally assumed it to be basically an act of economic self-interest: taking on fiduciary risk will increase potential liabilities and thus, at a minimum, the industry’s overall insurance and legal costs. Dr. Susan Mangiero, one of my favorite experts on business valuation, however, has published an excellent article explaining the complexity of appraising and valuing the holdings of pension plans, which illustrates another component to the industry’s opposition to turning appraisers into fiduciaries; the appraisal process for a particular plan can be particularly complex, with significant judgment calls. At the end of the day in any particular case, an appraiser, if a fiduciary to a plan and thus a defendant in ERISA litigation, may be found to have acted prudently in making those calls and thus not liable as a fiduciary under ERISA. However, that broad range of judgment calls leaves plenty of room for litigation over each of those calls, making it an expensive and long process for an appraiser to reach that point of exoneration. I am not certain that imposing fiduciary risk on each one of those calls by an appraiser is really likely to improve the analysis provided to plan fiduciaries – it seems to me it is more likely to simply create a “CYA” mentality when making appraisal calls, with one eye on the risks those calls pose down the road in a courtroom. I don’t see how creating that dynamic, rather than a dynamic that increases the accuracy and thoughtfulness of the information provided to those who operate a plan, is really likely to improve plan performance.
ESOPs, Appraisers and Fiduciary Liability
There is much uproar at the moment over the possible expansion of fiduciary status to include appraisers, whose work includes valuing the assets held by the participants in ESOPs. Appraisers understandably do not want to assume that status, with its potential to turn them into defendants in ESOP breach of fiduciary duty litigation under ERISA; at a minimum, it opens them up to incurring defense costs (or the premium costs of insuring against that risk) from being named as a defendant. Personally, though, the risk seems to me to be overstated: appraisers will have to price that risk into their services, driving up the costs of operating an ESOP somewhat, but they are certainly not going to abandon the business, as some critics of this possible change have claimed. It’s a substantial business, providing appraisal services to ESOPs, and it is hard to imagine all the appraisers in America walking away from that work simply because of this risk, and the need to factor it into their pricing.
That said, however, I don’t believe it is necessary, or warranted, to expand the definition of fiduciary to capture appraisers of ESOP assets. I discussed this issue in depth in a presentation over a year ago to the New England Employee Benefits Council, as well as in a latter article in the Journal of Pension Benefits. Put simply, the structure of fiduciary responsibilities and liabilities that currently exists under ERISA is, in my view, sufficient to protect participants against problems with appraisals, and protecting participants from any such problems does not require turning appraisers into fiduciaries. I discussed this point, and my reasoning, in detail in this article.
Valuation and Appraisal Risks for ESOP Fiduciaries
Chris Rylands and Lisa Van Fleet's recent, very pithy summary of the Department of Labor’s enforcement initiatives with regard to ESOPs has been rattling around in my head for a couple of weeks now. The more I think about it, the more impressed I am by their ability to set out, in a couple of paragraphs, pretty much a cheat sheet of everything that really matters in running an ESOP. Focusing on the use of valuations by outside appraisers, they explained that, in the view of the DOL:
[ESOP] trustees . . . have a duty to prudently select . . .appraisers and that, even if the appraiser is prudently selected, the trustee still has an obligation to make sure the assumptions on which the valuation is based are reasonable under the circumstances. [The DOL] also said that trustees should be wary of a seller’s role in selecting the appraiser [and that] trustees should also read the appraisal.
The authors then captured what the DOL identified as key failings in appraisals that can make a valuation suspect:
•No discount applied for lack of marketability;
•Failure to take into account the risk associated with having only a single supplier or customer;
•Inconsistencies between the narrative of the valuation and the math in the appendices;
•Use of out of date financial information;
•Improper discount rates;
•Incomparable comparable companies – for example using a large public company as a comparable to a small private company; and
•Failure to test the underlying assumptions.
What is most interesting to me about this is that, although the authors were focusing on valuation and appraisal issues that risk drawing the attention of the DOL, they have also captured the fundamental issues in breach of fiduciary duty litigation arising out of ESOPs. These types of mistakes by ESOP plan fiduciaries in using and relying on appraisals will support breach of fiduciary duty litigation by ESOP participants, and if such mistakes caused a loss to the plan, will be sufficient to impose liability on the fiduciaries. In contrast, avoiding all of these potential traps is likely enough to insulate fiduciaries of ESOP plans from liability for breach of fiduciary duty.
The takeaway for ESOP fiduciaries? Pay attention to each one of these points in the handling of valuations, and you may prevent not just DOL enforcement action, but being named as a defendant in breach of fiduciary duty litigation instituted by plan participants.
A Football Story for Super Bowl Sunday, or Why Alex Smith Would Make a Great Fiduciary
Many, but probably not all of you, know the story of Alex Smith, the San Francisco 49ers quarterback. Long derided in the early part of his career, he came into his own over the past two seasons, succeeding especially well this past season, according to mathematical standards widely accepted among the football loving public as fair measurements of performance by quarterbacks (I would point out that since these measurements don’t demonstrate that the best quarterback in Sunday’s game – Baltimore’s Joe Flacco – is in fact the best quarterback in Sunday’s game, that they are deeply flawed measuring rods, but that is a story for a different day). It turned out though, that for Mr. Smith, all that statistical success is worth, for now, a grande cup of coffee at Starbucks, assuming he also has two bucks and eight cents on him. This is because he lost his starting job to his backup after an injury, and despite returning healthy within a short time, was never able to regain his job.
Has he pouted, caused trouble for the new quarterback, gone to twitter to rant, or tossed a hissy fit? No, no, no and no, according to all published reports. In fact, again according to all published reports, he has been helping the new quarterback – his former backup and the man who took his job from him – succeed, and has focused on helping the team win the championship.
I am sure Mr. Smith will get another starting job soon as a professional quarterback, but when his football career is over, I have the perfect job for him: ERISA plan fiduciary. I joke somewhat, but the reality is that his story, sketched in outline form above, is a perfect metaphor for the role of a fiduciary. Smith put the team ahead of his own interest, including financial (there’s a lot more money to be made as a starting quarterback, particularly one with a Super Bowl ring on his hand, than as a backup), and has focused on helping his teammates and employer succeed.
Isn’t that exactly what a plan fiduciary is supposed to do? A plan fiduciary is supposed to act prudently in the best interests of the plan participants and on behalf of the plan sponsor, who has placed him or her in that role. It requires, legally speaking, prudent decision making that is in the best interest of the fiduciary’s team – namely the participants and the plan – without regard to whether or not it is beneficial to the fiduciary. In fact, what could be a more accurate description of the prohibited transaction rules, than to say that they preclude a fiduciary from engaging in transactions to his or her own benefit, as opposed to transactions that benefit the plan and the participants? This is essentially the same thing as what Alex Smith has done in his workplace, which is avoid acting in ways that might benefit him at the expense of his teammates (such as undermining the new quarterback), conduct which would likely be seen as prohibited in the culture of his workplace.
Similarly, one can understand the structural conflict of interest rules in deciding claims for benefits as simply a codification of the idea that a plan or its fiduciary must not put its interests ahead of those of plan participants when deciding claims for benefits. Alex Smith, in the context of his work environment, has likewise elected to not favor his interests over those of his teammates, despite the fact that the interests of each conflict. He has, in essence, subjugated his interests – financial and otherwise – in being “the man” to his team’s conflicting interest in having him be a team player as they prepare for the biggest game of the year and, for many of his teammates, of their careers.
Smith has, in effect, demonstrated the exact obligation of putting others first, ahead of his own interest, that the law – both statutory and judicial – imposes on plan fiduciaries. One can also view it in reverse, as well. Imagine the chaos that would erupt in preparing for Sunday’s game if Smith instead took umbrage, undermined his coach or the starting quarterback, or otherwise acted out while his team tried to prepare for the Super Bowl. Not a good situation, one can be sure. Is this any different than the impact a fiduciary has when he puts his interests ahead of those of the plan’s participants? Think, for instance, of the circumstance where the fiduciaries of an ESOP are company officers, who, by dint of that role, may benefit from certain corporate actions that would not benefit, or might harm, employees participating in the ESOP. Acting in their own best interest and in disregard of the interest of the fiduciary’s team, namely the plan participants, would likewise create chaos, in the form of losses to plan participants and inevitable breach of fiduciary duty litigation. At the end of the day, both Smith in his realm and the fiduciary in his realm can make only one correct decision, which is to put the team, in the first instance, or the plan, in the second, first; anything else is a disaster waiting to happen.
So yes, Alex Smith – plan fiduciary. I like it.
Notes on The John Marshall Law Review's Special Edition on "The Past, Present, and Future of Supreme Court Jurisprudence on ERISA"
Here’s a neat special edition of the John Marshall Law Review, covering Supreme Court Jurisprudence in advance of an employee benefits symposium at the law school. Several of the articles in particular jump out at me as a practitioner as being right on point with key issues playing out in the courtroom; I think it is notable in this regard, and possibly causally related, that several of the authors are practicing lawyers who focus on ERISA litigation.
One article addresses fiduciary obligations with regards to holding employer stock in a plan, or what the rest of us commonly refer to, by shorthand, as the Moench presumption. As I discussed in this post, the courts are in the process of working out the application of these obligations and the presumption under the real time circumstances of actual cases. Another focuses on the development and application of equitable remedies after Amara, and one other speaks to the role of SPDs after Amara. The two are linked, in that the communications contained in SPDs are central to the prosecution of the types of equitable relief claims opened up by Amara. And finally, one other article addresses the restricted scope of remedies available to plan participants as a result of the Supreme Court’s historically narrow reading of ERISA remedies in conjunction with its historically broad reading of ERISA preemption. Interestingly, and as I have written elsewhere, the expansion of equitable remedies by means of surcharge and other types of relief recognized by the Court in Amara is likely to serve as a curative to that problem, by creating an avenue to use the equitable relief prong of ERISA to provide relief to participants in circumstances in which, previously, the combination of ERISA’s limited list of remedies with its broad preemptive effect would have precluded relief being granted to the participant.
The Lessons of Fannie Mae, or How to Defeat the Moench Presumption
I have written at different times about the likely expansion, as we move forward, of fiduciary liability in ERISA litigation, despite the existence of a number of decisions and doctrines – such as the Moench presumption and the numerous decisions applying it – that seem to pose significant barriers to such liability being imposed. I have argued that, over time, lawyers for participants will develop effective tactics to get around those types of barriers, and will become more astute in their analysis of plan conduct and fiduciary behavior, which will have the effect of expanding fiduciary liability. I have also written, both here and elsewhere, that fiduciary exposure is going to increase dramatically once participants become more effective at avoiding these types of legal barriers that tend to defeat claims at the motion stage, and are instead able to move their claims into the fact intensive stages of summary judgment practice and trial. This is because court decisions over the past few years are suggesting that, once courts look under the hood at the actual operation of plans, they tend to find problems sufficient to allow the imposition of fiduciary liability. It is important to understand, in this regard, that the long running trend, which may now be turning, in favor of fiduciaries in high-stakes ERISA class action litigation was based more on legal rulings at the motion to dismiss stage, than on fact intensive inquiries by courts. In the excessive fee cases, for instance, fiduciaries made out quite well when the cases never made it out of motion practice, but have not made out as well when such cases have been tried.
The same phenomenon may be occurring in stock drop litigation under ERISA, given United States District Court Judge Paul Crotty’s decision this week denying, for the most part, the defendants’ motions to dismiss in the Fannie Mae ERISA stock drop action, which concerned the overwhelming collapse in the stock price of company shares held in an ESOP, along with a corresponding massive collapse in the value of the assets of the ESOP. The Court applied the Moench presumption, and found that, on the facts pled by the plaintiffs, it did not bar the claims. In essence, the Court found that the detailed facts pled by the plaintiff went far beyond the simple collapse in stock price that past cases, applying the presumption, have found is insufficient to sustain a stock drop case of this nature, and instead was sufficient to overcome the presumption of prudence that would have otherwise attached to the defendants’ decision to continue to hold company stock in the ESOP. In this, you see plaintiffs who have learned the lessons of the stock drop litigation to date and who now understand how to sustain such claims past the motion to dismiss stage, despite the power of the Moench presumption. You also see something else in the Court’s decision, which is a recognition of the key role that the actual facts will and should play in a stock drop case in deciding whether or not fiduciary liability exists, in contrast to allowing the presumption itself to dictate the outcome at the motion stage. The Court found that the detailed knowledge of the defendants pled by the plaintiffs would, as opposed to the allegations in cases that have failed to overcome the Moench presumption, be sufficient to maintain the action and overcome the presumption, stating that “if [Fannie Mae’s] alleged situation . . . is not sufficiently ‘dire’ to state a claim, it is not clear what would be sufficient.”
The Impact of Appraisals on the Potential Liability of ESOP Fiduciaries
This is an interesting story on a number of levels. The article tells the tale of the Department of Labor suing the fiduciaries of an ESOP for failing to properly scrutinize and challenge an appraiser’s report valuing company stock, which was used to support the price paid by the plan for company stock. The article illustrates a significant problem in ESOPs that hold private company stock, which is the need to have appraisers set the price of the stock for purposes of the ESOP’s operations. This becomes a closed circle in valuation, consisting of the plan fiduciaries and the appraiser; no one else really plays a role or is involved. This absence of sunlight creates an environment in which, if the plan and/or the fiduciaries have a motivation to do so, the valuation of the ESOP holdings – i.e., of the portion of the company owned by the employees – can be distorted. Even in the absence of a motivation to do so, this closed process, in which there is no competing public market valuing the holdings or other outside check on the valuation, can result in a distorted valuation out of sheer error. The only check on that potential problem are the fiduciary obligations of the ESOP’s fiduciaries, and the enforcement tools, whether of the DOL or participants, provided by breach of fiduciary duty litigation, which allows participants and/or the DOL to pursue fiduciaries for problems that crop up in this process.
One of the most important takeaways from the article, as well as from my own experience in ESOP litigation, is the fact that the fiduciaries of ESOP plans should not assume they can simply obtain a valuation, treat it is correct, rely on it, and be safe from potential personal liability for a fiduciary breach. As the article points out, the fiduciaries, even when they rely on an appraisal report, can violate their fiduciary obligations, and be liable for doing so, if they do not properly analyze and vet the appraisal. ESOP plan fiduciaries should not simply receive an appraisal, use the numbers in it to run the plan, and put the report in a drawer; they need to analyze it, quiz the appraiser, and test its numbers. Only these later steps – and only when done well - will give those fiduciaries any real protection from breach of fiduciary duty litigation involving the valuation of ESOP assets.
Plan Administrators and the Risk of Personal Liability: A Primer
Often when I chat with middle and upper level managers of mid-size and larger companies who have been assigned the job of administering their employer’s 401(k), ESOP or other benefit plans, I wonder if they are fully cognizant of the risks of personal liability they are taking on, and whether they have made sure that, through insurance or otherwise, they are protected against breach of fiduciary duty lawsuits. I particularly wonder this in those cases in which it appears that, while they are taking on the role, they are simultaneously not high enough up the corporate food chain to clearly have enough power to control for and avoid potential problems in the plans they have been charged with administering. This leaves those administrators in the situation of being exposed as fiduciaries to personal liability for problems in the plan, while not having enough power to avoid or cure the problems. As fiduciaries, of course, they risk personal liability for the plan’s losses, and, as this excellent piece here explains in detail, it’s a liability they will have trouble ever shaking, even if their employer goes belly up and leaves them sitting there holding the bag.
Lanfear, Home Depot and Moench
If you like an extended metaphor – and anyone who has read this blog for awhile knows I do – you should enjoy the Eleventh Circuit’s decision this week in Lanfear v Home Depot, adopting the Moench presumption and explaining exactly how it is to be applied in that circuit. What’s a better analogy than the hard working ant who stores food up for winter, to stand in for plan participants?
But the decision has other things going for it that are much more useful than a nice analogy. In particular, it nicely synthesizes the current state of the case law among those circuits that apply the presumption, and explains exactly how, under its synthesis, a stock drop case needs to be analyzed. In so doing, it also explains how to plead one if you want to get around the barriers that the Moench line of cases has created. Its as good and workable an explanation of a standard as any of the cases offer, and one that, frankly, seems to grant participants as fair a shot at recovering on a stock drop claim as they are likely to see. In my view, it nicely balances the conflicting interests and obligations that come into play when you allow, as occurs in stock drop cases, corporate insiders, securities laws and ERISA to intersect.
On the Other Hand, There May Not Be Any Structural Impediments to Breach of Fiduciary Duty Class Actions in the Sixth Circuit
An astute and clearly knowledgeable reader passed along the point that the recent Sixth Circuit decision in Pfeil v. State Street Bank implicitly rejected the structural barriers to bringing class actions over fiduciary breaches that had been created by the developing case law in other circuits and which were discussed in my recent article, Structural Impediments to Breach of Fiduciary Duty Claims. The Pfeil decision, in allowing the putative class action to proceed past the stage of motion practice, refused to allow a stock drop type case to be ended, prior to the full development of the facts needed for the plaintiffs’ case, by the early application of lowered – or merely altered and fact specific, depending on your point of view - fiduciary standards with regard to employer stock holdings in defined contribution plans, in circumstances in which the plaintiffs could not have, at the outset of the case, full and complete information about the fiduciary breaches at issue. In this way, the Sixth Circuit, deliberately or not, mitigated the difficulties for plaintiffs, identified in my article, that are caused by the intersection of the Iqbal and Twombly pleading standards with the limited information available to plaintiffs at the outset of the case.
Pfeil is interesting for a couple of other reasons as well. One is that, in some ways, it is not a pure stock drop claim, because the plan documents imposed an obligation on the fiduciary to divest under certain circumstances, and the question is whether the fiduciaries failed to comply with those plan terms, rather than simply being the question of whether the holding of the stock under the stock drop scenario in and of itself constituted a breach. Second, I have always felt that the stock drop case law reflected an attempt, implicitly at least and perhaps even subconsciously, to balance the obligations of a company under the securities laws and under ERISA when it comes to stock held in employee plans; Pfeil, by focusing on the liability of an outside fiduciary, does not have that dynamic. Three, I have written before about the evolutionary nature of plaintiffs’ class actions in ERISA, with the idea being that, over time and in response to early defeats – such as Hecker or the stock drop cases – the plaintiffs’ bar will craft more sophisticated and carefully targeted theories of liability, that will eventually pass muster. You see that here in Pfeil, in which a more nuanced approach to a fiduciary breach involving employer stock is able to leap a hurdle – a motion to dismiss – that earlier, less nuanced stock drop theories were not able to clear.
Structural Impediments to Breach of Fiduciary Duty Claims
As many of you know, I write a regular column on ERISA litigation for Aspen’s Journal of Pension Benefits, usually focused on whatever issue has my attention at the moment, although I try to balance that against what readers might have an interest in as well. When it came time to write my article for the publication’s winter issue, I was musing on what seemed to me to be a contradiction in a webinar I had listened in on, in which two prominent experts – who shall remain nameless to protect the innocent – discussed liabilities arising out of the operation of defined benefit and defined contribution plans. The contradiction resided in the fact that they discussed the range of problems and difficulties facing such plans, and the seemingly incongruous fact that, nonetheless, plan sponsors and fiduciaries were unlikely to face liability in a courtroom for their handling of such problems and difficulties. How could that be, I wondered? So I fleshed out an answer, which became this article, titled Structural Impediments to Breach of Fiduciary Duty Claims.
Although I didn’t spell it out explicitly, the article focuses on the barriers to prosecuting such claims as class actions, because that is the forum in which these issues and impediments really manifest themselves, although the issues apply as well to breach of fiduciary duty claims brought by individuals solely on their own behalf. I also used ESOP class actions as an exemplar, for several reasons, running from my own experience with litigation over them to my somewhat morbid fascination – as a lover of newspapers - with the legal morass that the ESOP of the Chicago Tribune (and other affiliated papers) tumbled into.