An Overview of 401(k) Litigation, Courtesy of Chris Carosa's Excellent Interview with Jerry Schlichter
Chris Carosa of Fiduciary News has a tremendous interview with Jerry Schlichter, who has carved out an important niche litigating class action cases against 401(k) plans. Schlichter has litigated nearly all of the key excessive fee cases of the past few years, and currently has one pending before the Supreme Court. I discussed the case he currently has pending before the Supreme Court, Tibble v. Edison, in an article way back after it was decided by the trial court, where I contrasted the trial court’s analysis of the excessive fee issues to that provided around the same time by the Seventh Circuit. You can find that article here.
Chris’ interview with Schlichter is important and valuable reading. The opposite of a puff piece or personality profile, it contains some real thought provoking comments on 401(k) plans and the risks of fiduciary liability, and I highly recommend reading it.
Interestingly, I am speaking next week at ACI’s ERISA Litigation Conference in New York on conflicts of interest and other ethical issues arising with regard to ERISA litigation. Chris, in his interview with Schlichter, goes right to the heart of the question, when he turns the conversation to the “obvious and serious conflicts-of-interest” that can exist in 401(k) plans given their structure, compensation schemes, and the sometimes contradictory interests of fiduciaries, participants and service providers. In the interview, Schlichter provides a nice window for approaching the issue, when he presents three key rules that he believes fiduciaries should follow, which are:
1) Putting participants’ interests first – this should be the beacon that fiduciaries follow; 2) Developing a fully informed understanding of industry practices and reasonableness of service providers’ fees – in other words becoming a knowledgeable industry expert; and, 3) Avoiding self-dealing – you simply cannot benefit yourself in any way.
A great deal of conflicts of interest in this area of the law can be avoided simply by keeping those three principles first and foremost. Indeed, many of the conflict of interest issues that I will be discussing next week on a granular level are violations, on a macro level, of one or the other of those three ideas.
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.
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.
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.
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).
More on the Golf Course RFP
Susan Mangiero, one of my favorite experts on financial deals and transactions, was kind enough to post on my presentation to the Boston Regional Office of the Department of Labor, where I spoke on common mistakes by plan sponsors. I spoke as part of a day long training program that Susan presented at as well, even if she was too modest to mention it in her post, and I was very pleased and impressed by the audience, their participation and their questions. I have written before that I generally hold a high opinion of the Department’s staff, and the audience participation at the training session did nothing to lessen that opinion. Both in my primary talk, on plan sponsor mistakes, and during a subsequent panel that I participated in on litigation issues, fee disputes, and fiduciary governance of plans, the audience raised great points and asked pointed questions. One member of the audience shared with me an additional important mistake plan sponsors make, that I had not previously thought of as a significant problem, primarily because it is not one that arises in litigation but is instead more of a day to day compliance issue. There is nothing better as a speaker than having walked away having learned something from the audience that you did not know the day before.
Susan’s reference to the “Golf Course RFP,” which actually is a slide in my PowerPoint deck, concerns one of my chief cautions to smaller and mid-size companies, where benefit plans, particularly 401(k)/mutual fund programs, may be chosen by a company owner simply based on the vendors that are already in the owner’s social circle, such as, yes, those at his or her country club. If it turns out down the road that employees were paying too much for or getting too little from the plan, in comparison to what could have been located in the marketplace as a whole at that time, picking a plan’s vendor in that manner will most certainly come back to bite the company owner. Indeed, from a trial lawyer’s perspective, such a selection process would, in a fiduciary duty lawsuit over that plan, be a smoking gun used to show poor processes and a corresponding breach of a fiduciary duty. At the end of the day, RFPs aren’t normally conducted on a golf course, and this is one area of business life where it is especially important to remember that.
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.
Ayres is Wrong, and Hecker is Wrong: Establishing a Fiduciary Breach Through Excessive Fees
A further thought on Ayres’ focus on what he calls dominated funds, namely funds with higher than necessary fees that nonetheless contain a disproportionate amount of a 401k plan’s assets, and whether their inclusion by a plan sponsor should be seen as a fiduciary breach. As I discussed in a recent post, it’s a viable theory, and a welcome antidote to the very low bar set by the Seventh Circuit in Hecker on the question of fees when it found that simply including lots of funds with fees set by the market as a whole represented a sufficient effort by fiduciaries when it came to protecting participants against unnecessarily high fees. However, as I also pointed out in my recent post, the Eighth Circuit, in Tussey, cabined that mistake by the Seventh Circuit, without needing to take the broader step urged by Ayres, which is to treat the excessive use in a plan of one fund with higher fees, in and of itself and without anything more, as a breach (as Ayres and a co-author argue for here). It is probably a bit much to say that this later circumstance, without more (such as the circumstance being caused by a mapping strategy that benefits a plan sponsor by driving down operational costs), should be enough to impose liability for breach of a fiduciary duty.
And why is that? Probably because such an approach applies a very paternalistic view to 401k plans, employees, and their employers (in the guise of plan sponsor and/or plan fiduciary). Ayres’ thesis presumes the existence of low cost – presumably index – funds within a plan, along with higher cost funds, and assumes that it is effectively a breach to allow funds to flow into the latter. It seems to me, though, that it places too low a burden on participants, and gives them too little credit. If there are a range of funds available in a plan, and mapping or other decisions are not driving employee withholdings into the higher priced funds, then it seems to me participants should be free to make their own call on what funds to hold. Further, unless one accepts the premise that no knowledgeable investor would ever use any fund other than the lowest cost funds (which requires living under a presumption that only index funds or similar passive investing funds can ever be an appropriate investment), then it is not legitimate to say that a prudent person in the position of the plan fiduciary could not make available higher cost funds along with lower costs funds. If that is the case, then it cannot be a breach of fiduciary duty to include such a range of funds in a plan – even if it results in some participants over investing in the higher cost funds.
In essence, while the Seventh Circuit – as I have often said and written – was wrong to believe that the inclusion of many funds is enough to preclude a breach of fiduciary duty by the inclusion of investment options with excessive fees, so too is the premise that simply having an excessive amount of assets invested in a higher price product that is included among many funds with varying fee structures is enough to constitute a breach. The truth, as with most things, lies somewhere in between – you need more than simply excessive investing in a higher priced fund, and less than simply inclusion of many fund choices, to have a fiduciary breach based on the costs of the investment options in a 401k plan.
Tussey v. ABB - Opening Up New Avenues for Excessive Fee Litigation and Putting the Final Nail in the Coffin of Hecker v. Deere
This Forbes opinion piece by Yale Professor Ian Ayres is interesting for two things, one of broader relevance and one of interest perhaps to me alone. In it, he argues that our analysis of excessive fees as a potential fiduciary breach should not be based solely on fees in general, but also on an analysis of whether excessive amounts of plan assets are being placed into the one or two investment options in a plan that have particularly high fees, rather than in the many other investment options in a plan that have lower fees; those lower fee options give a plan the image of having reasonable fees, by balancing out the fees charged in the more expensive options. He suggests that Tussey v. ABB should be thought of and analyzed as a case concerning this type of a fiduciary breach, where the problem with the fiduciary’s conduct was the decision to map plan assets into higher fee funds for the benefit, in the longer run, of the plan sponsor. This broader argument for rethinking how we analyze fiduciary prudence in the context of fees opens up new avenues for prosecuting fee claims, but also raises a red flag that prudent and conscientious plan sponsors need to pay attention to; namely, is the overall structure of plan choices optimal for the participants, rather than just whether there are some low cost choices open to the participants who are sophisticated enough to want to avoid the higher cost options. In essence, it is an argument that plan sponsors who want to do a good job for their participants need to see the forest, not just the trees, in structuring a plan.
And this is important because, jaded and cynical as I may be after litigating ERISA disputes for decades, I still think most plan sponsors are truly motivated to put together a strong plan for their employees, and are not motivated – at least not knowingly and consciously – by nefarious purposes. (Before people start bombarding me with emails and comments about their own experiences or particular cases they have been involved with that are to the opposite, note that I said “most,” not “all,” and that I made the word choice deliberately). Diligent plan sponsors who want to create the best possible plan would do well to keep Professor Ayres’ thesis in mind in formulating a plan structure and selecting its investment options.
I also said that the article was interesting to me, as well, on another level, one that may be of interest only to me. A few years back, right after the Seventh Circuit had decided Hecker v. Deere, I took the decision to task in an article,”Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees after Tibble v. Edison International.” In it, I argued that the Court was wrong to believe that having a range of fee options spread among many investment options was enough to defeat an excessive fee claim. Ayres likewise takes exception to the Seventh Circuit’s analysis in this regard, finding that it was not consistent with plan reality. To me, one of the most important parts of the holding in Tussey v ABB was not the float issue, heavily focused on by most reports, but the Eighth Circuit’s ringing rejection of the thesis, pressed by the Seventh Circuit in Hecker, that it was enough to defeat an excessive fee claim that a plan provided a range of investment options with a range of fees; the Eighth Circuit, in my thinking, put a well-deserved end to that line of argument, when the Court explained:
The ABB fiduciaries contend the fact the Plan offered a wide “range of investment options from which participants could select low-priced funds bars the claim of unreasonable recordkeeping fees.” In support, the ABB fiduciaries rely on Hecker v. Deere & Co. (Hecker I ), 556 F.3d 575, 586 (7th Cir.2009), Loomis v. Exelon Corp., 658 F.3d 667 (7th Cir.2011), and Renfro v. Unisys Corp., 671 F.3d 314, 327 (3d Cir.2011), which the ABB fiduciaries propose “collectively hold that plan fiduciaries cannot be liable for excessive fees where, as here, participants in a self-directed 401(k) retirement savings plan that offers many different investment options with a broad array of fees can direct their contributions across different cost options as they see fit.” The ABB fiduciaries' reliance on Hecker I and its progeny is misplaced. Such cases are inevitably fact intensive, and the courts in the cited cases carefully limited their decisions to the facts presented.
I have always thought that Hecker was wrongly decided with regard to this issue, and that one of the reasons for the mistake was that the Court did not fully develop and analyze the factual context before reaching a decision. As a result, I don’t necessarily agree with the Eighth Circuit that Hecker is limited to its own circumstances by its own facts; I think it is limited to its own circumstances by its poor reasoning in this regard. Nonetheless, I can live with the Eighth Circuit approach, which I think all other courts are likely to follow as well, that Hecker’s erroneous analysis in this regard cannot control other cases because of the fact-intensive nature of the inquiry.
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.
Excessive Fee Litigation Remains a Hot Topic
There’s a nice overview from Bloomberg BNA on plan fee litigation, and its status in the courts at this point in time. The article opens up by setting the stage:
Plan fee litigation had a big year in 2013, with divisive appellate court decisions affecting standards of judicial review, statutes of limitations and functional fiduciary status that may open the door for increased and novel litigation, employee benefits attorneys said during a conference panel presentation.
Its interesting to read the rest of the article, which summarizes the current status of cases such as Tibble and Leimkuehler, and discusses the totally conflicting views of the defense bar and the plaintiffs’ bar over these cases. If there were ever a case of two sides not being able to agree on whether it is day or night, it is the two sides of the bar arguing over the propriety of judicial decisions over ERISA liability, particularly with regard to excessive fee litigation. I thought there was a divide bordering on the ecumenical decades ago, in my earlier life as an insurance coverage litigator (which I still sometimes am, when not busy with ERISA fiduciary problems or other types of litigation) between policyholder and insurer lawyers over oddities like the asbestosis exclusion, the meaning of the words “expected or intended,” or what the words “sudden and accidental” actually mean, but they had nothing on the current divide between the plaintiff and defense bars when it comes to high stakes ERISA litigation (a division I wrote about at length here).
Substantively, though, the best takeaway from the article comes in its last line, in a quote from someone with the Department of Labor, who notes on one particular issue raised by the fee cases that it is “an interesting issue, and I don't think we've heard the last of it.” One can say that across the board about all of the excessive fee litigation, and its spin off of other types of cases all targeting the question of whether plan participants are paying more than they should for plan benefits. Tibble itself is a wonderful example of the extent to which excessive fee litigation is a gift that keeps on giving, of a sort, for everyone from the lawyers involved, to plan participants (in those instances where they either obtain a recovery as part of a class or receive the incidental benefit of having lower plan expenses because sponsors are responding to the threat, real or perceived, of excessive fee litigation), and, yes, commentators. I wrote substantially about Tibble way back at the trial court level, in 2011, and here we still are, these many years later, writing and talking about the further history of that case.
The Fiduciary Exception to the Attorney-Client Privilege: What It Is and Why It Matters
One of the great advantages a Massachusetts ERISA litigator has is that our federal magistrate judges are very good with ERISA issues, which is something that is well illustrated by this decision on the scope of the fiduciary exception to the attorney-client privilege in ERISA litigation. In Kenney v. State Street, the magistrate judge dealt, in a very clean and easily understood manner, with the key issues that come into play under that doctrine, which have to do with its borders: to be exact, what attorney-client communications are subject to disclosure under this exception, and what ones are not. This is a more complicated issue of line drawing than it might appear at first glance because, in essence, you are considering the same course of communications, between the same lawyers and the same plan representatives, dealing with the same general topic (the plan’s operations), sometimes as part of the same in-person meeting, and deciding where the line falls as to the communications that must be produced and those that do not have to be produced.
The takeaway from Kenney on this line drawing is summarized nicely in this blog post by an unidentified Paul Hastings lawyer or two:
First, the attorney-client privilege is available for settlor matters, such as "adopting, amending, or terminating an ERISA plan" because those decisions do not involve ERISA fiduciary functions of managing or administering the plan.
Second, the attorney-client privilege is available to a plan fiduciary who seeks the advice of counsel in response to a threat of litigation by plan beneficiaries (or the government) against the fiduciary.
This is not an issue, by the way, that is just of academic interest, or something for clients and litigators to be concerned about after the fact, when a lawsuit is pending. A few years back there was a major top hat plan case in which some of the key evidence relied upon by the plaintiff consisted of emails and communications between the plan sponsor and its lawyers that were discoverable under these standards: that evidence was very helpful to the plaintiff, and was information that simply should not have been communicated in the manner it was (without, for instance, context and qualification) if it was ever going to see the light of day, rather than being forever cloaked behind the attorney-client privilege. Plans and their outside ERISA lawyers, who on a day to day basis in establishing and running a plan are typically not litigators, need to remember that their communications can end up in a courtroom in later litigation that cannot even be foreseen at the time of the communications in question, and should be careful with regard to the accuracy, context, phrasings and tone of such communications as a result.
The International Paper Settlement and the Continued Vitality of Excessive Fee Claims
One of the first long articles I wrote on ERISA (I had already penned some opuses on patent infringement litigation and insurance coverage disputes) was on excessive fee litigation, and was based, at heart, on the Seventh Circuit’s then recent decision in Hecker v. Deere. Titled “Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees After Tibble v. Edison International,” the article set forth my view that, in Civil War parlance, the decision in Hecker, which was being highly trumpeted by the defense bar at the time as a major victory, was, in fact, little more than the high water mark for plan sponsors and vendors in defending against excessive fee class actions. My thesis was that, when the decision was broken down and analyzed in its constituent parts (and particularly with a focus on the Court’s reasoning), it was unlikely that the decision would be replicated, and more likely that other courts would come to different conclusions in the future that would validate excessive fee claims and invigorate the theory as a basis for class action litigation.
From where I sit, four years of court decisions, settlements and courtroom results appear to have borne out my prognosis. Humble scribe that I am, I don’t believe I have ever pointed out before that I was right in this regard, but, as Thomas Clark pointed out earlier this week in an excellent post on the FRA PlanTools Blog, the recent $30 million settlement entered into by International Paper is solid evidence that I was right.
My real purpose for writing today, though, was to pass along his post on the settlement, which does an excellent job of breaking down the issues, the claims, the alleged breaches, and the settlement of the International Paper case. It comprehensively covers everything any outsider to the litigation would want to or need to know about the case.
Thoughts on Rolling Stone, Matt Taibbi and "Looting the Pension Funds"
Well, I did not really set out to write “public pensions” week on my blog, although it ended up working out that way, solely because two different articles on the fiscal crisis impacting government pensions caught my eye earlier this week. Having, for better or worse, gone down that rabbit hole, though, I now feel obliged to discuss Matt Taibbi’s new article in Rolling Stone on the municipal pension crisis, which, serendipitously, appeared on-line this week.
Taibbi, for those of you who don’t know his work, is, at a minimum, whether you agree with him or not, a talented polemicist. And that is not to damn with faint praise: this country was founded, in part, by great polemicists. And to be fair, there is certainly no doubt that you can take the facts of the public pension crisis and paint any of a number of pictures, all of them accurate to some degree; Taibbi presents his own impressionistic take on those facts, and his portrayal, like many other views of this problem, has some truth to it. Indeed, in many ways, the public pension crisis reminds me of one of those old trick pictures, that if looked at one way you see one thing (like an old woman’s face) and looked at another way, something else (like a young woman’s face).
The one consistent fact that holds true across all of the competing narratives, however, is this: public pensions are in a whole lot of trouble, and truly are, as a general rule, facing a fiscal crisis. The narratives vary on who is to blame for this, on how to fix it, and who should bear the costs of fixing it, but they don’t vary on that basic fact. Taibbi points to decades of pension underfunding by politicians as the primary cause, and argues that the proper solution to that is not to cut benefits back to a level that can be funded by the amounts left in the plans. His diagnosis and solutions, unfortunately, essentially fall in the category of locking the door after the horse has run off; although he targets the fact that, legally, state and municipal governments were able to avoid funding pension plans properly for years, there is no magic trick nor time machine that will allow anyone to go back and fix that. It falls into the category of what’s done is done, and the question becomes what to do now: absent some sort of massive federal bailout of underfunded public pension plans, the choices become reduce benefits below what was promised or tax the living heck out of current taxpayers to make up the difference. I am not even going to pretend to have a ready answer on how to address that problem.
Going forward, though, is a little easier, when it comes to prescribing a fix, and Taibbi feints toward it in his article, when he references ERISA and the ability of state governments over the years to underfund pension plans. Certainly a federal law, perhaps modeled on ERISA, that obligates appropriate funding by states and municipalities going forward with regard to future pension obligations is a necessary start. However, there are at least two (and probably many more, but these are the ones that jump out at me right off the bat) problems with such a scheme. First off, how will it be enforced? It certainly cannot be done by assigning, under any such new statute, personal liability as a fiduciary to state elected or appointed officials, in much the same way that ERISA assigns fiduciary liability to those who run private pensions. It is hard to picture a law with such a measure in it ever passing, and even harder to picture who would agree to run state pension plans, with all their potential issues, under those circumstances. Perhaps a stick, in the form of withholding some types of federal funds from states or municipalities that violate the law might work, in much the same way that the federal government withholds highway funds or education funds or the like from states that don’t comply with federal wishes in those realms.
Second, though, is a problem I identified in my prior posts on the public pension crisis. The moment you do anything like that, and make state governments account in real time for future pension liabilities, you will see the end of pensions in the public sector, replaced by defined contribution plans instead. It will only be a matter of time. Is that a good or a bad thing? I don’t know, and all have their own ideas on that. I have been in the private sector my whole career, and have never seen hide nor hair of a pension, other than when it is the subject of a case I am litigating, so I have my own biases in that regard.
CalPERS and Passive Investing: A Couple of Thoughts
I have had a couple of interesting conversations recently about CalPERS considering going to index/passive investing. As I have noted in the past, if a major and highly influential pension fund goes that route, how long will it be until others follow, seeking both safety in numbers and the potential defense to breach of fiduciary duty claims of pointing to CalPERS’ decision as reflecting an industry-wide standard of reasonableness?
Two questions have come up in that event, however, in recent conversations I have had. First, how long will it be until fiduciaries who switch their plans to index and passive funds are sued by participants claiming they would have done better under actively managed funds, and that, given the make up of the particular participant base for that plan and their investment objectives, active investing was the prudent course? Second, and more fun/theoretical, is this: what happens when everyone follows along and goes index only? Who do you trade with on the other side of the deal, and what – if everyone is just moving along with the market index – drives the price one way or the other, when there is no one out there buying and selling in the hope of beating that index?
Both are simply theoretical concerns to a certain extent, and mostly entertaining thought experiments. But still, one has to wonder whether index investing can really be the answer to everything, in all circumstances. Seems to me that once upon a time all the funds in my 401k all held internet stocks at the same time to boost their returns, even when their stated investment objectives wouldn’t have called for those holdings, and that uniformity of approach didn’t work out too well for anyone. Maybe let a thousand flowers bloom in investment choices and approaches, anyone? Isn’t that what diversification is supposed to be – holding different categories of investments, selected in different approaches, rather than all holding the same portions of an index, all moving in lock step? One has to wonder.
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.
My Journal of Pension Benefits Article on Operational Competence after Amara
For years, in speeches and articles, I have preached the gospel of what I have come to call “defensive plan building,” which is the process of systemically building out plan documents, procedures and operations in manners that will limit the likelihood of a plan sponsor or fiduciary being sued while increasing the likelihood that, if sued, they will win the case in the end. Over the past couple of years, doctrinal shifts related to remedies available to participants under ERISA have made defensive plan building even more important, for at least two reasons. First, these shifts have expanded the range of potential liabilities and exposure in offering, and running, a benefit plan. Second, these developments have, to a significant degree, given rise to an increased focus in ERISA litigation on the actual facts concerning the plan’s activities, as the lynchpin of the liability determination. The combination of expanding liability risks with an increased focus on plan actions makes it more important than ever to focus on the steps of defensive plan building, including by focusing on operational competence in running a benefit plan.
I discussed this concept in much greater detail in my recent article in the Journal of Pension Benefits, “Looking Closely at Operational Competence: ERISA Litigation Moves Away from Doctrine and Towards a Careful Review of Plan Performance.” The article discusses how the last several years of ERISA litigation, including in particular the Supreme Court’s recent activism in this realm, has created this phenomenon. You can find a much more fully realized presentation of these points in the article.
And a Third Post on Tibble: Thoughts on Revenue Sharing and the Small Recovery for the Class
A few more thoughts to round out my run of posts (you can find them here and here) on the Ninth Circuit’s opinion in Tibble. First of all, where does revenue sharing go as a theory of liability at this point? The Ninth Circuit essentially eviscerated that theory, and I doubt it has much staying power anymore, at least as a central claim in class action litigation. Revenue sharing hasn’t, generally speaking, had much traction in court, and I think it is because, at some level, judges understand that someone has to pay for the plan’s operations. That said, you should still expect to see it as a claim in cases against DC plans and their vendors, even if only as a tag along, with liability only likely to follow in cases where someone comes up with a smoking gun showing that the plan sponsor acted in ways harmful to participants specifically because of a desire to save money for the plan sponsor through its revenue sharing decisions. But revenue sharing in and of itself as an improper act or a fiduciary breach that can warrant damages? Probably not much of a future for such claims.
Second, there is a lot of talk about the expansion of litigation against DC plans and their providers, and has been for sometime now. How does that fit with the minimal recovery by the class in Tibble? To some extent, Tibble, although affirming a trial court award to the class, is not much of a victory, given that the class only recovered a few hundred thousand dollars. In fact, to call it a victory for the plaintiffs, while correct , reminds me of nothing so much as the comment of British General Henry Clinton after the Battle of Bunker Hill, when he noted, given the extent of British casualties, that “"a few more such victories would have surely put an end to British dominion in America." Likewise, a few more victories similar to this one for class plaintiffs in excessive fee cases will put an end to this area of litigation quicker than anything else could, as these types of cases simply would no longer be worth the costs and risks to the class action plaintiffs’ bar. However, it is important to remember that the dollar value of the recovery in Tibble was likely driven down substantially by the statute of limitations ruling, which took much of the time period of potential overcharging out of the case and with it, presumably much of the recovery. If participants bring suit over fees closer to the time that the investment menu that included the excessive fees was created, they will not face that barrier to recovery and the likely recovery could easily be high enough to justify the risks and costs of suit. This, interestingly, is where fee disclosure should come into play – participants, and thus the plaintiffs’ bar, should have enough information about fees to bring suit early enough to avoid the statute of limitations problem that impacted the plaintiffs in Tibble. As a result, there should be more than enough potential recovery in many possible excessive fee cases to motivate plaintiffs’ lawyers to pursue the claims.
Tibble, the Ninth Circuit and the Scope of the 404(c) Defense
Do they still teach administrative law in law school? I don’t know if they need to bother anymore, because the Ninth Circuit’s exposition of Chevron deference in Tibble, when discussing the 404(c) defense, pretty much sums up everything a practicing litigator needs to know about the subject. It is a first class explanation of the law of administrative deference, as well as a pitch perfect explanation of how one analyzes the issue.
Of import to ERISA, however, is a much narrower and more specific point, which is the Court’s cabining of the scope of the 404(c) defense so as to only encompass participant decisions that take place after the selection of the investment menu, on the basis that this reading matches the Department of Labor’s interpretation of 404(c). Based on this reasoning, the Ninth Circuit concluded that a fiduciary’s selection of investment options is not protected by 404(c). This is, at the end of the day, perhaps the most important aspect of the Court’s opinion, although in the immediate aftermath of the ruling it may well not be the aspect that garners the most comment and attention. However, it is really the one key part of the ruling that expands the scope of fiduciary liability and that adds to the arsenal for lawyers who represent plan participants, in that it clearly demarcates the selection of plan investments as an issue that falls outside of a 404(c) defense. Not only that, but the opinion does so in an articulate, well-reasoned manner, making it likely to have significant persuasive force when the issue is considered by other courts.
And the Ninth Circuit Swings Away at Tibble v. Edison . . .
Well, the United States Court of Appeals for the Ninth Circuit has affirmed the District Court’s well-crafted opinion in Tibble v. Edison. I discussed the District Court’s opinion in detail in my article on excessive fee claims, Retreat From the High Water Mark. From a precedential perspective, as well as from the point of view of what the opinion foretells about the future course of breach of fiduciary duty litigation in the defined contribution context, there is a lot to consider in the opinion. There is too much, in fact, for a single blog post to cover, or at least without the post turning into the length of a published paper. I try to avoid that with blog posts because otherwise, to misquote a poet, what’s a journal or law review for?
I plan instead, however, to run a series of posts, each tackling, in turn, a separate point that is worth taking away from the Ninth Circuit’s opinion. The first one, which I will discuss today, concerns ERISA’s six year statute of limitations for breach of fiduciary duty claims. The Court held that, in this context, ERISA’s six year statute of limitations starts running when a fiduciary breach is committed by choosing and including a particular imprudent plan investment. The Court held that the fact that it stayed in the investment mix did not mean that the breach continued, and the statute of limitations therefore did not start running, for so long as the investment remained in the plan.
Beware future arguments over this holding. You can expect defendants to regularly argue that this case stands for the proposition that the six years always runs from the day an investment option was first introduced, and that any breach of fiduciary duty claims involving that investment that are filed later than six years after that date are untimely. You can also expect defendants to argue to expand this idea into other contexts, and to ask courts to rule that anytime the first part of a breach began more then six years before suit was filed, the statute of limitations has passed. This would not be correct. The opinion only finds this to be the case where there were no further, later in time events that, as a factual matter, should have caused the fiduciaries to act, or which, under the circumstances of those events, constituted a breach of fiduciary duty in its own right; if there were, then those are independent breaches of fiduciary duty from which an additional six year period will run. Those independent, later in time breaches would presumably be their own piece of litigation, evaluated independent (to some extent) of the original breach.
Directors and Officers Liability Meets the Accidental Fiduciary
I joked in a tweet the other day that I could be busy for the rest of my professional career if I could just represent all the company officers and officials out there who don’t know they are ERISA fiduciaries until after they are sued for breach of fiduciary duty. The joke was in response to a comment by Chris Carosa of the highly valuable Fiduciary News website about the expanding liability exposure of these officers, whom he dubbed “accidental fiduciaries.”
And it is true that company officers who play roles in company benefit plans – often simply as an adjunct to their usual list of job responsibilities – are sitting ducks for fiduciary exposure. I have spent years extracting company officers, whose real job focus was elsewhere (marketing, or sales, or operations, or the like) from suits against them for breach of fiduciary duty related to company benefit plans that they were involved with simply as a sideline to their “real” responsibilities. At the end of the day, though, what such officers have to understand is that they face potentially significant, and substantial, personal liability under ERISA for problems in the operations of such plans and therefore, if for no other reason than self-preservation, they need to treat this part of their responsibilities as also part of their “real” responsibilities. It can cost them too much money if they don’t.
I was prompted to write about this today by this interview with Samuel Rosenthal, the author of a deskbook on the potential legal liabilities of directors and officers. There isn’t much doubt that the significant risk of ERISA exposure, and the details of how to avoid that risk, need to be in any such book. There are standards of conduct that officers can follow that will avoid liability in this area; actions in contemporaneously documenting that conduct that can mean the difference between winning and losing lawsuits against them over company benefit plans; and issues with insulating themselves prospectively from potential liability for breach of fiduciary duty under ERISA, such as through insurance or indemnification agreements.
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.
Some Thoughts on Kirkendall v. Halliburton
I have passed along on Twitter (https://twitter.com/SDRosenbergEsq) some of the better reviews that have crossed my desk of the Second Circuit’s recent decision in Kirkendall v. Halliburton, Inc., in which the Court held that a plan participant did not have to exhaust administrative remedies in an ERISA plan where the plan document itself was unclear in imposing such an obligation. Frankly, I wasn’t sure the case itself warranted any more extensive discussion, because I don’t find the Court’s conclusion particularly unusual or controversial in any manner. That said, though, the amount of commentary the case has generated reminds me that, at the end of the day, the Second Circuit is like E.F. Hutton: when they talk, people listen. So to expand on my Twitter thoughts about the case, here are some more expansive thoughts, ones that require more than 140 letters to communicate.
The most important way of viewing the decision, in my thinking, is to remember that exhaustion of administrative remedies in this scenario is not a statutory requirement, and is instead a judge-made doctrine that is based on certain assumptions about ERISA plans and certain premises that are thought to be implicit in the statute. In practice, the imposition of an exhaustion of administrative remedies standard on ERISA claims has generally not been a problem, has worked well, and has been effective in effectuating many of the goals for the statute, such as cost efficiency, limited litigation, and encouraging employers to create benefit plans. That said, however, there is certainly no clear cut basis in the statute for believing that, if a plan sponsor doesn’t clearly communicate the need to appeal within the plan, a plan participant should be required to do so or be shown the courthouse door for having failed to do so. This is essentially all that the Second Circuit concluded: if the plan sponsor doesn’t make it clear to the participant in the relevant documents that certain internal administrative appeals are required, along with explaining how to do that, an obligation to do so cannot be imposed on a plan participant.
This is not a new issue, although the decision in Kirkendall may be the most significant authority to date for this proposition. I have litigated this issue in the past, but most often you see it in one-offs like top-hat plans (or virtual one-offs, like SERPs for just a few executives), where a custom document is created for certain employees to address compensation-related issues, and the ERISA procedural component of doing so is not front and center in the authoring attorney’s mind. Usually, the outcome of any dispute over administrative exhaustion in those situations ends up the same as the ruling by the Second Circuit in Kirkendall for all intents and purposes, but getting to that result is harder than just citing a leading decision from a prominent appellate bench; you instead had to rely on a collection of lower court decisions finding exhaustion to not be required for a multiple of different reasons. Certainly, at the end of the day, Kirkendall will make it easier for lawyers for plan participants faced with this scenario to support their arguments that they can prosecute a claim in court without first exhausting internal administrative appeals, but I don’t think it will much change the outcome from what would have occurred without that decision.
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.
Using the Economic Loss Doctrine to Defend Company Officers
One of the interesting aspects of litigating ERISA cases is the extent to which, for me anyway, it is part and parcel of a broader practice of representing directors and officers in litigation. From top hat agreements they have entered into, to being targeted in breach of fiduciary duty cases for decisions they participated in related to the management of an ERISA governed plan, directors and officers of all size companies spend a lot of their working life operating – in terms of legal issues – under the rubric of ERISA. In some ways, this is even more true of officers of entrepreneurial, emerging or smaller companies; due to the relative lack of hierarchy or distinct departments, in comparison to the largest corporations, officers of these types of companies often find themselves involved to one degree or another in almost every aspect of the company’s business, including retirement and other benefits that are likely to be governed by ERISA.
For me, one of the more interesting aspects of representing officers and directors in litigation is the question of when, if ever, they can be reached personally for actions that one would otherwise expect to be the responsibility of the company itself. Although lawyers are all taught in law school about the sanctity of the corporate form and the protection against liability it grants to company officers, lawyers quickly learn that, in practice, that is a principle more often honored in the breach. Both common and statutory law offer plaintiffs various ways around the protection of the corporate form, including, when it comes to retirement or benefit plans, breach of fiduciary duty claims under ERISA. The theories of piercing the corporate veil and participation in torts can also be exploited to avoid the shield against liability granted by the corporate form in many types of cases, although those can be difficult avenues to use to impose liability on a corporate officer.
All of these issues have one thing in common, which is a question of line drawing, consisting of determining exactly where the line should rest between the protection of the corporate form and the ability to impose liability on a company’s officers. One aspect of this line drawing that has always held great interest for me is the economic loss doctrine, which holds that contractual liabilities cannot be used as the basis for prosecuting tort claims. In the context of defending officers and directors against claims for personal liability based on a company’s actions, it serves as a strong defensive line against imposing tort liability on a corporate officer for the contractual liabilities and undertakings of the company itself. You can find a good example of this defense tactic in this summary judgment opinion issued by the business court in Philadelphia last week in one of my cases, in which I defended a corporate officer in exactly that type of case.
On Getting Out of the Pension Business
Nobody wants to be in the pension business anymore (other than, I guess, vendors who provide defined benefit plan services, annuities, etc. to plans and their sponsors). The Washington Post had an interesting article recently on the vanishing pension, and of course everyone who works in this field has long known that plan sponsors have been aggressively moving from defined benefit plans to defined contribution plans for years. In fact, as I have discussed in other posts and address again in an upcoming feature article in the Journal of Pension Benefits, the most important aspect of the Supreme Court’s watershed decision a few years back in LaRue may very well not turn out to be the express grant to defined contribution plan participants of the right to sue for fiduciary breaches based only on harm to their own accounts, but the Court’s express recognition that the legal rules established over decades governing pension plans should not automatically be applied to defined contribution plans. All of this sturm und drang - and much more -is part and parcel of the death of the pension, at least in the private sector; economics are almost certain to eventually kill them in the public sector as well, given enough time.
But getting rid of pensions and out of the pension business, if you are the fiduciary of a pension plan, is not easy and not without legal risk, including of being sued for breach of fiduciary duty for taking that step. One of my favorite commentators on pension governance issues, Susan Mangiero, and ERISA litigator Nancy Ross provide an excellent overview of this point in this article on CFO.com. This subject has come up a lot recently in discussions with clients, potential clients, and other ERISA lawyers, and this article is a terrific introduction to the subject.
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.
Stephan v. Unum, the Attorney-Client Privilege, and the Need for Independent Counsel for Company Officers and Plan Fiduciaries
Tidal Wave! Landslide! Look out below!
Pick out the metaphor of your choice, because Unum just got taken out behind the woodshed by the Ninth Circuit and spanked hard. Frankly, the Ninth Circuit’s opinion is a rout in favor of the participant, and participants in general. In many ways, the case presented a perfect storm for such an overwhelming opinion against a long term disability carrier. The case involved: a very sympathetic plaintiff who suffered a horrible, fluke injury that most readers could sympathize with; a lot of money; and a long term disability carrier with a documented history of claim disputes that the court could point to in further support of its ruling. I have to tell you that the facts painted by the Ninth Circuit in this opinion, related to both the claim and the carrier, are clearly of an outlier event, one not representative of the handling of most claims by most long term disability carriers, or of most long term disability carriers at all, for that matter. Twenty years of experience tell me most attorneys representing participants would, even if only off the record, agree with that assessment.
Frankly, despite Unum’s own documented history with regard to claims handling, cited by the Ninth Circuit to support its opinion, I am not sure that the depiction of the carrier in this opinion is even representative of that carrier at this point in time, but I don’t know enough to comment knowingly in that regard.
More importantly though, and moving away from the overflowing kettle of clichés with which I deliberately chose to fill the first couple paragraphs of this post, it would be a shame if courts, participants, companies and their lawyers allowed the unusual nature of the case to become the focus of their attention. This is because there are several key takeaways from this case, some specific to long term disability cases and others, even more important, to ERISA litigation in general.
With regard to these types of benefit claims, one should look closely at the Court’s handling of the structural conflict of interest issue. The Court not only points toward significant discovery and even a possible bench trial over this issue, but also demonstrates how to use the contents of an administrative record in support of proving the impact of such a conflict. This is all strong stuff, and for many who thought the Supreme Court’s structural conflict of interest ruling in Glenn opened up a Pandora’s box or put us all on a slippery slope towards ever expansive, and more expensive, benefits litigation, here is the proof for that hypothesis.
To me, the most worrisome aspect of the decision, and one that sponsors and companies need to pay very careful attention to in terms of planning their benefit operations and obtaining legal services, is the Court’s very broad application of the fiduciary exception to the attorney-client privilege. The issue here isn’t so much the conclusion that the exception makes internal legal discussions related to a claim subject to disclosure, but the line drawing it demonstrates with regard to when legal advice is, and is not, subject to disclosure. In short, plan administration – including benefit determination issues – are subject to disclosure and not protected. At the same time, though, what is protected is advice related to the protection of fiduciaries against personal liability, civil or criminal, when that advice is clearly distinct from the handling of claims under a plan and the administration of a plan.
Now the interesting thing about that distinction is that, as anyone who litigates breach of fiduciary duty or other ERISA cases knows, there is clearly some overlap between the two types of legal advice and there is not always a clear separation between the two. Certainly a fiduciary sued for misconduct is being sued because of events involving a claim and a plan’s administration, and thus legal advice rendered to the fiduciary falls somewhere in the middle of those two extremes. Further complicating this issue is a fact that the Ninth Circuit points out, which is that plan sponsors and plan fiduciaries often rely on the same lawyers and law firm for advice on all aspects of their plans, from formation to termination and everything in between, including the handling of claims and the representation of officers sued as fiduciaries.
In that latter instance of breach of fiduciary duty litigation against officers, it is crucially important for numerous reasons, as every litigator knows, to have a safe, secure and fully privileged attorney-client relationship. The standards enunciated by the Ninth Circuit, however, place that privilege at some risk in instances in which the same firm that has represented the plan in general is also representing fiduciaries or other company officers with regard to their personal potential liability. The best answer, for numerous reasons, to protecting those fiduciaries and officers, and maintaining the attorney-client privilege that is crucial to their protection, is going to be separating out the representation of such individuals from the routine legal work related to the plan’s formation, operation, administration and claims handling, and using independent, distinct counsel for the representation of such individuals. By segregating out and using separate, independent counsel for any issues related to their potential exposures, you make clear that the legal advice at issue involves privileged issues concerning the potential liability of officers and fiduciaries, which should still be privileged after the Ninth Circuit’s ruling, and is not intermingled with or otherwise part of the broad range of legal services typically required by a plan, which the Ninth Circuit’s opinion holds is likely to be subject to disclosure.
In short, the pragmatic solution is to continue to use one firm for the overall handling of a plan’s various needs, but separate, independent counsel for any and all needs – whether involving litigation or only the potential risk of litigation or exposure – of a plan’s fiduciaries or the officers of the company sponsoring the plan.
That’s my two cents for now. The case is Stephan v. Unum, and you can find it here.
On the Problem of Remedying Errors in Providing Plan Information
Here is a great fact pattern that illustrates a number of recurring problems in ERISA litigation. In this case (Tocker v. Kraft Foods North America, Inc. Retirement Plan), decided by the Second Circuit last week, a mid-level benefits manager worked on accommodating the needs of a terminally ill plan participant, by working out an arrangement by which the participant could first receive long term disability benefits and then receive workforce reduction payments, rather than having to choose one or the other. Naturally, of course, since it turned into litigation, the arrangement did not work out without a hiccup, as it affected the participant’s pension credits. The participant sought to remedy that problem by use of a breach of fiduciary duty claim. The breach of fiduciary duty claim failed, however, because the benefits manager was found to have only been engaged in ministerial duties, and not fiduciary duties, and thus a breach of fiduciary duty action was not viable.
The case nicely illustrates and establishes the dividing line between fiduciary and non-fiduciary acts by executives of a company involved in running a company’s benefit plan, and the opinion’s first and best use will be in cases where that point must be established, particularly cases where one side or the other needs to prove that someone was, or was not, a fiduciary for purposes of a particular dispute. The decision is particularly on point with regard to the question of when does the provision of information about benefits render someone a fiduciary (the answer according to this decision is, effectively, never, although I am engaged in a purposeful bit of overstatement there).
However, it also illustrates a point I discuss in detail in an upcoming article in the Journal of Pension Benefits, which is the difficulty, under ERISA, of redressing problems in plan administration that are not merely denials of benefits clearly owed under a plan (and thus can be remedied under the denial of benefits prong of ERISA) and cannot be shown to involve fiduciary conduct. The dispute at issue in Tocker was exactly that type, and the plaintiff, despite having possibly been harmed by an operational misstep in implementing the agreed upon arrangement to coordinate the participant’s disability benefits and workforce reduction award, was unable to construct a viable cause of action under ERISA to address that problem and possible loss. The statute’s remedial rigidity had long been a problem in ERISA litigation over the years, impacting the ability of participants to address these types of problems. As I discuss in my upcoming article, this problem has likely been solved by the surcharge remedy recognized by the Supreme Court in its recent decision in Cigna v. Amara: the best approach open to the plaintiff in Tocker today would have been to structure his claim as one for equitable relief based on the surcharge remedy, rather than as a breach of fiduciary duty claim. When his case began, though, well before the decision in Amara, this option would not have been open to him.
Small Employers and the Problem of Plan Compliance
I often think of the story of the cobbler’s kids having no shoes when I read about problems in a law firm’s benefit plan; lawyers spend their time fixing other people’s business problems, often to the exclusion of paying attention to their own business issues. Festering problems in a law firm’s 401(k) or other benefit plans fit this rubric well. This story, about a small Philadelphia law firm sued by the Department of Labor for operational problems in its 401(k) plan, illustrates the point nicely. As the story makes clear, the law firm does not seem to have engaged in any nefarious conduct, but to instead have dropped the ball on various technical, operational aspects of running a defined contribution plan, such as segregation of assets, timing of deposits, and the like. I have represented smaller and mid-sized law firms in disputes over their defined contribution plans, and I can tell you that, as this story likewise reflects, smaller law firms face the same burdens and problems in running profit sharing and 401(k) plans as do most other mid-sized and small businesses: the technicalities, the time demands and the complexity of doing it correctly are often beyond their internal capacities, and certainly outside of their core competencies. I have preached many times that the key to not getting sued, whether by the Department of Labor or plan participants, is an obsessive focus on compliance in plan operations; for many smaller businesses, as this story about the Philadelphia law firm reflects, this can only be accomplished by outsourcing to a competent vendor.
On the Ambiguous Nature of Fiduciary Status
It is actually amazing, if you really step back and think it through, the amount of energy and analysis that goes into the question of determining who is, and who is not, a fiduciary under ERISA in various scenarios. There is a reason for this, though, and it is that acquiring – or being assigned – the status of fiduciary when the assets or operations of an ERISA governed plan are at issue can be highly fact dependent, and someone who is a fiduciary in one context may not be one in another. The Department of Labor has tried, through rulemaking, to simultaneously expand and make more consistent who is a fiduciary and when, a project I have expressed some doubts about both in speaking engagements and in a recent article in the Journal of Pension benefits. The issue becomes even more complicated, though, if and when you try to coordinate that issue under ERISA with similar, but not identical, obligations imposed by the SEC, a point addressed in detail in this article here, which emphasizes that the different roles and obligations of advisors and consultants operating in one sphere as opposed to those operating in the other argue against trying to create one consistent, overriding fiduciary definition applicable in both spheres. As a wit once noted, a foolish consistency is the hobgoblin of little minds, and I am not sure that isn’t the case here: rather than trying to shoehorn two different regulatory and legal regimes into one supposedly consistent fiduciary definition, it may make at least as much sense to allow different fiduciary standards to apply to different statutory bodies of law.
The Zeitgeist of Chris Carosa
I used to be a fan, back in the old days when The New Republic was actually meaningful and influential, of its zeitgeist table, as it really did, in a glance, sum up what people were thinking and talking about, albeit in a humorous way. I couldn’t help but think of that this morning when I read Chris Carosa’s “FiduciaryNews Trending Topics for ERISA Plan Sponsors: Week Ending 7/27/12.” Its like a college survey course on one page of what everyone in the retirement industry either is or should be thinking about right now, from the costs of plans to fee disclosure to the coming tax wallop you are going to suffer to fix the public pension system to the misinformation, non-disclosure and outright confusion rampant in the knowledge base of plan sponsors and participants.
Tails I Still Win, Heads You Still Lose: More on the Fiduciary Status Under ERISA of Traditional Banks
Looks like everybody knows a good story when they see it. Here’s a nice CCH piece on the same Sixth Circuit decision I discussed in my last post, concerning the fiduciary status of a depository institution under ERISA.
Interestingly, the whole deconstructionist/critical legal studies movement (I know I am dating myself by at least decades here by this reference; what’s next for me, a link to an article about Bruce Springsteen, or the 1980 Olympics?) had at its heart the idea that if you trace back a thought to its earliest formulation you can learn a lot about how the current conception came to be, and whether the current conception should be accepted at face value. I bring this up because I have done enough work on the fiduciary status of commercial banks to know the judicial history of the assumption – and of the case law to the effect – that they should not normally qualify as fiduciaries for purposes of ERISA. If you trace the history back far enough, you find that what is, in essence, a prevailing presumption against finding such entities to be functional fiduciaries isn’t all that well-founded.
Heads I Win, Tails You Lose: The Privileged Position of Traditional Banks in ERISA Litigation
All right now, its time to get back up on the horse – the blogging horse, that is. I didn’t actually go on vacation for the last month, believe it or not – I had a major brief concerning a piercing the corporate veil case against a corporate officer due not long after the July 4th holiday, followed almost immediately by briefing concerning the First Amendment rights of internet posters. Fun stuff, but it hasn’t left much, if any, time for blogging.
So I am now going to try to catch up on a number of items that I spotted – but was never able to find the time to post on – over the past month. I am going to start today with this story right here, about the Sixth Circuit ruling that ERISA claims against a bank failed on the ground that the bank did not qualify as a fiduciary, while the state law claims against the bank could not go forward because they were preempted.
Speaking last month at an MCLE seminar on the subject of litigating top-hat and other compensation disputes, I discussed one of my favorite conceptual points, which is the theoretical possibility in certain cases of prevailing, as a defendant, by showing that the ERISA claims fail on technical grounds while state law claims are preempted at the same time because the underlying fact pattern – whether or not capable of supporting successful claims under ERISA– turn on the terms of an ERISA governed plan. The end result is that a plaintiff would not be able to recover at all – or even have any viable causes of action – against the defendant. I discussed it, in fact, right here in this PowerPoint slide in my presentation, which referenced a case, Aubuchon v. Benefirst, in which I pursued that defense strategy. As my fellow panelists at the seminar and I discussed, it is a conceptually elegant and perfectly logical argument, but one that courts generally don’t like, finding that, much as the dissent did in the Sixth Circuit case referenced in the article, the circumstances either cannot or should not be interpreted in a manner that would leave the plaintiff with no viable cause of action under ERISA itself while simultaneously eliminating any state law rights by operation of preemption.
Here, though, the Sixth Circuit accepted that argument and found the plaintiff to have no viable claims, for this reason, against a defendant. It is interesting to note, though, that the defendant who benefited from that here is a bank. For whatever reason, banks – traditional, old-fashioned depository/lending institution type banks – make out very well in ERISA litigation when a party tries to bring them in, as happened in this case, as a functional or deemed fiduciary, based on the bank’s role in handling and distributing a plan asset; there is a long history of cases, although perhaps relatively few in number, placing such an institution outside of the role of fiduciary for purposes of ERISA litigation, when the bank is serving in a traditional banking role as a depository or lending institution. Add in the impact of preemption, and a bank that is merely holding the plan assets or lending against them (or supposedly only doing that, as the facts alleged in the case before the Sixth Circuit, as is often true in similar cases, could be construed as involving much more than that on the part of the bank in question) is in a very privileged position when it comes to defending litigation over its involvement with an ERISA governed plan.
The decision is McLemore v. EFS, and you can find it here.
A Bunch of Cliches About Scary Things (Or a Few Words on Why Fee Disclosure Isn't Scary)
Here’s a very nice piece on fee disclosure, as mandated by the Department of Labor, and the idea that it is to everyone’s benefit. I have long maintained that fee disclosure of the type at issue falls squarely in the ballpark of the old saying that sunshine is the best disinfectant, and that running from fee disclosure – whether as a plan sponsor or a service provider – is the intellectual equivalent of running from the bogeyman; there is, in fact, nothing to fear from it, for well-run plans and above-board advisors, and for those who aren’t yet those but aspire to be.
Why is that? Well, let’s run through the list of players in the 401(k) rubric. Plan participants obviously benefit from knowing what their funds costs, and from the opportunity to use that information to demand proper attention to fees from their plan’s sponsors, administrators and fiduciaries. Where is the downside to them? I can’t see one. And then there are plan fiduciaries. Plan fiduciaries should be avoiding fees that are higher than needed, both to protect themselves from fiduciary liability and to best serve participants. Now this doesn’t mean they are required to, and nothing in fee disclosure or the law governing fees requires them to, chase the lowest possible cost investment options. What it does mean, though, and which cases like Tibble make clear, is that they have to investigate and follow a prudent process directed at using the right investment option at the right price. The more information they have, the better they are able to do this; likewise, the more they are pressed by participants to do this, the more likely they are to install a good process to review these aspects of their plans and, correspondingly, the less likely they are to fall below their fiduciary duties in this regard. This all make them less likely to be sued for, or found liable for, excessive fee claims, and thus protects them from financial risk in running the plan. These outcomes flow naturally from the public disclosure of the fees inherent in a plan. And finally there are the investment advisors and other service providers. More than one such provider has told me that they already make this information available or have changed their business models to build around the open disclosure of this information, and that they believe their ability to compete both on transparency of and attention to controlling expenses is a competitive advantage for them. I have long believed that transparency works to the business advantage of the best players in this area, and aren’t those the ones who should be winning business? Just another side benefit of fee disclosure, and one more reason why, when it comes to fee disclosure, there is, to quote a former president who knew a thing or two about creating a retirement plan, nothing to fear but fear itself.
Trust But Verify: The Importance of Private Attorney Generals to Plan Governance
Here is a neat little story that illustrates a bigger point. The article describes the resolution of a Department of Labor lawsuit brought against a small company to recover approximately $100,000 of participant holdings in a profit sharing plan that was diverted to other uses. Its own moral is clear – plan sponsors need to remember that plan assets belong to the plan, not them – but one that is too often forgotten in closely held, smaller companies. The bigger story, though, is the one this case illustrates. I have written before about the idea that ERISA is really a private attorney general statute, one that uses the awarding of legal fees to a prevailing participant as a means of allowing individual participants to retain counsel and enforce fiduciary discipline, even in cases where the amount at risk – such as the one hundred thousand at issue in the article – wouldn’t otherwise justify either a participant paying out of pocket to hire counsel or a lawyer taking the case on contingency. And yet, as this case shows, there are real breaches, real problems, and real losses in many plans that require legal redress; this remains true even when the amounts at issue aren’t particularly large, as the losses are still significant to the participants who incur them. The Department of Labor itself does not have the litigation resources, relative to the number of plans out there, to litigate each and every such case, and has to pick and choose. Allowing recovery of attorneys fees allows those participants whose cases are not pressed by the Department of Labor to still bring breach of fiduciary duty actions and thereby enforces a level of legal oversight on plan sponsors that might otherwise not exist. The ERISA structure is, to a certain extent, dependent upon – and assumes the existence of – such private enforcement actions; they impose a level of discipline on fiduciary conduct that would otherwise be absent.
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.
The IRS - A Safe Port in a Storm for Plan Fiduciaries (Sometimes, Anyway)
Well, as if there weren’t enough barriers to successfully prosecuting breach of fiduciary duty actions under ERISA, it turns out that you also can’t do it if the fiduciary’s errors consisted of wrongfully withholding benefits and turning them over to the IRS as tax payments. A participant, according to this opinion fresh off the presses of the Northern District of Illinois, can only remedy that mistake by getting the IRS to refund the money to them.
Defense lawyers are always fond at trial of having an empty seat – i.e., a missing potentially culpable party – to point to while saying my client didn’t do it, the person that should be sitting in that other chair at the defense table did. For those of you old enough to remember it, this defense theory is similar to, but not exactly the same as, the famous “Plan B” of noted fictional defense lawyers Donnell, Young, Dole, & Frutt, who somehow always managed to make that strategy work. For a plan fiduciary charged with fiduciary breaches or other errors related to tax aspects of a plan, pointing to the IRS and saying the participant’s only recourse is to seek a refund from the IRS is an extraordinarily potent variation of this defense. It also, as the decision in Mejia v Verizon et al appears to make clear, has a sound foundation in the federal code.
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.
The Dam Breaks: Tussey v. ABB
Tussey v ABB, Inc., an excessive fee and revenue sharing case decided on the last day of March after a full trial before the United States District Court for the District of Western Missouri, is a remarkable decision, imposing extensive liability for acts involving the costs of and revenue sharing for a major plan, on the basis of extensive and detailed fact finding. It is hard to sum up in a quick blurb, and I recommend reading it in full. However, Mark Griffith of Asset Strategy Consultants has a terrific write up of its its import here on his blog, and here is a nice case summary from Dorsey. Beyond that, I would highlight a few key points about the case, viewed from 30,000 feet (the case itself is going to provide grist for tree level, finding by finding analysis for some time to come).
First, and to me most interesting, is that it confirms several conclusions about excessive fee litigation that I have come to in the past and written on extensively, including my insistence that the pro-defense ruling in Hecker was not the last word on this issue (despite the desire of much of the defense bar to believe it was) but was instead the high water mark in defending against such claims. I argued in the past, with regard to the Seventh Circuit’s handling of this issue in Hecker, that the entire issue of fees and revenue sharing would look different than it did to the court in Hecker once courts began hearing evidence and conducting trials on the issues in question, rather than making decisions on the papers, and this ruling bears that out. Like the trial court decision in Tibble, another key early excessive fee case to actually reach trial, the taking of evidence by the court on how fees were set and revenue shared has, in Tussey, resulted in a finding of fiduciary breach in this regard. Tibble and Tussey reflect a central truth: when courts start hearing evidence on what really went on, it becomes apparent to them that plan participants were not fully protected when it comes to the setting and sharing of fees in the design and operation of the plans in question. To deliberately mix my metaphors, what Tussey reflects is that when courts start looking under the hood of how plans are run, they are not liking how the sausage was made. They quickly (relatively speaking, of course, since it takes a long time to get a case from filing through to a trial verdict) conclude that the fees were set and shared in ways that did not properly benefit the participants.
This particular aspect of Tussey is very important. Tussey involved a major plan and a market making investment manager and recordkeeper, applying what the court characterized as standard industry practices in some instances. It is therefore unlikely that the scenarios found by the court in Tussey to be problematic are unique to that case. Other excessive fee and revenue sharing cases that, like Tibble and Tussey, get past motions to dismiss and into the merits are therefore likely to uncover factual scenarios and problems similar to those identified by the court in Tussey.
What also jumps out at me about Tussey is the extent to which revenue sharing, which has often been characterized in the professional literature as harmless in theory, is strongly depicted as problematic as practiced with regard to the particular plan and by the sponsor and service providers at issue. I would have real question, going forward as a plan sponsor, as to whether it makes any sense at all to continue with revenue sharing. Better to just pay a fixed cost, than to risk extensive liability for engaging in revenue sharing. Absent that choice, the treatment of revenue sharing in Tussey makes clear the need for extensive, on-going, documented analysis by the plan’s fiduciaries of whether the level of compensation generated by the revenue sharing was, and remained at all times, appropriate.
Other aspects of Tussey worth noting include these two. First, the opinion provides as good an explanation, in detail, of what revenue sharing really is and how it works as you are going to find. If you want to understand what all the hullabaloo about revenue sharing is about, this opinion is as good a place to start as any.
Second, the opinion contains a nice analysis of one of the most misunderstood issues in ERISA breach of fiduciary duty litigation, namely the six year statute of limitations and how it applies to the implementation of a fiduciary’s decisions related to plan investments. A decision to change a plan investment takes time, starting with an analysis of whether to do so, followed by the steps needed to effectuate it, and eventually resulting in the final steps needed to permanently conclude the change. As the court explained in Tussey, the statute of limitations in that scenario does not start to run – for any of the losses related to that event – until the last act in that run of conduct occurred.
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.
The Tin Man's Heart
I spoke last week at the New England Employee Benefits Council on the Department of Labor’s efforts to redefine the word fiduciary by regulation, so as to capture within that rubric more of the vendors, providers and advisors involved in the retirement industry. Overall, my sense is the regulatory effort is over-expansive, and risks divorcing the regulatory definition of fiduciary from the statutory provision that creates fiduciary status under ERISA. My comments when I spoke ran in this direction. I also have an article in for publication in the Journal of Pension Benefits to the same effect.
That said, though, there are clear problems that the regulatory effort is directed at, and it is fair to say that, at a minimum, the Department’s heart is in the right place, as this interview with Phyllis Borzi makes clear. It is important to remember both of those things, even in criticizing particular redrafts of the relevant regulations. I mention this now partly because the issue is not going away, and the Department of Labor will be coming back later this year with a new, revised proposed rewrite of the regulatory definition of fiduciary, as explained here.
On ERISA and the Potential Liability of Senior Executives
Susan Mangiero of FTI Consulting, who blogs at Pension Risk Matters (as well as at Good Risk Governance Pays) and is one of my favorite sources of information concerning the investment and risk management realities that lie behind the façade of ERISA governed plans, is, along with a few other worthies, presenting a webinar on Wednesday, March 7, on “The ERISA and Securities Litigation Snapshot: Things You Can Do Now to Minimize CFO and Board Liability.”
The webinar is scheduled to cover:
•Why ERISA litigation claims against top executives and board members continue to grow
•How securities litigation and ERISA filings are related and what it means for corporate directors and officers
•What ERISA liability insurance underwriters want clients to demonstrate in terms of best practices
•What steps the Board and top executives can take to minimize their liability
•When to Get the CFO and board members involved
My quick thoughts on each of these topics, and why they mean this webinar is worth a listen if you have any responsibility for the financial and liability risks generated by ERISA governed plans? Lets go in order.
Why do ERISA litigation claims against top executives and board members continue to grow? There a number of reasons, but here are three quick ones in a nutshell. First, the market losses suffered over the past few years by participants has highlighted the investment risks faced by participants, and made them look closely at others’ possible responsibility for those losses. Second, decisions such as LaRue and Amara, while not opening a floodgate, have nonetheless created an environment in which it is easier to structure and prosecute claims against fiduciaries on behalf of participants. Three, plans are where the money is; there is more potential damages sitting in a company stock plan than you can shake a stick at. Remember what Willie Sutton said about banks? None of this is changing anytime soon, and ERISA litigation claims against senior officers will continue to be a growth stock as a result.
How are securities litigation and ERISA filings related and what does it mean for corporate directors and officers? Short answer: over the past several years, court decisions and congressional action have made it harder to recover in securities cases, while the same is not true for ERISA cases. In many instances, ERISA theories allow another way to target stock losses without having to jump through the hoops that exist in a securities case. For directors and officers, this means they will face more ERISA suits down the road, including against them personally. They need to have the right business structures in place to protect them against such claims, and the right insurance in place if they are found liable.
What do ERISA liability insurance underwriters want clients to demonstrate in terms of best practices? Underwriting needs in this area in many ways overlap with the same steps that should be put in place to protect the fiduciaries against suits, to reduce the risk of a judgment, and to minimize the likelihood of a suit being brought in the first place, regardless of the insurance issues. These steps are what I have often called defensive plan building, which is the need for due diligence, active understanding of the plan, accurate communications with participants, developing expertise and/or hiring it as needed, and following the same level of sophistication and investigation that would be applied to any other crucial part of a company’s operations.
What steps can the Board and top executives take to minimize their liability? This pretty much concerns taking the same steps, mentioned above, that the company’s insurance underwriters will appreciate. Interestingly, this is an area of the law and of insurance where all of the incentives line up well. The same steps reduce the risk of liability, reduce the risk of getting sued, and likely reduce premium dollars all at the same time. There is one other key step that should be looked at closely though, when considering how to protect senior executives and Board members against liability under ERISA, which is to carefully think about who will be involved in the plans and in what manner; the selected ones will be at risk for ERISA breach of fiduciary duty claims, while the others can be carefully and deliberately kept out of harms way. This means, though, that this has to be considered in advance and the proper structures put in place to accomplish it; if you do this after the fact, you are bound to end up with a lot more potentially liable fiduciaries among the executives and board members than anyone at the defendant company ever expected would be the case, due to ERISA’s concept, embedded in statute, of the functional, or deemed, fiduciary.
When should you get the CFO and board members involved? Yesterday, if possible, and right now, if not, for all the reasons noted above.
Fiduciary Prudence? 9.5 Million Reasons to Care.
Here’s something very interesting, which I thought I would pass along with a couple of comments. It is the Court’s order concerning the proposed settlement of the class action at issue in George v. Kraft Food. George, which I discussed here, involved a particularly minute attack on the stock fund structure in a company 401(k) plan and on the decision making process by which the recordkeeper’s fees were determined. A panel of the Seventh Circuit found those claims viable as presented at the summary judgment stage, and allowed them to move forward. I discussed at the time of the Seventh Circuit’s ruling the fact that the decision ran counter to a wide spread sentiment that the Seventh Circuit’s earlier decision in Hecker v. Deere, which threw out an excessive fee and revenue sharing case with great vim and vigor, effectively foreclosed breach of fiduciary duty claims premised on the expenses of running a plan. What George showed, however, is that all Hecker precluded were broad, sweeping attacks on the fee structure and design of a plan; precisely targeted criticisms, with factual support for them, addressed to specific issues concerning the fiduciary’s conduct regarding the plan’s pricing and structure, can still move forward, as it did in George. And to what end? The settlement order in George indicates a settlement fund being paid out to the plan participants of $9.5 million.
So what to make of that? Here’s a good start. First, carefully targeted and supported breach of fiduciary duty claims targeting plan expenses, fees and structures are not guaranteed to go away through motion practice, as though a motion to dismiss or for summary judgment is akin to a wand at Hogwarts. Many, many, many fiduciaries – or at least their lawyers - have become convinced in recent years of the opposite, in my view. Second, if they don’t go away, their settlement value becomes significant, because of the sheer amounts at risk in a breach of fiduciary duty case involving a plan of any meaningful size. Third, breach of fiduciary duty cases, especially class actions, targeting the design and expense structures of plans are going to continue, no matter what lesson anyone hoped to take from the outcome in what was one of the earliest cases, Hecker. They are simply going to have to be better targeted and designed, and more carefully grounded in facts, than were the earliest cases, for this line of litigation to continue.
Speaking of New Department of Labor Regulations . . .
By the way, I and a cast of thousands (no, not really a cast of thousands; more like a very knowledgeable cast of several) will be speaking on “New Retirement Plan Regulations and Legislation Impacting 401(k) and 403(b) Plans” on Friday, March 9th. Ed Lynch of Fiduciary Plan Governance and I will be speaking on the Department of Labor’s effort – now in abeyance – to expand the definition of fiduciary by regulation. Earlier speakers will be covering the new fee disclosure regulations, and later speakers will cover target date funds, among other issues. The program is part of the Strategic Connection series hosted by the New England Employee Benefits Council, and you can find details, as well as registration information, here.
At the Intersection of Insurance and Plan Fiduciaries
Well, given the title of this blog, I couldn’t exactly let this decision pass unnoticed. In this decision from the Court of Appeals of New York, Federal Insurance Company v. IBM, the Court denied insurance coverage for IBM under an excess fiduciary liability (apparently) policy, for a settlement by IBM of a claim that amendments to benefit plans in the 1990s violated ERISA. The Court, in short, found that the claim did not invoke IBM’s status as a fiduciary under ERISA, essentially because it involved settlor, rather than fiduciary, functions. The Court applied standard rules of policy interpretation, under which insurance policy language must be given a reasonable construction under the circumstances, to conclude that policy language that applied to claims against a fiduciary involving ERISA meant claims where the insured qualified as a fiduciary under that statute, and did not, contrary to IBM’s arguments, involve any broader meaning of the word fiduciary.
Three points about the case interested me, which I thought I would mention. The first is the case’s status as an exemplar of a phenomenon of insurance work that I have frequently mentioned in the past, which is that all major litigation disputes end up in court twice: the first time as against the insured, and the next time as against the insurer, involving the question of whether that first dispute is covered under the insurance policies held by that insured.
The second is that the case illustrates one of the most important aspects of another theme of this blog, which is the importance of what I have come here to call defensive plan building, which is a fancy way of saying developing benefit plans and affiliated structures that protect plan sponsors and fiduciaries from liability. Having liability insurance in place to protect them from the costs and potential liabilities of litigation is crucial. While in this case IBM can easily afford the uncovered exposure, this will not be the case for the vast majority of plan sponsors. Careful attention to the scope of, and holes within, insurance coverage for benefit plan operations is crucially important.
And finally, the humorous aspect of the decision is the third item, consisting of IBM being put in the position, to seek coverage, of having to argue for a broad definition of fiduciary in the context of a plan dispute. As we know from the controversy over the Department of Labor’s recent attempt to expand the definition of fiduciary under ERISA to catch more fish, most entities run from the label of fiduciary like a groom from a shotgun wedding.
The ERISA Decision of the Year?
If you were going to read just one ERISA decision this year – or were starting from scratch, with a blank slate, and wanted to know the law governing breach of fiduciary duty claims under ERISA – I would read this one, Judge Holwell of the Southern District of New York’s opinion in Prudential Retirement Insurance and Annuity Co. v. State Street Bank and Trust Company. To set the stage in a nutshell, one can do worse than to borrow the opening paragraph of the Court’s opinion:
Plaintiff Prudential Retirement Insurance and Annuity Co. ("PRIAC"), brought this action pursuant to sections 409(a) and 502(a)(2) and (3) of the Employee Retirement Income Security Act of 1974 ("ERISA") against defendant State Street Bank and Trust Company ("State Street") on October 1, 2007. PRIAC commenced this suit as an ERISA fiduciary on behalf of nearly 200 retirement plans (the "Plans") that invested, through PRIAC, in two collective bank trusts managed by State Street—the Government Credit Bond Fund ("GCBF") and the Intermediate Bond Fund ("IBF") (collectively, the "Bond Funds"). This Memorandum Opinion and Order follows a seven day bench trial on the issue of whether State Street breached its fiduciary duty to the Plans by (1) failing to manage the Bond Funds prudently, (2) failing to manage the Bond Funds solely in the interest of the Plans, and (3) failing adequately to diversify the Bond Funds' assets.
In the process of awarding over 28 million dollars in damages to the plaintiff, the Court’s opinion roams in an orderly manner (can you roam in an orderly manner? I am not sure) across the most important issues in breach of fiduciary duty litigation, presenting detailed explanations of the relevant legal standards, including an excellent explanation and analysis of a fiduciary’s duty to act prudently, of the fiduciary’s duty to act with loyalty and of the same fiduciary’s duty to diversify. One particular issue that the opinion handles with great subtlety and depth concerns damages, with the Court presenting an excellent and thoughtful analysis of the burden of proof on this issue and of the relevant standards for calculating damages in this context. As the Court’s analysis reflects, this aspect of breach of fiduciary duty litigation is not fully fleshed out in the case law and is subject to real dispute, but the opinion addresses the issue masterfully.
One reason, by the way, that the damages issues are not fully developed in the case law at this point is the relative infrequency with which they arise in court, in comparison to the liability issues raised by a breach of fiduciary duty claim. There are a number of reasons for this. One is the trend in many circuits, post-Iqbal, towards deciding such claims at the motion to dismiss stage, resulting in many cases being decided at an early stage on liability in a context in which the legal issues governing damages never become relevant and never get aired. Another is the tendency of liability to be decided at the summary judgment stage, leading – more often than not – to settlement before the damages issue is ever presented to a court, if the summary judgment ruling finds a breach of fiduciary duty to have occurred. The combination of these events means that liability is far more written about by the courts than is damages in the context of ERISA breach of fiduciary duty litigation. As the opinion in Prudential makes clear, though, the subtleties of the damages determination become very important when the breach generates extremely large losses.
What Vanity Fair Teaches About Fiduciary Obligations
Not to be too flippant or cynical, but whenever, over the years, I have heard an economist base a nice, highly logical, elegantly structured analysis on the underlying base assumption that investors or business people or consumers are acting rationally – without accounting for the likelihood that they won’t actually do that – I understand anew why cynics call economics the dismal science (I often like to cross-examine economists by asking them about that reputation, if for no other reason than the sport of it). As a result, nothing about this article by Michael Lewis on the extensive literature in psychology – including Nobel Prize winning work –concerning the utterly non-rational behavior of individuals and the problems it exposes in economic theory really came as a surprise to me.
But if not a surprise, the article and the ideas it elegantly presents have a special significance for ERISA litigation and fiduciary obligations, believe it or not. Much of breach of fiduciary duty litigation is about establishing the parameters of what is the responsibility of the fiduciaries and what is instead the responsibility of plan participants. The Seventh Circuit, most famously, in Hecker seemed to have concluded that participants in defined contribution plans need to apply a caveat emptor approach to selecting mutual fund options and that fiduciaries do not have a particularly heightened duty to police the fees and expenses inherent in those investment choices, a point I discussed here; similarly, the history of employer stock drop litigation suggests that many courts and judges now believe that in almost all circumstances, employees – and not fiduciaries – have the duty to keep watch over whether retirement investing in employer stock is prudent, a point I discussed here.
This approach, though, places an awfully high burden on participants who are generally speaking, not particularly sophisticated investors and certainly not professional ones, and who are instead simply sorting out investment options in the spare time they have after doing their real jobs, the ones that they have to do well enough that they will stay employed so that they can continue to be a participant in such plans in the first place. Worse yet, as pointed out above, it is an unfair assumption to believe they will even act rationally in that role in the first instance. So does it make any sense, then, to place the burdens of investment decision making on plan participants, rather than on fiduciaries? Fiduciaries, after all, are charged by statute with acting in this regard with the care, skill, prudence, and diligence of someone knowledgeable about the subject, and there is no such statutory obligation imposed on participants. When you combine the original statutory calculus as to which side of the equation – participants or fiduciaries – should carry the responsibility of expertise, with the likelihood of irrational investment decision making by amateurs (a/k/a plan participants), one has to ask whether the line between the responsibilities of fiduciaries and those assigned to plan participants in recent court decisions is being drawn in the wrong place.
The Devil is in the Details: Failure to Provide Forms Can Be a Fiduciary Breach
I like this case, and these two stories about it here and here, for a number of reasons, not the least of which is their focus on operational competency in operating defined contribution plans and the fact that an occasional act of incompetence can be a pricey breach of fiduciary duty. The case is the story of a participant in a profit sharing plan who did not receive rollover forms in a timely manner, which was deemed a breach of fiduciary duty; perhaps of more import to plan sponsors and fiduciaries is the remedy, which was an award of the market losses in the account during the time the money sat, without being rolled over, while the plan participant waited for the necessary paperwork.
One of the reasons I like the case and the story is that it brings us back, in a world in which we spend a lot of time focused on and writing about major potential exposures like excessive fees and stock drops, to the more mundane day to day events that both impact participants and place fiduciaries at risk. It reminds us that it is the little things (although there was certainly nothing little about this case to the participant whose money was lost) that have to be done right in running a plan, or else fiduciaries and plan sponsors are placed at financial risk.
Another reason I like the case is that it is a perfect illustration of one of the mantras of this blog, which is that, in running a plan, an ounce of prevention is worth a pound of cure. Posts I have written along the way that emphasize this theme focus on the fact that investing time and money in perfecting compliance and operations pays off many times over in exposures that are avoided, in litigation costs that are never incurred, and in awards to participants that are never paid. This case is the touchstone of that idea. One relatively minor seeming operational failure cost the plan hundreds of thousands of dollars in damages and defense costs, all because of something that many would construe as nothing more than a minor oversight in compliance. For want of a horse my kingdom was lost; here, for want of some paperwork, hundreds of thousands of dollars were lost.
Citigroup, McGraw-Hill, and Moench
Not unexpectedly, the Second Circuit has just adopted the Moench presumption, in this ruling here and this one here involving stock drop cases. For those with less time on your hands, here is an excellent news media summary of these stock drop rulings out of the Second Circuit yesterday. I have long posited that, given the trend in the case law, such an adoption of this approach by the Second Circuit would essentially spell the death knell for this theory of liability; I have essentially always been of the view that, should the Second Circuit apply the Moench presumption approach to these types of cases, the stock drop theory vanishes. It’s a strange legal structure, in a way, that an area of plan management involving vast sums of employee wealth can essentially be subject to no court oversight whatsoever, even to the minimal extent of the actions getting past the motion stage and into a court review of whether, on the actual facts, the fiduciaries’ conduct was prudent, simply because the company wasn’t on the precipice of outright collapse (which is the layman’s language version of what the Moench presumption requires for a stock drop case to get past the motion to dismiss stage). Now, this isn’t the same as saying the outcome at the end of the day in stock drop cases should be different, and that the fiduciaries shouldn’t walk under these fact patterns; it may well be a fair statement, given the ups and downs of the market and the potentially conflicting duties imposed by the securities laws, that the exact conduct made not actionable at the pleading stage by means of the Moench presumption should also pass muster on their actual facts after a review of whether the behavior was prudent under all the circumstances. But the Moench presumption is essentially a get out of jail free card that insulates the conduct without such review, simply on the basis that the plaintiffs cannot plead that the company was in near fatal financial distress; as a result, the propriety or lack thereof of holding employer stock in the stock drop scenario becomes free of any review – and of the healthy discipline imposed by the risk of court review – under pretty much all other circumstances. That’s a weird little outcome, really, if you think about it. It essentially consists of the courts making a decision to divest themselves of any jurisdiction to oversee the propriety of fiduciary conduct in the circumstances presented by stock drop cases.
Defensive Plan Building After Loomis
Many of you may remember the race among law firms, after the trial court ruling in Tibble, to issue client alerts advising plan sponsors to make sure they were not holding retail share classes in their 401(k) plan investment options. Now, of course, we have the Seventh Circuit holding that it is just plain fine to have retail shares in the investment mix. So which is it? Well, of course, as I alluded to in my last post, it is really both.
In my article on Tibble, Hecker and excessive fee claims in the Journal of Pension Benefits, I took exception to the idea that Tibble effectively barred holding retail share offerings and explained that, under the detailed fact based approach applied by the court in Tibble, holding retail share classes instead of institutional share classes would not be actionable, even if the former were more expensive than the latter, if there are legitimate “issues with performance, availability of information, investment minimums, or other concerns about an institutional share class in a particular plan that would justify a deviation from including them as investment options” in favor instead of more expensive investment options, such as retail share classes. The Seventh Circuit took this exact same approach in Loomis, allowing the holding of the retail share classes in part because other possible investment selections that the plaintiffs asserted would have been preferable were not realistic, feasible, cost effective or practical alternatives to the retail shares. Thus, as was not the case in Tibble, in Loomis there was a finding that there was a legitimate basis for holding the retail share classes instead of other, proffered alternatives.
Now one can quibble with the Seventh Circuit’s preemptive determination that there were legitimate reasons for holding the retail shares and no compelling reasons not to on two potential grounds: the first that the court is substantively wrong on them (I haven’t formulated a full opinion on that yet), and the second that it is too early in the litigation process to determine that (in Tibble, for instance, it was clear that it was only on the actual facts learned in discovery that one could properly evaluate that issue, and one of the places that the Eighth Circuit, in Braden, broke from the Seventh Circuit was in allowing the plaintiffs to move forward with trying to prove the existence of issues beyond simply the holding of expensive shares). But it is fair to say that Loomis, like Tibble, rightly recognized the need to review whether there were proper alternatives to the retail share classes before determining whether or not holding them can constitute a fiduciary breach.
This means that, from a practical, boots on the ground perspective for those who build and run plans, the focus on diligent effort and investigation remains; what I always call defensive plan building, which is simply a catchy way of saying building a plan structure that will protect the fiduciaries against suit, continues to require putting in the effort of considering the propriety of different types of investment choices, and documenting that this was done. Do this, and it won’t – other than in terms of the amount of defense costs incurred before a case ends – matter one whit whether a suit is filed in the Seventh Circuit, in the Eighth Circuit, or before the same District Court judge who ruled in Tibble.
Loomis, Hecker, Tibble and the Evolution of Excessive Fee Claims
Well, well, well. Here is the story – well-presented by two lawyers from Williams Mullen – of the Seventh Circuit deciding this month, in the case of Loomis v Exelon Corporation, that holding retail class mutual fund shares, rather than cheaper institutional share classes, in a defined contribution plan was not sufficient to establish fiduciary liability. Here is the decision itself.
Reading them together raises more than a few thoughts about the decision and the Court’s reasoning. I wanted to focus today on one particular point, which is that, as the authors of the article point out, the Seventh Circuit, in the opinion, continues its heavy reliance in rejecting excessive fee claims on the idea that marketplace competition is sufficient, in and of itself, to police the expense levels of retail class shares offered to plan participants. This idea is, in many ways, the theoretical foundation of the Seventh Circuit’s seemingly categorical rejection of excessive fee claims, with the Court reasoning that, if market forces have set those fee levels, it is appropriate for plan sponsors to offer them.
However, it is important to recognize what the Court is really saying in Loomis, which is that the mere holding of retail shares – without more - under circumstances in which their pricing is subject to market discipline is not a fiduciary breach; the Seventh Circuit’s rulings in this regard, including in Loomis, are best understood as meaning that something more than that must be shown to make out a fiduciary breach. The Court, in fact, seemed to recognize this when it claimed for its own the Eighth Circuit’s decision in Braden, asserting that it was consistent with the Seventh Circuit’s approach in Hecker (and thus by extension in Loomis) because “the plaintiffs in Braden alleged that the plan sponsor limited participants’ options to ten funds as a result of kickbacks; while adopting the approach of Hecker, the eighth circuit held this allegation sufficient to state a fiduciary claim under ERISA.” The Seventh Circuit then went on in its decision in Loomis to explain why none of the additional assertions of potential fiduciary misconduct, above and beyond simply holding retail class shares, alleged in Loomis was sufficient to demonstrate the existence of the type of additional conduct that constitutes a fiduciary breach, such as existed on the allegations in Braden.
Loomis is therefore not properly read as meaning that excessive fee claims are futile, although it certainly means, in the Seventh Circuit anyway, that alleging excessive fee claims based solely on the decision to hold retail share classes without more is futile. The authority is instead properly read as meaning that something more than that has to be attributed to the fiduciaries to sustain an excessive fee claim, and that this something more must add up on its own to a fiduciary breach. This means that one should put little stock in news flashes, articles and client alerts that claim that Loomis means that excessive fee claims are futile or that holding retail share classes is per se fine; rather, what Loomis means is that excessive fee claims are futile and that holding retail share classes is fine only if participants can find no additional aspect of the fee related decisions that falls below a fiduciary’s standard of care. This is a subtle but clear, and important, difference, one that can cost a plan sponsor a lot of money if that sponsor turns out to be the one that left retail funds in place under circumstances where that additional lack of diligence can be shown.
Further, as many readers know, the federal district court’s decision after trial in Tibble, now up on appeal to the Ninth Circuit, is seen by many as contrary to Hecker and as finding a fiduciary breach in a plan’s holding of retail, rather than institutional, shares. The trial court’s opinion in Tibble, however, did not really find a breach just for that reason, but instead found a breach due to the lack of prudence and diligent investigation by the fiduciaries that led to holding retail share classes. Understanding both Loomis and Tibble in their proper light suggests that they are more in harmony than would appear on first glance; both require something more than just the holding of the retail class shares alone to demonstrate an excessive fee claim and a corresponding breach of fiduciary duty.
Retreat From the High Water Mark: Excessive Fee Litigation After Tibble
By the way, I never did make available a full copy of the article I referenced in this blog post here, which I wrote for the Spring 2011 edition of the Journal of Pension Benefits. The article analyzes excessive fee litigation in light of the trial rulings in Tibble, against the backdrop of the motion to dismiss ruling in Hecker, and essentially concludes – as you might expect a trial lawyer to conclude – that the world (including that of fiduciary decision making with regard to investment selections in plans) tends to look a lot different after discovery and with evidence in hand, than it does when a complaint is drafted. You can find the article here.
The Lessons of Unisys
Here is a very nicely written opinion out of the Third Circuit in Renfro v Unisys rejecting a breach of fiduciary duty claim alleging excessive fees in the mutual fund options in a company’s 401(k) plan. A few particular points are noteworthy. The first is the detailed explanation in the opinion of the reason that the directed trustee, Fidelity, was immune to suit for those decisions. The opinion lays out the written structure used by Fidelity to avoid being exposed to claims of this nature and, quite frankly, it is really well done. Pats on the back all the way around to the Fidelity legal department, or at least that part that over the years has formulated this structure and its documentation. While I mean that sincerely, I mean something more serious as well: somebody over there invested significant resources to get this right, and you see the value of that in this opinion. Investments in ERISA compliance and liability prevention can pay off down the road in spades, and this is a perfect example of it.
A second nice aspect of the opinion is the Court’s nice synthesis of Hecker and Braden, which otherwise can be seen as standing in conflict with each other. However, this leads to the third point, which is that the opinion reasonably and quite intelligently explains that the allegations concerning the mix of investments are not enough to show a breach, even though some of the fund choices were of the retail class in circumstances in which one can assume the sponsor had sufficient negotiating power to avoid that class of investments. As I discussed in this article here, one of the wrong lessons many people took from the District Court opinion in Tibble, which followed a trial of an excessive fee case, was the idea that having retail share classes as investment vehicles is a per se problem and needs to be avoided. That, however, was not really the case in that litigation; what was the problem there was not the use of the retail share classes, but the manner in which they ended up in the investment mix. The Third Circuit’s opinion is essentially driven by the absence of allegations that would match the evidence in Tibble showing that there were errors by the fiduciaries that caused the plan to unnecessarily and improperly carry retail share class investments. Rather, the Third Circuit’s opinion simply rejects the idea that the inclusion of retail share classes alone shows, without more, flaws in fiduciary decision making.
Talking About Fees
Summer time and the living is easy. Well no, not really – which is fine, because nothing makes a lawyer (at least this lawyer) more nervous than having time on his hands. Time demands have, though, cut down on my posting since the 4th. Still, I have had time over the past few weeks to think a little bit about this educational seminar I spoke at that was hosted by Asset Strategy Consultants on the role of fees and revenue sharing in designing 401k plans. My talk focused on defensive plan building, or defensive lawyering in other words, which I define as the process of building out the investment options in a manner that will reduce the risk of getting sued on the theory that fees and expenses in a plan were excessive, or, if sued, of being found liable.
This particular seminar was very interactive, with a lot of give and take with the audience, which is something I like, not least of all because I inevitably learn something. What did I learn this time around? A few things, but the following stuck with me. First, it is important to remember that there are a lot of plans out there, and many of them are staffed by committed professionals working hard to provide participants with the best plans possible. One can lose sight of this in litigation, or even in reading about the various lawsuits, settlements and judgments involving 401(k) plans, because the contentiousness of those cases, along with the real and often significant breaches of fiduciary duty that occurred in them, can obscure that reality. However, there are many more plans – some of them represented at the seminar – where people are doing the work of really diving into the plan’s investment structure, and making sure it is optimal, from both the perspective of fees and the perspective of returns. As I discussed in my talk, fiduciary prudence requires weighing both of those aspects – as well as a whole host of others – in choosing investment options.
Second, when it comes to fees and expenses in investment options, there is a lot of expertise out there, and there really is no reason not to tackle this issue prospectively. Looking backwards, the issue was not on many sponsors’ front burners, and thus I have little doubt that there may be plans out there that never put resources into controlling fees and expenses. However, at this point in time, there is no reason for any plan sponsor to be ignorant on this issue and of the risk of liability it imposes going forward, and there is more than enough expertise out there that can be brought to bear to address such concerns. I would hope that, down the road, excessive fee and expense cases will eventually go the way of the Pterodactyl, now that plan sponsors have learned to pay attention to this issue and to address it.
Third, while I am not a skeptic of excessive fee claims (the math on the impact on participants of a lack of diligence on this front is undeniable), I am of revenue sharing claims, as a general rule. Unless and until revenue sharing in a particular plan is shown to actually impact the investment choices or returns of the plan participants, it seems to be a “no harm, no foul” type of problem. If, as I discussed at the seminar in response to an excellent question, the participants can get a strong return at low fees while at the same time plan costs are driven down by revenue sharing, I don’t see a basis for finding a fiduciary breach, even if the revenue sharing was not disclosed or poorly disclosed. Obviously, this is a best case scenario, but that is my general view of that subject. I did get a good dose of reality on this issue, though, from the presentation of Mark Griffith of Asset Strategy Consultants, who illustrated the extent to which certain revenue sharing arrangements can, over time, result in too much money being paid for administration, relative to the actual costs; at the same time, Mark did a nice job of emphasizing a fact which often gets overlooked when the lawyers start yelling at each other in court about revenue sharing, which is that the costs of administering a plan are significant and have to be paid for one way or the other, a reality check that should not be overlooked when regulators, courts and lawyers are considering the propriety, or instead lack thereof, of various revenue sharing arrangements.
Owning Your Advice
I have blogged many times on the DOL’s progressive or aggressive (the adjective you choose depends on your view of the changes) program to alter the fiduciary landscape of defined contribution plans, by - in general – increasing the flow of information among providers, participants and plan sponsors on the one hand, and on the other hand decreasing loopholes that allow some providers to avoid fiduciary status. This story here gets right at the heart of one proposed regulatory change that would make it easier for providers who offer financial advice and products to be transformed into fiduciaries, by focusing on the key element of the regulatory change that has the effect; as the author explains:
ERISA regulations [currently] allow many investment service providers to escape fiduciary accountability for the advice that they provide to retirement plan sponsors and participants. The problem is that the Employee Retirement Income Security Act of 1974's definition of “fiduciary” is too narrow and nuanced. In particular, only advice that is both regular and serves as the primary source of decision making gives rise to fiduciary standing. Last October, the Labor Department proposed changing the definition by dropping the “regular” and “primary” requirements so that even one-time or periodic advice that is considered part of the decision-making process by the recipients would make the provider a fiduciary.
I like to think of this change as you make the advice, you own it. As a lawyer, that’s the rule I live by, and frankly I have no choice in the matter, from both the perspective of legal malpractice standards and the profession’s rule of ethics. For me, the fact that outlier lawyers who don’t live up to this will, in my experience, eventually find themselves in trouble, either with judges on their cases, malpractice carriers, or the state bar, means that abiding by this golden rule does not disadvantage me either in the courtroom or in the marketplace for legal services, because it creates what is in general a level playing field: most lawyers abide by this principle, and the ones who don’t will eventually be pushed out of the equation.
To me, for the quality providers of investment advice, this proposed change would do little more than have the same effect. If they are already doing a good job, they should not face any greater barrier to their work simply by this codification of a standard that they are already living up to: if they are doing prudent and informed work already, they have nothing – on a day in day out basis – to fear from being rendered a fiduciary by this change. It is the competitors who are skating by and competing with them by providing a lower quality product who will be at risk, and who will either have to raise their game to the level of the better providers or face the legal exposure that comes from doing shoddy work while operating under the title of fiduciary.
Fiduciary Liability: Risks and Insurance
What’s that old saying - your lack of foresight doesn’t make it my emergency, or something to that effect?
I am a little guilty of that here, in my advice to you, at the relative last minute, to hurry up and register for a webinar on the intersection of insurance law, ERISA and fiduciary liability. It is not that last minute, really, in that the webinar isn’t until Thursday, but still, I certainly could have given you more notice.
Either way, I wanted to recommend this upcoming presentation, “ERISA Fiduciaries Under Attack: Key Litigation and Regulatory Developments,” presented by blogger Susan Mangiero and a cast of thousands (well, two actually, but they are good ones), which will cover fiduciary liability issues and the management of those risks through fiduciary liability insurance. As you will no doubt note immediately, the presentation strikes right at the intersection of the two main topics of this blog.
Speaking for myself, I think there is a great deal of misunderstanding out there as to the scope and usefulness of insurance coverage in this area. I don’t think I have previously seen a webinar directly targeting this issue, so I think it’s a good one, and I highly recommend it. You can find out more about it on Susan’s blog, here.
Extrapolating From Employer Stock Drop Cases to Other Types of Investment Losses
Susan Mangiero, who brings expertise in finance and investments to the discussion over the propriety of various investments in defined contribution plans and whether their presence in a plan can support a claim for breach of fiduciary duty, has written this interesting post on the issue I discussed here, namely the role of CFOs in running plans and different approaches to reducing the fiduciary liability risks of including employer stock as investment options. What she points out is something we litigators, with our backwards looking focus – what is litigation, after all, but a fight over something that already happened? – may not have noticed: namely, that the fights over employer stock are likely laying the ground work for future fights over other investment choices. This idea is interesting, in that breach of fiduciary duty litigation is, in fact, much like the old saying about people who accomplish something who are standing on the shoulders of the people who came before and tilled the ground. Fiduciary duty suits involve the courts confronting a new situation, such as employer stock drops, and creating rules to deal with them, and then later suits involving other similar fiduciary acts build upon, flow from, or distinguish the rules created in those earlier cases. In future cases involving other types of investments, such as the bond losses Susan references, one key factual distinction is going to come into play, which is that stock is unique to a certain extent in this context, because of the competing obligations imposed on company officers by the securities laws and ERISA, which has driven much of the development of the law of stock drop claims in the ERISA context (along with a concern that the class action bar should not be allowed to easily reframe securities class actions as ERISA breach of fiduciary duty cases, a concern that either flows directly from or fits very easily with the recognition that corporate officers are in a position of having to serve different masters with differing agendas, in the form of the securities laws and ERISA, when employer stock is held in a plan). The question for the next round of cases, such as disputes over bond losses, is how comparable those scenarios are to that conflict, as it only makes sense to extend the breach of fiduciary duty rules developed in the employer stock drop context to other types of losses to the extent that similar concerns are as present in those cases as they were in the employer stock drop context.
Live Blogging from Bentley College . . .
Live blogging is usually used to mean that someone is attending a seminar and putting up posts about it while there. I mean it differently, that I will be talking live, about the topics I regularly address in my blog posts, at this seminar on May 10 hosted by Asset Strategy Consultants-Boston. The seminar is open to plan sponsors and their advisors, and I will be opening the event by speaking on "Hot Topics in Fiduciary Governance: Limiting the Risks Inherent in Selecting Plan Investment Options.”
Other speakers include Mary Rosen from the Department of Labor, as well as Todd Mann of AllianceBernstein Investments and Mark Griffith of the host, Asset Strategy Consultants-Boston. Mary and I spoke together on a panel awhile back in Boston, and her comments on the current focus of the DOL alone tend to be worth the price of admission.
Information on registering for the seminar can be found on this invitation, if you would like to attend. I hope to see many of you there next week.
Playing Hot Potato With Employer Stock
This is an interesting piece on one of the most loaded issues in ERISA litigation, namely the potential personal liability of corporate officers who run a company’s benefit plans, in particular their defined contribution plans, such as 401(k)s or ESOPs. The article drives home the fact that when CFOs or other officers are named as the fiduciaries, as is often the case with company plans, they are thereby opened up to liability for any problems in the operation of the plans that can be characterized as breaches of fiduciary duty. Importantly, however, and on a topic that the article skips over (it’s a short article, and a point likely deliberately beyond its scope), corporate officers who get intimately involved with the operations of such plans are likely to be targeted as fiduciaries in litigation, and may well be found to be fiduciaries, even if the plan at issue avoids naming them as fiduciaries; their involvement is bound to render them so-called deemed or functional fiduciaries, which opens them up to much the same liability risk.
The article focuses on the problems for those corporate officers, and in particular CFOs, that stem from holding employer stock in plans, which are acute as a result of the inherent conflict between the business needs of the company with regard to its publicly traded stock and the potentially distinct risks to plan participants of financial loss from holding that stock in a plan. When problems with a stock arise, a corporate officer’s actions in response in one direction may benefit one side of that equation at the expense of the other, at the same time that different actions by that same officer could reverse that calculus. When the resolution of that problem results in losses to the company stock held by the plan or its participants, the fiduciaries enter the cross-hairs for litigation and potential resulting liability based on the possibility they have breached their fiduciary duties to the plan participants by those actions.
The article poses as one solution the creation of a data driven system that preordains decision making with regard to company stock holdings, based on such issues as changes in stock price, etc., thereby taking the day in, day out discretion over what to do with the stock holdings out of the hands of the fiduciaries. There are many benefits to such an approach when it comes to defending possible breach of fiduciary duty claims down the road involving those stock holdings, but it is far from a get out of jail free card. At a minimum, the corporate officers who have been serving as plan fiduciaries, whether in name or by operation of law, are likely to be accused of having breached their fiduciary duties by erring in creating, selecting and putting the automatic system into place in the first place, and by failing to monitor or adjust the system along the way in response to any changing dynamics in the marketplace. As the Seventh Circuit’s decision this month in Kraft Foods reflects, there is no doubt that good class action lawyers and good financial experts can identify and target financial anomalies in any system designed to process employer stock holdings, and they will do that with this approach as well. It doesn’t mean the author’s proposal doesn’t have merit, and I can see many ways in which it would strongly aid in the defense of a breach of fiduciary duty claim against corporate officers.
However, it doesn’t change the fact that the best approach to the defense of such corporate officers is either to keep employer stock out of the plan itself or, in a move court tested and approved by at least one circuit, move the entire management and decision making on whether to hold company stock or not, and if so when to buy and sell it, out of the company and onto very qualified outside advisors. This will still, just like the case as noted above with regard to the author’s proposal for creating an automated system, not completely exempt the corporate officers who are fiduciaries from the risk of liability, but will make it very, very hard to recover from them; they can still be sued for alleged errors in selecting and then failing to monitor that outside advisor, but if the outside experts are well-chosen, that’s going to be a hard row to hoe to recover from them.
What Exactly is the Investment Drag of Macaroni and Cheese?
This is interesting – it’s the story, in abbreviated form, of the Seventh Circuit breathing new life into an excessive fee class action case, by finding that there is a factual question of whether the fiduciaries properly evaluated their options and that the defendants cannot insulate themselves easily from their obligation to properly monitor and test fee levels. Its also an interesting case on the question of the fiduciaries’ obligations with regard to structuring an employer stock fund and on the effect of such choices on returns net of expenses. The case itself is George v Kraft Foods Global, and you can find the opinion itself here.
The case jumped out at me for three reasons. The first is that it runs counter to the assumption, expressed in many quarters, that the Seventh Circuit’s prior and highly publicized ruling in Hecker created a significant barrier, and possibly spelled the death knell, for claims built around excessive fees and costs for plan investment options. Many, including me, thought the Seventh Circuit went too far in that regard at that time, and that excessive fee claims needed to be evaluated on the micro-level of the actual facts of the fiduciary’s conduct to decide whether a claim was viable, which was not the approach taken in Hecker. This latest case out of the Seventh Circuit seems to move in that direction, as it is clearly a fact specific investigation of the issue, one that found that the plaintiffs were free to make out such a case on the actual facts of the fiduciaries’ conduct.
The second is that this ruling thereby fit perfectly with the thesis of my article on excessive fee claims after Hecker, referenced here, which posited that subsequent judicial and regulatory developments would move the case law away from the approach of the court in Hecker and toward the approach taken in this most recent Seventh Circuit case. Time seems to be bearing out my forecast.
The third is the nature of this claim involving breach of fiduciary duty involving employer stock holdings. We all know that the traditional form for such claims is the stock drop case, in which the complaint is that the plan should not have been holding employer stock which then dropped significantly in value. In many jurisdictions, this is no longer a promising approach (although not in all, and for good reason, an issue for another day). Here, however, we see a revamping of the traditional approach to such claims, one that makes the stock holdings aspect of an investment plan a possibly significant basis for a breach of fiduciary duty claim under ERISA. Those plaintiffs’ class action lawyers – what will they think of next?
Fiduciary Definitions Change Hand in Hand with the Real World
One underlying theme of much commentary about 401(k) plans is the idea that their replacement of pensions as the primary retirement vehicle for most private sector workers was not intended, and is the walking, talking example of the law of unintended consequences. Seen as it was in its origin myth – as a supplemental retirement investment vehicle – its flaws become less significant; for instance, questions of the appropriate levels of fees, or whether and under what circumstances to include employer stock, are less important when the risks of reduced return from those issues impact not the participant’s primary retirement investment, but rather a supplement to it. In some ways, that is the revolution of BrightScope. I have spoken with lawyers and industry people who quibble (and sometimes outright quarrel) with its math, but the reality is that, regardless, it is the first public forum (that I know of, anyway) to really treat 401(k)s as what they truly are: the primary retirement vehicle for a vast swath of the public. Viewed in that light, every piece of information that impacts or reduces performance, which BrightScope tries to capture and communicate to the participants, is of the utmost importance, something that would not be the case if 401(k)s played a less central role in employee retirement planning.
I was thinking of this today because of two stories on issues involving the use of ESOPs and 401(k) plans for purposes other than retirement income accumulation; in both cases, for the more traditional purpose – in my mind anyway – of motivating employees and managing tax exposures. As tools for these purposes, they have more value and less risk than they do as primary retirement vehicles. Both though are subject to distortion depending on the nature of the management of them: the ESOP by misuse, as I have written before, as a tempting tool for corporate transactions and the 401(k) by mismanagement of its investment selection and cost. Each risk is countered, or supposed to be, by the fiduciary obligations of those operating the plans, and at heart this is what the Department of Labor initiatives to expand the scope of fiduciaries is targeted at: making sure that all those who play a management or similar key role in the operation of these types of plans become fiduciaries and are subject to the discipline imposed by that status, in terms of potential liability exposure, behavioral demands and expectations, and litigation risks.
Adam and John on the Obligations of Reasonableness and the Problems with SPDs, Respectively
Well, geez, I am embarrassed by the awkward silence in this space over the past couple of weeks. I was out of the country on business for a bit, and digging out ever since. Not that I ever lost sight of the ball, though, as I kept jotting down stories and developments that I wanted to pass along in a blog post. I am going to do that right now, clearing my desk of two of them.
In the first one, I had wanted to pass along this excellent and thought provoking post from Adam Pozek’s Pozek on Pensions, in which he discusses the regulatory changes being developed by the Department of Labor related to who is a fiduciary and what information has to be disclosed to and by fiduciaries. Adam makes the point that what should not be lost in these developments, and in the controversies the changes engender – see here, for instance – is that they do not change the actual obligations of plan fiduciaries to act reasonably and conduct appropriate investigation; those obligations have always been there and continue to be there. The only thing that is changing is what information is available as part of that obligation and how it may impact a fiduciary’s compliance with that obligation. I have discussed before that the disclosure of further information through this regulatory structure will almost certainly shift the nature of fiduciary liability and litigation, and affect how such claims are structured and how they are defended. They don’t, however, change the fundamental, underlying legal obligation of fiduciaries, a point Adam drives home in his post and which, perhaps implicitly, he is reminding us of as we get lost in the details of these regulatory changes.
The second item I had wanted to highlight was this blog, by John Lowell of Cassidy Retirement Group, titled – in a walking, talking exemplar of transparency - Benefits and Compensation with John Lowell. John’s experience shines through in his posts, which are detailed, thought provoking and frankly, compared to much of what one finds on blogs, highly original. For my purposes, and for any of the rest of us waiting for the Supreme Court to rule in Amara, I particularly liked his real world discussion of the problem of misleading and inaccurate summary plan descriptions, which you can find here.
Class Actions, the Diamond Hypothetical and the Seventh Circuit
I have written before about the various implications of the Supreme Court broadening fiduciary duty claims in LaRue to allow individual participants to sue for losses only to their own accounts, rather than just for harms suffered by all participants, or in other words, by the plan as a whole; among other aspects, I have discussed its interplay with the class action rules, and the importance for the development of the law of ERISA of the Court’s distinction in that case between defined benefit plans and defined contribution plans.
On the first point, I have noted that the famous - to a small group of interested observers otherwise known as ERISA lawyers and scholars - role played in LaRue by the so-called (by me, anyway) diamond hypothetical may have a wide range of implications for the development of the law, not all of them either intended or even foreseeable. Under the diamond hypothetical, each participant’s account in a defined contribution plan can be understood to contain its own specific bunch of diamonds, which all together add up to make up the totality of the diamonds held by the plan; this is different than a defined benefit plan, in which the diamonds are not subdivided in that manner, but instead are merely held in their entirety as the plan’s assets. I have blogged before about the question of whether this meant that an individual plan participant who suffered no harm to his particular account - i.e., his diamonds didn’t vanish - could proceed as a class representative where other plan participants did suffer harm in their accounts - i.e, their diamonds did vanish - or could seek relief on a plan wide basis. Judge Gertner of the United States District Court for the District of Massachusetts has a nice discussion of the diamond hypothetical in the footnotes of her opinion that is discussed in this post.
In a decision interesting on a number of fronts, the Seventh Circuit has now addressed this same issue in detail, in the context of deciding whether class certification orders in excessive fee cases involving defined contribution plans were appropriate. In Spano v. Boeing, the Court focused on the implication of the diamond hypothetical structure of defined contribution plans (without mentioning the diamond hypothetical), finding that class certification can be proper, despite the fact that each plan participant has his or her own individual account and possible loss, after LaRue, but that the particular injury to the different participants’ accounts had to be examined to determine whether class certification was appropriate with regard to the particular theory being pursued by the class and the representative plaintiffs. In essence, class certification may not be appropriate if there is too much variance in the impact on different participants’ accounts of the challenged conduct. The opinion is a fascinating read on this question, and you can find it here.
The opinion is notable for a number of other reasons as well, some of which I may return to in further posts, but one of which I will mention here. I have posted in the past that the Supreme Court’s opinion in LaRue invited courts to revisit the rules in place with regard to defined benefit plans when instead evaluating claims concerning defined contribution plans, and emphasized that the rules applicable to the former may not properly fit the latter. I have pointed out as well that figuring out where or how the rules should diverge in the two contexts should open up avenues for participants’ lawyers to try to advance their cases when pressing claims involving defined contribution plans. The Seventh Circuit drives home both this point and this new reality in Spano, recognizing this dynamic put into play by the Supreme Court in LaRue.
The Ever Evolving Risks of Fiduciaries
Well, I am not sure I could have said this better myself, although in post after post, I have spoken of the increasing litigation risk for fiduciaries, and of the need to respond by emphasizing compliance and diligence in designing and running 401(k) plans. At the end of the day, ERISA has become a fertile ground for litigation, and the inherent conflicts and difficulties in running 401(k) plans are exposing fiduciaries to lawsuits and the potential of personal liability. Susan Mangiero, in this post on her blog Good Risk Governance Pays, surveys this landscape and explains what is putting fiduciaries ever more at risk. Two particular aspects of her post are worth highlighting. The first is her reference to a leveling off of fees, and her attribution of that event to litigation risk; we are coming through a storm of lawsuits over investment fees and expenses in 401(k) plans, all alleging - in one way or another - that sponsors and fiduciaries should have used their market power to obtain lower fees. It is often remarked that litigation is a terribly blunt instrument to effect change (its also expensive and not terribly efficient), but it may have done so here and, if so, those of us who labor in the vineyards of the court system should be pleased by the system’s ability to effect change. The second is her discussion of the series of changes that are affecting fiduciaries, each of which in one way or the other has the potential to expand fiduciary liability, if manipulated well by counsel for participants. I have written many times that we are in an era of evolution of fiduciary liability under ERISA, driven by the old Marx line that at the end of the day, everything is economics. As I have written before, the simple fact is that 401(k) plans - and worse yet losses - have become the fundamental reality of retirement for most employees, and with that change in the economic environment is going to come change in the risks, obligations, demands and legal exposure of the fiduciaries of such plans; we see that here in Susan’s post as well.
On Disclosure and Conflicts of Interest
In my life as a trial lawyer, I have found myself in a recurrent situation, in which a judge or an arbitrator eventually looks at me in an argument over discovery and asks if I really want the information I am after, as it could run against me. I always answer the same way, to the effect that I am comfortable with facts, believe that more information is more likely to lead to the just result in the case, that I will trust the facts to show us which way to go, and that I am more than willing to let the facts come out in the open and drive the case. Now, the truth is that, before ever seeking the discovery that is at issue, I will have long since thought through the subject and become convinced that the evidence in question, once brought out, is far more likely to help my case than to harm it; the reality, from a tactical perspective is that, otherwise, I would not have pressed the point in the first place, with me going so far as to ask a court or arbitration panel to order production of the witness, or documents, or whatever else is in question. That said though, my response - to the effect that I favor the facts coming to light - is a true sentiment. Facts are stubborn things, in the classic formulation, and they decide cases; I am more than happy to have them see the light of day. Heck, I would certainly like to know of them while I can do something about them, even if they are bad for my case, than have them just show up for the first time out of some witness’ mouth on the stand in the middle of a trial.
I thought of this when I read this investment manager’s discussion of the Department of Labor’s expansion of the term fiduciary, which I discussed in my last post, and of the Department’s various initiatives related to fee disclosure, in particular his discussion of lobbying against those actions. Like facts in a lawsuit, the facts of revenue sharing, fees, and the like belong in the open, and can do nothing at the end of the day but improve outcomes for participants, plan sponsors, fiduciaries and the better advisors. What’s wrong with a little sunshine, a little transparency, and a lot of disclosure in this context? Frankly speaking, probably nothing. Participants will eventually end up with better outcomes, while plan sponsors and fiduciaries will have the information needed to best do their jobs, which will - if they use the information right - make them far less likely to get sued or, if sued, be held liable for fiduciary breaches. Meanwhile, we all know that advisors get paid fees, as of course they should; the only change is that everyone involved in the decision making will know who is getting paid what and for what exact services. Under that - possibly excessively rosy - view of the world, the end result should just be that the better advisors, who are providing better products and services at better prices, will get more of the business. What’s wrong with that, from a forest eye view?
Interview in Fiduciary News
I have written before, on many occasions, about the evolving nature of fiduciary status, and in particular on the shifting regulatory landscape in this regard. Here is an interview I gave to Fiduciary News on the latest proposed Department of Labor regulatory change concerning the meaning of the word fiduciary in the ERISA context. If you want more background detail on that regulatory change itself, you can find it here.
Governmental Plans, Annuities, and the Intersection of ERISA with the Securities Laws
I have discussed in many posts the idea that the plaintiffs’ class action bar has alighted on ERISA and breach of fiduciary duty claims as a preferable tactical alternative, in many cases, to proceeding under the securities laws. This approach was a particularly nice fit for stock drop cases, in which company stock held in employee benefit plans rendered ERISA, and its relatively - at least compared to the securities laws - more malleable breach of fiduciary duty doctrines, a viable approach to seeking recovery for precipitous declines in company stock prices. To date that tactic - which made sense as a legal and tactical theory in the abstract - has not really worked out all that well with regard to decline in the value of company stock holdings, because of the oft-discussed Moench doctrine, which provides a strong presumption in favor of plan fiduciaries when it comes to holding company stock.
This article here, however, discusses what has, at least in perfect hindsight, turned out to be an excellent example of taking a good idea - at least if you are a class action lawyer or a plan participant - a little too far, by choosing to proceed under ERISA in a large putative class action rather than under the securities laws, only to have the court subsequently conclude that ERISA cannot apply under the facts of the particular case, and that the participants should have gone forward under the securities laws in the first place. The case it discusses, Daniels-Hall v. National Education Association out of the Ninth Circuit, can be found here, and for the ERISA practitioner, it may be more significant for its detailed analysis of the government plan exemption in ERISA than for its conclusion that the plaintiffs had overreached by relying on ERISA rather than the securities law to proceed with their case. The issue of the choice of legal doctrine to pursue is one of tactics, and reasonable lawyers can disagree at the outset of a case as to which of many plausible lines of attack should be pursued; either way, over time, the current preference for ERISA over the securities laws as a matter of tactics will likely run its course. Debates over whether a particular plan is a government plan, however, will continue to pop up, and the Ninth Circuit’s decision provides a sound template for analyzing that issue.
Derivatives + No Transparency = Fiduciary Breach?
Can a fiduciary of a pension plan or other employee retirement account trade in derivatives without breaching his fiduciary duty? If this article from the New York Times is to be believed, then the answer is really no. If there is no transparency to fees and costs of the undertaking, than, theoretically, a fiduciary cannot truthfully say whether or not the transaction is financially appropriate in light of its costs to the plan and whether the assets of the plan are in turn being handled properly. Further, a fiduciary’s obligations run more to the duty to investigate and properly handle a plan’s investments than it does to ensure the best outcome; it would not seem that a fiduciary can engage in the due diligence necessary to satisfy his, her or its duty of prudence if the fiduciary cannot obtain clear and accurate information about an investment opportunity, which the article suggests cannot be done as part of a derivative based investment.
Now on some levels this reads like a perfect law school exam hypothetical: here is a widely used investment in which there is no transparency as to costs and the like; now identify all of the ways in which investing in them would violate the fiduciary obligations of plan sponsors and others with regard to an ERISA governed retirement plan. At the same time, though, ERISA has to have some flexibility to allow the real world to be accounted for, and if derivatives may in some instances be an appropriate investment for a pension plan, fiduciaries should be allowed to make use of them, despite having access to only imperfect information. The question, from a fiduciary liability perspective, is where in the middle of those two extremes does fiduciary obligation, duty and breach lie? It unquestionably is somewhere in the middle, and if and when a retirement plan is sued for underperforming due to the use of derivatives, we may well find out exactly where in the middle that line rests.
Of Fiduciaries and Liability
I have spoken before of the Department of Labor’s regulatory initiatives to target fee setting and disclosure issues, and how they are likely to expand fiduciary liability related to the expenses of 401(k) investment options. Of a piece is the Department of Labor’s yet more recent regulatory initiative to expand the scope of advisors who can qualify as fiduciaries, which, if and when enacted, will by definition expand the number of fiduciaries and the potential number of parties liable for problems in a plan or its investments. Although it comes from Canada by way of New York, I am partial to this blog post on this regulatory change, which covers it quite succinctly. For a further discussion of the proposed regulatory change, you can see here as well.
I mention this now because, in my view, we have already entered a world of expanding fiduciary liability, and this regulatory change will speed that change. With the change from a pension based system (which had relatively little risk for the individual participant) to a defined contribution plan system (in which all investment risk is borne by the participant), it was only a matter of time before the narrower application of fiduciary liability, ensconced during that earlier era and likely appropriate to it, shifted to accommodate this new reality. We are seeing that occur now, even if often just glacially.
For fiduciaries of defined contribution plans, this means an expansion of their own personal risk, one that in turn demands higher diligence by them in managing plans, selecting investments, and other potentially risky activities. Nevin Adams had a cute post early this week about what fiduciaries of 401(k) plans should know in a nutshell, which you can read here: its particularly apt advice in light of the expanding nature of their potential liability.
The Lesson in the Chicago Tribune ESOP Mess
Here’s a great story on the latest developments in the breach of fiduciary duty lawsuit arising out of the use of the Tribune’s ESOP assets as part of a complicated leveraged buy out. For some really deep background on this case, you can check out my post here from when the case commenced. I have been following it with one eye since it began, and think the summary in this newspaper article is pretty well-balanced. To the extent that there is a broader, more macro/forest and not the trees lesson here, it is the importance of thinking of ESOP holdings in the same way that a company would think of its employees’ 401(k) or other defined contribution holdings, and to both protect and respect them as retirement assets of plan participants. Unfortunately, the fact that ESOP accounts hold employer stock can make them instead appear to be another potential tool of corporate finance. The Tribune case reflects the fact that making use of that stock for transactional purposes can well end up, in at least the outlier cases, with large losses to plan participants, after which the class action bar or the Department of Labor are likely to try to transfer those losses to one or more of the parties involved in the transaction.
In the More Things Change Department . . .
I mentioned in a prior post that I was speaking on a panel with David Webber of Boston University Law School. David’s blog, Labor Capital, has a nice post on the financial weakness of public pension plans, and the questionable financial transactions that have led to it; you can find it here. I have commented in various posts on the same phenomenon at different times, but what was interesting to me about David’s post is how much it sounds like the gamesmanship with pension funding that eventually brought about the enaction of ERISA itself. One wonders whether the problems of state pension funds will eventually lead to some sort of broader national reform effort of a similar nature targeted at those funds.
This in turn leads to another thought, which again links to the seminar I presented last week, which concerned the legal implications of the shift from pensions to 401(k) plans. ERISA was enacted, as noted, in response to pension problems and to create some uniform rules and regulations to govern them. One can argue that, in hindsight, the system that was created - a mix of regulation, insurance and private enforcement - did a pretty good job controlling pension issues. Now, however, we have, in essence, moved out of the pension world and, for all intents and purposes, into the defined contribution world, and ERISA in all its forms - litigation theories, judicial doctrines, regulatory provisions, etc. - have not yet caught up, resulting in ERISA not currently being as well suited to govern defined contribution plans as it was for governing pension plans. From this perspective, one can see the new fee disclosure regulations, for instance, as steps towards grafting on the type of regulatory and other controls that are appropriate for the defined contribution world, and that were not needed before, when pensions roamed the earth.
I think it is important to realize this, as we watch both the DOL develop new rules and the courts develop doctrines to govern employer stock drop, excessive fee, and other hot topics related to defined contribution plans, so that we are aware of exactly what we are watching proceed, which is - from a very broad and macro perspective - the creation of a framework for applying ERISA, and its fiduciary duty obligations in particular, to the defined contribution world which we now inhabit. In hindsight, in terms of jurisprudential philosophy, that is what the Supreme Court’s decision in LaRue was about: the recognition that the fiduciary liability rules applicable to defined benefit plans may have to change to match the reality of the defined contribution world.
The Ninth Circuit Adopts Moench and Why It Matters
Now here’s an interesting tale, namely the story of the Ninth Circuit’s adoption of the Moench presumption with regard to breach of fiduciary duty claims alleging that fiduciaries erred by allowing a plan to hold too much employer stock or otherwise failing to act to protect participants from the risk of holding that stock as an investment option. As I discussed in this post, the Moench presumption essentially shields the fiduciaries from such claims where the plan expressly authorizes employer stock as an investment unless the company and/or its stock value had been placed at extreme risk. As the blog post on the Ninth Circuit’s decision notes, and as I have commented elsewhere, courts vary in how they frame the circumstances in which the presumption can be overcome and a breach of fiduciary duty claim maintained, but in all circumstances it can fairly be described as requiring a significant risk to the investment, beyond just a major stock decline. The Ninth Circuit, in its opinion, notes the variance in formulating the standard, and then formulates a pretty high bar for overcoming the presumption.
As I discussed in this post, the Department of Labor is in the process of arguing to the Second Circuit that this presumption should not exist, and the outcome of this at the Second Circuit becomes key, I think, for the future of this theory of liability against fiduciaries. If the Second Circuit joins the Ninth and a few other circuits in adopting this presumption, this becomes a very unattractive potential theory of liability for the class action bar or anyone else to pursue; large scale breach of fiduciary duty cases against large, well run and sophisticated plans are tough cases to win in the first place, before adding in the significant defense at the motion practice stage that this presumption grants to plan fiduciaries. If, on the other hand, the Second Circuit agrees with the Department of Labor and rejects the Moench presumption, it doesn’t take a soothsayer to suspect the issue goes from there to the Supreme Court, given the obvious circuit split on a significant issue of federal law that such a decision would create. On that front, with regard to the question of what the Second Circuit may do in response to the Department of Labor's arguments, it is worth noting that the Ninth Circuit's opinion in many ways anticipates and provides the rejoinder to much of the Department of Labor's argument in its briefing to the Second Circuit, on whether the presumption is compatible with ERISA; the opinion actually presents a well reasoned framework for viewing the presumption as consistent with the statutory framework.
The Ninth Circuit decision, in Quan v. Computer Sciences Corporation, adopting the presumption, is interesting for another reason. I will confess - and frequently do, to anyone who will listen - to a preference for issues being decided on their merits and, preferably, at trial, after thorough investigation and vetting. As discussed in this interview I did awhile back with Tom Gies, right after he argued the LaRue case before the Supreme Court, I believe the jurisprudence develops better, and we get more accurate results, when key issues are decided after an evidentiary record is developed that will shed light on the propriety, or lack thereof, of challenged conduct, than is the case when such issues are decided based upon the legal arguments, hypotheses and assumptions that checker any decision made in advance of factual development, such as at the motion to dismiss stage. My experience as a trial lawyer has taught me to put my trust in facts, and to believe that they are more likely than not to lead one to the right result. They are, as the saying goes, stubborn things, far less manipulable than legal doctrine and argument.
That said, though, the Ninth Circuit case adopting the presumption presents a perfect justification for the presumption. As detailed in this blog post, the stock drop at issue in the case, and on which the claim of breach of fiduciary duty rested, was a 12% single day decline, which was recovered in a reasonable length of time. Given the variability and the volatility of the market in general, it is extremely hard to think of a convincing rationale for imposing fiduciary liability simply because of a moderate, but not company threatening, short term decline in the value of the company stock, or for allowing expensive, time consuming litigation over that stock drop. In that particular case, the presumption resolves this, by establishing that the stock drop alone isn’t enough, and much more must be shown to justify the suit going forward.
Moench, the DOL and the Future of Stock Drop Litigation
I had the pleasure yesterday of presenting the September Advisor Success Webinar for BrightScope, in which I discussed the law and practice of fiduciary liability and exposure in detail. Its for subscribers only and not publicly available, but for those of you in the Boston area who are in the insurance industry, I will be touching on some of the same points when I speak as a member of a panel next month at a meeting of the Professional Liability Underwriting Society; more details on that to follow.
For now, though, I thought I would comment on one particular issue that seemed to strike a chord yesterday, which is the current status and likely future direction of stock drop litigation under ERISA. To date, stock drop litigation has not, as a general statement, been terribly successful, as least not from the perspective of those seeking to represent classes of participants; its been pretty darn successful for those representing plan sponsors and fiduciaries. The reason, as many readers already know, is the famous - or infamous, depending on which side of the “v.” you sit on - Moench presumption, which in essence imposes a powerful presumption that allowing substantial amounts of employer stock to be held in a defined contribution plan cannot constitute a breach of fiduciary duty unless the company was in severe financial distress, with severe meaning something more than just a significant decline in the stock price (courts' exact phrasing on this point can vary).
What was of interest in the webinar was the question of whether this presumption will remain effective, or will instead fall by the wayside, which would open the door to more suits and likely as well to greater liability as a result of electing to offer employer stock as an investment option. The answer is that it will fall by the wayside, resulting in an increase of these types of suits and a rebirth of interest in this theory among the class action bar, if the Department of Labor has its way. In an amicus brief filed before the Second Circuit in the case of Gearren v. McGraw-Hill, the Department has outlined its position in this regard, which is, in a nutshell, that the presumption is inconsistent with ERISA’s mandates, and that, with regard to employer stock, the only exception to the generally high duties of care imposed on fiduciaries is the removal of any duties related to diversification of investment options. A Second Circuit ruling adopting this viewpoint will unquestionably expand stock drop exposure and increase lawsuits based on stock drop claims, by allowing the participants to focus on proving as a factual matter through discovery that it was not prudent to include employer stock, rather than being forced to prove that the company was under the level of severe financial distress needed to trump the Moench presumption before ever being able to investigate and prove that thesis. You can find a copy of the Department’s brief on this issue here.
Private Attorney Generals and ERISA
Here’s an interesting, although at a minimum somewhat overstated, diatribe against 401(k) plans from Forbes, in which the author complains about four specific risks to participants: greater investment risk than would exist investing outside of such a plan; problems with employer or vendor record keeping and management; the possibility of employer failure; and a lack of regulatory oversight, at least in comparison to the extent of regulation applicable to other investments. The author overstates some of his points - for instance, some of his complaints about regulatory oversight are more accurately seen as complaints about sponsor capabilities, such as with regard to publishing and timely distributing summary plan descriptions or making timely distributions.
What’s more interesting to note, though, than quibbling about the details of the author’s complaints, is the extent to which they primarily concern the fact that the 401(k) world, much more than being a regulatory driven regime, is governed more on a private attorney general model, in which breach of fiduciary duty lawsuits and denial of benefit claims are the tools that address and remedy the problems the author identifies. For instance, in his discussion of increased investment risk, he references the fact that, outside of 401(k)s, an investor can pick from the universe of funds, while within the 401(k), the investor is limited to the several funds included in the plan, which may not be the best performers or the cheapest (or, if neither, at least the funds with the optimum combination of performance and cost). This, though, is at heart what all breach of fiduciary duty claims related to excessive fees or other complaints about fund selection are directed at, namely whether the fiduciaries included the right mix of funds. In theory, fiduciaries will do that, if for no other reason than out of fear of being sued if they don’t. Anecdotally, there seems to be, for instance, greater attention being paid now by plans to fees and fund selection in the wake of the class action litigation that has been pursed over excessive fees and alleged non-disclosure of fees. This is a perfect example of a private attorney general mindset, in which the issues of concern - here, the operation of 401(k) plans - are expected to be avoided by the threat of liability and, if they are not, are remedied by private litigation; this is, theoretically anyway, the counter to the type of more regulated regime to which the author compares the 401(k) world.
Pay Now and Later: High Plan Fees Pose an Increasing Risk of Fiduciary Exposure
Chip, chip, chip. No, that’s not the sound of the polar ice caps shedding ice, although I suppose it could well be. It’s the sound of the Fortress Europa that some of the more optimistic lawyers for 401(k) plans thought was being enacted against excessive fee claims - in the wake of cases such as Hecker - slowly being whittled away. Cases such as this, in which the fiduciaries were found to have fallen down on the job by accepting retail class fees, are going to open the door to more of these cases, and to more settlements to resolve them, than seemed possible when the first wave of excessive fee type cases were being ruled on; indeed, as this client advisory points out, it is no longer possible for plan fiduciaries to simply ignore the question of the propriety of retail fees in their plans. I have long believed that it will take only a couple of district courts who are willing to allow excessive fee cases to proceed into discovery and to adjudication on their merits to turn excessive fee cases into a potentially significant risk for fiduciaries, and I feel comfortable predicting that this is the start of that trend. To add a Civil War metaphor to my earlier climate change and World War II metaphors, these types of cases are going to bear out my prior prediction that Hecker was likely to be the high water mark in the defense of excessive fee cases.
Breach of Fiduciary Duty Litigation: When the Best Defense is a Good Offense
Anyone who writes anything for a long time, as I have this blog, cannot help but end up with certain recurring themes. When it comes to the management of 401(k) and similar plans, one of those themes has been the importance of compliance and a careful decision making process by fiduciaries, an idea borne out of this litigator’s belief that, in the courtroom, the best defense is a good offense. In the context of breach of fiduciary duty litigation, this old chestnut should be understood as meaning that the best way to defend fiduciaries against such claims is to present a long history of active oversight of investment and other decisions by the defendant fiduciaries. Not only is that good for plan returns themselves in the long run in most instances, but it goes far towards insulating the fiduciaries themselves against being liable on claims for excessive fees, too much stock, or other alleged problems. Many claims of this nature will never even reach the point of really examining the specific conduct of particular fiduciaries, and are instead often decided at an earlier stage, such as motions to dismiss, on the basis of broader defense theories, such as the existence of presumptions in favor of the retention of employer stock in a plan, or “law and economics” type theories, such as in Hecker, that the marketplace shows that the decision making was fine, or on the application of ERISA safe harbors. But one cannot be sure that this will always be the case, and some breach of fiduciary duty litigation against fiduciaries will always get past these types of early suit Maginot lines, and in those instances the next best line of defense is to be able to demonstrate specific conduct by the defendant fiduciary that shows strong efforts being made to get the challenged issues - whether the expenses or fees of a plan, or something else - correct. If the plaintiff or class gets to that point of the case, being able to show that will more often than not determine who wins.
I write of this today, and it is on my mind, because of a press release that crossed my desk this week concerning the decision of a major defined contribution plan to use an index BrightScope created from its data to benchmark the performance of its target date retirement funds. The release notes that:
The BrightScope On Target Index will help [the plan sponsor] measure the performance and risk attributes of their target date portfolios while giving participants the ability to see how accurately their target date portfolio lives up to its stated goals.
At the end of the day, anything and everything plan sponsors can do to put accurate, transparent information in front of fiduciaries as part of their decision making process makes it harder for liability for breach of fiduciary duty to be imposed on those fiduciaries, and this is a perfect example of a plan sponsor doing so.
Could the Deepwater Horizon Alter the Trajectory of ERISA Stock Drop Litigation?
BP has a giant employee savings plan, making it a prime target for stock drop type ERISA breach of fiduciary duty claims in light of the Deepwater Horizon leak, as I mentioned here in this post, and the lawsuits and the investigations that will eventually result in lawsuits are coming out of the woodwork as fast as vampires in one of the Twilight movies. As I noted in this earlier post, I am beyond skeptical of any such claims that are premised on the simple thesis that the fiduciaries breached their duties by not anticipating and accounting for the risk of this type of a loss when deciding to include or emphasize company stock in the plan. However, less flippantly and more exactingly, the same is not necessarily true for the alternative thesis, which I assume to be what many of these claims will play out as, that the fiduciary breach doesn’t relate to this specific environmental loss and its impact on the stock holding, but rather is that, in light of the regulatory and environmental universe in which BP operates, it was imprudent to hold or allow employees to hold a disproportionate amount of company stock; in other words, that the risk profile of the accounts as a whole was too high because too much of the investment was in company stock in an industry subject to unique and potentially catastrophic risks. Just a quick, non-analytical glance at BrightScope indicates a large company stock exposure in the BP employee savings plan, incidentally. In this sense, these claims, and the BP fiduciaries’ exposure, is no different than other instances of companies whose stock fell at a time that employee retirement accounts held a disproportionately high share of that one stock. What makes the claim here a little different, however, is the argument that there is something unique to the industry that calls for less company stock being offered to employees and instead a greater fiduciary emphasis on diversification than would be the case in other industries. For instance, if a Gillette or a Grace is sued after a stock drop, the argument is essentially that prudent investing practice as a whole calls for greater diversification, and the claims against the fiduciaries, to dress them up, may also include the argument that the fiduciaries should have anticipated stock market risks based on their knowledge of the company and its industry that should have caused them to prevent the excessive accumulation of company stock. With the BP claims, though, what you would have, I suspect, is less the argument that greater diversification was needed as a general principle, in favor instead of the argument that the oil industry itself is so subject to unique, stock value demolishing risks - from tanker crashes, to oil well blow outs, to nationalization, to wars - that it was simply imprudent to allow an excess exposure to the industry and certainly to any one particular company in that industry. (Incidentally, there is no better overview of these topics and the peculiar risks of the oil industry than Daniel Yergin’s The Prize, which may perhaps be necessary background reading for the law clerk of any judge assigned one of these cases).
Its an alluring theory, but one that raises the question of whether it plays out against the backdrop of past case law and the development of fiduciary standards when it comes to employer stock holdings, which would suggest that the claims on their merits have weaknesses, or whether instead they play out against the political backdrop of the Deepwater Horizon event and the economic losses it is strewing across a range of actors, including but not limited to the employee shareholders. If it plays out against that later backdrop - as a, perhaps, unseen or unspoken influence - the question becomes whether this fact pattern could shift the nature of these types of claims in a direction that could give them far more traction than the past history of claims of this nature suggests would otherwise be the case.
Can the Deepwater Horizon Spill Sink the Fiduciaries of BP's 401(k) Plan as Well?
Well, someone thinks so. You can count me, though, as monstrously skeptical that you could tag the fiduciaries of the BP 401(k) plan with breach of fiduciary duty for overexposure to company stock because they failed to expect the Deepwater Horizon explosion and account for it by greater diversification. On the other hand are two notes: (1) perhaps there is a circuit, somewhere out there, with fiduciary liability standards for company stock investment that are so loose that including BP stock ahead of such an event could be deemed an actionable breach; and (2) the decline in the value of the plan’s assets may be so large that, if a class gets certified, even a minor settlement to avoid a potential ruling against the fiduciaries could easily run into the tens of millions.
On Named and Functional Fiduciaries
I have been a fan of Scott Simon’s Morningstar articles on the various fiduciary relationships among those who run plans and those who advise them. This one here is a good, practical, business oriented view of the different forms of fiduciaries - named and functional (or deemed) - in 401(k) and other plans. It is written more from the business perspective, of who are the different players and what fiduciary niches do they occupy, in the structuring and operation of a plan. This is somewhat different than how we lawyers, particularly litigators, tend to look at these issues, because it is forward facing and addresses the deliberate structuring of the plan and of these roles. We litigators in particular tend to look at things from a different vantage, more in hindsight, and say did this person or that entity, looking at what they actually did, acquire the status of a fiduciary for purposes of liability exposure, whether they were intended to be put in that position or not at the outset of the plan’s establishment. And from that perspective, one of the most useful comments in his most current article is his explanation of one type of functional fiduciary, namely the party that assumed control over plan assets to some extent unintentionally, but that nonetheless then became a fiduciary with fiduciary responsibility for any acts taken in that regard. As he points out, that party assumes fiduciary liability in that situation, even if it did not knowingly cross the line into that role. As Simon Says:
A more serious scenario is where a person unilaterally exercises discretionary control or authority over a plan without express authorization. Such a person can become a "functional" 3(21) limited scope/non-named fiduciary--without a written contract--through its mere conduct of providing unauthorized advice or exercising unauthorized control or discretion. Given that no contract is present in this situation, the entity obviously doesn't intend to become a 3(21) limited scope/non-named fiduciary but becomes so anyway through its inadvertent conduct.
From a litigation perspective, this is a far more common circumstance than one might assume, and is a central point in much breach of fiduciary litigation, where a key question is often whether a particular defendant became a fiduciary by its actions concerning the plan and its assets, where it was not intended by the plan’s authors and founders to be a fiduciary.
Harris, Hecker, Excessive Fees and Marketplace Discipline
Yesterday, the Supreme Court effectively rejected the idea that mutual fund fees, in the non-ERISA context, are not actionable if consistent with the market as a whole, in response to a Seventh Circuit decision finding that a fund did not pay excessive fees to its investment advisor in light of marketplace discipline (I am oversimplifying the Supreme Court ruling a little bit, as this is not actually a blog on the Investment Company Act of 1940). Shrewd observers of ERISA excessive fee case law, or even most casual ones, will likely quickly note that, in the ERISA context, the Seventh Circuit essentially applied the exact same thesis to an ERISA excessive fee claim in its highly influential decision in Hecker, finding, in part, that fees were not excessive if consistent with the market as a whole. In the new Supreme Court decision, the court instead applied a different test - albeit in a different context than ERISA excessive fee claims - to determine whether the fees were excessive, asking instead whether a fee is being charged “that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
Is this a what is good for the goose is good for the gander situation? Is the same market based approach to testing fees that the Supreme Court has now rejected in the investment advisor scenario also, by implication, unwarranted in the context of a fiduciary’s obligations to protect participants against excessive fees in ERISA governed plans? Isn’t the test that the Supreme Court references for the investment advisor context equally a good fit for ERISA excessive fee cases, by asking not whether the fees were consistent with the market as a whole but instead whether the fees are disproportionate to the services provided and whether the evidence reflects them to be the product of an arms length negotiation? In many ways, this is what critics of the Hecker test - at least in my case - have complained about: not that the fees being paid by the defendant company in that case were necessarily too high, but rather that the court didn’t adequately test and vet them before deciding that the excessive fee claim had no merit. The Supreme Court’s new (well, actually a restatement of an old) test for fees in a different context would fit the situation very well, much better than the Hecker approach. The standard would still give a great deal of deference to plan administrators, sponsors and fiduciaries, allowing a wide range of fees to pass muster. The standard, though, would require that there be a reasonable linkage between the fees being charged and the value received by the plan, and that the evidence support the conclusion that the fees came about as a result of arm’s length, business like negotiating by the fiduciaries. In essence, this would bring the test back to the prudence required of the fiduciary, by asking not whether the fees were per se too high, but rather whether the evidence reflects that the fiduciary engaged in the basic business activity of seeking appropriate fees.
Here is the new decision from the Supreme Court, in Jones v. Harris Associates, and here, pat on the back to me, is a post I did last November suggesting that the opinion in Jones may well impact the Hecker line of thinking on ERISA excessive fee cases.
Attorneys as Fiduciaries
Are you, or have you ever been, a fiduciary? Sometimes I am tempted to open a deposition with exactly that question, phrased as a derivation of the famous McCarthy era line. While I doubt I ever would do it, it’s the million dollar question in most breach of fiduciary duty litigation under ERISA. It is so often outcome determinative, that many cases go away after a ruling on that threshold issue (whether by dismissal if the answer is no, or settlement if the answer is yes), without anyone ever tackling the question of whether imprudent conduct that fell below the fiduciary standard of care ever actually occurred.
That’s a long lead in to this interesting article published by BNA, in which I am interviewed, on the role of attorneys and whether they can become fiduciaries to the benefit plans with which they work. Lawyers who are in essence working in the traditional role of outside advisors to plans and their sponsors really shouldn’t be deemed fiduciaries, but one can envision, at least in theory, an attorney crossing the line and taking on decision making authority that rightly belongs to plan fiduciaries in a manner that could give traction to a claim that the attorney was, in fact, a fiduciary.
On a side note, I know creating content isn’t cheap, so thanks are due to BNA for freely allowing me to republish the article here.
The Fiduciary Status of Investment Advisors
I often explain to people that as a litigator, I am typically presented with a knotty, tied up problem, consisting of all the decisions and plan choices that have been made in the past that eventually resulted in litigation, and that I then have to unravel the knot into its constituent pieces, which can then be used to defend the decisions that led to the knotty problem (if I am defending the case) or to attack the decisions that created the knot (if I am instead representing a plaintiff, whether a plan participant or a plan sponsor or other fiduciary). This is a much different perspective on plans and their design and development than that of those who assemble plans, who look at things in a more prospective manner, from the vantage point of the one developing the world from scratch. In essence, their view is the mirror image of mine, as they look at all the independent strands of a plan and assemble them into what, eventually, will become the knot that I get charged with unraveling in litigation.
That more prospective view comes through in Adam Pozek’s excellent post yesterday on the difference between different types of fiduciary advisors to plans, and how to select them, as well as in the excellent source article on section 3(38) and section 3(21) advisors he references. Adam presents a typical scenario of a plan sponsor trying to work through the issues of how to use such advisors, when to use each kind, and the factors to be considered in making such a decision. To someone like me who normally only sees those types of transactions in the rear view mirror, as they are recounted for purposes of litigation (such as in a deposition), it is very interesting to read a presentation of the decision making and the transaction back at the start of the whole process.
In re Lehman
I have been wanting to post about the decision early last month in In re Lehman Brothers ERISA Litigation, in which the Southern District of New York dismissed ERISA stock drop claims against a number of officers and a named fiduciary, but, as it turns out, I have been too busy using the decision for my own purposes in my own practice to find time to post about it. Well, all that changes today, driven in part by this client advisory memorandum from Shearman & Sterling on the decision, which provides an excellent overview of the decision. The interesting thing to me about the memo, and its interaction with the decision itself, is the memo’s focus on the named fiduciary being exonerated on the basis of the famous - or infamous, depending on which side of the bar you sit on - Moench presumption. There is much to be said about the Moench presumption, and when it is appropriate to apply it or not apply it, including both the question of whether this single Third Circuit decision should have been allowed to morph into the de facto standard applied across the board in many circuits and district courts to an often somewhat disparate series of factual scenarios, and the issue of whether its sweeping acceptance should be understood as reflecting a judicial predisposition against allowing ERISA to be turned into an easier to plead version of securities class action litigation. I am not going to talk about all of that today, and neither did the Shearman & Sterling memo. What I am going to talk about is a particular point in the Lehman Brothers decision that is less the focus of the Shearman & Sterling memo, but, in many ways, of more significance to the day in, day out practice of handling disputes over ERISA plans, which is the status of company officers and directors. If there has been one consistent bone of contention between defense lawyers and lawyers who represent participants - whether individually or as a class - it has been the question of whether lumping in the directors and officers of the company sponsoring a plan as defendants, based solely on that capacity (or, more often, that capacity with just a little window dressing added on top) is appropriate. Lehman Brothers answers that in an authoritative voice, pointing out that such directors and officers do not become fiduciaries solely by means of that status, and further cannot be sued as fiduciaries based on the additional allegation that they had some authority to select those who made plan decisions unless they are being sued for mistakes stemming directly from taking action in that regard. Too often, lawsuits treat the directors and officers as additional deep pockets who should be named as defendants, but as Lehman Brothers points out, such individuals do not belong in the case unless they actually exercised operative control over an aspect of the plan that allegedly went awry and are being sued for that exact aspect of the plan’s operations.
A Parable About the Cable Man
For reasons too obscure and uninteresting to mention, I have had almost nothing to do with the cable tv industry since, well, it was invented. What’s a DVR, anyway, and why would I want one? But yesterday, I had to obtain digital cable from my local cable company, and called them, braced to be gouged. Instead, I was offered a special deal for a year, much less than I was expecting to pay, with stuff I would never pay for thrown in. A few hours later, of course, the reason occurred to me. The cable monopoly I recall from my youth is not what I was dealing with, and I was instead talking to a cable company that had competition from dishes - Dish.com, I guess? - and the local telephone/internet/cable company, so instead of gouging me, they had to offer me a deal they figured would keep me as a customer. Classic economic, legal and antitrust theory holds that there are really just two ways to police pricing - competition or, in its absence, regulation. Competition, of course, is why I got my sweet deal on cable yesterday.
So what does this have to do with the topics of this blog? Seems like plenty, in that it is the absence of above board open competition that is at the root of much of the problems discussed in these pages concerning ERISA governed plans. I have discussed in many posts that the problem with health insurance coverage through employers has much less to do with the question of whether employers want to provide it than it has to do with the ever escalating cost of health insurance and the fact that providing health insurance is a punishing cost. Employers, in my view, are unfairly demonized as trying to avoid providing health insurance, but it is the cost that is driving their increasing balkiness about being, as I have described it in other posts, unofficially deputized as the providers of health insurance in this country. From where I sit, one of the fundamental problems with acts mandating health insurance provision or payments by employers is that they don’t account for this, either by reducing health insurance costs or by recognizing the business costs imposed by these types of statutes. Does anybody really think that the restaurants targeted by the San Francisco statute are swimming in profits? This article here, profiled on the Workplace Prof blog, describes this exact concern about costs as the driving force behind employer, and particularly small employer, health insurance decisions.
And perhaps one solution to the problem of the cost of providing health insurance - perhaps the most important one - is that what is good for the cable industry should also be sauce for the gander, i.e., much greater competition among, and significantly less market control by, health insurers, as pointed out in this op-ed piece here by Robert Reich (when even the archetype liberals are arguing that market competition is the answer to all evils, you know the world has turned upside down).
And the same thought continues across to 401(k) plans, and the ongoing issue of fees and costs in investment options, and how they are disclosed. What if, instead of arguing after the fact about whether the fees in a particular plan were too high, prudent fiduciary practices were deemed to require a competitive process for selecting investment options, in a manner forcing putative vendors to put their lowest cost options forward to win the business? Isn’t that what all the complaining about large asset plans that don’t use their size to win better pricing is about, after all? Instead of just complaining in the abstract that plan sponsors should have acted that way, or engaging in after the fact litigation to try to police how much should have been charged in fees, wouldn’t it make more sense to just require a fully competitive process among vendors for selecting investment options, conducted by fiduciaries - or their delegates - who have the knowledge base to understand the pricing structure of the proposed options?
In that version of the world, it would be a fiduciary obligation to impose a fully competitive, open call for investment options, and to select the best - including on fees, costs, disclosure and performance - from among them, with it being a fiduciary breach for failing to pursue this process (rather than it being a fiduciary breach for ending up with fees that are too high). The focus would return in this way to fiduciary practice, both in terms of judging conduct as meeting or failing to meet the standards of a fiduciary and in terms of whether to impose liability, rather than on an after the fact, necessarily subjective evaluation of the amount of fees, costs, or disclosure in a particular plan that resulted from the fiduciary’s decisions.
Open competition would certainly drive down the fees and costs in plans, while simultaneously giving fiduciaries a clear standard - namely their obligation to decide on the basis of such competition - against which to work. I can’t help but think that, like the cable customer, plan participants will end up with better and cheaper products to pick from, while plans - and their insurers - will spend substantially less on litigation costs.
On Attorneys Fees and Hecker
Honestly, I have spent a week scratching my head, off and on, over the Supreme Court granting cert to consider the standards governing when attorneys fees can be awarded in an ERISA case, particularly when they denied cert shortly thereafter in Hecker, which presented the opportunity to address the much more substantive issue of the scope of fiduciary responsibility for the amount - and corresponding degree of disclosure - of 401(k) fees. In my mind, there is already a conflict among the circuits over that issue, with the Seventh Circuit finding outright that there was no viable theory against fiduciaries of large plans with market standard fees, and the Eighth finding this same theory worthy of factual inquiry. However, as I thought more on it, the denial of cert for Hecker makes some jurisprudential sense. Hecker itself was decided on a motion to dismiss, leaving essentially no factual record for evaluating these types of claims (critics will say, of course, that this didn’t stop the Seventh Circuit from deciding the theory had no merit) and forcing any Supreme Court ruling to turn solely on the allegations in the pleadings. This is a complicated issue, one I have said before would have been more properly evaluated by the Seventh Circuit after factual development, and I suppose it is likewise fair to say that a Supreme Court review of the issues posed by Hecker by means of reviewing Hecker itself would have suffered from the same flaw; Supreme Court review of the fee issues raised by the Hecker line of cases is probably better suited to a case that has played out sufficiently to allow all of the factual and legal fault lines to develop prior to Supreme Court review.
But the attorneys fee case itself still doesn’t make a whole lot of sense to me, as a practicing litigator who spends plenty of time with cases pending in the federal courts that are governed by that fee statute. The reality is that such attorney fee awards are either subsumed within settlements, or the courts award them under current standards only, typically, where there is significant merit to a party’s position and the party obtains significant relief; the district court judges, in my experience, do a good job of utilizing the current standards and understanding of the fee shifting provision of the statute to bring about that result, such as in this case here. And at the end of the day, no matter certain peculiarities that exist in the wording of the statute, this is really the only standard for awarding or not awarding fees that makes practical sense in the real world. After all, do we really want attorneys fees awarded for less than obtaining at least a significant portion of the relief sought by a plan participant?
I understand that the Fourth Circuit, in the case under review, applied a somewhat more stringent test than what I am discussing here, but, from a courtroom level view, courts get this issue right often enough that it doesn’t seem to warrant Supreme Court intervention. But the Court seems to have a thing for ERISA cases these days, for whatever reason.
A Nice Explanation of the DOL Advisory Opinion on Target-Date Funds
I like this (relatively) new blog here, the Benefits and Employment Observer, by the lawyers at the small - only in numbers - Washington D.C. shop of Bailey & Ehrenberg. This is the cleanest, most easily understood presentation of the findings of the DOL’s recent advisory opinion “addressing the issue of whether the assets of ‘target-date’ or ‘lifecycle’ mutual funds constitute ‘plan assets’ of employee benefit plans which invest in the funds” that I have come across over the couple of weeks since the opinion’s issuance.
Marx on 401(k) Litigation
I have a stack of substantive ERISA matters that I have been trying to post on for the last week or two, and I am going to try to work through them over the next few weeks. The thing about a blog, though, is the world keeps on spinning, and each day you find something new you want to post on, which keeps shunting those older items further into the background. That’s happened again today.
Regular readers know I am fond of the saying that Marx was wrong about a lot of things, but he was right that everything is economics. It is economic reality that is driving the increase in ERISA litigation, both at the big ticket class action level and at the micro level of individual participant claims; as I often say, the same compliance errors or high plan fees that participants ignored while their account balances were just going up, up, up, are being sued over, now that account balances have spent a year or more going down, down, down (yes, I know, I am not accounting for recent upticks, but you get my drift). Along this line, fiduciary liability insurance expert and fellow blogger, Joe Curley of U.S. Reinsurance, and I were discussing a couple days ago the ticking time bomb posed by the impending retirement - for the first time - of a generation of employees devoid of pensions and forced to rely instead on their 401(k) plans. It is conventional wisdom and common knowledge that these retirees are not, as a class, financially prepared for retirement by the assets in those accounts, particularly after the recent market downturn. Those people are not going to go quietly into decades of financial struggle in retirement, if there is a target for complaints about the operation, returns, or anything else concerning their 401(k) plans who can be sued; they make for a nice big pool of potential class action representatives, a huge pool of potential class members, and gazillions of potential individual claimants, for the latter of whom even a relatively small recovery will be significant relative to the values of their accounts. On a practical, day in and day out level, this means two things for plan sponsors, named fiduciaries or functional (who are often simply accidental) fiduciaries. One is to make sure there is sufficient fiduciary liability insurance in place; as Joe noted when we spoke, some service providers and others who may become functional fiduciaries by their roles in company 401(k) plans are not aware of that risk, and are not necessarily prepared for it. The second is an old hobby horse of this blog - compliance, compliance, compliance. ERISA litigation, particularly breach of fiduciary duty litigation, is an area of the law where a good defense is always the best offense - watch the fees, watch the operational compliance, document a sound practice for selecting investment options, etc. A fiduciary who does that severely decreases the likelihood of being sued, and strongly increases the likelihood of not being found liable if suit is filed.
This is on my mind today particularly because of this article from the Wall Street Journal about unemployed workers in the age 55 to 64 bracket who cannot find work and are, for all intents and purposes, being forced to retire, long before they intended to and long before they are financially prepared to do so. These people - or at least the lawyers they go to - are not going to overlook problems in their retirement accounts, even if they are just arguable or comparably minor or, as is often the case, were things that no one paid attention to years ago, like fees and costs. And this is where we loop back around to the Marx quote - there may be nothing different about the operational aspects of these 401(k) plans then there ever were, but the economic forces that are driving these people into retirement are going to likewise drive them to pursue any opportunity to bolster the returns on their accounts, even if that is by suing those who ran the plans.
Three for Thursday
I am going to catch up on a number of items I have meant to blog on this week, all in one fell swoop. So here goes:
• I posted before about my appearance in an article in the Boston Business Journal, but one that was only available on-line to subscribers. Here it is in another forum, openly available.
• I, and a cast of thousands, have been saying for some time now that the plaintiffs’ class action bar has wisely latched onto ERISA breach of fiduciary duty theories as an excellent replacement for bringing pure securities actions. As I have discussed in other posts, there are a variety of reasons for this, including easier discovery and possibly easier avenues to recovery. In addition, securities law in the area of what we in ERISA would call “stock drop” type litigation is much more well developed than it is under ERISA, leaving more room for tactical and theoretical maneuvering. Beyond that, the sort of backlash in public opinion, in Congress and in court decisions that existed - at least prior to the most recent market meltdown - with regard to securities class action litigation was non-existent with regard to framing the same types of cases under ERISA. Here’s a dog bites man story out of Business Insurance reporting on this phenomenon. Anyone who has been reading this blog or similar sources over the past few years already knows what the article is reporting, but it is still a nicely done introduction to the topic.
•And speaking of using ERISA for class action litigation, one of the central questions with regard to the increasing use of that statute to press stock drop litigation and its cousin, excessive fee litigation, has long been whether it is a successful tactic. The successful defense of the excessive fee claims in Hecker v. John Deere, in the Seventh Circuit, at an early procedural stage and prior to detailed discovery into the facts of the plans and the fees at issue, strongly suggested that ERISA claims of this nature may be no more likely to get past the procedural stage and into expensive litigation of the merits than a pure securities theory would be. The Supreme Court’s subsequent pronouncements in Iqbal seemed to confirm the approach taken by the Seventh Circuit in Hecker, of testing the legal viability of the underlying ERISA based theories before allowing the plaintiffs to conduct discovery that might more strongly establish the legitimacy of their claims (or lack thereof, for that matter). As many have been reporting, the Eighth Circuit has just essentially taken the opposite tack, in a putative class action case against Wal-Mart, Braden v. Wal-Mart Stores. Braden can be understood, in part, as rejecting the approach taken by the Hecker court and finding that discovery is necessary before the merits of a complex excessive fees type claim can be decided. For more detail on Braden, here is Paul Secunda’s take on the matter over at the Workplace Prof (including a link to the case itself) and Roy Harmon’s take on the matter (which focuses nicely on the Rule 8 pleading requirements) at his always illuminating Health Plan Law blog. I have said before that with the increased focus on fees, the increased focus on the lack of retirement savings of most Americans, and the economic impact of high fees on returns in 401(k) plans, Hecker may turn out, in hindsight a few years down the road, to have been the high water mark for the corporate bar in defending against such claims. I am not sure whether that’s a good or a bad thing (I suspect, actually, that it’s a mix of both, but addressing that in depth here would make for an awfully long post), but it may well be the case either way.
On Fiduciary Liability Insurance
I have written before that one of the things that makes insurance coverage law interesting is the fact that almost every trend in liability or litigation eventually shows back up in insurance disputes, in a sort of fun house mirror sort of way. Whether it is corporate exposure for asbestos liabilities, or the sudden invention of Superfund liability, those liability risks eventually end up in insurance coverage litigation over the question of whether insurers have to cover them. I cannot think of one major doctrinal development in tort liability or one trend in liability exposure in the last 20 to 30 years that has not, eventually, resulted in litigation to determine whether insurance policies cover the new exposures flowing from those developments and trends.
Anyone who reads this blog knows that ERISA governed plans, and in particular pension and 401(k) plans, have become a huge target for large dollar claims over the past several years. Just a click through the posts on this blog detail many of the claims, such as stock drop and excessive fee litigation, that are working their way through the legal system. And with this, hand in hand, has come a new focus on whether plan fiduciaries have appropriate insurance coverage in place for those risks. Some do, some don’t, and others - consistent with insurance coverage litigation trends in the past when relatively new theories of liability have had to be analyzed under policies written before the theories themselves were developed in depth - won’t know unless and until courts pass on the meaning and scope of their policies. But here, though, is a good initial primer on the question and here, likewise, is a webinar that looks likely to provide much greater detail on the subject. One thing that is for sure is that this is an area of the law that anyone involved with the representation of plan fiduciaries needs to have more than a passing familiarity with at this point.
Hecker, Fees and A Broad Public Market
To me, intellectually, all roads lead to Hecker right now, as the sort of touchstone around which all thinking about fiduciary obligations and the amounts of fees charged in 401(k) plans must revolve. Hecker, of course, found not only that a broad range of offering meant that marketplace discipline guaranteed appropriate fees, but also that this could be determined at the motion to dismiss stage. This whole question of whether a broad marketplace for mutual fund offerings can be counted on to guarantee appropriate fees is at issue before the Supreme Court in a different context in an upcoming case, as commented on here: once again, you see that the question is the propriety of the assumption that market discipline is all that is needed to protect against overcharging of this type, and thus whether there is a legitimate basis for the assertion that the existence of a broad market is all that is needed to ascertain that fees were not so high that a fiduciary breach has occurred. It would take many more pages, and an analysis much more suited to a different forum, such as a law review article, to break down the potential flaws in the base premise of that assumption, but for this venue, at least one comment is warranted, and that has to do with the Supreme Court’s relatively recent conclusion that the same thesis - that marketplace discipline would prevent the problem from actually coming into existence - was not an acceptable answer to the problems potentially posed by structural conflicts of interest with regard to ERISA benefit claims. There, the Court rejected the view of many circuits that the risk of the marketplace punishing companies that misbehave did not represent a legitimate basis for assuming that administrators who both decided and funded benefit decisions could not be acting out of a conflict. There is independent evidence for the argument that fees are, in fact, too high with regard to 401(k) plans, as discussed in this report here (and thanks are due to the ever vigilant eyes of the folks at BrightScope for passing that along) and other places too numerous too detail in a few minutes this morning, causing one to ask whether, much like the Court decided with regard to structural conflict claims related to benefit decisions, it is a realistic economic assumption to believe that a large public market alone is a guarantor of appropriate fees, as the Seventh Circuit assumed in Hecker.
Harmon on Delegation of Fiduciary Duties in the First Circuit
Just briefly, as I have been traveling and haven’t reviewed the case myself, Roy Harmon on his excellent Health Plan Law blog, analyzes a decision out of the First Circuit on the manner in which a fiduciary can properly delegate its authority; the decision found that excessive formality wasn’t mandated. You can find Roy’s analysis, trenchant as always, here.
You Say Securities, I Say ERISA
I have to admit I have found the Workplace Prof blog tough sledding since the site’s founding blogger, Paul Secunda, took retirement from the site, apparently to spend more time in the snow in Wisconsin. Without Paul, the blog has trended heavily towards labor law and lacks the type of frequent, insightful commentary about ERISA that was a hallmark of the Secunda regime.
I mention this today because the blog has a guest/drop in post from Paul, commenting on a Wall Street Journal law blog story about the decline in securities class action litigation. Paul comments that one reason for this that was overlooked in the story may well be the discovery of the class action plaintiffs’ bar over the past few years of ERISA as a better tool for prosecuting such claims and as an excellent stand-in in many cases for securities suits. This is something I have discussed frequently over the years on this blog, but I have to admit, until Paul, the law professor formerly known as the Workplace Prof, mentioned it in his post, it had not jumped out at me as something relevant to the Wall Street Journal piece. But there you have it - more anecdotal evidence for the idea that ERISA is displacing securities actions in many circumstances.
Excessive Fee Litigation and the Small Plan
It has become a given in any talk on 401(k) plans and fiduciary liability that I give these days - my comment that, when the market was always going up, up, up, no one cared that they might have made 15% instead of 14% but for some unresolved problem with a plan’s structure, but with the market going down, down, down, anything and everything even allegedly wrong with a plan is going to get sued over. The point is always the same: it is doubly important now to always dot all the eyes and cross all the tees, which translates into watch your investment selection mix, watch your fees, watch your level of disclosure, watch the process by which you select your vendors, and so on. It all adds up to the idea that in this market, someone is going to come after you if you are a fiduciary or a plan vendor, so be prepared to defend everything you do.
That is why I liked this post here, from the folks at the Float, about excessive fee litigation trickling down to the level where suits based on fees are being filed against plans with as little as $2 million is assets, and their advisors. There’s nowhere to hide anymore, folks. Get it right in the first place, and then defend yourself; being the small fish isn’t going to keep you out of the churn.
More ERISA Blogging for Those of You Who Can't Get Enough
Kevin O’Keefe, the lawyer turned blogging evangelist behind the company that hosts this blog, told me when I was picking a topic for my blog that I should choose a subject where there was plentiful source material to work from on a day in, day out basis. They were oddly prophetic words, in that not too long after launching the blog, fiduciary litigation and concerns exploded, generating a seemingly endless stream of cases and business developments to blog about. Excessive fees, company stock declines, subprime meltdowns, the rise of ERISA as the new securities class actions - all of these issues that I have covered extensively here really exploded after the launch of this blog.
There is so much information and activity going on out there now in this area that it is always good to have other bloggers, the more knowledgeable the better, likewise chiming in on developments in this area, and few are more knowledgeable than long time ERISA blogger B. Janell Grenier, who has just launched a separate blog dedicated to developments concerning the law governing fiduciary status titled the ERISA Fiduciary Guidebook (A Work in Progress). Her new blog captured, for instance, a recent Massachusetts federal court decision that I didn’t cover, involving some of the issues raised by an employer who becomes delinquent in making plan contributions.
Hecker, InsideCounsel and Defensive Plan Building
Hecker is the gift that keeps on giving, for either an academic or a blogger (or perhaps a blogger with an academic frame of mind). It presents a wealth of issues warranting further consideration, running from those commented on in my prior posts on the Seventh Circuit’s decision, to one I haven’t even passed on yet, namely the propriety from a jurisprudential perspective of using every trick in the trade, as the Seventh Circuit did, to go outside the complaint for extensive evidence that would allow the case to be decided on a motion to dismiss. It is fair to say that the circuit’s heavy reliance on those maneuvers (and I don’t criticize those tactics in general, as they are a litigator’s stock in trade in presenting motions to dismiss and I am one of those who thinks that, used properly, they provide an opportunity to focus a court on issues that should be decided in a lawsuit at the earliest stage possible) renders the opinion more akin to a law review article that now has the force of law - at least in the Seventh Circuit - than the type of factually based analysis that we normally think of with regard to a binding judicial opinion.
But that’s a topic for another day. What I wanted to pass along today was this excellent article - quoting yours truly extensively, although that’s not what makes it excellent - in InsideCounsel magazine this month on the Hecker decision. It is a well written, interesting report on the case, but I wanted to focus on what I am quoted on at the closing of the article, in which the author writes:
"Hecker is almost a quintessential law and economics opinion. It assumes the 401(k) plan included funds that charged the same [fees] as the market as a whole, and that’s all we need to know," Rosenberg says. "I would be surprised if many other courts are willing to just stop their analysis at that point."
Although Hecker provides a lot of protection for companies, he advises general counsel to assume the decision is just a baseline for ERISA compliance.
"Hecker didn’t impose a very high standard," he says. "Far and below Hecker is going to get you in a lot of trouble in a lot of different jurisdictions."
The defense bar, of which 80% of the time I am one, is very pleased with the decision and thinks it protects and/or validates much of what plans have done when it comes to fees in 401(k) plans. I am not so sure, and I think that prospectively at least it warrants more vigilance from plan sponsors, not less. To my mind, everything follows economics, whether its fashion, car design, house sizes (think McMansions), the social propriety of using company jets and, yes indeed, legal regimes. I have little doubt that with the baby boomer generation looking at becoming the first cohort to both lack pensions and have battered 401(k)s, the economic impact will eventually increase the level of performance and fiduciary expertise demanded of plan sponsors and those they select to run their 401(k) plans. It might take one year, it might take ten years, and I don’t know if it will come about by new regulation, statutory enaction or the development of case law, but it will happen.
Prospectively, as a result, plan sponsors and other fiduciaries can and should assume that, down the road, there will be much tougher looks taken at their 401(k) plans on issues such as fees than the very deferential approach taken by the Seventh Circuit in Hecker; when that comes to pass, they will have been much better off having understood Hecker as presenting only the base minimum standard for the plans they operated, and having targeted a much higher level of participant protection in building their plans than Hecker seemed to them, today, to have required. After all, if you think about it, what really is so hard about looking closely at fees as part of putting together a 401(k) plan’s investment options from here forward, and documenting that this was undertaken, as an additional step in defensive lawyering and plan building, rather than just stopping at the Hecker level of analysis and conduct? It doesn’t take all that much - there are independent fiduciaries out there right now who will try to do it for you - but the legal protection in the long run, and the participant goodwill in the short run, that it will buy far outweighs the costs.
Looking at Fiduciary Performance from the Vantage Point of a Plan Participant
I had dinner recently with the brothers Alfred, Mike and Ryan, two of the co-founders of BrightScope, and much of the conversation centered around the question of transitioning the management and analysis of 401(k) plans from a practice oriented perspective to a plan participant oriented one. Translated into practical terms, this encompasses the idea that fiduciary standards for plan sponsors currently take the approach of considering whether the fiduciary’s practices in operating the plan, for instance with regard to deciding which vendors to use or funds to offer, were prudent and reasonable; this is particularly evident in the case law that is developing concerning the current bete noir in this area of the law, the amount of fees and costs in a 401(k) plan and their impact on plan participants. In the context of fiduciary liability, this plays out in cases like Kanawi and Hecker as courts finding that fiduciaries did not breach their obligations because the evidence showed that the means and methods by which those plans were built was reasonable, rather than by looking at whether the fiduciaries built a strong plan in terms of the fees and costs and performance of the investment options; in Kanawi, the court was swayed by the fact that the sponsors had followed a reasonable course in selecting the plan options, and in Hecker the court was persuaded by the simple fact that the plan sponsors included funds that were publicly available at the same cost structure.
Case law routinely takes the approach that fiduciary obligations when it comes to fees charged in a plan or other aspects of the operation of a plan relate to the nature and manner in which the plan is built or operated, rather than the actual returns or costs structures of the plan itself. As a result, the focus of plan sponsors who are trying to be proactive in protecting themselves and of lawyers counseling them on how to do so has long been on pursuing a “best practices” approach: solicit multiple bids, have them compare themselves against benchmarks they use, bring in outside advice if needed to evaluate them, and then pick the best one. The end result of this process isn’t necessarily going to be a plan with the best ultimate outcome (something driven heavily in a 401(k) plan for instance by the plan’s fee and cost structure) for plan participants, but will instead be a plan that looks best from among the range of options considered. This is an approach that most ERISA lawyers recognize is defensible if the plan sponsor is sued, because it allows for the argument that, regardless of what problems there might have been in the plan, the approach used to put the plan together - and to run it - was prudent and reasonable. To a large extent, courts have accepted this idea, that the manner in which the plan was built and, for instance, fees settled on is the central issue to be tested, with the fiduciaries having lived up to their obligations if the approach to building the plan and selecting the funds (and accompanying potential fee structure) was reasonable.
This approach to the issue by courts is understandable, in that it is almost the only approach that practical reality leaves open to them on many difficult issues, such as the amount of fees and costs in a 401(k) plan. There is no uniform, consistent, hard data driven, accepted benchmark for what such fees and costs should be, or how one particular plan’s fees and costs compare to those across the industry. Courts are, quite understandably, therefore devoid of an appetite for allowing disputes over the cost and fee structure in a plan to devolve into a simple battle of experts, with each side putting up an expert saying the objective amount of fees and costs in a plan are, according to one expert, too high, and according to the other, just right. It would quickly turn into the Goldilocks school of ERISA litigation - these fees are too high, these costs are too low, these are just right. Beyond that, there would be tremendous practical barriers to such an approach due to the general absence of uniform, broadly accessible industry wide data on many of these points, which results in serious questions as to whether, and if so with what credibility, experts could even testify to an opinion as to whether fees in a particular plan are too high or too low; the difficulty of accessing industry wide data that would allow for a detailed and defensible opinion in this regard would undercut both admissibility and credibility of any such expert testimony. Courts, to a certain extent, have thus to date been better served by a practice oriented analysis of fiduciary conduct in areas such as 401(k) fees because of the difficulty of effectively testing fiduciary conduct against any other standard.
But what if you could test fiduciary obligations against a more definitive standard, particularly with regard, for instance, to the fees and costs built into a 401(k) plan? You could then rightfully have a standard for determining whether fiduciary breaches have occurred that is based on the outcome to the plan participants, such as whether the fees were too high and drove down returns. If you could do that, because a true benchmark for testing the performance and management of a plan existed, there would be no reason to base a decision about the propriety of fiduciary conduct in running a plan on an analysis of how the plan was run, but instead one could base the analysis on how the operation of the plan impacted outcomes for the plan participants. Such an approach to fiduciary liability would be entirely different than the one currently employed, and would instead ask whether the fees, costs or other challenged operational aspects of the plan negatively impacted - and if so to what extent - the plan participants. You would then be focusing the question of whether fiduciaries have lived up to their obligations on whether the optimal results were achieved for the plan participants, rather than simply on the question of whether the fiduciaries followed industry wide practices in operating the plan, practices which may or may not create the optimal results for plan participants. The latter approach always threatens to be a race to the bottom, moderated only to whatever extent some sponsors are driven to provide good returns to motivate their own workforces, which can keep the bottom from falling too low. In contrast, the former is a race to the top, or at least near enough to the top that fiduciaries can be said to have lived up to their obligations to the participants by shooting for the best results possible; it goes without saying that everyone cannot be at the top unless everyone simply buys the same products from the same vendors, which basic economics tells you is antithetical to driving down fees and thereby increasing returns, so something short of the very pinnacle of performance as against a legitimate independent benchmark would have to be sufficient to satisfy a fiduciary’s obligations. Isn’t that approach far more consistent with fiduciary obligations than the current practice oriented focus, given the oft used cliche about ERISA, that the fiduciary obligations are the highest known to the law?
And that is the idea behind BrightScope: to collect independently verifiable data on fees, costs and performance variables behind the 401(k) statements given to participants, and use that data to create a defensible, industry wide benchmark allowing fees, costs and performance to be compared across plans. When you reach that goal, done to a level of mathematical sophistication and defensible data sufficient to allow its use as evidence in a courtroom or as a foundational piece for expert testimony on how a particular plan’s fees, costs or performance compare to the broader universe, you have the linchpin on which you can turn analysis and the standards for fiduciary conduct in this area from the practices by which a 401(k) plan was run to the outcomes for the participants. And that, in a nutshell (though an admittedly long one) is what I meant in the first paragraph in this post when I referred to the question of transforming fiduciary obligations from a practice oriented perspective to a participant outcome oriented perspective.
Hecker and the Development of the Law on the 404(c) Defense
One of the Seventh Circuit’s most interesting tricks in its recent decision in Hecker was the extraordinary breadth it gave to the 404(c) defense. This was an aspect of the decision that raised a lot of hackles, and I noted in my own post on the case that I doubted this was the last word on the subject and that it would be interesting to see how the case law developed as other courts tackled this question. Well, here’s a decision from a week or so ago out of the United States District Court for the District of New Hampshire taking a much narrower approach in interpreting the amount of protection granted to fiduciaries by section 404(c), finding that the defense does not apply to “a fiduciary's designation of the investment options that are available to plan participants.” The court reached this conclusion because:
First, section 404(c) is unclear as to whether it can be used to bar a claim based on a fiduciary's designation of investment options. Second, section 404(c) requires the DOL to adopt regulations explaining when a participant or beneficiary has sufficient control over his assets to be subject to a section 404(c)defense. 29 U.S.C. § 1104(c)(1)(A). Third, the DOL's implementing regulations are themselves unclear as to whether section 404(c) applies to a fiduciary's decision to designate investment options. Fourth, the DOL reasonably determined in the preamble to its regulations that losses which result from a fiduciary's designation decision are neither a "direct" nor a "necessary" result of a participant's exercise of control over plan assets. Finally, both the Supreme Court and the First Circuit have recognized in similar circumstances that an agency's reasonable interpretation of its own regulations in a regulatory preamble is entitled to deference.
Frankly, I am inclined to think that a close review of the actual statutory text and regulations suggest that this judge is closer on the mark on this issue than was the Seventh Circuit in Hecker, leading to what I think is the real takeaway from the continued development of the case law on this issue: namely, that plan sponsors should not overly rely on Hecker in evaluating their potential exposure and their obligations. Rather, as I have said in other forums, Hecker should be understood by plan sponsors and their vendors as setting forth the base minimum in terms of how a plan should be structured with regard to investment option fees, and should not be seen as a get out of jail free card by a sponsor who does no more than build a plan consistent with the reasoning in that case.
Pension Fiduciaries in the Hot Seat - What to Avoid and How to React if Sued
I and a cast of thousands will be speaking at a webinar on April 14th on “Pension Fiduciaries in the Hot Seat - What to Avoid and How to React if Sued,” put on by Pension Governance, Inc. Well, its not really a cast of thousands, just me and four very experienced worthies, who know so much about the subject that they seem like a cast of thousands.
I have to say that, long before ever being invited to participate in one of Pension Governance’s webinars, I attended as a member of the audience, and not only found them informative but enjoyable as well.
How Much Information Is Enough to Decide A Breach of Fiduciary Duty Lawsuit?
Is a motion to dismiss a good tool for disposing of major breach of fiduciary duty lawsuits? In essence, should it be treated as a mini-summary judgment proceeding, that tests the sufficiency of the case’s theories against, not the detailed facts of a specific case, but instead against the world as a whole as understood by the court? Or are these cases instead ones that are better decided by - and both litigants and the development of the case law better served by - a decision on the actual factual merits of a case, after drilling down into the conduct in question?
The former scenario is, in essence, the route taken by the court in Hecker, and Kevin LaCroix provides another example in his post yesterday, on the dismissal of the breach of fiduciary duty lawsuit in the Huntington Bancshares ERISA litigation. What happened in both cases is, in a nutshell, the court comparing the allegations of fiduciary errors to the market as a whole, finding that what took place was not inconsistent with what was occurring in the broader market (in the case of Hecker, that being the pricing on mutual funds in a plan, and in the case of Huntington, that being the stock losses in the plan), and that therefore, essentially by definition, the plan fiduciaries could not have fallen below the standard of care imposed on them. I can understood the arguments on both sides, and particularly those in support of this approach. A fiduciary is charged with acting with the skill and care of a prudent person in that position, and one can argue that this standard was not breached if the plan losses were consistent with what occurred across the market and with regard to others similarly situated; after all, if all the other investment managers took the same beating, then the plan’s fiduciaries, by definition, were acting like all others with expertise in the area when they likewise took the same pummeling. Plus, of course, conducting extensive class action litigation to further analyze what the market itself seems to be telling us - that the fiduciaries were acting like all other prudent investors since all got clobbered to the same extent - is a tremendous drain on the defendant’s resources. Then you add on top of that the realpolitik of the situations, which is that we know that most cases of these types settle after expensive litigation if they survive the motion to dismiss stage and possibly the summary judgment stage, so in many ways these procedural stages dictate the outcome, and there will never actually be a trial to allow a full drilling down into the actual facts of fiduciary conduct which can serve as the basis for a decision; delaying the day of reckoning from the motion to dismiss stage to the summary judgment stage, in this way of thinking, doesn’t really change that, as there will undoubtedly be factual disputes at the summary judgment stage that will preclude a fact based decision and instead any decision at that stage will, like the motion to dismiss rulings, likewise be based on the types of broader legal theories addressed by the courts in the motions to dismiss in these types of cases.
But on the other hand, is it really safe or fair to just assume that fiduciaries have lived up to their obligations, simply from the existence of broader market indicia? I am thinking in particular of two sets of data that crossed my desk recently, the first courtesy of 401(k) blogger Josh Itzoe and the second courtesy of the guys at BrightScope, who slice and dice the data on this field for fun and profit. In this post, Josh points out survey results showing that a large number of plan sponsors don’t really have a structure in place for operating 401(k) plans at a high level, while this chart here, passed along by BrightScope and based on its data, shows the wide range of fees that plans assume in their 401(k)s. This information reflects the tremendous diversity one can find in operating talent, execution, fees and other aspects of a plan that can seriously impact performance. Under those circumstances, is it really appropriate to stop the analysis of fiduciary conduct at the motion to dismiss stage, before investigating the aspects of a particular plan, just because the market as a whole lines up in a reasonably consistent manner with the performance of or fees in a particular plan? Market performance may be down, or fees across the market may line up with those in a plan, but this doesn’t by definition mean that a plan sponsor is living up to its obligations without further analysis. Behind those market numbers and the relationship of a particular plan’s performance to those numbers, may very well be a fiduciary whose operational structures and/or charges to plan participants fall below what other fiduciaries are doing; I am not sure it is fair to allow the muck of a bad market to provide cover for that.
Asking the Seventh Circuit to Revisit Hecker
I was going to post on something else today - namely the scope of contractual obligation clauses in insurance policies - but my Google Alert pulled in something else that I wanted to pass along first instead, namely, this post by Paul Secunda at Marquette on an amicus brief filed by several law professors asking the Seventh Circuit to reconsider Hecker v. Deere en banc. The brief asks the Seventh Circuit to consider the exact issues that I noted in my post on Hecker as being the debatable parts of the decision, namely the panel’s decision to link a very narrow interpretation of fiduciary obligations with a very broad interpretation of the 404(c) safe harbor. I am very curious to watch how the panel’s analysis of those issues gets played out as the case law develops on excessive fee issues, 401(k) plans, and the application to them of the safe harbor and of breach of fiduciary duty claims, whether that takes place in the courts of other circuits who are confronted by the Hecker decision, or in an en banc revisiting of the issues by the Seventh Circuit.
Fun stuff, either way.
Notes on Hecker v Deere
The Seventh Circuit’s opinion in Hecker v Deere is interesting in a number of ways, and on a number of levels. I won’t detail the facts of the case in depth here, but the case turns on the question of the plan sponsor’s and service providers’ potential fiduciary liability for allegedly high fees in the mutual funds offered in a 401(k) plan and the limited degree of disclosure provided to participants about the fees. You can find the case itself here, and for those of you who don’t have an interest - or possibly the time - in reading the entire 33 page opinion, a readers digest overview of the case itself right here. It is, though, a well-written, fluid, almost elegant opinion, an easy read if you care to take the time.
Perhaps most notable, from an overview perspective, is the fact that the Seventh Circuit simultaneously gave the scope of protection granted to fiduciaries by Section 404(c) pretty much as broad an interpretation as possible, and the scope of fiduciary obligations with regard to investment selection and fee disclosure as narrow a one as possible. Its an interesting double whammy. I am not saying its right or wrong (although Ryan Alfred at BrightScope has made a detailed argument that the court is off base in reading the protections of section 404(c) so broadly), but it is certainly a very interesting framework. If you think of it as a Ven diagram, with one circle the world of problems that can arise with mutual funds and 401(k) plans, and the other the extent of fiduciary obligations in the view of the Seventh Circuit, the overlap is smaller than one would have anticipated.
Then there is the question of the court’s view of the fiduciaries’ obligations of disclosure with regard to fees in the plan, finding that the statute and the regulations did not require more disclosure than was made, and thus there was no breach in failing to disclose more information about the fee structure. Paul Secunda in his piece on the intersection of preemption and the statute’s limited remedies (in which he emphasizes how those two aspects of ERISA can result in harms that cannot be remedied) discusses what he views as two competing ideological camps with regard to the interpretation of ERISA, literalists and remedialists. I don’t fully agree with this particular bicameral division of the world, but it offers a handy frame of reference for understanding the Seventh Circuit’s ruling: the panel took a truly literalist approach to the question of disclosure, finding that what the statute and regulations don’t expressly require, is not required. This seems, I have to say, hard to square with the idea that a fiduciary’s obligations run to a high level of care, which would seem to raise the question of whether a fiduciary has more obligations than simply those that are required by express mandates, but the panel does not squarely address that question.
This leads into a central point that animates the case, in my opinion, and which can be summed up in two famous words: caveat emptor, at least if you are the plan participant. The court finds that the mutual funds in the plan are numerous and also sold to the public as a whole, and therefore the fees are, in some broad sense, fair and appropriate, as they are what the public marketplace as a whole is willing to bear. But is the public pricing as a whole a fair determination of whether fees charged within a 401(k) plan are excessive or not? Isn’t this just using the lowest common denominator to make this call? After all, a public buyer does not have the leverage or the expertise - at least in theory - that a plan sponsor brings to negotiating investment options and their fees. Part of the problem in analyzing this question is that the district court, and now the appeals court, resolved the case on a motion to dismiss, where argument and supposition play too much of a role and factual development of these types of questions have not occurred. Deciding whether the fees are excessive on an actual factual record may suggest an entirely different answer than just the assumption that the market as a whole has acquiesced in the pricing, so therefore it was not excessive when a plan sponsor signed off on it. But for a plan participant, the ruling clearly means one thing: it is your responsibility to engage in the same full due diligence that you would have to pursue if you just purchased the mutual fund from a 1-800 number, and you are not entitled to rely on the plan’s fiduciaries to have done that for you.
Shining a BrightScope on Heckler v. John Deere
Still parceling out items of interest that have stacked up on my desk in the last week or so. Among the things I still haven’t gotten to, I have to admit, is a careful reading of the Seventh Circuit’s recent decision in Heckler v John Deere, but I will, shortly. In the meantime, though, the bright guys over at BrightScope have, and their’s is a very interesting take. You can find it right here. Its clear, when you read the post, that they don’t just have the analytics down when it comes to 401(k) plans, but also their structure and the manner in which they operate.
Do People Who Are Told the Truth Sue?
I love this story. A couple of weeks ago I blogged about BrightScope’s launch, and pointed out my view that more information generally means less litigation. I learned thereafter that some think that is a counter-intuitive thought; presumably, people who believe that think that if you cover up problems and don’t let people know what’s going on, they may not find out and thus may not sue you. The oldest saying in the book, of course, is that the cover up is worse than the crime. Rather, people who are legitimately wronged will sue no matter what, as they should; but people on the margins are more likely to sue if they feel they were not told the truth, than they would be if they feel they were given a fair shake, even if it worked out badly for them. More technically as well, many breach of fiduciary duty claims are based on allegations of non-disclosure - that the sponsors did not disclose problems with the company stock, or backdating, or cdos. etc., that would have changed the participants’ investment strategies had they known. Obviously, something that is disclosed, rather than kept under wraps, cannot be the basis for a breach of fiduciary duty claim based on the failure to disclose.
This thesis, which I maintain is hardly counter-intuitive, but just plan common sense, is borne out beautifully by this story about a long time Merrill Lynch broker who has lost millions of dollars in company stock held in an ESOP. He points out that had he been told the truth and given the opportunity, he would have divested and diversified along the way, but did not, and that he was regularly told things by management that were not true. Now, in the close of the article, he points out that what he needs now are “the services of a sharp labor and ERISA attorney." Had he been told the truth and given the opportunity to move his retirement savings out of company stock in light of information given to him at that time, he may be worse off today than he was before the Wall Street meltdown, but he is likely well enough off still that he isn’t looking for a lawyer to file suit for him.
Bunch v. W.R. Grace: What a Breach of Fiduciary Duty Doesn't Look Like
I cannot do better by anybody interested in fiduciary obligations under ERISA than to recommend to you the First Circuit’s decision the other day in Bunch v. W.R. Grace & Co.. For those of you not familiar with the lower court proceedings in that case, what was at issue is whether it was a breach of fiduciary duty to sell company stock, rather than maintain it as an investment option, after retaining outside advisors to investigate the stock’s value, potential and appropriateness as an investment option. At the District Court level, and again now on appeal, the courts have found the fiduciaries’ conduct to be almost literally above reproach with regard to the handling of this issue. The First Circuit’s brief is notable for two points. The first is its synopsis of the duties of a fiduciary with regard to investment options, including company stock, and the court’s emphasis on the fact that it is the appropriateness of the fiduciaries’ conduct in the face of uncertainty that must be judged, not the dollar value outcome of any particular investment decision in isolation. As the First Circuit opinion noted:
what ERISA calls for from a fiduciary is that it use the "care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." 29 U.S.C. § 1104(a)(1)(B). As the district court aptly stated, "in common parlance, [what] ERISA fiduciaries owe participants [are] duties of prudence and loyalty," Bunch, 532 F. Supp. 2d at 288 (citing Moench v. Robertson, 62 F.3d 553, 561 (3d Cir. 1995)). The district court noted that other courts faced with allegations similar to those of appellants in this case had looked at the totality of the circumstances involved in the particular transaction. Id. Among the key decisions relied upon by the district court for reaching this conclusion was DiFelice v. U.S. Airways, Inc., in which that court stated: [W]e examine the totality of the circumstances, including, but not limited to: the plan structure and aims, the disclosures made to participants regarding the general and specific risks associated with investment in company stock, and the nature and extent of challenges facing the company that would have an effect on stock price and viability.
And second, if you want to read an outline of what a thorough and, once in court, easily defensible, course of conduct by a fiduciary looks like when it comes to investment options, it’s the underlying course of action by the fiduciaries that is described in the First Circuit’s opinion.
Talkin' ERISA Litigation Trends
I will be presenting a seminar next week, on Wednesday January 14th, to the ASPPA Benefits Council of New England, entitled “ERISA Litigation: An Update from the Front Lines.” After three full days of outlining my talk, I now actually have a pretty good idea of what I am going to say; the talk will blend the latest developments nationally and at the Supreme Court in ERISA law with ERISA litigation trends and realities in the First Circuit. If you are interested in attending, its not too late to register. The brochure and registration form for the talk is here.
More Evidence that Including Company Stock in a Retirement Plan May Not Be Worth the Litigation Risk
A few months back, I discussed the broad conception of damages in stock drop type cases articulated in the case of Bendaoud, which essentially found that damages exist if the participant could have done better in an alternative investment option. This concept makes it fairly easy to construct a damages theory in 401(k) and ESOP cases that will survive the scrutiny of a motion to dismiss, and that can support a significant award of damages. A prerequisite to getting to the damages analysis, however, is a basis for attributing an actionable error in the plan to the fiduciaries; the fact that a participant could do better in a different investment is irrelevant if there was no mistake in offering the original investment option in the first place.
That, however, is not too hard to show either. The bar, for instance, is low when showing that offering company stock as an option is an actionable error. For instance, "a stock can be imprudently risky for an employee savings plan even in the absence of fraud or imminent collapse,” according to a federal judge sustaining an ERISA case against Ford alleging that the offering of company stock as an investment option was a breach of fiduciary duty, given the extensive problems in the industry at the time and the lack of broad disclosure of how those problems may affect the investment.
With numerous major industries heavily roiled, and a stock market that has tanked, I can’t say that it should really tax the imagination of any good lawyer to come up with both damages to participants and errors by plan fiduciaries in any case involving the inclusion of company stock in a retirement plan or ESOP.
On Fiduciary Bonds and Fiduciary Insurance
Well, I suppose nothing could be located more squarely at the intersection of the two topics in this blog’s title than the difference between fiduciary liability insurance (which lets fiduciaries sleep at night) and fiduciary bonds (which protects a plan’s assets, rather than insuring the fiduciaries themselves). Scott Simmonds, who consults, writes and blogs on business insurance issues (and other things) provides this nice overview of this issue, distinguishing among the range of insurance products and bonds that come into play in running an ERISA governed benefit plan:
The Fiduciary Responsibility Liability Insurance Policy is the solution to the ERISA problem [of personal liability of fiduciaries]. Also called a FRIP, the policy provides protection for "wrongful acts" that result in a claim against the administrator of benefit plans. Premiums range from a few hundred dollars to thousands, depending on the size of the employer.
By the way, many people confuse ERISA fiduciary liability with the ERISA bond requirement. The law mandates that employee pension and retirement plans have a bond of 10% of the assets (up to $500,000) to cover loss of the funds through embezzlement. Some fiduciary policies include the fidelity coverage. Most do not.
Some businesses and insurance agents confuse employee benefit liability insurance with the FRIP. Bad call! The FRIP covers errors and omissions in the administration of benefit plans. The employee benefit liability policy covers mistakes but excludes ERISA liabilities.
I have written before (such as here, for instance) about the importance of properly structuring insurance programs to protect company officers, and making sure that gaps don't appear that may leave them exposed to personal liability. Scott's commentary targets this exact same point in structuring insurance programs for protecting fiduciaries of ERISA governed plans.
The Tribune Bankruptcy and Breach of Fiduciary Duty Litigation Over its ESOP
I had a whole line of things I was planning to blog on, but events keep overtaking them. Today, that is the story of the Tribune bankruptcy, and its effect, detailed here, on the Tribune ESOP. We have all been watching the booming industry in filing ERISA breach of fiduciary duty cases based on the latest events in the market with, for the most part, some skepticism, as we try to deduce which ones are legitimate and whether some reflect just a piling on in the pursuit of settlements and accompanying legal fees. However, you will recall that, not too long ago and in a very prescient move, a number of participants in the Tribune’s ESOP filed a breach of fiduciary duty suit related to Sam Zell’s use of the ESOP stock in the transaction by which Zell or entities he controlled acquired the Tribune; we now are learning that this apparently deeply flawed transaction (time will tell, but all indications suggest it was deeply flawed right from the get go) placed the ESOP plan participants’ holdings at greater risk than the assets of others involved in funding the transaction, including Zell himself. Targeting the fiduciaries for possibly having allowed the ESOP assets to be used in a more risky way than others were willing to do with their own investments sure smells like a pretty credible theory to me.
On the Scope of the Attorney Client Privilege In ERISA Litigation
This really isn’t an instance of logrolling (or blogrolling, as the case may be), I promise, even though Roy Harmon’s post that I am passing along here refers to me and my electronic discovery post a few times; the subject of Roy’s post got my attention and led me to read it long before I realized the peripheral role I played in it.
Roy provides a very erudite discussion of a particular quirk and issue of some real concern in litigating ERISA cases, which is the scope of the attorney client privilege that exists - or often doesn’t - between a plan’s fiduciaries and its legal counsel, when engaged in a dispute with a plan participant. As Roy details, there often is no privilege in that situation that would prevent disclosure to the plan participant of legal advice obtained by the plan fiduciary. Its an interesting problem, one that arises in everything from determining the contents of an administrative record to be produced in a benefits denial case (i.e., is legal advice received by the plan administrator in deciding to deny benefits privileged or not?) to the extent to which the privilege can be raised in defending a deposition in a breach of fiduciary duty case. Roy’s analogy to multi-level chess with regard to these issues is apt, and illustrative of exactly the type of complicated gamesmanship that keeps litigators interested in the otherwise often dull interstices between trials.
Back Again at the Crossroads of Securities Law and ERISA
Here is a case from a week or so ago that I haven’t had time to post on yet, but which warranted a little more discussion than suited inclusion in Monday’s Thanksgiving Week potpourri post. In his latest ruling in In re Boston Scientific Corporation ERISA Litigation, Judge Tauro of the United States District Court for the District of Massachusetts delves in depth into the question of whether and when putative class representatives satisfy the requirements to represent a class in an ERISA breach of fiduciary duty case involving alleged securities law violations by the defendants. Building on the work of Judge Gertner, of the same bench, in her opinion in Bendaoud, issued two months ago, Judge Tauro analyzes the question of whether the requirements of both ERISA and constitutional standing, including injury in fact by the putative class representatives, are satisfied, finding that the requirements were not satisfied. The case provides a good tutorial on these issues. Beyond that, however, of perhaps even more interest, given the ongoing development of the law with regard to the intersection of securities violations and ERISA, is that the court’s analysis is heavily influenced by certain defenses to standing and injury in fact that are borrowed from securities law. Normally, in most instances, we are seeing ERISA used as a broader forum for attacking these types of violations, as compared to relying on the securities laws to do so, but in this case, doctrines developed as part of securities litigation serve to blunt a related ERISA case.
A Thanksgiving Week Feast
Some of the more prolific bloggers manage to be prolific by posting short notes on various topics of interest written by others, which isn’t my usual style. But over the past week or so I have managed to back up a good stack of things that I have wanted to talk about in detail, but haven’t had the time to comment on. So in the spirit of a Thanksgiving host laying out a big spread, here’s a whole bunch of things at once:
First, here is a good follow up story providing more detail on Wal-Mart’s success in defending itself against excessive fee litigation, a topic I first discussed in this post here. This particular story, in PlanAdvisor, does a nice job of illustrating the point I made in my earlier post, which is that the court, in ruling in favor of Wal-Mart, did not focus on or analyze the propriety of the particular fees themselves, but rather focused on the method used by the fiduciary to select the investment options in question and whether that was prudent. Interestingly, the article describes the Wal-Mart investment menu, and it reads like one you would find in just about any 401(k) plan. Does this suggest that most plans are actually fine on this front? Or might it suggest that fiduciaries as a whole accept fees that are too high, and that perhaps comparing a particular plan’s investment choices, such as Wal-Mart’s, against industry benchmarks is not really the right focus for deciding whether the fees in a particular plan were too high? Just asking.
Second, here’s one court’s answer to an oft asked question: is a plan participant seeking benefits entitled to attorney’s fees for the administrative appeal portion of his claim?
Third, here’s an interesting webinar rounding up the Supreme Court’s treatment of ERISA issues during the 2008 term. The Court’s fascination with ERISA during the past year has been well documented and the biggest item of discussion in ERISA related media, and pretty much everything about those developments has been chronicled on this blog and a million other places. But if you haven’t seen it all enough by now, the webinar may be for you. Interestingly, one of the topics noted in the webinar is the Court’s involvement in a case, still pending and not yet decided, concerning waivers by divorcing spouses of plan benefits. This is the quickly becoming infamous Kennedy case, which to date has caught the eye for two reasons: first, many people have some question as to why the Court took on this case and whether it merited the Court’s involvement, and second, because of the Court’s decision to seek supplemental, post-argument briefing on the very basic issue of the extent to which plan administrators are bound - barring an effective QDRO - to the express written terms of a plan. As a very experienced benefits consultant recently commented to me, the Court is going to upturn an awful lot of apple carts if, intentionally or even (probably by accident) implicitly, they indicate that administrators are not strictly controlled by the actual written terms of the plan instrument. As a result, a case that started out as perhaps the least substantively significant of the ERISA cases taken up by the Court in the past year threatens to become one of the more disruptive to settled practices, in a manner similar to how the Court reopened much settled thinking on fiduciary duty issues by indicating in LaRue that rules long established in the defined benefit context may not hold true for all other situations.
Okay, that clears some of the backlog.
Excessive Fees in 401(k) Plans: Its What You Do, Not Who You Know, That Counts
I am a real big fan of this article here, on two recent rulings in major excessive fee 401(k) lawsuits, one against Wal-Mart and the other against Bechtel. While I haven’t read the rulings in those cases themselves yet, what I like about the rulings, at least as depicted in the article, is that they apparently did not focus on the actual amount of the fees, but rather on the process used by the defendant companies in selecting them, to decide whether the amount of fees attached to the plan’s investment options violated fiduciary obligations. As the article sums up the rulings:
The details in the recent rulings in the Wal-Mart and Bechtel suits vary, but both cases offer a reassuring message to large corporate plan sponsors: In determining whether a corporation breached its fiduciary duties to 401(k) participants, the actual fees charged to workers are not nearly as important as the procedure a sponsor has in place supporting its decision to hire, and keep, any firm that provides 401(k) services to plan participants.
So, for instance, if plan sponsors offer actively managed mutual funds on their 401(k) platforms, sponsors are not acting negligently if these funds wind up underperforming—even if the funds are more costly to participants than passive investment options that could have generated better returns for a lower fee. As long as 401(k) sponsors can document that there was sound reasoning and process underlying its selection of the actively managed funds, then they are not breaching their fiduciary responsibilities.
I like this because it is a perfect match for something I have been preaching on this blog for some time, and which is exactly what I tell reporters who call up asking for suggestions as to how plan sponsors and administrators can best protect themselves against fiduciary liability: follow and document best practices that show that the company tried to locate the best funds at the best fees. Sponsors and fiduciaries can do this by such steps as: (1) bench marking selections against other options and the market as a whole; (2) bringing in outside experts who can provide that information; (3) choosing funds whose costs are consistent with the industry and not outliers; and (4) considering multiple vendors, options and choices before settling on the best overall option, just as the company would in picking vendors for any other service or product. What this really means in the real world as to follow, or mimic, an RFP type approach to selecting funds and vendors, and never, ever, just buy funds from someone a fiduciary knows from playing golf.
You Say Securities Law, I Say ERISA
Stop me if I am beating a dead horse, but this press release/short story on a class action law firm’s investigation into a stock drop involving Hartford’s stock reads exactly like one that, a few years ago, would have been issued prior to pursuing a securities class action; now its written in advance of pursuing an ERISA breach of fiduciary duty claim, with the class consisting of the company’s 401(k) participants. There is no better or more succinct illustration of the movement away from using the securities laws to pursue these types of claims and towards instead using ERISA to pursue these types of claims than this brief story. The facts at issue haven’t changed; they just replaced the words “securities act” with the word “ERISA.”
More grist for the mill for those who believe that the merging of the two areas by plaintiffs’ firms needs to be met by integrating the obligations under both areas of law so that fiduciaries are not operating under two separate and sometimes contradictory legal regimes.
Revenue Sharing, Fees, Indemnity and Contribution: A Potpourri of Hot Button Issues Confronting Fiduciaries
So you’re an amateur fiduciary, nominally in charge of a company’s pension plan or 401(k) plan but generally relying on your outside vendors and service providers for substantive advice and decision making, and you get sued for breach of fiduciary duty because of losses resulting from the investment advice you received from them. So what’s the first thing you do? File third party actions for contribution or indemnity against the outside vendors on the theory they were fiduciaries as well and must reimburse you for any loss you are held responsible for because of your role as a fiduciary? Well, not necessarily in Massachusetts, where at least one judge has now concluded, on an issue that has been treated differently in different courts, that ERISA did not expressly incorporate such rights as against other fiduciaries, and so therefore they do not exist. The case is Charters v. John Hancock, and here is a nice article on it, here is nice post elsewhere on it, and here is the decision itself.
The central issue of the case and of the court’s reasoning is presented well in the article, where the court’s reasoning is explained as follows:
Under the indemnification and contribution principle, when one person is subject to liability because of another person's action, the second person has to make good the loss, and contribution requires the loss to be distributed among several liable fiduciaries. In his ruling, Groton noted that federal appellate courts are divided on the issue of whether ERISA permits indemnification and contribution, but said Groton was siding with those courts that have found that courts should not imply statutory remedies, which are not allowed under ERISA.
"Here neither party disputes that ERISA does not explicitly provide for claims of contribution and indemnification among co-fiduciaries. Allowing fiduciaries who have breached their duty to resort to contribution and indemnification to recover from co-fiduciaries is not 'of central concern' to ERISA," Groton asserted.
There is a lot of room for argument on both sides of this issue, as to whether a fiduciary should have or does have such a claim against another fiduciary, and I can certainly see both sides of it, or argue either side of it. It is more of a policy issue as to how ERISA should be applied, than it is a jurisprudence question of understanding and interpreting the statute, and is one that the entire system would benefit from a simple declaration one way or the other, by Congress or the Supreme Court, as to what the rule shall be on this going forward.
In the Charters case itself, it is worth noting, and important to practitioners to recognize, that the court was confronted by this issue in a case where the defendant was using indemnification as a counterclaim to ward off a breach of fiduciary duty claim against it by a trustee by trying to pass the liability back to the trustee; it may well be that the court would have reached a different conclusion if presented with a more traditional contribution/indemnification scenario, where the defendant fiduciary was not trying to use the doctrines offensively, but instead simply to spread the liability owed to the plaintiff as a result of fiduciary breaches among all fiduciaries who may have participated in the breach.
Finally, although it seems to be the court’s rejection of the contribution and indemnity doctrines as applicable under ERISA that has caught the attention of observers, of at least equal interest is the court’s further discussion of a particularly timely issue, which is the defendant’s status as a fiduciary and possible breach of fiduciary duty based on failure to disclose fees fully and on receiving “revenue sharing payments in the form of 12b-1 and sub-transfer agency fees from
the funds in which it invested on the Plan’s behalf.” The court provides a nice analysis of these issues, making the case a good starting point for analyzing them with regard to the ever growing number of such cases being filed.
The Amateur Fiduciary
Geez, I hate to do this, but sometimes you have to play connect the dots. Reading this story about amateur (some would call it democratically run - small d, local government style) municipal pension plans and their investment strategies that got them caught up in the current collateralized debt obligation/securitization mess, I kept thinking to myself, where is the responsible, professional, knowledgeable fiduciary (or fiduciary retained vendor) in the investment decisions being chronicled. I don’t see them anywhere in the story. I see what appear to be the fiduciaries in over their heads and taking advice from what, in essence, are sales people. So what happens now in those cases (I mean besides the pension plans taking big losses)? Well, either the fiduciaries are liable for the mistakes they made, or they need to find - and sue - someone who is, as suggested in this piece here.
Many commentators often have a problem with fiduciary obligations and how they are interpreted, but to me, they play an essential role, and reflect a perfect fit between aspirations and legal obligations. The fiduciary alone stands in a position to protect plan assets, while simultaneously bearing the initial exposure for failing to do so, and thus has both an obligation and a deep rooted need to actually manage a pension plan well. It is not a job for amateurs, and is not simply a role in which it is enough to just do your best. Plan participants deserve, and legal obligations require, a level of expertise far beyond what is reflected in these types of stories.
Between a Rock and a Hard Place: Pity the Poor Fiduciary, Trapped Between the Securities Laws and ERISA
One continuing theme in the posts on this blog is the replacement by plaintiffs’ class action firms of securities actions with ERISA breach of fiduciary duty actions in stock drop and similar type cases; the large class actions are brought on behalf of plan participants who hold company stock, often in an ESOP, against the plan fiduciaries. Such claims, for all intents and purposes, serve as independent securities type lawsuits against the company involved, through the guise of a breach of fiduciary duty lawsuit against the company’s designated fiduciaries, without having to meet all the rigmarole of a traditional class action securities fraud suit. I have posted often about this developing trend pretty much since launching this blog, and it has become a commonplace among other commentators as well.
Well, Georgetown law student Clovis Trevino Bravo has taken this line of thinking one step farther, authoring a detailed look at the advantages of prosecuting these types of cases under ERISA instead of under the securities laws, with a particular focus on the procedural and discovery advantages that accrue to the litigator who files such cases under ERISA rather than under the securities laws. Beyond that, she does an admirable job of synthesizing the often conflicting case law as to the intersection of the two legal regimes, providing an understanding of an evolving consensus - which is still a bit of a moving target, though, as she notes - as to the obligations of an ERISA fiduciary trapped between two separate lines of legal duty, that provided by the law of ERISA and that provided under the securities acts.
You can read her article in full right here, and you should - it will be worth your while.
TARP and ERISA Litigation
Here’s an interesting looking and timely webinar from West next week on the stock market meltdown, the bank bailout, and their effect on ERISA governed plans. The short version of their pitch for the webinar, which ought to be in 20 point type spread across a banner headline, is “here come the breach of fiduciary duty lawsuits.” Overhyped? I doubt it. If the markets are down 40%, so are gazillions of dollars in 401(k) assets. If an individual financial company’s stocks are being battered, then so to are megamillions of dollars in that company’s stock likely held by its own employees in esops and other vehicles. Who are all of these plan participants going to be looking at? Who can they actually make out a claim against, and have standing to sue? To ask these questions is to answer them: the applicable plan’s fiduciaries.
Now the interesting question, more so than whether such lawsuits are coming (the answer to that question falls in the dog bites man category) is the structure of the defenses that will be raised by the fiduciaries. You can expect some consistencies across the positions raised by the defendants, not the least of which - and the best of which may well be - that prudent investment processes were followed, so no breach occurred, and proper levels of disclosure to the plan participants were maintained, so again no breach occurred, but the fiduciaries got blindsided, with the underlying theme of, one, so did everybody else (supposedly, anyway) and, two, no one could have anticipated and avoided these losses. What do I think of these likely defenses? Well, it would take a book length piece to address the ins and outs of these defenses, their holes, their strengths, and their weaknesses. But I do know this - any fiduciary relying on such defenses better have a squeaky clean documented trail of disclosures to participants, investigation into investment options and vendors, and informed decision making to back it up, or they are going to be writing very big checks when all is said and done.
To Be or Not to Be (a Fiduciary, That Is)
I talked about a case last week that addressed the damages aspect of making out a breach of fiduciary duty claim related to stock drop type issues, and pointed out the broad, ambiguous and easy to manipulate nature of a damages claim in that scenario. Another case last week, also out of the United States District Court for the District of Massachusetts, points out that other aspects of making out a breach of fiduciary duty case on a class action basis based on the administration of 401(k) plans provide a real check on such cases. The issue in that case? Namely that not everyone involved in operating a 401(k) plan is a fiduciary, and that while deep pockets involved in allegedly inappropriate behavior with regard to such a plan may make tempting targets, they cannot be sued successfully for breach of fiduciary duty if the prerequisite of having acted as a fiduciary is not satisfied.
As Judge O’Toole’s opinion in Columbia Air Services v. Fidelity Management Trust Company illustrates, an administrator of a plan - and who is not a named fiduciary of the plan - is only a functional fiduciary with regard to those specific limited areas in which it exercised discretionary, decision making authority; alleged wrongdoing by it with regard to other areas of its work for the plan do not subject it to fiduciary liability because the administrator is not deemed to have been serving as a fiduciary in those other contexts, regardless of the fact that it served as a fiduciary for other purposes. Thus, in that case, claims that improper fees were paid to the administrator as part of the structure of the 401(k) plan it was administering could not be the basis for a breach of fiduciary duty class action, because that did not occur as part of the activity where the administrator was, in fact, a fiduciary. As a result, ERISA granted no avenue for redressing those allegations of improper fees being paid to the administrator as part of its work for the 401(k) plan in question.
Although, as I have discussed in the past and as is discussed as well in this interesting article here, ERISA is becoming a favored structure for bringing securities related class actions, as this case shows, there are hurdles to these types of claims as well, ones that should dissuade anyone who thinks that bringing a stock manipulation class action under ERISA rather than the securities laws themselves equates with shooting fish in a barrel.
On Backdating, ERISA, and the Possibly Unintended Consequences of the Diamond Hypothetical
If you have an interest in both ERISA and in well written, logical judicial opinions, I can’t recommend highly enough this opinion, by Judge Gertner of the United States District Court for Massachusetts, in Bendaoud v. Hodgson, deciding a number of issues at the motion to dismiss stage. I have a trial starting on Monday, so, unfortunately, I can’t delve as deeply today into the range of issues the opinion discusses and that warrant comment as I would like, but a few issues are worth commenting on right off the bat, even in the limited time I have today.
First, I have discussed before the trend, which others are recognizing as well, of ERISA replacing securities law as a preferred structure for attacking stock drop and similar stock related manipulation type cases. Judge Gertner comes as close as anyone has to demonstrating in her opinion why this state of affairs has come to pass, in her analysis of standing and the question of whether the plaintiff, since he sold his stock holdings in the company plan before the stock manipulation in question came to light and drove down the stock price, could still show he suffered injury. The court found that the plaintiff could show injury by demonstrating that the alleged fiduciary breaches resulted in less profit than the plaintiff would have earned “had the funds been available for” other purposes than the investment made by the plaintiff. This is a pretty open damages theory, and not one as closely tied to the actual timing of disclosures and its impact on stock prices that the court recognizes would control the issue if it were more of a traditional stock manipulation securities action.
Second, the case raises questions about whether, after Justice Breyer’s famous diamond hypothetical in LaRue, a single plan participant can actually sue for losses to the plan anymore in defined contribution cases, if the diamond that was lost did not actually come from that participant’s account (or safe deposit box, in the terms of the hypothetical). The court suggests that such a plan participant may not seek recovery for the other plan members on his or her own, but that instead a class action structure may be required.
And finally, reading the court’s opinion and the analysis of the damages issue, I couldn’t help but think of the LA Times ESOP case that I discussed here and my thought that, regardless of the merits of that particular case, it certainly illustrated the risks of using ESOP held stock in corporate transactions, because the interests of those pursuing the transaction, while not by definition wrong in any way, may not line up perfectly with the best interests of the employees holding that stock in the ESOP, raising risks of breach of fiduciary duty. The damages analysis in Bendaoud goes right to this point; under that analysis, the issue is not whether the stock holding employees made out okay in the deal, but whether the ESOP assets would have been worth more had the stock been used in a different manner or different transaction. That analysis suggests a broad range of attacks on a complicated ESOP implicating transaction such as that in the LA Times case.
Fiduciary Duties: It Ain't Easy
With regard to my post yesterday about fiduciaries having the power, authority and motivation to act to protect plan participants, of course, that’s a lot easier for a fiduciary to do if its vendors are giving it advance notice of losses before the rest of the market finds out, and a lot harder to do if a fiduciary is one of the vast majority who aren’t given that advantage. See this story right here. A little less flippantly, this story - of alleged advantageous information given to some customers in advance of disclosure to the market as a whole - goes right to why its easy to say (as class action complaints always do) that fiduciaries owe a high duty of care to protect plan assets and beneficiaries, but it isn’t all that easy for fiduciaries to actually do.
Joshua Itzoe on Fixing the 401(k)
In an odd coincidence, at the same time Wall Street has been imploding, laying bare valuation and other problems with investments in retirement plans and elsewhere, I happen to have been reading independent fiduciary/401(k) advisor Joshua Itzoe’s book, Fixing the 401(k), which is premised on the idea that 401(k) plans are compromised by inherent, systemic problems, ranging from issues in plan design to the significant impact of fees charged against plan assets (Susan Mangiero, who knows as much as anyone around about valuation, fee, and other issues impacting pension investments, has a valuable review of Joshua’s book here). I hope to return to some specific chapters in the book and discuss them in detail and in the context of the types of cases that I see and that appear on the court dockets, but for now what struck me most was the extent to which the problem that Joshua identifies as needing to be fixed is really one of fiduciary talent and application; excessive fees that decrease performance, poor investment choice selection, and controlling plan costs - all items that he identifies as systemic problems at this point in the 401(k) regime - are all issues that are or should be right in the wheelhouse of plan sponsors and fiduciaries. They alone, either on their own or by exercise of their authority to bring in outside expertise, are in the position and have the authority to protect plan participants against essentially every one of these problems; further, by operation of the liability imposed on them for failing to do so, they are the one and only players in the system who both have the power to address these issues and the legal incentives to do so. Plan participants have neither the power, responsibility nor authority to do so, and outside vendors - particularly ones who do not rise to the level of a fiduciary or who will at least argue that they do not - likewise may lack, at a minimum, the incentives to address these problems. The Wall Street implosion just drives these points home further; fiduciaries alone are in a position to protect plan participants from the pressures and potentially explosive risks in retirement investing by means of company plans such as 401(k)s, and there really isn’t anyone else with the authority, power or interest in doing so. Indeed, at heart, isn’t this really what a breach of fiduciary duty lawsuit really is - a claim that the only party in a position to put the participants’ needs first, didn’t?
Does a Dying Industry Guarantee Pension Litigation?
This is one of those days in which the possible blog topics come fast and furious, many of them driven by the once every hundred years or so events on Wall Street and what they tell us about both the obligations of fiduciaries of retirement plans and their concomitant ability to live up to those obligations. That may or may not be a story that can be covered adequately in the blog format, but at least some of the highlights of those issues may make for some posts along the way. For today though, I thought I would focus on something a little more concrete, namely the LA Times/ESOP/ERISA /breach of fiduciary duty case that I blogged about in my last post. Here is a nice article giving a little more context to the suit, and which is probably worth a read if you have an interest in ESOPs, ERISA, newspapers or all of the above. One thing in particular caught my eye in the article, which relates to its discussion of the underlying problems in the newspaper industry and how it relates to the lawsuit; one of the class plaintiffs comments that those problems are not with the product turned out by the reporters, but with the industry’s difficulties with “monetizing the product online.” As someone who used to read three newspapers a day in law school and now skims three or more a day on-line and on my blackberry without spending a dime for the content, I can only say amen to that. I am not sure, though, that this point really has anything to do with the validity or viability of the suit itself, other than to the extent of pointing out the underlying problems that gave rise to the transaction that allegedly harmed the ESOP participants and gave rise to the class action. Either way, the story illustrates an important point, which is that there is a need for caution in any transaction of this nature that is going to impact the dollar value of stock held in ESOP plans, in light of fiduciary obligations that run in tandem with such plans.
ERISA, ESOP and the LA Times
What happens when journalists, Sam Zell, ERISA and employee stock ownership plans collide? Well, at a minimum, you get a really interesting and well written complaint alleging breach of fiduciary duty under ERISA. Here is the WSJ Law Blog post on this, and thanks to the post, here is the complaint itself. A couple of brief thoughts off the top of my head. First, this case fits in nicely with the trend that I have discussed in the past on this blog, which concerns the replacement of the securities laws with ERISA as the preferred means of attacking large scale corporate transactions. Second, like most such complaints filed as potential class actions, the complaint tells a wonderful story. As a litigator, I often wonder who is the target audience for these types of dramatically written pleadings, as a jury will never see them (not that any cases like this ever reach trial or, if they do, before a jury) and I am hard pressed to think that judges pay much attention to them when it comes time to consider the merits of a case. And third, if there is any fire behind the smoke that makes up the complaint’s allegations, then it will be an interesting case to follow as it proceeds along.
Systemic Losses and Fiduciary Liability
We have all taken note of the run up in filings of very large breach of fiduciary duty cases against plan fiduciaries that are based on the tremendous losses incurred in investments held by plans as a result of the subprime lending mess. The filings themselves are noteworthy, and the numbers, losses and alleged misconduct depicted in them are eye-grabbing, in ways reminiscent of tabloid headlines that focus on the most sensational elements of a story for the purpose of separating readers from their three quarters. Most lawyers, myself included, and other observers have immediately delved into the ERISA defense lawyers playbook in thinking through these cases, looking towards the procedural, and if they fail, substantive defenses that the fiduciaries can present. But it may well be that the best defense is in the fact that fiduciary obligations may be high, but they do not require omniscience, and therefore in the argument that even a fiduciary who did everything at the level of competent industry professionals was still going to have the plan assets suffer these large losses, and thus cannot be liable here. I thought about this as I read this article here (the latest in what I have always thought of as Paul Krugman’s simplified economics seminars for the non-economists among us, including myself), which could almost serve as a trial lawyer’s closing argument that, whatever happened to the plan’s assets, it wasn’t the fiduciary’s fault, but a systemic problem giving rise to losses that could not have been avoided.
I am not entirely sure I believe that argument myself, at least in all cases, but in the case of a fiduciary who can document that standard, best investment practices were pursued, and the losses happened anyway, it’s a pretty persuasive argument. For the plaintiffs’ bar bringing these cases, and for the plan participants who have suffered large losses in their retirement holdings, what does this mean? It means that pragmatically, the case to be put in will probably have to combine the existence of the large systemic losses with compelling evidence that the fiduciaries in question in any particular case did not actually follow the industry’s best practices, but instead fell down on the job somewhere along the way, before those losses struck home. That second piece of the case is where the fun will be for the lawyers, in the nitty gritty of discovery battles seeking that evidence and in the fights to submit or exclude expert testimony as to whether the professionals did not pursue appropriate practices and whether that caused or increased the losses.
The First Circuit on ERISA Standing
Permalink | Very interesting case out of the First Circuit the other day on the question of whether former employees satisfy ERISA standing requirements with regard to defined contribution plans. Short answer is they do, but the Court’s analysis and discussion is an interesting open field run across a range of issues that are both explicit and implicit to any consideration of this question. One particular point, basically noted in a footnote, was of particular interest to me. I have discussed frequently in past posts my thesis that much of the evolution in ERISA law is and will continue to be driven by the economic effect on employees of the replacement of the pension system by 401(k) plans; this is partly because employees have become the persons at risk from investment mistakes, which they generally were not - barring complete failure of the employer and its pension plan - when employees were instead covered by pensions. In an interesting footnote, the Court addresses the distinction between the two types of benefits, and hints at the impact of that difference on employees:
Under a defined benefit plan, participants are typically promised a fixed level of retirement income, computed on the basis of a formula contained in the plan documents. See 29 U.S.C. §1002(35). The formula generally accounts for an employee's years of service and compensation level at retirement. Graden, 496 F.3d at 297 n.10. In contrast with a defined contribution plan, where the amount of benefits is directly related to the investment income earned in an individual account, the investment performance of the portfolio held by a defined benefit plan has no effect on the level of benefits to which a participant is entitled, provided that the plan remains solvent. See LaRue,128 S. Ct. at 1025 ("Misconduct by the administrators of a defined benefit plan will not affect an individual's entitlement to a defined benefit unless it creates or enhances the risk of default by the entire plan.").
The case is Kerr et al. v. W.R. Grace, et al.
From Preemption to ERISA Standing, and Lots of Things In-Between
Permalink | Philadelphia, New York, court hearings - I have been everywhere the past week or so other than at my desk where I could put up blog posts. Here’s a run down of interesting things I came across along the way that you may want to read. First, for those of you who can’t get enough of this topic - I know I can’t, but then I am fascinated enough by this stuff to maintain an entire blog on the subject of ERISA - Workplace Prof passed along this student note on preemption and “pay or play” statutes: Leslie A. Harrelson, Recent Fourth Circuit Decisions: Retail Industry Leaders Ass'n v. Fielder: ERISA Preemption Trumps the "Play or Pay" Law, 67 Maryland L. Rev. 885 (2008).
Second, SCOTUS passed along that the Supreme Court decided not to accept for hearing Amschwand v. Spherion Corp., which, I noted in a previous post, presented an opening for the Court to address when monetary awards for breaches of fiduciary duty can qualify as equitable relief that can be sought under ERISA. I have commented before that the Court has advanced the ball on equitable relief under ERISA into almost untenable terrain, and I am not sure whether the Court can bring any greater clarity to the issue without backtracking from its recent jurisprudence on the subject; given the unlikeliness of the Court doing so already with regard to such relatively recent decisions, it is probably just as well that the Court did not take on the issues presented by that case.
Third, you could learn everything you need to know about the standards of review for benefit denials and the impact of the Supreme Court’s decision in MetLife v. Glenn by clicking on the “Standard of Review” topic over on the left hand side of this blog; or you could spend an hour listening to this webinar on the topic.
Fourth, Pension Risk Matters passes along this Sixth Circuit decision enforcing the Supreme Court’s approach to individual claimants in LaRue, finding that two participants could sue for breach of fiduciary duty. There are two particularly interesting side notes about this. First, it illustrates a particular point I - and others - made in a number of media outlets after the Supreme Court issued its opinion in LaRue, namely that, while it may not result in an avalanche of litigation that otherwise would not have been filed, the ruling is certainly going to lead to an increase in the filing of smaller cases on behalf of a few participants in circumstances that, in the past, would not have generated suits unless a class wide action could be brought. Second, the case presages what may be the dying off, by a thousand cuts, of the long held use of standing to cut off ERISA breach of fiduciary duty suits at the earliest stages of procedural wrangling, long before any litigation over the merits of a case, something which occurred at the federal district court level in the original LaRue case itself. Roy Harmon, over at his Health Plan Law blog, has a detailed analysis of this question, one I have been thinking about since LaRue was decided but which Roy has thankfully saved me from addressing in detail at this point.
A Brief List of Things Worth Reading
Permalink | Even when trying cases, I have never had a week so busy since launching the blog that I haven’t been able to find time to post. David Rossmiller likes to say that work is the curse of the blogging class, but even when really busy, I have always found writing up a blog post to be a nice chance to recharge my batteries. So for those of you looking for something ERISA related to read on this upcoming summer weekend, I thought I would at least pass along some of the more interesting things I have been reading this week. These include: Kevin LaCroix’s latest post summing up the status of all of the subprime related lawsuits filed around the country’s courthouses, including two new cases brought under ERISA alleging breach of fiduciary duty as a result of subprime related exposures; the Workplace Prof’s series of posts on, in order, the Supreme Court’s request for the government’s view on a cash balance plan issue, the Ninth Circuit’s view that a disability benefit plan claim can be denied if the claimant does not cooperate with investigation of the claim to the extent required by the plan’s terms, and on recent appellate authority on the effectiveness - or ineffectiveness - of particular approaches to delegating discretionary authority to administrators; and the Florida Appellate Blog’s post on an Eleventh Circuit decision finding that an administrator did not have to provide a copy of an IME report to a claimant prior to conclusion of the internal appeal procedure.
Two More ERISA Cases for the Supreme Court?
Permalink | The good folks who write the SCOTUS blog are engaged in one of their periodic attempts to read the tea leaves and predict what cases the Supreme Court will choose to hear. This time, they think the Court will review two ERISA cases, Geddes v. United Staffing - which concerns the standard of review to be applied to benefit determinations when fiduciary duties are delegated to a non-fiduciary - and Amschwand v. Spherion Corp., which presents an opportunity to clarify when monetary awards for breaches of fiduciary duty can qualify as equitable relief actionable under ERISA. If the Court hears both cases, we will see a continuation of the trend of the Court focusing on and likely reframing the course of ERISA litigation. Geddes provides not just an opportunity to understand the impact of delegation to third party administrators, and to open up for further development some of the unsettled issues in that realm, but also an opportunity, on the heels of whatever the Court decides in the currently pending MetLife v. Glenn case, to alter the settled understandings of when and how to apply the differing standards of review that apply in benefit cases. Amschwand, in turn, presents the Court with an opportunity to address a very technical and specific question, but one that continues to bedevil courts and litigants, namely the question of what types of claims for monetary recovery can proceed, under current Supreme Court jurisprudence, as claims for equitable relief under ERISA. Of note, the Solicitor General’s office, in recommending that the Court accept review of that case, seems to emphasize a need to broaden the range of theories that can be brought as equitable relief claims under ERISA so as to ensure an acceptable range of remedies and recourse to aggrieved plan participants, a proposition that many who favor broader remedies might not have expected to be forwarded by the administration’s legal team.
Follow the Numbers: the Evolution in ERISA Law
Permalink | I have noted two things - well, many things, only two of which are relevant to this post - in the past, one the line that Marx was wrong about a lot of things, but he was right that everything is economics, and the second that we are beginning to see an incremental evolution in the law of ERISA to account for the reality that pensions - predominant at the time of many of the earlier, key court rulings on ERISA - have been supplanted by defined contribution plans. We saw the latter, for instance, in dramatic fashion in the Supreme Court’s ruling in LaRue, with the justices’ discussion of how rules applicable to pensions may not be equally applicable to 401(k) plans. The two ideas - that everything is at base driven by economic reality and the evolution of ERISA law - are linked, in a way driven home by this column in the Washington Post yesterday arguing for a new retirement structure based on the belief that the defined contribution approach simply is not going to work for most employees. The author noted “that when ERISA went on the books in 1974, employers were contributing 89 percent of the funds in pension plans, but by 2000, the employers' share of contributions had dropped to 49 percent.” With that change, as I have argued before, we are going to see a real shift in court rulings on ERISA as applied to defined contribution plans, with rulings providing more protection - or at least more recourse - to plan participants when the conduct of plan fiduciaries, particularly in the realm of investment choices, is challenged. When ERISA was only concerned with a world in which almost all retirement benefits were in the form of a pension, investment mistakes were, speaking generally and in sweepingly broad terms, the problem of the sponsor, as the employee was still promised his or her benefits; defined contribution plans invert this paradigm, making investment mistakes by fiduciaries the employees’ problem, and the law of ERISA will continue to shift to give those employees more redress than they have traditionally had in that situation under ERISA.
Millions for Defense, Billions for Damages: State Street's Exposure
Permalink | Backdating. It’s a scandal. No, not that backdating. I mean when bloggers can’t get to something when it first comes up, and then go back in time to talk about it. That’s what I mean by backdating, and that’s what I am going to do today. Last week, I read, but didn’t have a chance to discuss here, this article from Bloomberg on the State Street Bank subprime losses and potential ERISA related exposure. The article was particularly interesting because it takes a tack someone different than most articles that, like this one, rely on lawyers to evaluate the litigation against State Street arising out of those events; most such articles focus on liability issues, the procedural defenses available to State Street under ERISA, and the defensive position that the company can assert. This article, though, asks and attempts to answer the million dollar - or in this case, more like the billion dollar - question of how much losing these cases will cost State Street. The numbers bandied about by well informed lawyers are staggering, even to the jaded eye.
The article rounds up the usual band of worthies to comment, including the Workplace Prof’s mild mannered alter ego, Paul Secunda, who tacks the eye popping number of “hundreds of millions to the billions” on State Street’s potential liability, and Boston ERISA lawyer Marcia Wagner, who noted that the plan administrators filing suit against State Street may have had no other options but to sue. To quote the article:
Wagner said fund managers hurt by the drop may have an obligation to sue as the existing plaintiffs have. “To the extent plans were misled into purchasing something they were not authorized to purchase, they may have a fiduciary obligation to sue,'' said the lawyer, who isn't representing the investment manager or plaintiffs. ``It's sue or be sued,'' she said. ``They allowed bad investments, so they should be attempting to make the plans whole.”
This echoes something I said in my last post on the State Street mess, in which I raised concerns about the fact that pension fund managers invested in the State Street products without properly understanding what they were buying. As I suggested in that post, administrators fall down on their own fiduciary obligations in such circumstances. As Wagner’s comment suggests, it may well be that the administrators’ fiduciary duties under those circumstances require them to then try to remedy their initial mistakes by suing to recover the losses, rather than compounding their own fiduciary breaches by simply absorbing the loss; that latter course of action would likely just make the administrators themselves targets for breach of fiduciary duty lawsuits based on their own mistakes in investing in the State Street funds.
Big Questions From A Small Story on a (Relatively) Small Loss
Permalink | Here’s a short newspaper story of a local municipal pension plan that suffered a $2.4 million loss to its pension fund, which is only about a $53 million fund, as a result of investments in subprime mortgage backed assets made either by State Street or in State Street funds (the article isn’t clear on the relationship between the pension plan and State Street, the current poster boy for breaching fiduciary duty by subprime investments). As the article points out, the pension plan has retained counsel to pursue State Street over the loss, on the theory that State Street did not adequately disclose the nature of the investments and the risk; this is pretty much par for the course for the various State Street subprime lawsuits being brought by pension and 401(k) plans, which essentially allege that volatile subprime related exposures were not disclosed but were instead contained within investment products sold as safe, conservative bond investments. Although dressed up to suit ERISA and breach of fiduciary duty issues, they can essentially be understand as highly gussied up bait and switch claims, in which retirement plan administrators and fiduciaries allege that they thought they were buying one thing from State Street - a conservative investment vehicle to balance out riskier investment allocations - but instead were sold something else, namely a highly volatile and risky exposure. State Street, of course, as the article reflects, views the cases otherwise, as instances in which the proper disclosure was made, but market downturns harmed the investments.
This whole scenario raises an interesting question, aside from whether it is the plaintiff administrators or instead State Street that is right, because no matter which one is correct in their interpretation of the events at issue, you still end up in the same place, which is that the plans signing off on these investments just plain didn’t know what they were buying. This is certainly the case if, as the plaintiff fund fiduciaries claim, they weren’t told the truth, but it is likely also the case if, as State Street claims, plan sponsors were told the truth and are now simply complaining about market outcomes; if it’s the later case, one can only assume that the sponsors didn’t understand the risk being taken when they signed up for the investment.
And this goes right back to the most important question of all here, which is what were the plan sponsors and fiduciaries doing when they were offering these investment options or making these investments themselves? This scenario speaks of poor investigation and over reliance on the investment provider, namely State Street, and suggests the plans themselves did not have proper processes, including independent administrators with the sophistication to analyze the investment choices and risks, in place for choosing investment options, prior to offering them to plan participants or investing the plans' funds directly. In this day and age, I think we are moving past the point of debating whether those types of processes are part of the fiduciary obligations of those running retirement plans.
And by the way, for the record, I am not buying the article’s spin that the loss was not that damaging to the pension plan discussed in the article, because it was only about $2.4 million. Against total plan assets of approximately $53 million, and with the taxpayers on the hook to fund the pensions because it is a municipal plan, that’s an important hit, both financially and to the public pocketbook.
Excessive Fee Litigation: A Real Problem or An Imaginary One?
Permalink | Here's a piece passed along by the Workplace Prof, noting the rise in excessive fee litigation under ERISA. I have noted before that the combination of demographic and economic factors with the ruling in LaRue is going to create more of these types of actions over the years, not less, and thus I share the skepticism the Prof expresses over whether, as a defense lawyer quoted in the piece suggests, these cases don't pose a significant problem for plan administrators. Moreover, I don't necessarily buy the sentiment suggested by defense counsel quoted in the article, to the effect that these cases are about a battle of the experts over whether any particular plan's fees were too high relative to the market or not. I think of them more as due diligence and best practices cases, as really revolving around whether the administrator followed a proper process to pick providers and funds, and to make sure the fees involved remained appropriate as measured against appropriate benchmarks.
Pension Estimates: Not Worth The Computer They Are Printed On
Permalink | Here’s an interesting decision out of the First Circuit yesterday, concerning errors in providing estimates of pension amounts to participants and whether a participant can hold the sponsor to the erroneous estimate, rather than receive only the correct amount under the actual terms of the retirement plan in question. Short answer? A participant only gets what the plan, by its express terms, grants, and not the larger erroneously estimated amount. Although it is fair to say that the actual outcome of any such dispute will depend on the actual facts of a given circumstance and the particular theories under which a particular participant elects to proceed, this case reflects that enforcing the estimate, rather than simply receiving the lower actual amount due under the plan, is an uphill battle, at best. In this particular case, Livick v Gillette, the employee struck out both on attempts to obtain the higher amount by arguing that the erroneous estimate was an actionable breach of fiduciary duty, and on an estoppel theory. The court’s analysis of the estoppel theory is particularly noteworthy, as it provides great fodder for any sponsor or fiduciary defending against an estoppel claim related to an ERISA governed plan. If you are litigating a case in the First Circuit concerning an estoppel claim related to the benefits available under a particular ERISA governed plan, this case would be the place to start.
Does Employer Stock Even Belong In Retirement Plans?
Permalink | Should there even be employer securities in a 401(k) plan or other retirement vehicle? That’s the million dollar question (or more like the hundred million dollar question) that cases like those arising out of the Bear Stearns collapse raise. Moreover, it goes right to the underlying tension between ERISA and the securities laws that plays out in the concept of fiduciary duty: namely, the extent to which it is appropriate for a fiduciary to continue to allow employer stock holdings in a retirement vehicle when the company is simultaneously facing market pressure on its stock price and an obligation to comply with the securities laws in dealing with the marketplace as a whole. The legal and philosophical issues of this inquiry go on and on, spinning on like a fall into the rabbit hole; this is manifest in cases such as the Seventh Circuit’s ruling in Baxter, discussed here, in which these types of issues are merely raised, but not resolved. It’s a good topic for a law review article, but since blog posts traditionally don’t run to the hundreds of pages, I am not going to get very far into answering those issues here, but rather want only to raise the topic, which I think will be played out in a fundamental manner in the case law as the subprime mess lurches its way through the legal system. And on a practical level, what raised this thought this morning was this story here in the New York Times about pension funds moving out of equities, because, while there is a certain apples and oranges aspect to any comparison between that issue and employee holdings of employer stock in defined contribution plans (in that pension funds are moving in this direction because of future liabilities related to pension plan payouts and not necessarily for the same reasons that an employee might not want to be invested in his or her own employer’s equities), that fact does raise an interesting question. Simply put, if the professionals who run pension funds are moving out of the stock market for, in part, volatility reasons, should comparatively unsophisticated 401(k) investors be allowed to, even in some instances encouraged to, overload with one particular company’s equities?
Passing Along Some Reading on Excessive Fee Cases and Other Timely ERISA Topics
Permalink | What would this blog be if it was done as a newsletter instead? Well, probably something like this new ERISA newsletter out of Proskauer Rose, with its detailed but readable length discussions of current events in the field, such as the Supreme Court’s recent decision in LaRue and the Supreme Court’s consideration of whether to hear a case that will allow it to return again to the problem of defining the available scope of equitable relief under ERISA. For me personally, I particularly liked the discussion of the latest trends at the trial level in the federal court system with regard to lawsuits filed over allegedly excessive fees charged on mutual fund investment options, as it takes an approach that I like to pursue whenever possible in my own posts here on this blog: it discusses the early decisions on the issue at the motions stage in the trial courts, and looks ahead to what this may mean for the industry as a whole and service providers. Its worth a read, and if you enjoy this blog, you will almost certainly enjoy this newsletter as well.
What Happens When ERISA and the Law of Insurance Coverage Collide?
Permalink | Wow, I guess this is really Seventh Circuit week here, with, I guess, a particular focus on the jurisprudence of Judge Easterbrook, whose opinion in Baxter I discussed in my last post. This time, I turn to his decision from Wednesday in Federal Insurance Co. v. Arthur Andersen, which strikes right at the intersection of the two subject areas in the title of this blog, insurance and ERISA. The Arthur Andersen opinion concerns the extent of coverage, if any, for Arthur Andersen’s massive settlement of lawsuits related to its retirement liabilities upon its well publicized, post-Enron collapse, under a policy covering breaches of fiduciary duty. The court found that there was no coverage, for a number of reasons, the most salient of which being that, first, the losses in question were the actual pension amounts, which the policy does not cover (it instead covers only other losses related to a pension plan, separate from the actual amount of the pension benefits in question), and second, that although the claims in question related to pension plans, they were not actually for breaches of fiduciary duty related to such plans, which is all that the policy actually responds to. There are some interesting lessons for plan sponsors and plan administrators in these findings: first, that it is important to remember that, in buying fiduciary liability coverage, this is not the same thing as insuring the benefits owed to pensioners themselves, and, second, that the exact scope of the coverage is narrow and limited by its exact terms, which may not extend coverage to the specific allegations of any particular lawsuit arising from the pension plan. What’s the take away? A close look by an expert is needed when selecting insurance coverage for pension plans and the people who run them, if for no other reason than to have an accurate understanding of the extent to which potential problems with the plans may actually be covered.
Beyond these lessons in the case for people on the ERISA side of this blog’s title, the decision provides a fascinating run through a number of complicated insurance coverage topics for those of you who are interested in the insurance coverage half of this blog’s title. The judge - or perhaps his clerk, I don’t know the practices in that particular court - writes fluidly on the law of estoppel, waiver, the duty to defend, and the respective rights of the insurer and the insured when it comes to control of the defense and settlement of a covered lawsuit.
What LaRue Wrought
Permalink | Suzanne Wynn has the story of the day when it comes to ERISA litigation, as she posts on the Seventh Circuit’s application of LaRue to exactly the type of case that, had the Supreme Court ruled otherwise, would have gone away without any potential liability on the part of the fiduciaries or, for that matter, recovery by the plan participant. The case, as Suzanne explains, concerns a single plan participant who charges plan fiduciaries with breaches of fiduciary duty related to the amount of company stock held in that particular participant’s account; the plaintiff’s theory holds that the fiduciaries breached their duties because they “allowed participants to invest in [company] stock despite knowing that the stock was overpriced and therefore was a ‘bad deal’.” The Seventh Circuit recognized that, after LaRue, a plan participant can move forward with such a claim, at least in terms of having standing to pursue relief that is not plan wide.
The Seventh Circuit’s decision touches on a number of themes that are not fully addressed in the opinion, but which really rest at the crossroads that the law of ERISA finds itself at today. The first has to do with the extent to which LaRue will or will not increase litigation. I have previously discussed that, in my view, the real impact of LaRue is that the types of cases, such as stock drop cases of the kind considered by the Seventh Circuit in this case, that in the past would only be brought if the scale was sufficient to attract the interest of the organized plaintiffs’ class action bar, will now be brought in many instances even if the scale is insufficient to give rise to class or plan wide litigation. Rather, as this case illustrates perfectly, these types of theories will be pressed now if even only one participant has enough loss to warrant the action, as LaRue expressly authorizes and as occurred in this case. This is where you will see the impact of LaRue with regard to expanding litigation, not necessarily in terms of a massive increase in numbers of suits, but rather in an incremental increase in the types and natures of suits brought against fiduciaries. And don’t kid yourself - as the baby boomer generation moves towards retirement, there are going to be a huge number of plan participants in 401(k) and ESOP plans and the like who have large enough accounts and holdings (for instance of company stock) for it to be worth their while to bring these types of suits if their accounts take a significant hit.
The second that I wanted to mention relates to something that is certainly not going to be news to any long time reader of this blog, and its certainly not an idea unique to me, namely, the fact that, in the aftermath of judicial and political responses to the growth - and some would say overuse - of class action securities litigation, the plaintiffs’ bar has begun using ERISA to prosecute what are in essence securities fraud claims of the kind that, in the past, would have been simply litigated under the securities laws. The plaintiffs’ bar has found that, given the evolution of the securities laws and of ERISA, ERISA may well be the better theory to prosecute in stock drop type cases. The swarm of litigation already being filed over the collapse of the Bear Stearns stock is a perfect example of the type of event that we have long been conditioned to expect to be litigated under the securities laws, but which is instead generating putative class actions under ERISA related to the company’s ESOP and other retirement vehicles. Among the many issues that this evolution in securities related litigation raises is how to integrate the securities laws and ERISA under these types of scenarios, to prevent ERISA from being distorted from its original purpose and transformed instead into simply some type of alternative securities law regime; Judge Easterbrook, writing for the Seventh Circuit, raises exactly these points, but doesn’t resolve them, noting instead that they will have to be developed in the future.
The case is Rogers v. Baxter International, and thanks to Suzanne for bringing it to my attention.
The Meaning of Justice Roberts' Concurrence in LaRue
Permalink | There’s nothing really new in this piece for those who have already closely followed and studied the LaRue decision (how’s that for opening with a bang?), but this column on the decision in the April 2008 issue of Metropolitan Corporate Counsel magazine by two Proskauer attorneys is interesting. They focus on playing out the meaning of Justice Roberts’ concurrence concerning whether such claims need to be pursued as denial of benefits claims, rather than as breach of fiduciary duty claims, and just what that means practically if the lower courts take him up on that suggestion.
Back to the Well: Fiduciaries and Subprime Assets
Permalink | I guess this is the flip side of all the grief that is starting to come down on fiduciaries for excessive - or at least what seems to plaintiffs’ lawyers to be excessive in hindsight - exposure to the subprime mortgage mess in pension and 401(k) holdings: pension plan fiduciaries now adding such exposure to their funds in the hope of goosing returns by buying these beaten down assets at fire sale prices (kind of like they are playing at being Jamie Dimon). Here’s the story, and thanks to my colleague Eric Brodie for bringing this development to my attention.
Back From Trial, But the World Kept Spinning In the Interim
Permalink | My trial finally concluded late yesterday after two weeks, with the jury returning a verdict in favor of my client (pause here for self-congratulatory pat on the back). While I was able to get some posts up last week, during the first week of trial, events during trial this past week left me with no time to post. A lot went on during that week that would be of interest to readers of this blog, running from the almost certain ERISA litigation that will follow from the Bear Stearns collapse, to further Department of Labor attempts to mandate transparency, to the Commonwealth of Massachusetts’ continuing efforts to single handedly prove that state regulation of employer provided health insurance benefits should, in fact, be preempted. We’ll return to these themes, and other topics, next week, now that we have time to get the printing press rolling again here.
Want to Learn More About the Post-LaRue World?
Permalink | I am trying to kick the LaRue habit, but couldn’t resist going back to the well one more time (how’s that for mixing my metaphors?). I know from readers of this blog and from talking to other lawyers that people are very interested in LaRue and the Supreme Court’s current interest in ERISA cases - in fact, one lawyer told me that right after LaRue was decided he was at a meeting on an entirely different topic but LaRue is all anyone wanted to talk about that day- so I wanted to pass along this very interesting looking teleconference next month on individual 401(k) suits post-LaRue. The faculty includes Tom Gies, who represented the plan and its sponsor in LaRue, and Karen L. Handorf, an attorney currently in private practice who previously worked for the Office of the Solicitor of Labor, background that may make her ideally suited to comment on one of the biggest mysteries of all raised by LaRue and the Supreme Court’s selection for its docket of two more ERISA cases, namely what’s with the Supreme Court’s sudden fascination with ERISA litigation.
More on LaRue: Lawyers USA Weighs In
Permalink | Thought I would pass this along right now, while the article is still available to non-subscribers - I suspect if you read this post tomorrow, you will have to subscribe to get access to the article by then. Either way, here’s an interesting article available on Lawyers USA today on the LaRue decision, and on the broader topic of what impact it will have. I am quoted in it on the issue of whether it will spawn more litigation; to quote the article:
Some see the ruling as spawning multiple lawsuits by individual 401(k) account holders.
"It will open the door to a lot more litigation. I don't think it will be an avalanche, but plan sponsors are definitely looking at death by a thousand cuts," said Stephen Rosenberg, an attorney with The McCormack Firm in Boston, who blogs on ERISA issues.
This is pretty consistent with what I said in my post last Friday, in which I discussed my views about how much litigation will result from this case. It is hard, as I said then, to quantify, but it is clear that the case paves the way for sponsors to face a steady stream of smaller cases, whereas in the past they really - or at least predominately - only had to worry about whether they were in a position to be targeted for a large dollar value, class wide type suit.
Fiduciary Obligations - and Common Sense - Support Hiring Outside Expertise for 401(k) Plans
Permalink | One of the common themes of many of my posts, as well as of many of the judicial opinions, concerning fiduciary obligations of companies sponsoring 401(k) plans is the need to bring in outside expertise to manage the plans, particularly for the purpose of insuring that investment selections are appropriate and priced right. As I have discussed both in numerous posts and in a range of articles in which I have been quoted, smaller and mid-sized companies generally lack the expertise to properly handle all of the aspects of 401(k) plans and can best discharge their fiduciary duties - and best protect themselves against litigation - by retaining outside experts to manage a plan. There is an entire industry that exists to service such companies and their plans. Here is a story out of New Hampshire that illustrates this point brilliantly; it concerns a small company that believed it could operate its own 401(k) plan without an outside vendor, and ended up, without any intention to defraud, being pursued by the Department of Labor for $33,000 in employee contributions that were never paid into the plan. By all accounts, the company was not engaged in anything underhanded; it just was wrong in thinking it could handle the logistics itself.
And not to beat the LaRue drum too much, but obviously the establishment in that case of the right of plan participants to sue fiduciaries for mistakes affecting their 401(k) accounts (whatever may be the exact parameters of that right, an issue up for some debate in light of some of the vagaries of the three opinions from the Supreme Court), just drives home the importance of making sure that a 401(k) plan is run absolutely as well as possible.
A Couple of Other Perspectives on LaRue
Permalink | There’s a lot out there on the Supreme Court’s ruling in LaRue, and I thought I would pass along today a couple of articles and blog posts that approach the issues raised by the case from a slightly different perspective than simply the technical legal issues raised by the case. Employee benefits lawyer George Chimento discusses the LaRue decision in this client advisory here, with a focus on a particular question, namely, whether in light of the problems posed by LaRue type cases, it makes any sense to sponsor a 401(K) plan that allows participants to pick and choose among investments. He makes a compelling argument that it just may not make any sense to do this, given the liability risks, amply illustrated by the LaRue case, and the investment skills of the average participant. He sums that issue up in this paragraph from his article:
With all this additional liability, is it wise to sponsor self-directed plans, with the extra expenses associated with open-end mutual funds and daily investment switching? Are participants really better off self-managing their retirement assets, doing something they were not educated to do? Perhaps it's safer, and better for all parties, just to have an "old fashioned" managed fund, without participant direction, and to employ properly certified investment managers who can be delegated fiduciary liability under ERISA. A dividend of LaRue is that it may cause employers to step back and reconsider the current, expensive, and dangerous fad of self-direction.
And Kevin LaCroix, a lawyer/expert insurance intermediary, tackles LaRue in this interesting blog post on his well-regarded D&O Diary blog, in which he focuses on the issues for fiduciary liability insurance raised by the case. One interesting point he makes is that the availability of coverage may be affected by exactly that split between the Justice Roberts’ concurrence and the other two opinions, related to whether or not claims of this nature should actually be prosecuted only as denial of benefits claims, or instead as breach of fiduciary duty claims. Anyone interested in the insurance implications of LaRue should find it a useful and informative post.
Permalink | Some follow up thoughts on the Supreme Court’s opinion in LaRue, after having some time to digest it. First, the court’s three opinions make for an interesting assortment of analyses of the issue, but what is most important on the front lines, down at the trial level where these issues play out in court, is the unanimous agreement that an individual 401(k) participant can sue for losses to just his or her account. This resolves a key dispute that, I know from my own practice, has become a key issue in the question of when and how participants can seek legal redress with regard to their 401(k) accounts.
Second, the three opinions set forth almost radically different answers to the question of how and why such an individual participant can sue for losses just to his or her account in a 401(k) plan. The majority opinion posits that this is the appropriate reading of ERISA in the context of defined contribution plans, which may be different from what the rule should be with regard to defined benefit plans. The second opinion, by Justice Roberts, poses the extremely thorny argument that, while a plan participant can sue for such losses, he or she should do so under the denial of benefits portion of ERISA, rather than under the breach of fiduciary duty portion of ERISA. The third opinion, by Justice Thomas, finds that the plain language of the statute warrants individual participants being allowed to bring such claims, and holds no truck with the idea, relied on by the majority, that there is some underlying principle distinct to defined contribution plans that either justifies - or is necessary to justify - this conclusion.
The competing opinions present some interesting issues. First off, Justice Roberts’ suggestion that the law governing denied benefits, rather than the law of breach of fiduciary duty, should apply to the circumstances of the LaRue case appears unworkable in the context of that particular type of claim, for a variety of practical and legal reasons; there is a certain extent to which it seems to me that even suggesting that is to work mischief, particularly for the judges and litigants who, going forward, are going to have to work out the myriad issues that claims like that brought by the participant in LaRue raise, none of which were preemptively resolved by the Supreme Court. Second, there is something telling in the contrast between Justice Thomas’ approach and that of the majority, something that may well be a clash of philosophy, not just with regard to statutory construction for purposes of the instant case, but also perhaps as well with regard to the road that lays ahead for the law of ERISA. Justice Thomas is correct in his opinion that the issue can be resolved, in the participant’s favor, simply off of the plain language of the statute, without relying on any special considerations raised by the fact that the case involves a defined contribution account rather than a defined benefit plan, which is the issue animating the majority’s opinion. Does the majority’s heavy emphasis on the fact that LaRue concerned a defined contribution plan hint at a belief among the majority that, in fact, ERISA needs to be treated as an organic, evolving body of law that needs to shift from its past precedents to account for the rise of defined contribution plans? And if so, is the emphasis on this point in the majority’s opinion a subtle suggestion to lower courts to approach new issues brought before them concerning defined contribution plans - or even old issues never before resolved under defined contribution plans - with an eye to how ERISA should develop to fit those types of plans? At a minimum, it is hard not to see lawyers for participants arguing exactly that to district courts and circuit courts of appeal in the aftermath of the ruling in LaRue.
The Supreme Court Decides LaRue, In Probably Predictable Fashion
Permalink | As a practicing litigator, I often can’t delve too deeply into a particular issue right when it arises, and instead have to return to it that night to analyze it for further discussion the next day. With a trial set to start in one of my cases and a court appearance this afternoon, this is one of those instances, but I did want to pass along the Supreme Court’s opinion in LaRue, just issued today. I will give it a more in-depth read tonight and may post more on it tomorrow, but in the interim, here is the opinion itself, along with two initial, superficial thoughts. First, as I - and others - expected, the opinion goes in favor of the plan participant, and expands the right of individual plan participants to sue for breach of fiduciary duties. Second, on first glance, the opinion seems animated by the need to account for the particular risks of defined contribution plans such as 401(k)s, and to recognize the need for the law of ERISA to develop in a manner that accounts for the transition to those types of benefit plans. In a weird bit of precognition, that’s something I just talked about in my post earlier this morning, on the Supreme Court accepting cert on still another ERISA case.
I Want My (Pension Tension Blues) MTV
Permalink | For better or worse, I’m old enough to remember where I was when MTV debuted, back when it actually played music videos. I am sure there is something to be said about the fact that a quarter century later, I now watch music videos about fiduciary risks concerning pensions, but I am not sure exactly what. You should watch it too, right here.
The Benefits of Relying On Investment Managers
Permalink | We all know that in reality, most companies that sponsor retirement plans, including 401(k)s, for their employees bring in outside advisors to manage the plan. There are at least two primary reasons for this, the first being that most companies don’t have the expertise to select investments and otherwise run plans themselves, and hope to get better retirement plan performance by relying on outside expertise. The second is the hope that fiduciary exposures will be reduced by bringing in, and relying upon, an outside advisor who has superior expertise with regard to retirement investing. These two factors ideally work in conjunction to improve retirement accounts for plan participants; the fear of legal liability inspires a desire to bring in experts, who in turn can do a better job in selecting investments than the company could on its own. In this way, we see the operation of a perfectly selected legal rule, and we see the important role that fiduciary liability rules play in the ERISA scheme; the exposure does not simply exist to support litigation after the fact, but also as a motivating force that improves plan performance on a day in, day out basis, by driving plan sponsors towards reliance on expertise that will both protect them and improve performance. It is possible, to some extent, to view almost all breach of fiduciary duty litigation as examples of failures in this dynamic. For instance, what are claims that companies breached their fiduciary obligations by excessively including company stock in a plan but instances in which a company, insufficiently afraid of its potential liability for breach of fiduciary duties, failed to either diversify investments on its own or bring in sufficient outside expertise to allow it to do so?
A good example of this dynamic at work can be seen in Judge Young’s just released ruling out of the United States District Court for the District of Massachusetts in Bunch v. W.R. Grace, in which the court found that the company was insulated from breach of fiduciary duty claims with regard to the retention and sale of company stock in one of its retirement funds by the company’s retention of and reliance on an outside investment manager to make those decisions. The court found that the investment manager had properly acquitted itself with regard to those issues, and therefore the company could not be liable on claims that it had breached its fiduciary duties by selecting and relying upon that advisor. The court explained that If the investment manager “did not commit a breach, then [the company] did not fail in the discharge of its duty to select and monitor” the manager.
But you can take that analysis one step further. The interesting aspect in this regard of the ruling in Bunch is that the company was absolved of liability by its reliance on an outside expert because the outside expert did not itself breach any fiduciary obligations by the actions it took and decisions it made in that role. But what if the advisor had violated fiduciary obligations in its handling of its delegated duties? What then of the company’s attempt to protect itself by retaining and relying upon an outside expert? The answer in general is that the company can probably still successfully defend itself against claims for breach of fiduciary duty, so long as it can show that its own steps in selecting and monitoring the outside advisor were prudent, even if the chosen advisor turned out, in hindsight, to be the wrong choice of advisor or investment manager. And in that lies the two real teachings of Bunch. First, that companies can protect themselves from fiduciary liability by selecting and delegating to an outside expert and, second, companies have to pursue that old cliche - best practices - in making that delegation if they really want to avail themselves of the protection that bringing in outside expertise can provide. By abiding by the second teaching, they should be protected even if the advisor they selected thereafter, unlike the advisors relied upon by W.R. Grace in the Bunch case, falls down on the job.
LaRue is Decided . . . Well, Sort of
Permalink | In an opinion it issued on Monday, the United States Court of Appeals for the Sixth Circuit confronted essentially the exact same facts and issues as are at play in the LaRue case currently pending before the Supreme Court, and effectively entered its own prediction as to how the Supreme Court will rule in LaRue. Tackling the same arguments that were presented to the Supreme Court in LaRue, the Sixth Circuit concluded that individual participants could recover on their own behalf for losses solely to their accounts in the plan, and that breach of fiduciary duty claims under ERISA are not limited to actions brought on behalf of the plan as a whole or for recovery benefiting the entire class of plan participants as a whole. This, of course, is the primary issue presented to the Supreme Court by the LaRue case.
Interestingly, the Sixth Circuit even borrowed and relied upon Justice Breyer’s diamond hypothetical that he posed to the plan's counsel in LaRue in reaching its ruling in favor of the participants, a hypothetical that clearly caught many lawyers’ fancy after it was offered up by the justice during oral argument.
The decision is Tullis v. UMB Bank, N.A.
The Governance of Retirement Plans in the Aftermath of the Subprime Meltdown
Permalink | Fellow blogger Susan Mangiero and I are quoted extensively in a very interesting article, available here, in the January issue of the Institutional Real Estate Letter. The article, titled Investing in Good Governance, focuses on one of - if not the only - potential silver linings in the whole subprime mortgage mess, namely the possibility that it will help to focus pension plan fiduciaries on the fiduciary obligations, particularly as related to protecting plan assets from ill advised and ill informed investments, that they owe to the plan itself and to plan participants.
Researching Pension Related Litigation
Permalink | Dying is easy, comedy is hard? No, ERISA is hard. I tell people all the time that there is almost no such thing as a simple answer to an ERISA related question, or at least no such thing as a straightforward answer. There are entire chapters in ERISA treatises dedicated to the seemingly, but actually not, question of the proper manner in which to request plan documents so as to invoke the statutory obligations, upon financial penalty, imposed on administrators to produce them. Or take the question of equitable relief in a cause of action brought under ERISA; in almost every other area of the law, we all know what equitable relief is, but in ERISA, we have to engage in a historical inquiry into the development of the law of remedies to know if a particular claim is equitable or not.
Now when you add in on top the fact that ERISA and its imposition of fiduciary obligations is beginning to supplant securities litigation theories as a method for suing corporations and investment banks for subprime, stock drop and other investment losses, as discussed here for instance, you can see just how complicated the topic becomes, as well as how potentially dangerous for fiduciaries and plan sponsors are the issues raised by ERISA. And of course, that’s what makes practicing in this area fun for those of us who handle these types of cases. But it also makes thorough and timely analysis of litigation risks and exposures crucially important, and what looks to be a promising new internet based research tool to help with this is now available. Pension Litigation Data is now up and running on line, and is meant to be a tool that will allow up to the minute research into the numerous pension related lawsuits pending in United States courts. The subscriber based site “debuts with over 1,500 retirement plan legal actions, each classified by nearly 100 fields, including court circuit, type of allegation, plaintiff, defendant and date [and provides a] continuously updated and searchable database” on the subject. A joint venture of a couple of companies, including fellow blogger Susan Mangiero of Pension Governance LLC, I think it looks promising, and you may want to take a look.
SmartMoney on the Practicalities of Complying With ERISA
Permalink | This is a law oriented blog, obviously, and one of the things that is always worth remembering is that the complicated legal issues played out in the cases discussed here have real world implications for plan participants and for businesses trying to provide benefits to their employees. A nice reminder of that is here, in this article on SmartMoney.com, in which I and others are quoted on the question of how business owners should operate 401(k) plans in light of the potential for fiduciary liability being imposed under ERISA.
On Regulation of Fiduciaries and Pension Plan Vendors
Permalink | I was interviewed by a reporter recently concerning the subprime mess and its implications for pension plan fiduciaries, and the issue came up as to whether further regulation was the answer, as she had heard from a number of others. To me, the ongoing problem we are seeing with fiduciary breaches - or at least allegations of them - arising from plan investments involve one type of flawed plan investment being replaced by another; first it was too much company stock in the plan, then when that problem worked its way out of the system, it was excessive fees being paid for investment options, with that quickly followed by the latest flaw du jour in investment selection, namely excessive exposure to subprime risk. Regulation can’t predict and thereby prevent whatever may turn out to be the next problematic interaction between the investment community and the obligations of pension plan fiduciaries to act prudently in selecting investments. Rather, regulation will inevitably target the last problem that popped up, not the next one that is coming down the pike. At best, one could improve things at the margins through further regulation by targeting not the fiduciaries themselves, but the vendors who provide investment products to them, and even then only by imposing more transparency, which may at least give pension fiduciaries a fighting chance at understanding the investments they are selecting and the risks or flaws inherent in them.
This news yesterday out of the Department of Labor, that it is proposing a regulation requiring further disclosure to plans by vendors of their compensation, fits this to a tee. The proposed regulation will require that “all compensation, direct and indirect, to be received by the service provider be disclosed in writing.” Well, excessive fees charged by mutual fund companies and others for the investments held by pension plans and 401(k) plans is last year’s litigation problem for fiduciaries, and the world has already moved on to the next problem. Indeed, I would speculate that many fiduciaries have already accepted the need to engage in due diligence as to all aspects of their vendors’ compensation arrangements, both hidden and not, simply out of awareness of the past lawsuits that focused on the issue. It’s a perfect example that regulation can’t predict and protect fiduciaries and the plans they serve from the next particular investment problem, but can instead only identify and prevent a reoccurrence of a past investment problem for retirement plans. At the same time, though, the regulation is focused on the transparency problem, and on obliging vendors to provide information openly to fiduciaries and plans; that’s the best avenue for using regulation to aid fiduciaries pro-actively, by adding to the information they have access to in evaluating vendors and proposed investment choices.
Talkin' With Tom Gies, Counsel for the Respondents in LaRue
I promised awhile back that I would run more interviews at some point on this blog, and we return today to our - granted, somewhat sporadic - series of interviews with movers and shakers in the worlds of ERISA and insurance. What provoked me to get back into the interviewing business, which I noted before are among the most difficult of posts to do well? The chance to provide more insight on the oral argument before the Supreme Court in LaRue v. DeWolff, Boberg, which was argued right after the Thanksgiving weekend. And with that lead in, here’s the blog’s interview with Tom Gies, a partner at Crowell & Moring in Washington, D.C., who was lead counsel for the respondents. Tom was gracious enough to provide some real thought provoking commentary on both the issues raised by the case and some aspects of the argument before the court:
Blog: How did you end up representing the respondents?
Tom Gies: We have represented the employer, and the plan, in a variety of employment, benefits, corporate and commercial litigation matters for years. They are longstanding valued clients of our firm. When this case was initially filed in the district court in South Carolina, we were retained to defend against the claim.
Blog: Many ERISA cases, particularly in the area of pensions and 401(k)s, never reach the merits, and instead are resolved by procedural motions addressed to whether there is even a cause of action or remedy available to the plaintiff. That’s what happened here. Would the law of ERISA be better developed, or the parties themselves better served, if courts were resolving questions such as those presented by LaRue after development of the facts of a particular case? On the merits, as it were, rather than on procedural issues?
Tom Gies: An interesting question. The case was pled and litigated in the district court solely as a Section 502(a)(3) claim. We moved for judgment on the pleadings because it was pretty obvious plaintiff sought compensatory damages that are not available under Section 502(a)(3), following the Supreme Court's "rather emphatic guidance" in Mertens, Great-West and Sereboff. Every court that has looked at this question so far agrees with us on this point. And, not to get too much into the prediction game, I think it is unlikely that the Supreme Court will use this case to reverse field on the question of what's appropriate equitable relief under Section 502(a)(3). Had plaintiff pled the 502(a)(2) claim in the district court, the litigation may well have proceeded differently. For instance, there may have been a more fully developed record after discovery, so that the case could be resolved on a motion for summary judgment. The Fourth Circuit was correct in observing that the 502(a)(2) claim was waived, having not been litigated in the district court. As with other types of litigation, the parties to ERISA actions are better served when the basic rules of engagement are followed and parties are not permitted to raise new issues for the first time on appeal. In our judgment, a more complete record in this case would have made it even easier for a reviewing court to understand that this is not a good vehicle for expanding the scope of Section 502(a)(2). A court looking at this fact pattern in response to a motion for summary judgment would readily conclude that this case does not present a triable claim for “losses to the plan” resulting from a fiduciary breach. More generally, I don’t think it’s wise to have some sort of special, more lenient, pleading rules in ERISA cases. The Supreme Court’s recent decision in Twombly recognizes the negative consequences, both to parties and the civil justice system, of the substantial costs imposed on defendants in having to go through discovery in complex litigation involving putative class claims. Those litigation costs are obvious in the 401k plan “stock drop” cases. The excessive fee claims present the same kinds of costs for employers and plan sponsors. The Court’s decision in Twombly wisely recognizes that bare allegations of a statutory violation, without more, should not subject a defendant to the tremendous cost of full-bore class action litigation. It shouldn’t make any difference whether such claims are brought by antitrust plaintiffs, Title VII claimants, or by lawyers representing ERISA participants.
Blog: Any particularly surprising questions or lines of inquiry at the oral argument directed at either you or LaRue’s counsel? What’s particularly interesting or surprising about it?
Tom Gies: Although the questioning of Mr. Stris regarding Section 502(a)(1)(B) was not a surprise (we mentioned it in our brief, and one of our amici devoted considerable time to the issue), I was intrigued with the implications in some of the questions asked by three of the Justices about the potential interplay between 502(a)(1)(B) and 502(a)(2). These questions suggest the Court will provide a careful analysis of the inter-relations of the various subdivisions of Section 502. The Court’s subsequent denial of certiorari in Eichorn v. AT&T may be another indication of the Court’s approach to this corner of ERISA law.
Blog: Any answers you’d like to have back? Any questions you’d like another shot at?
Tom Gies: I would have liked the opportunity to engage Justice Breyer more fully, perhaps in response to his second diamond theft hypothetical, on his question of "why" 502(a)(2) should not be read to extend to a situation like this. A decision to expand the remedies available under Section 502 has significant consequences because it is contrary to ERISA’s goal of encouraging plan formation. Permitting such lawsuits would inevitably require someone to make judgments as to a variety of issues, including: should there be a limit on damages, whether there should be jury trials for such claims, whether there should be an obligation on the part of the plaintiff to do some due diligence before bringing a damages action years after the alleged mistake, whether employers and plan sponsors can require arbitration of these kinds of claims, what should be done about the consequences of such litigation to the fiduciary insurance industry, and how would such claims be fit into the current rules for certification of class actions under Rule 23. There are surely others. These kinds of policy judgments seem best left to Congress.
Blog: Play it out for us. What’s the negatives for the industry if the Court reverses the Fourth Circuit and allows these types of claims to go forward?
Tom Gies: Imagine you have a new employee who joins your law firm, which, we assume, sponsors a 401k plan. Four years after you hire her, you get a lawsuit seeking compensatory damages for a violation of ERISA’s fiduciary duty rules. Her lawyer claims she was not given enrollment forms when she was hired, because of a mistake made by your HR director, and, as a result, employee contributions into the 401k plan were not made. The complaint goes on to assert that, had the contributions been made, she would have invested in Google the day after its IPO, and that the plan fiduciaries are personally liable for more than $500,000 in lost profits. When you look into it, your HR manager has a vague recollection that the employee took the paperwork and said she’d “think about” whether she wanted to join the plan. Should that case go to trial? Before a jury? Justice Scalia’s comment during oral argument in LaRue seemed to appreciate our point – there would be no end to the type of damages claims that plan participants could devise if these types of claims are permitted to go forward.
Imagine another situation. One of your employees who participates in your 401k plan had 75% of her account balance invested in mutual funds heavily concentrated in real estate. Now that those investments have lost considerable value, she seeks counsel. You get a complaint for compensatory damages that includes the allegation that someone in HR told the employee to “stay with” the real estate investments because that sector of the market would be sure to turn around soon.
The considerable costs of defending against such lawsuits will be born ultimately by employer plan sponsors. Fiduciary insurance will become even more expensive. Permitting these kinds of claims would undercut one of the fundamental assumptions made by employers in deciding to offer DC plans, rather than DB plans – the ability to shift investment risk to employees. All in all, a bad idea if you believe, as we do, that it’s critical not to take steps that would discourage employers, particularly small employers, from continuing to offer DC plan.
Blog: Paul Secunda, at the Workplace Prof blog, and I have been going around and around for a bit about whether ERISA is properly understood as having been intentionally enacted by Congress with only limited rights of recovery and remedy for plan participants. Clearly, that idea underlies DeWolff’s arguments to a substantial degree and, in fact, the lower courts’ rejection of LaRue’s claims can be understood as a recognition of this principle and of the fact that, as a result, LaRue simply has no recourse at this point. What’s your view on this? Are those of us who treat ERISA as specifically and intentionally limited in this way right about that?
Tom Gies: I start with Pilot Life and Mertens where the Court is clear in stating that ERISA represents a series of political compromises, not all of which were in favor of plan participants. ERISA is thus fundamentally different from other employee protection statutes. Encouraging plan formation, through the tax laws and otherwise, seems to me to be a cornerstone of the statute. And, of course, it’s not accurate to say that people like Mr. LaRue have “no recourse” in a situation like this. From what we know from the record, this is a case that could have been avoided by a telephone call. If you want to sell 100 shares of stock, you probably call your broker and place the trade. If you don’t get a confirmation order pretty quickly, you’ll call back, and if you don’t get a satisfactory answer, you’ll call her boss. If the boss won’t help you, you’ll escalate the situation until you get your trade executed. People like Mr. LaRue who want to trade securities in their 401k plan accounts have a variety of remedies available to them; they just don’t have a cause of action for compensatory damages based on a lost profits theory.
Blog: I shouldn’t put you on the spot, but I will - want to hazard a guess as to the outcome of the LaRue case?
Tom Gies: The Fourth Circuit will be affirmed 5-4, with the majority concluding that it is up to Congress to decide whether to extend the remedies currently set forth in Section 502.
Protecting Corporate Officers from Fiduciary Exposure
Permalink | Here’s an interesting article on one particular aspect of ERISA breach of fiduciary duty cases, namely the targeting as defendants of executive officers of the company sponsoring a pension or 401(k) plan; the gist of the article is that there are tactical and psychological benefits that accrue to counsel representing plan participants when they name officers of a company as defendants in such actions and allege that they are plan fiduciaries. Discretionary authority of any nature, of course, can render someone a fiduciary under a company’s pension or 401(k) plan, and those individuals can thereafter be rightfully targeted as defendants in a breach of fiduciary duty action related to that plan. As the article points out, allowing senior officers or directors of the company to engage in such activities can leave them open to suit, a bad idea because of the distraction and injury to company reputation of having senior management named as defendants in any major piece of litigation. The article’s suggestion to solve this problem? The old ounce of prevention is worth a pound of cure approach. The authors recommend that, well in advance of any litigation and even with none hovering off, threateningly, on the horizon, companies return to the plan documents and make sure they are structured to keep senior management out of the operation and decision making of the company’s pension plans. In essence, delegate that job downward in the company, as far away from senior management as day to day operational concerns - as opposed to concerns of preventive lawyering - allow. In a company retirement plan structured in that manner, the ability to credibly assert that any member of senior management exercised discretionary authority over the company’s retirement plan - and to therefore charge them as fiduciaries - is very limited and possibly non-existent.
More on that Grand Irony Theory
Permalink | Does the fact pattern below allow for a remedy under ERISA, particularly as the Sereboff/equitable relief line of cases has been interpreted in the First Circuit to date?
The plaintiff employee says that she purchased a life insurance policy on her husband through her employer's group coverage. When her husband was dying, she resigned her employment to care for him. She asked her employer for the proper forms to convert the group life insurance coverage to individual coverage, as she was entitled to do. Her employer refused or failed to provide the forms despite several in-person and telephone requests. In the meantime, the time for conversion (31 days) expired, her husband died, and now the life insurance company has denied her any benefits.
The United States District Court for the District of Maine just found in the case of Mitchell v. Emeritus Management that the fact pattern does not support a cause of action under any of ERISA’s remedial rights - for breach of fiduciary duty, for denied benefits and for equitable relief - available to a plan participant, a situation the court found “very troubling.” The court found that: (1) the participant could not recover the insurance benefits by means of an action for equitable relief because it was truly a claim for payment of the benefits at issue, rather than for equitable relief; and (2) the participant could not recover the proceeds on a claim seeking benefits because, under the facts at issue, there was no right to life insurance proceeds under the actual plan terms since there was no timely conversion, and therefore the administrator did not act arbitrarily and capriciously in denying the claim.
I guess two things jump out at me. One, the court rightly acknowledged that this result flows from the fact that ERISA simply leaves some harms incapable of remediation, something that is understood to have simply been part of the balancing act engaged in by Congress in enacting the statute, in which a decision was made to grant only limited rights of recovery in exchange for enacting a statute that would encourage the creation of employee benefits. Second, however, and at the same time, I think this is more what the Workplace Prof had in mind last month when he complained about what he considers the “grand irony” of ERISA, that a statute intended to protect employees can end up depriving them of a remedy, than was the case of the Wal-Mart equitable lien, that I discussed here, in which the Prof proffered the “grand irony” thesis, one which I took issue with in the context of that particular case.
Roundup at the LaRue Corral
Permalink | More on LaRue in the wake of Monday’s oral argument, and the inevitable commentary from all sides - including this one - on Tuesday:
• My last two posts on the LaRue case, here on the briefing and here on the oral argument, assumed a certain prior level of understanding on the part of the reader as to the issues and statutory provisions involved in the case. Workplace Prof has a more soup to nuts review of those, in the wake of the argument, here, which is also cross-posted here.
• Susan Mangiero was taken by the discussion in the oral argument of what powers may or may not have been identified in the summary plan description appended to LaRue’s complaint. I took this discussion by the Justices to be part of an inquiry into what are the constraining parameters of a claim such as the one brought by LaRue. As I have discussed before, I think the Court will allow this type of claim to be actionable, primarily because the law of ERISA is going to have to evolve to fit the brave new retirement world in which defined contribution plans, rather than defined benefit plans, rule, and establishing a right of remedy for the type of error alleged by LaRue is a necessary part of that evolution. However, I don’t expect, both for reasons related to the historically limited remedial reach of ERISA and the philosophy of various justices, that theory of liability and right of recovery to be unconstrained or left as simple as error by fiduciary plus loss to one account =s liability. Rather, although the Court may leave the parameters of the theory of liability to future cases for development, I expect the Court to at least indicate in dicta certain restraints and constraints on such claims. In this way, I think the eventual opinion will essentially walk the line between the concern of the respondent and its supporting amici that allowing claims of this nature will excessively increase the cost of providing plans to employees and the concern voiced by LaRue’s counsel that employees must be allowed a remedy for this kind of error.
• And here’s the New York Times’ highly readable account of the oral argument, by the excellent Linda Greenhouse.
• Finally for today, on a lighter and less substantive note, here’s the WSJ Law Blog’s post on the case, with a nice little profile of Tom Gies, who represented the respondent.
Thoughts on the Oral Argument in LaRue v. DeWolf, Boberg
Permalink | Just read the transcript of Monday’s oral argument in LaRue, which you too can read right here. Interesting argument, and interesting lines of questions from the court, although I am skeptical as to how much guidance as to the court’s thinking one can draw from the Justice’s questions themselves. In many ways, the lines of inquiry seemed to parallel my earlier post here on the arguments made by both sides. I had mentioned in my earlier post that the respondent focused heavily in its briefing on two points, the first being that prior jurisprudence of the Court concerning ERISA cases suggest that the narrow framework of ERISA remedies should not extend to encompass this type of claim, and the second that LaRue’s case itself was pled with holes that did not suggest it as a good vehicle for authorizing these types of claims. With regard to the first line of argument, questioning right off the bat of the respondent’s counsel targeted the fact that the prior jurisprudence relied upon by the respondent did not concern defined contribution or other retirement benefits and was based on a starkly different fact pattern; I mentioned in my earlier post on the parties’ briefing that I thought the earlier jurisprudence was too different in nature to provide much support for either side in the circumstances presented in the LaRue case, and after reading the argument, I think that remains the case. With regard to the second issue, LaRue’s counsel was peppered with questions concerning possible holes in the way he sought to recover for the alleged mistakes at issue, questioning that I thought was consistent with my earlier view that while the Court may well allow the type of claim at issue here to be actionable, the Court may well find that LaRue himself hasn’t placed himself in a position that he qualifies to go forward with such a claim. Perhaps the most interesting nugget to me in the transcript is that, with regard to the question of whether such a claim should be allowed at all - i.e., found to be authorized by the statute - the questioning seemed to consistently focus on one simple issue, namely that the only intelligible and consistently intellectually defensible position is that the plain language of the applicable statutory section would allow a loss to only one or a few plan participants’ accounts to be actionable, and would not require, as the respondent asserts, a loss to most or all of the plan’s participants before a claim for breach of fiduciary duty could exist.
Interestingly as well, the issue of whether a claim could proceed in the LaRue case as an equitable claim for relief under the Sereboff line of cases was discussed in only the most cursory terms by all involved, including the Justices. For various reasons, not the least of which is that the Court’s prior treatment of this issue has painted the Court into a bit of a corner from which it cannot back out without either repudiating prior holdings or engaging in intellectual gymnastics, I don’t see the Court advancing the ball on this issue in its opinion in this case.
LaRue v DeWolff, Broberg and the Concept of Administration Risk in ERISA Plans
Permalink | Oral argument at the Supreme Court is scheduled for Monday in LaRue v DeWolff, Broberg & Associates, which presents the technical question of whether a loss to only one participant’s 401(k) plan is actionable as a breach of fiduciary duty causing a loss to the plan, but which on a broader level concerns the question of who should bear the administration risk (defined as the problems of mistakes or malfeasance in the operation of a benefit plan) inherent in the operation of a 401(k) plan. Is it the participant or instead the plan fiduciaries who should bear that risk? To LaRue, who focuses his arguments around this idea, mistakes attributable to the administrators that harm the account balances of a particular plan participant represent a risk that should be borne by the erring administrator, and should therefore be actionable under ERISA even if the only losses in the entire plan from the mistake were suffered by one particular plan participant. The respondents reply, quite correctly, that ERISA provides limited remedies and some losses are simply - and quite intentionally under the terms of the statute - not actionable; to the respondents, LaRue’s loss, which stemmed from the administrator not following his specific investment instructions related to his specific account, is exactly such a non-remediable event under ERISA.
While the respondents are right that ERISA, presumably intentionally and certainly consistently with the general understanding of the statute and its history, provides only limited rights of recourse and leaves some losses to be borne by the affected plan participant, the statutory language itself at issue in the case - concerning whether an individual’s loss of the type described by LaRue qualifies as an actionable loss to the plan when only the individual was harmed - does not specifically leave in or leave out the circumstances of LaRue’s particular loss from the category of losses that are actionable under ERISA. And that is really where the Supreme Court’s involvement here comes into play, on the question of whether the type of administration risk described by LaRue belongs within or without the statute’s remedies; how the Court interprets the specific statutory language at issue will decide that question.
Personally, I’m of the view that the Court will find that the statutory language allows for the type of claim that LaRue is presenting. The language in question is capable, without any stretching of the language, of including the kind of claim at issue, and past jurisprudence doesn’t bar - or even present a significant impediment - to such an interpretation of the particular statutory language at issue. Moreover, and interestingly given the respondents’ - quite appropriate - tactical reliance on the general theme underlying past Court opinions on ERISA cases that suggest a claim such as LaRue’s is not actionable, the body of law that bears on this issue really was not created in response to one of the primary economic developments in American life over the last handful of years, namely the transition over to a regime of individual responsibility for retirement by means of defined contribution plans such as 401(k) plans and the accompanying transfer to individuals of the risks of retirement investing, and the corresponding disappearance of a defined benefit regime in which all such risks were borne not by individuals, but instead by their employers. Questions like the one presented by the petitioner in LaRue haven’t really been addressed at the high court level in the context of this new economic reality, and I am not convinced of the utility of past ERISA decisions concerning other contexts in resolving the statute’s application in the defined contribution context. I suspect that LaRue will present an early example of the Court accepting that the statutory language in ERISA that remains open to differing interpretations should be understood as transferring at least some of the administration risk inherent in the world of 401(k) plans from the individual saver and onto the party in the best position to avoid the risk, namely the administrator.
At the same time, I am not convinced that this is going to do much good for LaRue himself. The respondents take the tactical approach in their briefing of focusing on the particular flaws in LaRue’s presentation of himself as the poster boy for plan participants confronted by erring administrators, in an attempt to show that the particular claim he presented to the courts below does not justify interpreting the statutory language in a manner that would allow his claim to proceed. It’s a pretty good argument, and I wouldn’t be surprised to see a final opinion that opens up the type of claim he is arguing for, but puts him outside of its scope.
ERISA, Subprime Lending and Mortgage Meltdown
Permalink | One of the great things about writing this blog is that the technology of blogging - like links to other blogs and so-called trackbacks, showing who else on the internet is quoting a post - brings writers, topics and other bloggers onto my radar screen who I would otherwise miss out on. That cumbersome, semi-tech savvy sentence is an introduction to my real point, which is that my blog has introduced me over the past couple of weeks to some interesting blogs that I wanted to pass along, and to a particular website involving a unique and interesting insurance product. Barring being diverted by breaking news, I am going to try to discuss a few of those over the next handful of posts.
The one I wanted to mention today is the terrific (and wonderfully named) Mortgage Meltdown blog out of Wisconsin, by a handful of lawyers at the firm of Reinhart Boerner Van Deuren. The blog provides a lot of detail about the subprime mortgage problem as a whole, but what really stands out to me are several excellent posts by Ellen Brostrom on ERISA litigation arising from this problem. In addition to a discussion of my recent post on the ERISA breach of fiduciary duty litigation against State Street arising from plan investments that were exposed to subprime lending risks, she has a pair of interesting posts on ERISA class actions against subprime lenders themselves based on the inclusion in those companies’ benefit plans of company stock that was propped up by subprime lending; you can find those posts here and here. Her posts mirror my comment in my post on the State Street putative class actions that there are a lot of different avenues to target subprime losses through the mechanism of ERISA’s fiduciary obligations.
A Primer on Fiduciary Status Under ERISA
I liked the recent opinion in Bonilla v. Bella Vista Hospital, Inc., out of the United States District Court for the District of Puerto Rico (not available online from the court, but here's a Lexis cite for it: 2007 U.S. Dist. LEXIS 79939) for really only one reason, namely this terrific overview of the law of fiduciary status and duty:
ERISA reserves fiduciary liability for "named fiduciaries," defined either as those individuals listed as fiduciaries in the plan documents or those who are otherwise identified as fiduciaries pursuant to a plan-specified procedure. 29 U.S.C. § 1102(a)(2); see also Beddall v. State St. Bank & Trust Co., 137 F.3d 12, 18 (1st Cir. 1998). However, the statute also extends fiduciary liability to functional fiduciaries, who are persons that act as fiduciaries (though not explicitly denominated as such) by performing at least one of several enumerated functions with respect to a plan. Beddall, 137 F.3d at 18. Under 29 U.S.C.S. § 1002(21)(A), a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan.
The key determinant of whether a person qualifies as a functional fiduciary is whether that person exercises discretionary authority in respect to, or meaningful control over, an ERISA plan, its administration, or its assets (such as by rendering investment advice). See Beddall, 137 F.3d at 18; O'Toole v. Arlington Trust Co., 681 F.2d 94, 96 (1st Cir. 1982); see also 29 C.F.R. § 2509.75-8, at 571 (1986). The exercise of physical control or the performance of mechanical administrative tasks generally is insufficient to confer fiduciary status, a person is a plan fiduciary only "to the extent" that he possesses or exercises the requisite discretion and control. 29 U.S.C. § 1002(21)(A); see also Beddall, 137 F.3d at 18.
An ERISA fiduciary, properly identified, must employ within the defined domain "the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use." Id. (quoting 29 U.S.C. § 1104(a)(1)(B)). The fiduciary should act "solely in the interest of the participants and beneficiaries," and his overarching purpose should be to "provide benefits to the participants and their beneficiaries" and to "defray reasonable expenses of administering the plan." Id. (quoting 29 U.S.C. § 1104(a)(1)). A fiduciary who fails to fulfill these responsibilities is "personally liable to make good to [the] plan any losses to the plan resulting from... such breach." Id. (quoting 29 U.S.C. § 1109(a)).
Reads like a beautiful nutshell summation of the law of fiduciary duty under ERISA, doesn’t it?
Nutshells, by the way, for you non-lawyer readers, are relatively brief condensations of particular areas of the law that multiple generations of law students have read instead of law textbooks themselves, which not only often run the length of “War and Peace” but are also often as comprehensible as that classic - in its original Russian.
Is Subprime the New Stock Drops?
Permalink | The consensus in the legal community, and I don’t think it is just because they are looking hopefully for a new flow of work, has for awhile now been that fund investment losses resulting from exposure to the subprime mortgage mess will eventually generate substantial ERISA related litigation. There are plenty of avenues for these cases, not the least of which is plans and their fiduciaries bringing suit against investment advisors or investment funds for losses suffered by the plans on the theory that the advisors and funds improperly exposed the plan to such losses. This article here, out of the Boston Globe, provides a good example of exactly this line of litigation, detailing extensive losses to pension plans from investing in what were supposed to be conservatively managed bond funds at State Street. Here’s the overview provided by the article:
Institutional money manager State Street Corp. now faces three lawsuits over its management of bond funds that were touted for their conservative investment strategies, yet posted losses over the summer because of risky holdings tied to the subprime mortgage industry . . .The latest lawsuit was filed last week in federal court in Boston by Nashua Corp., a Nashua, N.H.-based maker of paper and imaging products, against State Street's investment arm, State Street Global Advisors. . . Nashua lost $5.6 million by investing company pension funds in State Street's Bond Market Fund, due to the fund's ’overexposure in mortgage-related securities,’ according to the lawsuit. Nashua's complaint seeks class-action certification, which could allow other companies that invested in certain State Street funds to join the case.
Perhaps of even more interest on this front is the complaint that was filed a few weeks ago in the Southern District of New York by Unisystems, Inc. Employees Profit Sharing Plan, an ERISA governed plan, alleging substantial breaches of fiduciary duties under ERISA by State Street related to the bond funds it managed that the Unisystems plan and other plans invested in. The complaint seeks to be certified as a class action, and was brought by the Keller Rohrback firm, which looks to be on its way to becoming the Milberg Weiss (sans the indictments) of ERISA class action litigation. The complaint itself in that case, which you can find right here, is a terrifically detailed, step by step overview of the subprime mortgage problem, how it impacts ERISA governed plans, and the fiduciary exposures which that credit crisis has created - at least in theory so far - for investment managers and other ERISA plan fiduciaries. If nothing else, it gives you the whole story of this line of potential liability for ERISA fiduciaries.
And the scope of this area of liability and potential litigation involving ERISA plans is as big as you would expect. State Street notes that:
the problematic [State Street] funds [at issue in these lawsuits] amounted to a small fraction of the $244 billion in fixed-income funds it manages. About $36 billion of that total is actively managed -- as opposed to passive funds that track indexes. The proportion exposed to subprime mortgages amounted to $7.8 billion as of June 30, and just $2.6 billion as of Sept. 30.
Well, you know what? That’s still billions of dollars of investments at issue, and that’s only involving one potential defendant in these cases. As the old saying in politics goes, a billion here, a billion there, and pretty soon you are talking about real money.
ERISA, Investment Strategies and the Duty to Investigate
Permalink | ERISA litigation, particularly in the area of retirement benefits, is one of those areas of the law that can be particularly complicated because both the governing body of law and the underlying fact pattern to which it is applied can be tremendously complex. Take, for instance, the example of disputes over whether the fiduciaries of a retirement plan erred in selecting investments for the fund. This example, as you have probably guessed, is not chosen at random, but instead because Susan Mangiero has this interesting post here on a particular equity investment strategy involving short selling, and on the question of whether such an investment strategy by a retirement fund would be prudent or instead a breach of fiduciary obligations. The strategy itself is relatively complicated, at least to anyone approaching it from outside the investment world, and so too is the question of how it compares to other investment tools the fund could have selected. Fortunately for those of us who litigate such questions, the rules of evidence allow those questions to be answered in court by the use of experts who actually know these points inside and out and can comment on them in depth. These underlying factual details are ones that must be considered in passing on whether a fiduciary breach has occurred before even getting to the question of how a particular investment strategy fits within the fiduciary obligations imposed by ERISA.
After mastering the details of the investment strategy at issue, one then still has to evaluate whether its use was a breach of fiduciary duty under the law of ERISA. I am quoted in Susan’s post on the fact that this in turn depends heavily not so much on whether the investment strategy itself was sound, but more on whether the approach taken by the fiduciaries to selecting that investment strategy was sound. As Susan discusses in her post, this in turn depends very much on whether the fiduciaries sought sufficient outside expertise on the particular type of investment strategy at issue to allow a third party looking in on the decision making after the fact - such as a judge or a jury - to say that the fiduciaries fully considered the merits of the particular type of investment in question before investing and thus did not breach their fiduciary obligations, even if the investment went south.
What struck me about this duty to investigate, for lack of a better phrasing, is that the obligations of the fiduciaries in this regard in many ways mimic the approach of the ERISA litigator handed a case after the fact involving the particular investment strategy and the question of whether its use was a breach of fiduciary duties: the ERISA litigator at that point brings in independent experts to advise on the appropriateness relative to the market of using that particular investment strategy, and bases a defense to a large extent on testimony from such experts that the investment strategy was sound. The fiduciaries themselves, however, could have effectively deflected claims of breach of fiduciary obligation in selecting the investment strategy in the first place by doing the same thing before ever making the investment; retaining outside experts to render this opinion prior to making the investment provides a strong defense against claims that the fiduciaries breached their obligations by making the investment. Indeed, contemporaneous reliance on outside, independent expertise to evaluate investment strategies is perhaps the best steps a retirement plan can make to head off potential claims of breach of fiduciary duty involving the selection of investments.
In this way, the question for fiduciaries and the plans they serve becomes as much as anything one of pay me now, or pay me later. They can avoid problems by paying for independent advice and investigation before making investments, or they can pay for the same advice later in defending themselves if they are sued. As a litigator, obviously, I am happy to retain experts and resolve the problem after the fact; as a counselor, though, I would always recommend the preemptive approach of obtaining such expertise before selecting a particular investment strategy.
Determining Fiduciary Status: And the Computer Says . . .
Permalink | Fiduciary status is the touchstone of the law of ERISA. From that status flows many of the obligations that ERISA can impose on a party, as well as extensive potential liability. For those of you wondering about who is a fiduciary and when for these purposes, Susan Mangiero has found a really fun (well, if you like this stuff, anyway) toy, the Department of Labor’s ERISA Fiduciary Advisor, an on-line tool for identifying whether or not someone has achieved fiduciary status for purposes of ERISA. Kind of like computer gaming for the ERISA set.
Number of Suits + Questionable Practices = X
Permalink | I have talked, certainly more than once, about the fact that the law governing fiduciary obligations in the realm of retirement plans is evolving, and most recently I commented on how it looks as though the Supreme Court is poised to weigh in on the direction of this evolution in the case law. Some of the evolution of the law in this area, it seems, is being driven simply by numbers. Susan Mangiero, author of the blog Pension Risk Matters, pointed out in a recent interview that we are seeing somewhere around 250 to 300 new lawsuits filed per quarter involving the liabilities of pension fiduciaries, mostly involving private company plans. As numbers of suits go up, simple experience tells us the courts will face new issues, or old issues under new fact patterns, and will issue rulings that advance the ball on what the shape of the law should look like in this area as a result. But the evolution is also driven, I think, by another issue I have commented on before, which is that, with pensions being replaced by 401(k) plans in which the employee bears all the risk, plan participants are motivated by that change to protect themselves against poor practices and oversights by those in charge of their retirement investments. And experts on the subject of pension governance suggest that they have good reason to concern themselves with these issues: Susan Mangiero points out in the same interview that pension governance practices quite simply leave a lot to be desired.
If there has ever been a roadmap to the evolution of a particular body of law, its right here in this scenario: more suits plus questionable practices by the targets of the suits.
More on Whether Socially Conscious Investing Is a Breach of Fiduciary Duty
I have raised before the question of whether so-called socially conscious investing would be a breach of fiduciary duty if undertaken by a pension plan or 401(k) fiduciary. The National Law Journal has a neat opinion piece by law professor Edward Zelinsky right now to the effect that it would be. Here’s a link, although you may have to be a subscriber to access it. Either way, I think I am going to exercise my fair use rights under copyright law, and quote the professor’s conclusion on this particular point:
Inconvenient truth no. 3: Social investment dilutes fiduciary standards. Divestment for worthy causes, like other forms of social investing, opens the door to less noble uses of public pension funds by diluting the fiduciary standards governing pension trustees' investment decisions. Suppose that a group seeks to use public retirement assets to support the Hamas-dominated regime in Gaza. There are, of course, persuasive distinctions between an anti-Sudan investment policy and a pro-Hamas policy. However, politicizing public pension investments for good causes will invariably turn such pensions into battlegrounds as others seek support for their causes, not all of which will be attractive.
Instructive in this context are the traditional standards of fiduciary conduct including, in Benjamin N. Cardozo's famous formulation, "the duty of undivided loyalty." The insight animating this formulation is convincing: It does not matter if a fiduciary (like a public pension trustee) dilutes his loyalty to beneficiaries' welfare for a commendable cause. Once fiduciaries weaken that loyalty by considering any objective other than the well-being of their beneficiaries, the door is opened to causes that may not be meritorious. Even if trustees only pursue estimable objectives, they pursue such objectives with others' money, i.e., retiree's retirement resources.
I discussed in an earlier post an academic paper by a different professor arguing to the contrary, and you can find that here. So now you have both sides of the coin, and can make your own call. For me, though, I will return to my own roots - and initial instincts - as a litigator, and repeat something I have said before: if representing a client sued for breach of fiduciary duty, I’d rather be in the position of defending an investment strategy that called for maximum possible returns than one calling for only the maximum possible returns available by investing in good doobie companies.
Reinsurance and LaRue, All in the Same Post
Permalink | Instead of posting twice in the same morning, I am going to try to address two distinct substantive issues, one involving reinsurance and the other ERISA, all in the same post, hopefully without turning this post into some sort of Frankenstein monster combination of topics that instead should have been kept entirely separate.
On the first, ever wonder why so many reinsurance companies are domiciled in Bermuda? I thought so. The New York Times has an excellent article today explaining why, and as one might have guessed, it has to do with taxes. As the New York Times sums up the matter:
At issue are federal rules that allow insurance premiums to be shifted from the United States to offshore affiliates — which reduces taxes — and allow the proceeds to be invested tax free, increasing the profit to parent companies. . . .The core of the dispute is an unusual tax treaty with Bermuda. It allows insurance companies based on the island to deduct from their American taxes premiums that their subsidiaries in the United States collect from American customers and send back to the headquarters abroad. In Bermuda and other tax havens, the money is invested tax free. This money is moved, under the law, through the purchase of reinsurance by the affiliates from their parent companies.
Personally, I really like Bermuda and have long wanted to have reinsurance clients there that would justify my opening an office in Bermuda, which I suspect influences my views on this issue, and so I will therefore keep them to myself.
The second is an ERISA issue, involving the Supreme Court’s decision to hear LaRue v. DeWolfe, Boberg and Associates. This case, which I discussed here and here, involves whether a plan participant can sue under ERISA to recover losses suffered only in that participant’s account, and not across the plan as a whole. As I discussed here, it makes sense that a participant can do so and I expect the Supreme Court to rule to that effect. The defendants, in an attempt to avoid the Supreme Court ever reaching this issue, moved to dismiss the appeal as moot on the ground that the plaintiff had cashed out of the plan and therefore cannot proceed with a claim against the plan for losses incurred in the plaintiff’s now cashed out account; whether such cashed out participants can proceed with such cases is something of a hot topic that has been decided in differing ways by trial level judges in the federal system, including by judges sitting in the same federal district court, as I discussed here. Well, Workplace Prof and SCOTUSBLOG are reporting that the Supreme Court has denied the motion to dismiss on that ground and the Supreme Court will go ahead and hear the case.
There, I did it - two items on two different issues, all for the price of one admission.
Some Thoughts on Behavioral Economics, 401(k) Plan Architecture and the Potential Liabilities of Fiduciaries
Permalink | I have blogged before about behavioral economics, and the question of whether how we structure retirement investment choices will affect whether plan participants successfully save for retirement. Two recent articles really drive home this point. In the first one, “Choice Architecture and Retirement Savings Plans,” the authors posit that the design of 401(k) plans will in fact affect retirement savings and investment choices. Here is the abstract, which lays out their thinking:
In this paper, we apply basic principles from the domain of design and architecture to choices made by employees saving for retirement. Three of the basic principles of design we apply are: (1) there is no neutral design, (2) design does matter, and (3) many of the seemingly minor design elements could matter as well. Applying these principles to the domain of retirement savings, we show that the design of retirement saving vehicles has a large effect on saving rates and investment elections, and that some of the minor details involved in the architecture of retirement plans could have dramatic effects on savings behavior. We conclude our paper by discussing how lessons learned from the design of objects could be applied to help people make better decisions, which we refer to as “choice architecture.”
In the second, "Individual Account Investment Options and Portfolio Choice:
Behavioral Lessons from 401(K) Plans," the authors present the honestly fascinating finding that as 401(k) plans disproportionately add higher cost actively managed funds to their menu selections, plan participants move disproportionately into those funds instead of into less expensive alternatives that are also present in the menu of investment choices available to them in their plans, with the result that plan costs increase and participants’ returns on investments decrease. Here is the abstract from their paper, more extensively describing the authors’ findings:
This paper examines how the menu of investment options made available to workers in defined contribution plans influences portfolio choice. Using unique panel data of 401(k) plans in the U.S., we present three principle findings. First, we show that the share of investment options in a particular asset class (i.e., company stock, equities, fixed income, and balanced funds) has a significant effect on aggregate participant portfolio allocations across these asset classes. Second, we document that the vast majority of the new funds added to 401(k) plans are high-cost actively managed equity funds, as opposed to lower-cost equity index funds. Third, because the average share of assets invested in low-cost equity index funds declines with an increase in the number of options, average portfolio expenses increase and average portfolio performance is thus depressed. All of these findings are obtained from a panel data set, enabling us to control for heterogeneity in the investment preferences of workers across firms and across time.
In other words, the architecture - or layout of investment choices - in a given 401(k) plan actively affects how participants invest, with the result that adding too much of the wrong kind of choices - in the view of these papers, actively managed high cost funds - negatively affects performance, even though the plans do not preclude participants from investing in better choices that are available to them in the plan and which would reduce expenses to them and increase the return in their portfolios.
The first question that jumps out at me from all of this concerns why such higher cost funds are added to menu choices more often than are lower cost, less actively managed choices. Is it because, given the fee structure, the fund companies have a greater incentive to sell those funds, and to convince the administrators and sponsors of 401(k) plans to include those funds in their roster of choices? And the second question that pops up is, if adding such funds is known to decrease returns even if the administrators also include less expensive choices in the investment menu, then is it a breach of fiduciary duty to overload the menu selections with higher cost choices? In essence, if the design of the plan itself will subtly affect the returns in this way, then don’t sponsors, advisors and administrators -at least those who rise to the level of a fiduciary, functional or otherwise, for purposes of ERISA - commit a breach of fiduciary duty if they don’t push back against fund companies’ pitches to include a disproportionate number of costly investment choices and don’t prevent the architecture of their plans from becoming distorted in this manner?
These questions raise a multitude of issues, including how far plan fiduciaries should really have to go to protect plan participants from themselves. For instance, if the plan gives the participants the choice to invest in lower cost funds, isn’t that enough? Should the plan’s fiduciaries really be responsible for decisions by participants to allocate their investments into other, higher cost options? But at the same time, one can certainly argue that it is proper for the fiduciaries to bear the responsibility of making sure that menu selections will not lead to reduced performance because they include a disproportionate amount of high cost options, when: (1) it is a given that most participants will not be sophisticated enough to effectively allocate across both low cost and high cost choices in the most effective manner possible; (2) it is known that inclusion of too many high cost investment choices in a menu will drive down returns; and (3) it is the fiduciary who is in the best position to avoid overloading menus with higher cost products, and who has the ability to bring in advisors to prevent this type of overloading of the investment selection menu to the detriment of participants and their return on investments.
More Education is Always Better than Less: American Conference Institute's Upcoming Seminar on 401(k) Risks
I mentioned in yesterday’s post that my goal for the week was to move rapidly through several items that had caught my attention over the last week or so, and that I wanted to pass on to readers of this blog. I thought the next one I would mention is this conference in New York in December, sponsored by the American Conference Institute, on litigation and regulatory issues related to 401(k) plans. The subject matter of the conference ranges across the hottest topics in litigation and potential exposures for sponsors and fiduciaries of 401(k) plans, including stock drop litigation, excessive fee issues, and in a topic that hits both primary subjects of this blog, insurance coverage for fiduciary liability risks. Here’s the brochure for the conference.
401(k) Plans and Increasing Liability Risks for Fiduciaries
Permalink | Coming off the holiday weekend, I have a long list of items I want to pass on or talk about. I will try to put up as many as I can over the next few posts, to work through the backlog. I thought I would start with this one, because it ties two of the items together. Susan Mangiero of Pension Governance and the Pension Risk Matters blog, passed along this article on last week’s decision by Judge Tauro that I blogged about here, holding that cashed out participants in a 401(k) plan could sustain breach of fiduciary duty claims, a finding contrary to that of some courts - including at least one by another judge sitting in the same district as Judge Tauro - but supported by the holdings of some other courts.
What I liked about the article, aside from the fact that it adds some further discussion about the case and the issues it presents to that contained in my earlier blog post on the case, is the article’s comment that the case is likely part of “a trend that will result in most courts following suit.” An animating theme of my posts and thinking on ERISA litigation concerning defined contribution plans such as 401(k) plans is that we are in the process of watching the case law evolve to hand more protections to plan participants, with a corresponding growth in the potential liability exposure of plan fiduciaries. As the world shifts from a defined benefit world - read pensions - to 401(k) plans, the law of ERISA is going to shift with it to better protect investors in those latter types of plans. For the first thirty years or so of the development of ERISA jurisprudence, defined contribution plans were simply not that important and the unique concerns of those plans - such as what becomes of the rights of cashed out plan participants, the issue addressed by Judge Tauro last week - played a relatively peripheral role in the development of ERISA jurisprudence. That is all changing and changing quick. Moreover, we can expect that evolution in the law to proceed with real force for some time, given the expected exponential growth in assets held in 401(k) plans. On this last point, three economist authors have done the heavy lifting, and document this point in this paper, as summarized in the abstract of their article:
Over the past two and a half decades there has been a fundamental change in saving for retirement in the United States, with a rapid shift from employer-managed defined benefit pensions to defined contribution saving plans that are largely controlled by employees. To understand how this change will affect the well-being of future retirees, we project the future growth of assets in self-directed personal retirement plans. We project the 401(k) assets at age 65 for cohorts attaining age 65 between 2000 and 2040. We also project the total value of assets in 401(k) accounts in each year through 2040 and we project the value of 401(k) assets as a percent of GDP over this period. We conclude that cohorts that attain age 65 in future decades will have accumulated much greater retirement saving (in real dollars) than the retirement saving of current retirees.
Follow the money is always a safe bet. As the majority of Americans’ individual savings move into 401(k) plans, the law governing those plans is going to shift with it.
Another View on Whether a Cashed Out 401(k) Participant Has Standing to Sue for Losses Under ERISA
Permalink | Judge Tauro, of the United States District Court for the District of Massachusetts, has weighed in lately on some of the more cutting edge and currently unsettled issues in ERISA litigation, such as the impact of ERISA preemption on the powers of a state agency. This week, he ventured into the now hot topic of whether a plan participant who has cashed out of a 401(k) plan has standing to sue for breach of fiduciary duty, in this instance for imprudently investing in allegedly inflated company stock. In the decision, involving a putative class action against Boston Scientific, the judge surveyed case law from other jurisdictions on the issue and broke from the opinion of another judge of the circuit, who had found that such a participant, once cashed out, lacked standing to bring a claim for benefits. Judge Tauro reviewed case law from other circuits to the contrary, and elected to follow those rulings.
The cases relied upon by the judge are an instructive lot, and almost a road map for briefing this issue when arguing in favor of standing for such a cashed out participant:
More persuasive is the reasoning of the Seventh Circuit, which recently reached an opposite outcome and found that a plan participant did have standing, despite having cashed out of the plan. [The Seventh Circuit found that] "[b]enefits are benefits; in a defined-contribution plan they are the value of the retirement account when the employee retires, and a breach of fiduciary duty that diminishes that value gives rise to a claim for benefits measured by the difference between what the retirement account was worth when the employee retired and cashed it out and what it would have been worth then had it not been for the breach of fiduciary duty." The Third and Sixth Circuits have adopted this line of reasoning as well. Also instructive is the analysis by Judge Hall in the District of Connecticut: “[T]he court is puzzled by the . . . assertion that a claim for benefits lost due to imprudent fiduciary investment becomes a claim for damages once the plaintiff accepts a lump sum payment constituting the balance of her account with the relevant plan. . . . Regardless of whether [the participant] accepted or refused the balance of her account, her underlying claim would still be for the money lost by the Plan as a result of the defendants' imprudent investments. The court sees no logical reason why such a claim seeks an ascertainable benefit when the plaintiff refuses a lump sum, but the very same claim seeks an unascertainable damage award once the plaintiff accepts a lump sum.”
I Got Them Low Down No Good Pension Blues
Permalink | On the first Monday morning in August I expect things to lighten up with lots of people on vacation and the like, so I scheduled a breakfast meeting this morning right in the middle of one of Massachusetts’ most congested highways (well, not really in the middle of the highway, more like at a restaurant off an exit off of one of the most congested highways), on the theory traffic would be lighter than usual. It wasn’t. But I still think August should be a lighter month, so today’s blog posting is musical. Here is a link to the song “Pension Tension Blues,” courtesy of Pension Governance. What is “Pension Tension Blues”? Pension Governance describes it thusly:
Inspired by those who bring attention to serious issues through humor, Dr. Susan M. Mangiero, [Pension Governance] president and founder, and Mr. Steve Zelin, the Singing CPA have co-created a (hopefully) memorable ballad about the state of affairs in pension land. Mangiero adds "Pension Governance, LLC is committed to helping fiduciaries do a better job of identifying, measuring and managing financial risk. We hope the song is a friendly reminder of the hard work ahead."
Functional Fiduciaries in the First Circuit
Permalink | I am kind of fond of this recent disability benefits case out of the United States District Court for the District of Maine for one particular reason, namely its discussion of functional fiduciaries, and thought I would pass it along as a result. Confronted with the question of whether Metropolitan Life, the administrator, was a fiduciary or possessed fiduciary authority with regard to benefit determinations, the court explained that although Metropolitan Life was not the Plan Administrator or a "named fiduciary" within the meaning of ERISA, the plan language clearly gave it authority that would render it a fiduciary. While there is nothing particularly out of the usual or fascinating about that finding, I liked the court’s further citation of the First Circuit’s recognition of the doctrine of functional fiduciaries as further support for its finding. The court noted that:
The First Circuit has recognized that ERISA's fiduciary duty provisions extend to "functional fiduciaries--persons who act as fiduciaries (though not explicitly denominated as such) by performing at least one of the several enumerated functions with respect to a plan." Beddall v. State Street Bank and Trust Co., 137 F.3d 12, 18 (1st Cir. 1998). "The key determinant of whether a person qualifies as a functional fiduciary is whether that person exercises discretionary authority in respect to, or meaningful control over, an ERISA plan, its administration, or its assets." Id.
In the disability benefits field, where many of the insurers and administrators are highly experienced, plan documents are usually clear as to who is playing what fiduciary role and who has discretionary authority, but in other cases, such as smaller self-managed plans or involving smaller third party administrators, the controlling plan documents often do not address the role of every person or service provider involved in the operation of the plan. In those cases, the functional fiduciary analysis can be quite handy in understanding the role of the players involved in the administration of the plan, and the possible liabilities of each as well.
The Interrelationship of Suits for Benefits and for Breach of Fiduciary Duty Under ERISA
Permalink | If it seems like I have been digressing a lot these past couple of weeks off of the primary topics of this blog and into other areas that interest me - such as the billable hour system - or that I practice in, like intellectual property litigation, it is because the courts of the First Circuit have been fairly quiet with regard to ERISA issues since the First Circuit issued its opinion in this case a few weeks back in which I represented the prevailing parties. Things change quickly in the forest, though, and the courts in this circuit have begun speaking again on ERISA issues. The United States District Court for the District of Puerto Rico has now provided this nice, handy summary of why an individual plan participant whose benefits have been terminated must bring solely a claim for benefits, and cannot press forward with an alternative theory for breach of fiduciary duty. In the words of the court:
ERISA recognizes two avenues through which a plan participant may maintain a breach of fiduciary duty claim: (1) a Section 502(a)(2) claim to obtain plan-wide relief, see 29 U.S.C. § 1132(a)(2); and (2) an individual suit under Section 502(a)(3) to obtain equitable relief, see 29 U.S.C. § 1132(a)(3). Cintron [the plaintiff] does not seek plan-wide relief. Consequently, ERISA authorizes her breach of fiduciary duty claim only if she seeks "appropriate equitable relief." 29 U.S.C. § 1132(a)(3); Varity Corp. v. Howe, 516 U.S. 489, 512, 116 S. Ct. 1065, 134 L. Ed. 2d 130 (1996); Watson v. Deaconess Waltham Hosp., 298 F.3d 102, 109-10 (1st Cir. 2002); Larocca v. Borden, Inc., 276 F.3d 22, 27-28 (1st Cir. 2002). The Supreme Court of the United States has described Section 502(a)(3) as a "safety net" that provides appropriate equitable relief for injuries that Section 502 does not elsewhere adequately remedy. Varity, 516 U.S. at 512. Section 502(a)(3), therefore, does not authorize an individualized claim where the plaintiff's injury finds adequate relief in another part of ERISA's statutory scheme. Id. at 512, 515; see also Watson, 298 F.3d at 112-13; Larocca, 276 F.3d at 27-28; Turner v. Fallon Cmty. Health Plan, 127 F.3d 196, 200 (1st Cir. 1997). Following Varity, "federal courts have uniformly concluded that, if a plaintiff can pursue benefits under the plan pursuant to Section [502(a)(1)(B)], there is an adequate remedy under the plan which bars any further remedy under Section [502(a)(3)]." Larocca, 276 F.3d at 28.
Section 502(a)(1)(B) provides Cintron the opportunity to obtain redress for the injury she alleges to have suffered--a wrongful termination of her benefits. If the defendants wrongfully stopped paying her benefits, Section 502(a)(1)(B) provides an avenue through which she may recover benefits due. She may not seek relief for the same injury under Section 502(a)(3). . . .Thus, she may not maintain a claim for breach of fiduciary duty under Section 502(a)(3).
As some of you know from other posts, I like to collect handy summaries like this to insert into future briefs in appropriate spots, and I pass this one along to anyone who may want to do likewise. The case is Cintron-Serrano v. Bristol-Myers Squibb P.R., Inc.
High Cost Investments, Payments to Sponsors, and the National Education Association
Been away from the desk for a few days, but not away from my reading, and there’s been a whole series of things in the media that may be of interest to those who read this blog that I have meant to pass along and comment on. I am going to try to post frequent but shorter notes for the next day or three until I cover them all, starting with one that most clearly and directly falls within the jurisdiction of this blog, concerning the payment of fees to a quasi-retirement plan sponsor. Many of you may have already seen the story, from the New York Times, which concerns payments received by the National Education Association from financial firms whose investment products it recommended to members. As the article explains:
A lawsuit filed last week in federal court in Washington State contends that the National Education Association breached its duty to members by accepting millions of dollars in payments from two financial firms whose high-cost investments it recommended to members in an association-sponsored retirement plan. The case was filed on behalf of two N.E.A. members who had invested in annuities sold by Nationwide Life Insurance Company and the Security Benefit Group. It contends that by actively endorsing these products, which carry high fees, the N.E.A., through its N.E.A. Member Benefits subsidiary, took on the role of a retirement plan sponsor, which must put its members’ interests ahead of its own. By taking fees from the two companies whose annuities N.E.A. Member Benefits recommended to its members, the N.E.A. breached its duty to them, the suit contends.
The article goes on to explain some tricks and twists that the plaintiffs face in trying to press their suit against the N.E.A. related to the payments and the high cost products, namely that the plaintiffs need to shoehorn the case into ERISA by arguing that “because the N.E.A. actively promoted the annuity products to its members, it essentially stepped in as a plan sponsor [thereby making] it subject to Erisa’s fiduciary duty requirements.”
With regard to this problem, concerning the plaintiffs’ need to figure out the best manner to structure their lawsuit, what you are really seeing is the problem of forcing a square peg into a round hole. I have argued in other posts that, as we move decisively from a defined benefit plan world to a defined contribution world, and thereby make plan participants the bearers of all the risks of their retirement investments, we need to simultaneously provide those plan participants with the legal protections and tools to manage those risks, including the types of risks alleged in this case, of misleading investment recommendations, undisclosed payments, and excessive costs.
I hope to keep an eye on this case going forward, as it may provide an excellent window on the question of whether, and if so how, the law can evolve to deal with these changes in the real world environment in which people now must prepare for retirement.
Why You Can Never Generalize When Considering Whether Brokers Are Plan Fiduciaries
Permalink | A couple of loyal blog readers have commented that I have veered off a good bit on digressions this past couple weeks, and I can’t deny it - maybe it’s a lawyer’s version of a summer fling. Anyway, today I return to a central focus of this blog, ERISA and, in particular today, investment advisors and their potential liability as fiduciaries. This law firm newsletter, passed on by the Workplace Prof, has a nice discussion of the question of when a broker or other investment advisor to a defined contribution plan (and I suppose a defined benefit plan as well) crosses the line, by rendering professional services to the plan, into the dangerous realm of being deemed a fiduciary. The Prof highlights the following discussion from the newsletter:
[T]here are lawsuits and NASD arbitrations claiming that brokers have become ERISA fiduciaries. They are, in the main, based on allegations that the brokers gave investment advice. The cases are usually filed by the plan sponsor or its fiduciaries (e.g., the responsible officers, the committee or the trustee) to recover investment losses. Some of those cases are won by the plans and others are won by the brokers. The legal issue is whether the broker made investment recommendations that rose to the level of ERISA-defined “investment advice,” which is different than either the securities law definition or the conversational meaning of those words. Stated slightly differently, ERISA did not make every broker a fiduciary, nor did it turn every investment recommendation into fiduciary advice. Instead, ERISA and the DOL regulations crafted a specific and limited definition of fiduciary investment advice.
This is a nice summary of the point addressed in the newsletter, but as one of my law school professors liked to say whenever someone stopped after the first part of a holding, you need to read on. When you go the newsletter itself, you find that the summary really reflects simply the holding under a particular, and detailed, set of facts from one particular case. And that is exactly as it should be. The determination of whether a particular broker or other financial advisor to a plan became a fiduciary as a result of investment advice rendered to the plan is highly fact specific, and should turn on exactly what events occurred in any one particular case. As a result, one neither can nor should jump to any particular conclusion about the fiduciary status - and accompanying potential exposure - of any particular broker or advisor (or of brokers or advisors as a class) from the newsletter, the case discussed in the newsletter, or the Prof’s post. Instead, it is important to analyze the status of a particular broker on the basis of the exact role played by that particular broker or advisor with regard to a particular plan.
Me and LaRue, and Business Insurance Too
Permalink | There is an article in Business Insurance magazine this week, the June 25th issue, on the Supreme Court accepting review of the LaRue decision, in which I am quoted. The article is here - subscription required - and if you read it, you will note that it ends on my comment that I expect the Supreme Court to overturn the Fourth Circuit. A short article intended really just as a little news blurb on the subject for the benefit of the magazine’s business management oriented readership, the reporter did not have the space to go into why I think the Court will overturn the lower court decision, but I, obviously, have the space to do so here. So to the extent anyone is interested in the question, here’s my thinking.
First, I don’t really expect the Court to do much, if anything, with the question of the scope of equitable remedies issue. If anything, given the language of the statute, despite the fact that many people want the Court to expand individual remedies and available damages under ERISA - including, I have found in my litigation practice, many District Court judges who are displeased with the limitations of the statute but nonetheless consider themselves duty bound to enforce its restrictions on recovery - the Court has probably read the range of equitable relief that can be pursued in as broad and pro-plaintiff a manner as the language allows, with its test of whether the relief sought would be equitable or not way back in the days of the divided bench. There simply isn’t much more you can do with the statute’s restriction of recovery in certain circumstances to equitable relief unless you are simply going to ignore the actual language of the statute and rewrite it by judicial fiat, which this Court certainly isn’t going to do and arguably, the thinking of Ronald Dworkin and his heirs aside, no court should do.
In a way, this issue is a perfect parallel to a long running and common problem in the insurance coverage field, in which there was an oft litigated dispute over whether insurance policies, because they only cover claims for damages, cover lawsuits seeking equitable relief, the issue being that the policies only cover damages and equitable relief is something different than damages. In both insurance coverage and ERISA cases - such as LaRue - the simple fact of the matter is that equitable relief does mean something particular, something that is different than a claim for damages, and the question is what is the impact of that difference.
Second, with regard to the more fundamental question of whether the individual plan participant could recover just for losses to his account in the plan, yes, I do think the Court will overrule the Fourth Circuit and find that such an individual plan participant can bring such an action. I can never recall whether the saying is that the Court follows the election returns, or is that the Court doesn’t follow the election returns, so I looked it up, and in fact the saying is that they follow the returns, although every author who writes this then adds qualifiers to the comment, such as in this piece here. Either way, the kind of relief sought by the plaintiff in the LaRue case, to be able to enforce his investment instructions in his own retirement savings account, clearly fits with the current Zeitgeist and, more interestingly, is of a piece - and a natural fit with - the changes to retirement savings plans put into place by the Pension Protection Act. Beyond that, the statutory language that is at issue in this part of the case is completely open to either the interpretation selected by the Fourth Circuit, or that sought by the plaintiff, and thus the Court can realign this part of ERISA without doing any violence to the statutory language. Combine these things, and I get a reversal.
Common Misperceptions and The Obligations of Plan Sponsors
Permalink | I wrote, it seems to me, an awful lot over the last couple of weeks on the question of the fiduciary obligations of plan sponsors and others with regard to the investment selections made by pension funds and the investment choices offered in 401(k) plans. Susan Mangiero has a lot more to say about this in her series of posts - here, here, here and (most recently) here - on the due diligence obligations of fiduciaries when investing plan assets.
One particular issue that constantly comes up in this area is the belief of many employers and plan sponsors that they have satisfied any obligations they may have and have immunized themselves, for all intents and purposes, from liability for breach of fiduciary duty, by hiring an outside company to administer the plan and make investment decisions. Whenever I speak to people who offer investment and other assistance to plan fiduciaries, their need to disabuse fiduciaries, and particularly plan sponsors, of this belief is a constant topic of discussion. Quoting Rick Slavin, an attorney and former regulator, Susan nails down in three sentences why this is not the case:
In his overview of case precedent and enforcement actions, Slavin offered that sloppy, obtuse or incomplete paperwork is usually the beginning of trouble. He reiterated that the use of outside parties does not absolve plan sponsors of their fiduciary duties. Oversight obligations remain.
You know, the simple fact of the matter is that, in all the areas I have litigated cases in over the years, plan sponsors have the easiest ability to preemptively and pro-actively position themselves to defeat an action against them - due diligence, due diligence and more due diligence throughout the life of the pension fund or defined contribution plan will come as close to serving as a silver bullet to protect plan sponsors as exists anywhere in the world of litigation. But plan sponsors who forget that they still have to engage in due diligence in the form of oversight and instead elect to rely simply on the fact that they retained an outside manager effectively forfeit this safe harbor.
An Evolution in Fiduciary Standards Means an Increase in Litigation Risk
Permalink | My email inbox is often inundated with seminar pitches, book offers, and informational material, much of which, even if it looks valuable, I could never get to unless I decide to give up the practice of law and just read all this stuff full time. Fortunately, though, I can cut through the junk pretty quick and spot the diamond in it within minutes of sitting down at my desk in the morning (or, more often than not, while remotely surfing my inbox in the middle of the night).
And here is one such diamond, a really terrific paper on the rapidly evolving nature of the fiduciary standards affecting plan sponsors of defined contribution - most commonly 401(k) - plans and the steps they should be taking as a result. The paper, authored by Laurence Cranch and Daniel Notto of AllianceBernstein, is Evolving Fiduciary Standards for Defined Contribution Plan Sponsors - The Impact of New Thinking About Employee Participation and Investment Selection, and you can find it here.
In short, the authors argue, correctly I believe, that we are not only in an era of rapid change in the standards of care expected of fiduciaries, driven to a large extent by advances in knowledge in the area of retirement investing and the transition from pensions to defined contribution plans, but also in a time of vastly increased litigation threats to such fiduciaries. Perhaps the most interesting part of the paper concerns using the tools provided by the Pension Protection Act, in conjunction with the investment selection thinking that underlies the statute and its enabling regulations, to simultaneously demonstrate prudence on the part of the fiduciary and decrease the likelihood of litigation.
Just a terrific paper, and well worth the time to read it.
Divestment and Fiduciary Duties
Apparently there is something in the air these days about socially responsible investing and the fiduciary obligations of pension fiduciaries. I discussed here, just the other day, the argument that it is not a fiduciary breach to utilize a particular social agenda in investing and the litigation implications of that approach. Susan Mangiero has more to say on the same subject at her blog, Pension Risk Matters, here. I don't know about this one, frankly. I know, as I discussed in my last post on this issue, that the more defensible position, if sued as a fiduciary, is to have stayed out of socially responsible investment in preference for a focus on maximum return investing. But geez, who wants to be the one who says fiduciary obligations preclude avoiding, in the scenario Susan discusses, investments in so-called terrorist countries?
Criminals and terrorists in my last two posts. I don't know, maybe I better get off the ERISA beat and over to the digressions section of this blog, to write about intellectual property for a bit, a subject where, I don't think, I can find any reason to write about such things.
Socially Responsible Investing and Fiduciary Duties
Here’s a little twist on an issue we have often discussed on this blog, namely the fiduciary obligations of plan sponsors and other fiduciaries. To what extent does the fiduciary obligation to properly manage and invest fund assets leave room to consider social, environmental or political agendas in selecting investments? This article, by Benjamin Richardson of York University in Canada, concludes that there is room, within fiduciary obligations, to engage in socially conscious investing. Here is the abstract with his conclusions:
In recent years, pension funds and other institutional investors have begun to give more attention to the environmental and social behaviour of the companies in which they invest. A recent movement for socially responsible investment (SRI) seeks to exclude companies that pollute or ignore human rights, for example, and to champion those that behave ethically and responsibly. However, some confusion among investment decisionmakers persists about the extent to which their fiduciary duties to beneficiaries allow policies that may sacrifice financial returns for environmental or other philanthropic causes. This is compounded by the belief that they cannot secure the best returns in respect of their fiduciary obligations with current socially responsible companies. With reference to the main common law jurisdictions, this article critically examines whether the fiduciary duties of pension fund investors hinder SRI. Contrary to some commonly held beliefs, SRI can often sit comfortably with fiduciary duties to invest prudently. However, legal reforms to improve the climate for SRI would help, as evident by some recent initiatives in several jurisdictions.
Interesting points. But I will tell you, that as a litigator, its always an easier case to make that returns were as high as possible if plan members sue, than to argue that they were as high as possible while still consistent with a reasonably appropriate social agenda. On the other hand, disinvestment movements, of which socially responsible investing can be seen as an heir, have a respected and valued social history, one that, whether or not it can be easily reconciled with fiduciary obligations, should not be disregarded.
Further Thoughts on Beck v Pace
There are a number of reasons I don’t, as I mentioned yesterday, play the game of first to post, in which bloggers race to be first on the scene with a post about a particular subject, not the least of which is that I just plain can’t type as fast as the Workplace Prof, whose detailed and intelligent analysis of yesterday’s ruling by the Supreme Court in Beck v Pace can be found here. Also of interest is this detailed description of the ruling at SCOTUSBLOG by a guest blogger, a summer associate at the firm that sponsors that blog.
Beck presented the question of the extent to which the fiduciaries of a pension plan, that rapidly vanishing dinosaur of the employee benefits world, were obligated to consider merging the pension into a different pension plan instead of terminating the pension by the option of purchasing annuities that would provide the benefits to the participants. The two writers both focus on the fact that the Supreme Court handled the dispute by finding that the fiduciaries actually could not have considered merger, rather than termination, and that the Court, in essence, concluded that this finding resolves the issue presented by the case. As SCOTUSBLOG puts it:
The issue before the Court was whether the decision to terminate a pension plan by purchasing an annuity, rather than merge the plan with another, was a decision subject to ERISA’s fiduciary obligations. This issue, however, was ultimately not decided by the Court, which found that merger is not a permissible method of termination and therefore did not reach the question of what constitutes an “implementation of a business decision to terminate.” Because merger was not a viable option under the statute, Crown [the employer terminating its pension plan] did not need to fully investigate the merger as an option in implementing the termination. In so finding, the Court deferred to the PBGC and the Department of Labor’s view that merger is not a method of termination but rather an alternative to termination, explaining that “to attempt to answer these questions without the views of the agencies responsible for enforcing ERISA would be to embar[k] upon a voyage without a compass.” <
For me, what I take away in particular about the ruling is a particular underlying fact, one that didn’t play a central role in the Court’s reasoning but that the author focused on late in the opinion as additional support for the conclusion that the fiduciary acted within its rights in terminating the plan, and was not subject to the additional merger related obligations that the union sought to impose on it; this was the fact that the employer had diligently and fully funded its pension plans, and its method of termination, although it had the side benefit of freeing up an extra $5,000,000 that would revert to the company and could be used to pay creditors, guaranteed the participants’ retirement benefits. In this day and age, where every day we see companies cutting back on pensions and we regularly see underfunded plans dropped in the lap of the Pension Benefit Guaranty Corporation, I am hard pressed to see how the company in this case could rightfully be faulted for terminating a properly funded pension plan in a manner that would protect plan participants. Too often, the law of ERISA is about cases in which participants are not fully protected, and the question is what remedy they do, do not, or should have - see, for example, the LaRue case. Here we have the reverse - fiduciaries who have fully acted to protect the plan’s participants, even if, by means of the surplus funds being taken out of the plan afterwards, some incidental benefit to doing so flowed to the sponsoring company. The underlying purpose of ERISA - to encourage and protect employee benefits - has been satisfied, so imposing possible exposure on the fiduciaries for not considering still some other approach to the ending of the pension strikes me as fundamentally inconsistent with the statute’s purposes.
The Supreme Court's opinion itself is here.
Supreme Court Rules on Beck v Pace
Permalink | I don’t generally like to play first to post, and would rather wait to see what I can add to the discussion of any particular issue before posting on a breaking story. But as I have been watching and waiting for the Supreme Court’s opinion in the ERISA fiduciary duty case of Beck v. Pace International to be issued, I was quick to read it today when it hit my in box and thought I would pass it along. Hopefully, I will return to it in the next few days - after a hearing tomorrow and a deposition on Wednesday - and talk more about it, because there are some interesting aspects to the Supreme Court’s opinion. In the meantime, here is a quick summary of the opinion from SCOTUSBLOG:
Continuing the pattern of unanimity, the Court ruled in Beck v. PACE International Union (05-1448) that a company that sponsors its own pension plan for workers has no duty to consider merging it with another plan as a method of ending the plan while carrying on the benefits. In this case, the bankruptcy trustee opted to buy an annuity rather than consider merging with an ongoing plan. Justice Antonin Scalia authored the opinion.
You can find the opinion itself here, and some news coverage summing up what the case was about here. My prior posts on the case are here and here.
More on Amaranth and Fiduciaries' Due Diligence Obligations
Permalink | In a post on Friday, I discussed how a large pension fund’s large losses from a hedge fund investment had given rise to litigation between the pension and the hedge fund, as discussed in this post in the WSJ Law Blog, and how it further raised the question of whether the pension plan’s fiduciaries might be liable to plan participants for their failure to properly vet and monitor that investment prior to the large loss. In essence, the question raised by the loss is whether the pension plan simply blindly - or at least half-blindly - invested the plan’s assets in the hedge fund without really understanding why or what they were doing, and was instead simply seeking to goose the pension plan’s returns without sufficient analysis of the risks, in much the same way individual mutual fund investors are often said to simply follow the latest investing trend without really knowing much about it or whether it is right for them.
Interestingly, I am clearly not the only one concerned whether pension fund fiduciaries and others charged with the management of pension assets are sufficiently knowledgeable about hedge fund investing and the ins and outs of any particular hedge fund, as the good folks at Pension Governance have now rolled out a series of webinars intended to educate retirement plan decision makers about hedge fund investing. Information about the series, called the Hedge Fund toolbox, can be found here.
A Thought About Litigation Against Fiduciaries For Hedge Fund Losses
Permalink | We’ve talked a lot on this blog about the due diligence obligations of fiduciaries and other advisors to pensions, 401(k) plans and the like when it comes to investment choices. A story yesterday offers the opportunity for a little thought experiment demonstrating why it matters, and why anything less than stringent oversight and investigation of investment choices will put fiduciary advisors front and center as potential targets of lawsuits.
The WSJ Blog yesterday had this description of litigation by a public employee pension fund against a hedge fund in which it had invested that managed to lose literally billions of dollars, in spectacular and newsworthy fashion:
Amaranth, the hedge fund that lost $6.4 billion in a few days last fall in the worst debacle in the industry’s history, responded today to a lawsuit filed against it in March by the San Diego County Employees Retirement Association, or SDCERA. SDCERA is the only investor to have filed suit against the hedge fund. . . At the time it filed the lawsuit, SDCERA said Amaranth’s collapse resulted from “excessive and unbridled speculation in natural gas futures that was directly contrary to statements made to SDCERA that Amaranth would be diversified and risk controlled.”
Amaranth says SDCERA knew exactly what it was getting into. In its motion, it quotes the funds private-placement memorandum, which read in big bold letters: THE FUND IS A SPECULATIVE INVESTMENT THAT INVOLVES RISK, INCLUDING THE RISK OF LOSING ALL OR SUBSTANTIALLY ALL OF THE AMOUNT INVESTED.
[A lawyer for Amaranth] said in a statement that he hopes “SDCERA will now withdraw its suit and stop wasting the resources of its 33,000 county employees and pensioners on this misguided and ill-fated litigation.”
So here’s the thought experiment to play out, the line of dots to connect. We know we are currently watching the rise of a pension/401(k) investment plaintiffs bar, clearly modeled after the securities litigation class action bar, ready and waiting to sue pension advisors and anyone else in the line of fire for excessive fees, poor investment choices, and anything else that affects returns in the plans. We see here as well in this blog post from the WSJ Blog that Amaranth’s defense to litigation by a pension plan is that the plan and its advisors knew exactly what they were getting into and should take responsibility themselves for the risks they took. Now here is where we connect the dots - if the hedge fund’s lawyers are right, then aren’t the plan’s fiduciaries and other advisors potentially liable for breaching their own obligations to the plan and its participants to properly select and monitor plan investments? And if so, then their best defense should the newly forming class action bar come after them for this mess would be that, contrary to what the hedge fund’s lawyers say, they actually did full and complete due diligence, and therefore lived up to their obligations and cannot themselves be liable for the fact that the investment went south.
And at the risk of sounding like a scold, that, I suppose, is what I would like fiduciaries to take away from the story of the Amaranth collapse, that hedge fund issues can come back on them, and they need to take steps in advance to insulate themselves. Just something to muse over on an early summer weekend at the beach, right?
Excessive Fee Litigation, 401(k) Plans and LaRue
Permalink | The current issue of the National Law Journal has an article providing an excellent overview of litigation over allegedly excessive fees charged on investments in 401(k) plans. The article notes the variations in the theories, and discusses what are likely to be large, class wide actions in the near future. There are those who think these types of claims are going away but, as this article suggests, that doesn’t actually look to be the case.
Now connect the dots between that story and the LaRue case, which I discussed here and about which more can be learned here, in which the Supreme Court is being asked to determine whether a single participant in a 401(k) plan can bring a breach of fiduciary duty claim for breaches that harmed only his account. Right now, with regard to the excessive fee issue, we are seeing, as the National Law Journal article reflects, the development of essentially plan wide suits. But if developments in the LaRue case establish that any individual plan participant can sue for breaches of fiduciary duty affecting that participant’s account, that will change. We will instead have a universe of individual participants, all with the capacity to sue over their own account balance and over any complaints they have that excessive fees drove down the balance of their own accounts over the course of years, and I suspect we will see plenty of lawyers appear who are ready and willing to represent individual account holders in such lawsuits. This will create a different litigation world for fiduciaries, plan sponsors, plan administrators and the like, then the current one in which the real risk is large plan wide actions by specialist plaintiff firms. In its place will be more of a death by a thousand cuts type of litigation regime that will confront plan fiduciaries and their allies.
I am not saying this is necessarily a bad thing, or a good thing. It is what it is. But in at least one way it may well be a good thing. We are all bombarded with the mantra that, in this defined contribution plan world we now inhabit, individuals are now responsible for their own retirement, as opposed to when companies provided it by means of guaranteed pensions. Well, I suppose if we are going to make individual plan participants the risk bearers and care takers of their own retirement funding, the least we can do is provide them with the legal tools to protect their investments.
LaRue v. DeWolff, Losses to the Plan and the Supreme Court
Permalink | SCOTUSBLOG is the NY Times, or maybe - given its focus on one particular field - the Wall Street Journal, of the legal blog world. With the backing of a major international law firm, it brings tremendous resources to its in-depth coverage of all things goings on at the Supreme Court. Cripes, the blog even has its own reporter, to supplement the work of the actual bloggers.
And of course that’s also why I read it, because you know you are not going to miss anything of importance to your own practice area that happens at the Supreme Court. And here, of interest, is their post on the United States Solicitor General’s brief recommending that the Supreme Court hear an appeal from the Fourth Circuit’s decision in LaRue v. DeWolff, Boberg & Associates, which presents the question of whether an individual participant in a 401(k) plan can sue to recover losses from errors by fiduciaries that affected only his or her account in the plan, rather than the accounts of all or most participants in the plan. In dispute is the question of whether it qualifies, first, as a loss to the plan, such that the participant can sue for breach of fiduciary duty, and/or second as equitable relief as the Supreme Court has interpreted that phrase for purposes of ERISA, such that the participant can recover on a separate equitable relief theory.
One thing’s for sure. If the Supreme Court puts its imprimatur on this theory, and makes clear that individual plan participants can sue for their own individual losses in their defined contribution accounts, there will be a whole range of new potential plaintiffs out there, and I am sure plenty of lawyers ready and willing to represent them. At the same time, to be fair, in a world of Enrons and the like, maybe there should be.
The Workplace Prof reads SCOTUSBLOG too, and here’s the prof’s take on these events.
Pension Performance, 401(k) Plans and Breach of Fiduciary Duty Litigation
Permalink | This is an interesting paper, that comes to us via Workplace Prof, and which provokes further thought on the issue of the litigation boom involving 401(k) plans. The paper finds that pension plans outperform mutual funds, and attributes that differential to costs buried within mutual funds, as well as to the size of pension funds, which allows them to negotiate better deals on cost and related issues than would otherwise be the case. If you think about it, exactly that type of action is likewise what is expected of the fiduciaries of 401(k) plans, that they will assert themselves so as to avoid performance being affected by unreasonable fees or by other asset management decisions (such as overloading with company stock). One can think of lawsuits by participants against company 401(k) plans as being, at heart, driven by the failure of plans and their fiduciaries to live up to that high standard. Lawsuits involving excessive fees paid by 401(k) plans are in essence claims for failing to do what this article shows pension plans routinely doing: protecting participants against excessive costs impacting the plans’ returns.
401(k) Plans and Breach of Fiduciary Duty Lawsuits
Permalink | I have written before, and frequently (such as here and here), about the coming boom in litigation against plan sponsors and fiduciaries over alleged excessive fees and other alleged malfeasance in the administration of 401(k) plans. One point I have tried to drive home in my posts, including here and here, is that the best defense to this litigation boomlet, possibly soon to be a boom, is a good offense, in the form of careful, regularly scheduled due diligence with regard to the funds offered in a plan and the fees charged for those funds.
This article, making the same points, by the lawyers at Littler Mendelson, crossed my inbox today. It provides a nice easy to digest overview of the issue, and recommends the same preemptive course of conduct, in the form of these recommendations for due diligence:
Sound advice in my book, and one I - and others - have been recommending for awhile.
What to Do? We believe that there are some actions that employers and plan fiduciaries can take to protect themselves:
•Continually monitor all plan and fund expenses and assure that they have negotiated the best deal for participants, but keeping in mind that fees are only one piece of the fiduciary puzzle; the others include risk, rate of return, and historical performance.
•Periodically review all aspects of the fund selection and monitoring, and document these efforts.
•Be sure that all plan expenses can be determined from documentation provided or made available to participants, and consider providing participants with a separate summary of those expenses.
•Review your service provider agreements, make sure you get legal counsel involved in negotiating those agreements. It is recommended that all 401(k) plan service provider agreements prohibit any undisclosed revenue sharing.
•Ask your plan service providers to provide you with a detailed written description of all plan fees – hard dollar and soft dollar.
•If you believe you may be vulnerable, consider having a legal audit performed on your 401(k) plan.
Beck v Pace International Union
Permalink | Well, my trial’s still ongoing, and I find myself short of time to really comment in any detail on the latest details in the always percolating and never quiet world of ERISA and insurance law. However, I do still find time to continue my own reading on the subject, and so I am able to pass along for your review items that I find particularly interesting. Head and shoulders above anything else on that list right now is this excellent analysis by Workplace Prof blog of the Supreme Court hearing in Beck v. Pace International Union, which concerns the issue of fiduciary obligations with regard to the distribution of a terminated plan’s assets. The analysis is timely, interesting, and probably, in a nutshell, all you need to know about this case until the time the Court actually issues an opinion on the case.
Defined Benefit, Defined Contribution, and The Psychological Effect on Litigants
Permalink | Here is a very neat and interesting paper contrasting defined benefit plans - i.e. pensions - with defined contribution plans - i.e. 401(k) plans - and addressing, in particular: (1) the decline in the former in the workplace and replacement by the latter; and (2) the problems engendered by that change. In essence, the authors argue that the defined contribution plans, as they currently are regulated and operated, simply are not satisfactory replacements for the vanishing pension system, and cannot be counted on to provide an appropriate stream of retirement income for most retired workers. The authors provide suggested changes for both types of plans that, they hope, will make pensions more palatable to employers and 401(k) plans more beneficial to employees.
I have spent a couple days musing on the paper, which was first brought to my attention in this post last week on Workplace Prof, and have a few thoughts to offer, mostly about how the facts and arguments in this paper fit in with the litigation climate involving, in particular, 401(k) plans. What jumps out at me is the central theme of the paper, that pensions are overly regulated and employee contribution plans like 401(k) plans insufficiently regulated, with the result that the latter plans are unlikely to meet the needs of the prototypical employee. And this leads to two thoughts about excessive fee, breach of fiduciary duty and other types of lawsuits against companies sponsoring 401(k) plans and the advisors they retain. First, are the suits driven, at core, by the defined contribution plans' absence of overarching regulation and government protection, placing the onus for policing them on employees and their lawyers, who can be seen to have been forced into serving almost in a “private attorney general” role with regard to such plans? And would this be the case if, like pensions, they were more heavily regulated and backstopped by the government, much like pensions are by the Pension Benefit Guaranty Corporation? And second, echoing a theme I have commented on in the past, to what extent is the litigation driven by the exact problem emphasized in the article, namely that workers cannot confidently assume an appropriate retirement income by relying on 401(k) plans and therefore may rightfully be afraid for their long term economic security? If they didn’t have that fear, and instead were confident in their retirement income, much as - sometimes wrongly - they generally are in pensions, would they be so quick to authorize lawyers to sue in their names?
The Supreme Court's Next Words on Fiduciary Duties and Pension Plans
Permalink | Here is a terrific and in-depth review of the underlying facts and issues in the pending Supreme Court case of Beck v. Pace International Union, which is scheduled to be argued later this month, and which involves the extent, if any, to which fiduciary obligations apply to a decision to terminate a pension plan by purchasing an annuity rather than by merging the plan into other existing plans. Thanks to Workplace Prof for the heads up about this on-line publication out of the Cornell Law School, a source that I don’t regularly follow (but of course, that is what I rely on the Prof to do, to follow academic sites like that in my stead).
On a side note, one of the things that I simply really enjoy about ERISA is that whenever the Supreme Court weighs in on an ERISA issue, we can look forward to years of - usually conflicting - district court and circuit court decisions trying to apply the Supreme Court’s ruling, giving us great material for litigating cases and for blog discussions.
Merger and Anti-Cutback Provisions of ERISA, and a Handy Rule of Thumb
Permalink | This case, out of the United States District Court for the District of Massachusetts, provides a nice little rule of thumb for amending, merging or otherwise altering retirement benefit plans - namely, that it makes it hard to get sued and lose if you make the changes in a way that avoids altering the actual benefit amounts of any given participant. In this case, an employee complained about changes to the company’s retirement plan made as part of a corporate acquisition and about a later change intended to protect other participants’ participation in the plan. The court found that the changes did not violate ERISA’s merger or anti-cutback provisions, as the evidence showed the changes had no adverse impact on the plaintiff’s benefits. In an interesting discussion of the merger and anti-cutback provisions, the court explained that:
Pursuant to ERISA § 208 and I.R.C. § 414(1), when benefit plans are merged, each plan participant must receive benefits immediately after the merger that are equal to the benefits he would have received had his plan terminated immediately prior to the merger. . . .At its core, this merger rule is a simple one, intended to prevent companies from eliminating an employee's previously accrued benefits when merging one benefit plan with another. . . . Much like the merger rule, the purpose of the anti-cutback provisions of § 204(g)(1) of ERISA is to prevent an employer from "pulling the rug out from under employees" by amending its benefit plan to eliminate or reduce a previously accrued early retirement subsidy. Specifically, the anti-cutback rule provides, with certain exceptions not relevant here, that "[t]he accrued benefit of a participant under a plan may not be decreased by an amendment of the plan." 29 U.S.C. § 1054(g)(1). . . .The Act requires that the merger or amendment of retirement plans does not result in a plan that has the effect of reducing an employee's previously accrued benefits.
The court ruled across the board in favor of the defendant, not just on the merger and anti-cutback counts but on all counts pled by the participant, with the decision driven in large part by the fact that the evidence demonstrated that the changes to the plan did not detrimentally alter the benefits available under the plan to the complaining participant.
The case is Gillis v. SPX Corp. Individual Retirement Plan.
Insurance Coverage for Pension Plan Fiduciaries
Permalink | There is an interesting interrelationship between the two primary subjects of this blog, ERISA litigation and insurance coverage, and one that I had not really thought much about until Rick Shoff, who works with Mike Pratico over at CapTrust Financial Advisors, raised it in a conversation recently. As I have mentioned in the past, Mike and his colleagues at CapTrust serve as fiduciary advisors to retirement plans and their sponsors, and he and Rick commented to me about the issue of errors and omissions insurance and the necessary amount of coverage for fiduciary advisors.
Two points came out of our conversation that I thought I would pass along. First, what is the appropriate amount of coverage for a fiduciary advisor under its E&O insurance? What should the relationship be between the limits selected and the amount of assets in the plans that the advisor works with? Obviously, the limits can’t match the asset amounts, as any good advisor is likely advising on plans with assets far higher than the amount the advisor could purchase in E&O insurance, at least not without paying every penny the advisor earns over to the insurance company as premiums (and even then, I doubt limits that high could be obtained). It also would not be necessary, since an advisor’s potential exposure to a lawsuit undoubtedly would never equal the total amount of the assets in a particular plan, but instead would equal only some portion of it that was supposedly affected by an error by the advisor. My own take is that the proper policy limit is somewhere around the amount that would make a plaintiff in a hypothetical claim consider settlement within the policy limits, without trying to obtain an excess verdict that the advisor itself would have to pay.
The second issue that popped up is the range of actors out there who are involved in providing advice to retirement plans, participants and the like. It may well be that not all such companies and consultants, even if they have professional liability or general liability insurance coverage, are actually covered for claims arising out of their role in providing such advice. Many policies, unless they are specifically underwritten to cover a professional engaged in ERISA related activities, contain exclusions for ERISA related claims that would preclude coverage of claims involving ERISA governed plans. As a result, a plan sponsor cannot assume that all advisors to a plan actually have coverage for claims arising out of their activities, and the sponsor must instead actually examine their advisors’ insurance coverage to know whether or not this is the case.
Equitable Relief Under ERISA in the First Circuit Post-Sereboff
Permalink | The district courts in the First Circuit have been so busy issuing ERISA related decisions recently that it has become difficult to find time to post on other things that I also want to talk about. That said, however, the District Court for the District of Maine just issued a remarkable opinion that I both wanted to comment on and to be sure to spotlight. The case is Curran v. Camden National Bank, and it involved the question of whether the defendant bank owed hundreds of thousands of dollars to a multi-employer health care trust upon its withdrawal from the group. There are a few things that are really note worthy about the ruling. First of all, the decision is a nicely crafted survey of the law in this circuit as it currently stands on a number of topics, in particular: the extent to which, after Sereboff, equitable relief is available under ERISA in this circuit; the proper analysis of preemption; and the determination of fiduciary status for purposes of a claim for breach of fiduciary duty.
One could pick the court’s analysis of any of these three issues to focus on, and have plenty to write about, but today I will comment in particular on the court’s discussion of the viability of claims for equitable relief in this circuit after Sereboff, particularly since the court points out that the First Circuit itself has not yet found reason to interpret and apply Sereboff, other than to cite the case for the proposition that “what forms of relief are considered equitable is a matter in dispute.” On this issue, the district court began by providing a handy blueprint for analyzing claims for equitable relief in this circuit, and whether they can proceed without running afoul of Supreme Court precedent. Addressing “29 U.S.C. § 1132(a)(3), which provides [that a] civil action may be brought by a participant, beneficiary, or fiduciary (A) to enjoin any act or practice which violates any provision of this subchapter or the terms of the plan, or (B) to obtain other appropriate equitable relief (I) to redress such violations or (ii) to enforce any provisions of this subchapter or the terms of the plan,” the court stated:
By its terms, however, section 1132(a)(3) authorizes only "those categories of relief that were typically available in equity." Sereboff v. Mid Atl. Med. Servs., U.S. , 126 S. Ct. 1869 (2006) (quoting Mertens v. Hewitt Associates, 508 U.S. 248, 256 (1993) (emphasis in original)). If the plaintiffs seek legal as opposed to equitable relief, "their suit is not authorized by § [1132(a)(3)]." Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204, 218 (2002).
The First Circuit has set forth a two-step inquiry to evaluate a cause of action under § 1132(a)(3): "1) is the proposed relief equitable, and 2) if so, is it appropriate?" LaRocca v. Borden, Inc., 276 F.3d 22, 27-28 (1st Cir. 2002). With respect to the first prong, under ERISA, "'equitable relief' includes 'those categories of relief that were typically available in equity (such as injunction, mandamus, and restitution, but not compensatory damages).'" Id. at 28 (quoting Mertens, 508 U.S. at 256). Turning to the second step, the purpose of § 1132(a)(3) is to serve as a "safety net, offering appropriate equitable relief for injuries caused by violations that §  does not elsewhere adequately remedy." Id. (quoting Varity Corp. v. Howe, 516 U.S. 489, 512 (1996)).
This is a very handy formulation that one can borrow to begin the section of any brief submitted in this circuit arguing over whether or not a particular claim can proceed under this section of ERISA. The court then went on, however, to provide far more analysis and guidance on this issue, explaining how a proper analysis of Sereboff and subsequent history from other circuits established that the plaintiffs were seeking a legal remedy dressed in the clothing of equitable relief, and that the claim therefore could not proceed under this statutory section.
Second of all, the bank’s lawyers did a terrific job here, drawing the court across a diverse range of ERISA issues and convincing the court that none of the plaintiffs’ claims were viable in light of the statute and case law interpreting it. I tip my hat to the bank’s lawyers for a terrific win.
Congressional Hearings on 401(k) Plan Fees and What They Mean for Plan Fiduciaries
Permalink | Wow. Don’t think the heat is on for company 401(k) sponsors and other fiduciaries of employee retirement benefit plans who may not have done enough benchmarking and due diligence to make sure that mutual fund and advisor fees are as low as possible? Then take a look at this article out of the Washington Post about congressional hearings into the issue. The gist of the testimony is to the effect that fees are too high, are not disclosed fully or understood by plan participants, and have a significant impact on returns in the plans. While the mutual fund industry disputes this characterization, anecdotal evidence certainly suggests that at least some significant portion of company sponsored plans suffer from these problems. It would certainly be nice if the sponsors of plans investigated right away whether or not their plans suffer from these defects and, if so, promptly remedied the problems. But for reasons I have discussed before in other posts, doing so would not only be good business and the right thing to do for company employees who participate in such plans, but is also necessary to protect the plan’s fiduciaries from legal exposure. It clearly appears at this point that conducting due diligence to root out these problems and then remedy them - or even better, to find out that the particular plan in question does not suffer from these problems and that there is nothing to remedy - is an essential element of satisfying a fiduciary’s obligations in the operation of these plans, and that the failure to do so is an open invitation for a breach of fiduciary duty lawsuit.
What Happens When Reimbursement of Overpaid Benefits Is Equitable for Purposes of ERISA, but Nonetheless Inequitable?
Permalink | Here is an interesting little twist on the common scenario of a plan overpaying retirement benefits and then seeking reimbursement, as allowed under the plan’s terms, of the overpayment from the plan beneficiary. Normally, these cases are focused on whether the reimbursement qualifies as equitable relief that the fiduciary is allowed to pursue. In this case out of the District Court for the District of New Hampshire, however, the court simply assumed the plan fiduciary could legally obtain that recovery as equitable relief under ERISA, even though the judge commented in the opinion that “the scope of this court’s equitable authority in an ERISA context is not well-defined.”
However, the court then went on to let the beneficiary off the hook (or at least to find a question of fact that precluded an award of summary judgment to the plan), on the theory that the beneficiary could have reasonably believed that he was entitled to receive the overpayments, even though they amounted to many thousands of dollars a month for a number of months beyond the one time lump sum he had elected to receive as his pension benefit, and had changed his position, by spending those funds, in reliance on that belief. The court found that ordering reimbursement from the beneficiary, under those circumstances, could be inequitable, and that the plan could not recoup the overpayments if that were the case.
Of interest, there was one factual quirk that made the case somewhat different than the usual recoupment case where the overpaid beneficiary argues that he or she already spent the money and it would be inequitable to order repayment as a result. There was actually evidence showing that the beneficiary, prior to the time of the request for reimbursement, had performed rough calculations that showed him entitled to a sum significantly larger than he was actually entitled to receive. Although the math was grossly incorrect, the court found that even if his “calculations are inaccurate, the mere fact that he prepared the estimate suggests that he may have reasonably believed that he was entitled to the erroneous payments.” Most of the published decisions where beneficiaries claim they didn’t know they were receiving large payments in error and thus should not have to repay them involve fact patterns where that assertion is simply hard to believe; the court here, rightly or wrongly, was clearly swayed by evidence that placed this case outside of that mainstream.
The case is Laborer’s District Council Pension Fund for Baltimore v. Regan.
Fiduciary Advisors, Due Diligence, and Avoiding Fiduciary Liability
Michael Pratico, a fiduciary advisor to retirement plans throughout New England for Captrust Financial Advisors, and one of my favorite touchstones for real world - i.e. non-lawyer - information about the actual operation of retirement benefit plans, pointed out an interesting conundrum to me the other day concerning the operations of retirement plans and the fiduciary obligations of those who operate them. As I have discussed in other posts, the fiduciary obligations of those who sponsor or administer such plans clearly require, at this point in time and in light of current developments in the law, a certain level of due diligence, requiring at a minimum a regular comparison of fees and other aspects of a 401(k) or other retirement plan to the broader market as a whole.
Michael points out an interesting side effect of this, however, which is that once a plan sponsor or other fiduciary undertakes such due diligence, the plan becomes obliged, for all intents and purposes, to act on any bad news uncovered by the due diligence. What this means is that, yes, the plan sponsor is obligated to do the due diligence, and it seems to me is a sitting duck for a stock drop or excessive fees type suit if it fails to do so based simply on that failure. But that is certainly not the end of it. Instead, it means as well that once the sponsor has done that, if the due diligence shows a disjunct between better results or costs in the market as a whole and what the particular plan is earning or paying in expenses, the plan sponsor or other fiduciary becomes obligated to act on that information and change the plan to address those problems, with the failure to take that step likewise then becoming a legitimate basis for a breach of fiduciary duty lawsuit.
This is what Michael and other fiduciary advisors of his ilk do, take the existing plan, see where it is off base relative to the mutual fund world as a whole, and then recommend how to fix it. Taking both steps, and not either playing ostrich and skipping the due diligence entirely or else doing the due diligence but skipping the action it points out is needed, is really the best way to avoid incurring liability from excessive fee and similar types of claims.
When Is a Plan Administrator a Fiduciary?
Permalink | Here is a fascinating decision out of the federal district court for Rhode Island arising out of a dispute over plan contributions required of a contractor under collective bargaining agreements in the construction context. What I most liked about the case is its discussion of the challenge to the plaintiffs’ standing to bring an ERISA action, on the ground that the plaintiffs were not participants, beneficiaries or fiduciaries of the plans in question. The central issue concerned whether the plaintiffs qualified as fiduciaries for these purposes, and the court’s primary analysis was directed at whether one of the plaintiffs, who was the plan administrator, qualified as a fiduciary.
The district court concluded that it did, and in addressing this issue, provides a terrific synopsis of the law in the First Circuit concerning when an entity qualifies as a fiduciary for these purposes, and in particular when a plan administrator qualifies for that status. The court stated (I have omitted the voluminous citations to statute and case law, but it is here in the opinion itself for those of you who are interested):
An ERISA fiduciary includes any person who "has any discretionary authority or discretionary responsibility in the administration of [an employee benefit] plan." ERISA also provides that a fiduciary "exercises any discretionary authority or discretionary control respecting management of [a] plan or exercises any authority or control respecting management or disposition of its assets." In addition: [r]egulations promulgated by the Department of Labor interpreting ERISA make clear that the administrator and trustees of a pension plan are fiduciaries within the meaning of the statue, for a plan administrator or a trustee of a plan must, b[y] the very nature of his position, have discretionary authority or discretionary responsibility in the administration of the plan within the meaning of section 3(21)(A)(iii) . . . . Thus, at least according to many courts that have addressed the issue, a plan administrator is per se a fiduciary. The Court of Appeals for the First Circuit appears to have expressed a similar tenet, although recently, the court has characterized this as an assumption, not a holding. Absent any clear authority in any circuit to the contrary, this court will also proceed on this assumption. Consequently, because the plan administrator is named as a plaintiff in this suit, and is acting in a fiduciary capacity, he therefore must be considered a fiduciary within the meaning of 29 U.S.C. § 1132(e)(1). Accordingly, because the plan administrator has standing this court has jurisdiction to hear the claims.
Insurance Brokers as ERISA Defendants
Roy Harmon, over at his Health Plan Law blog, has his typically scholarly take on two recent rulings out of the United States District Court for the District of New Hampshire in the case of Hopper v. Standard Insurance Company. The rulings primarily revolve around the question of which claims in the lawsuit are preempted under ERISA, and the law, reasoning and rulings of the court on these issues is consistent with First Circuit law, which grants a pretty broad sweep to ERISA preemption. What caught my eye about the case, however, and was of particular interest to me, was the discussion of whether the claims against one of the defendant entities that was involved in the insurance program at issue, namely the insurance broker, were preempted. The court, in one of its two rulings, determined that the broker did not play the role of a fiduciary, was not subject to ERISA, and that the claims against it were not preempted as a result. The court explained:
Hopper's misrepresentation claims against WGA [the insurance broker], however, are different. Unlike Standard, which functions as an ERISA entity, see Hampers, 202 F.3d at 53 (citing Stetson v. PFL Ins. Co., 16 F. Supp. 2d 28, 33 (D. Me. 1998))(explaining that the "primary ERISA entities are the employer, the plan, the plan fiduciaries, and the beneficiaries of the plan"), WGA is strictly an insurance broker, engaged in sales and marketing functions.
WGA had no direct control over Standard's insurance policy or the benefits plan. WGA did not administer the plan, and did not determine participant eligibility for benefits or consider appeals of benefit denial. Put differently, Hopper's claims against WGA are limited to WGA's "role as a seller of insurance, not as an administrator of an employee benefits plan." Woodworker's Supply, Inc. v. Principal Mut. Life Ins. Co., 170 F.3d 985, 991 (10th Cir. 1999).
This result is consistent with the underlying goal of ERISA "to protect the interests of employees and other beneficiaries of employee benefit plans." Morstein v. Nat'l Ins. Servs., Inc., 93 F.3d 715, 723 (11th Cir. 1996). "If ERISA preempts a beneficiary's potential cause of action for misrepresentation, employees, beneficiaries, and employers choosing among various plans will no longer be able to rely on the representations of the insurance agent regarding the terms of the plan." Id. As a result "[t]hese employees, whom Congress sought to protect, will find themselves unable to make informed choices regarding available benefit plans where state law places the duty on agents to deal honestly with applicants." Id. at 723-24.
Accordingly, Hopper's misrepresentation claims against WGA are not preempted by ERISA.
I think at least this part of the ruling, though arguable, is correct, so I don’t have any real quibble with it. What catches my eye, however, is the issue it raises, of whether an entity involved with an ERISA governed plan is better off staying out of the eye of the storm by avoiding a role that would grant it fiduciary status, or is instead better off playing a large enough role in the administration of the plan to end up being assigned that status. Falling outside of the ERISA framework leaves the entity exposed, as was the broker here, to a range of common law and state statutory claims; indeed, the potential exposure of such a defendant is limited only by the imagination of plaintiffs’ lawyers (and to a certain degree, the actual facts). On the other hand, coming within the realm of entities regulated by ERISA would preclude those types of claims from being asserted against the entity, while limiting recovery to that which is authorized by ERISA.
Granted, it is probably not something that the insurance broker in the Hopper case gave any thought to at the commencement of its involvement with the plan in question, but it might be something for any entity playing a role in an ERISA governed plan to consider at the outset of their retention: should they put themselves in a position to be a fiduciary subject to ERISA, or should they avoid that like the plague?
The Attorney-Client Privilege, ERISA and the Administrative Record
No doubt at least some of you have noticed my fixation on the attorney-client privilege, and where its borders should be drawn when a party’s counsel plays a central role in the events that may or may not trigger insurance coverage or show bad faith. I have the same sort of cartographer’s obsession with mapping where those borders should be when the administrator of an ERISA governed plan makes a benefit determination based on the investigation and legal conclusions of counsel. What happens to the privilege, for instance, if a company’s in-house counsel interprets the plan’s terms and applies them to the facts, thereafter recommending to the plan administrator what decision to render on a claim? And what happens if the plan administrator then adopts that recommendation as its determination? One can picture the same scenario involving reliance on outside counsel to do the same work.
Well, as this well-developed post from the Health Plan Law blog discusses, the plan administrator can delegate in this manner to counsel, and adopt counsel’s findings, at least as a general statement. But what effect would doing so have on the attorney-client privilege that would otherwise normally attach to communications between counsel and a client? Health Plan Law has this to say on that topic:
The question is this: while a plan may consistent with exercise of fiduciary discretion delegate duties as to claim investigation to legal counsel, is there a concomitant sacrifice in scope of privileged communications?
A fundamental legal principle states that the attorney-client privilege may be waived expressly or by implication. Implied waivers are consistently construed narrowly.See, In re Lott, 424 F.3d 446, 452 (6th Cir.2005). On the other hand, “an attorney-client communication is placed at issue when the party makes an assertion that in fairness requires examination of protected communications.” Clevenger v. Dillard’s Department Stores, Inc. Slip Copy, 2007 WL 27978 (S.D.Ohio 2007) (Dillard’s defendants impliedly waived the privilege for communications with legal counsel related to plan termination). The concern raised here is succinctly stated as follows: ‘the attorney-client privilege cannot at once be used as a shield and a sword.’ United States v. Bilzerian, 926 F.2d 1285, 1292 (2d Cir.1991)
And then again, to what extent does privilege apply in fiduciary matters in any event? In this connection consider the following regarding the “fiduciary exception”:
Most courts, including the Seventh Circuit, have recognized the existence of a fiduciary exception to the attorney-client privilege. In J.H. Chapman Group, Ltd. v. Chapman, No. 95 C 7716, 1996 WL 238863 (N.D.Ill. May 2, 1998), for example, the court explained that “[t]he fiduciary duty exception ‘is based on the notion that a communication between an attorney and a client is not privileged from those to whom the client owes a fiduciary duty.”See also Bland v. Fiatallis North America, Inc., 401 F.3d 779, 787 (7th Cir.2005) (recognizing fiduciary exception in the ERISA context).
On more of a concrete and less abstract level, you can think about this in terms of the administrative record; there are exceptions, but in most circumstances and in most courts, the administrative record would make up the universe of evidence that the court can consider in ruling on a challenge to an administrator's determination of a particular claim. Generally speaking, the administrative record is to contain the information relied upon or considered by the administrator in making that determination. But what about attorney advice received by the administrator and relied upon by it? The scope of the attorney-client privilege can impact whether or not that advice should be part of the administrative record.
The Effect of the Savings Rate on 401(k) Fee and Other Retirement Benefit Litigation
Permalink | Now here’s a curious little article from the New York Times on the question of whether mutual fund companies, including in their retirement calculators, deliberately overestimate the amount that people must save and invest to be able to afford to retire. The article notes that a number of respected economists find this to be the case, and the article notes that the mutual fund companies themselves obviously have much to gain if employees believe they must increase their retirement savings. As the article bluntly puts it, “financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.” Specifically - although without analyzing the data behind these conclusions, one can’t be sure whether these numbers fall into the old saw that the three types of lies are lies, damn lies and statistics - one of the economists claims that “Fidelity’s online calculators typically set the target of assets needed to cover spending in retirement 36.4 percent too high. Vanguard’s was 53.1 percent too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78 [percent] higher.”
The article engenders a couple of thoughts. For one, would 401(k) fee and other breach of fiduciary litigation related to retirement savings be quite as wide spread if the working/retirement saving public believed they were saving enough already for retirement, rather than having been taught that they are behind the eight ball in accumulating enough money for retirement? This raises something of a behavioral question, or maybe a chicken and the egg question. Would people care enough to sue over these types of issues if they thought they were safely prepared for retirement, and to what extent does the fear that they are not drive decisions regarding litigation? Or are these suits really driven by the imagination of plaintiffs’ lawyers, and thus it really wouldn’t make any difference at all what the actual world view is of employees as a whole with regard to whether they are on track for a secure retirement or should instead be very, very afraid of what the future will bring?
And finally, would it be a breach of fiduciary duty if plan administrators overstated the amount that employees should save for retirement when they educate employees? And if it was, what would the damages be, particularly if the oversavings produced significant investment gains for the plan participant?
Supreme Court to Review Fiduciary Duties of Administrators
Permalink | One of the things that makes practicing in and blogging about ERISA interesting is the fact that the subject area is never static. Other areas of the law can literally evolve at a near glacial pace (see, for example, this post here, involving the law of malicious prosecution and a change, for the first time in the modern era, to one of the elements of the tort), but not ERISA. And so there is always something new to talk about in a blog, and some new interesting development to keep track of for purposes of cases I am litigating.
Which brings me to today’s ERISA news you can use, courtesy of the estimable Russ Runkel and his LawMemo, Inc., who reports that the Supreme Court will be addressing the question of the scope of fiduciary duties, if any, that attach to the decision to terminate benefit plans. The Supreme Court is taking up a Ninth Circuit decision, in which, borrowing liberally from Russ, a company went into bankruptcy, after which the administrator of its 18 defined benefit pension plans decided to terminate the plans by purchasing annuities, rather than merge the plans with a different existing plan.
To quote Russ, the Ninth Circuit held that: “The decision to terminate the plan was a business decision not subject to ERISA fiduciary obligations[;] the implementation of the decision was discretionary in nature and subject to ERISA fiduciary obligations[; and the administrator] breached its fiduciary duty by failing to adequately investigate” the alternative plan of merging the terminated plan with another plan.
You can find a little bit more information on the appeal to the Supreme Court, along with links to the petition and related filings with the Supreme Court on this case, here at SCOTUSBLOG.
Excessive Fees, ERISA and 401(k) Plans
Here is an excellent article, by way of workplace prof, on the fees charged in 401(k) plans, their impact on performance, and the difficulty of even learning about them. We have talked before about how challenges to excessive fees charged to 401(k) plans is the new growth stock in ERISA litigation, and many people are always skeptical, often with good reason, when the plaintiffs’ bar moves into a new area and starts pressing a particular theory of liability against numerous companies and in many different jurisdictions. Yet articles like this one make clear that the underlying issue, of whether fees are appropriate and how they are arrived at, is a legitimate one with serious implications for the financial well being of the average investor, and for the retirement they can expect to afford. And at the same time, to the extent that excessive fees are a problem or the growth in this type of litigation is worrisome, it is clear that proper management by fiduciaries can eliminate both the problem of excessive fees and the potential liability of fiduciaries for allowing excessive fees.
Health Savings Accounts, Summary Plan Descriptions and Other Things
Permalink | A few short notes of interest from a weekend of reading:
• Jerry Kalish has nice things to say about (and agrees with) my recent post concerning the Second Circuit’s decision - correct in my view - precluding summary plan descriptions from trumping the actual plan terms.
• I don’t know quite what to say about this article from yesterday’s Boston Globe about town retirement boards and their travel expenses, other than to note that if you don’t want to face exposure as a fiduciary, this type of conduct probably isn’t the way to go about it.
• And finally, WorkPlace Prof collected this information about whether health savings accounts constitute employee benefit plans governed by ERISA. He cites a report to the effect that they do not. Of particular interest, the post points out that employer contributions to the accounts will not necessarily transform them into ERISA governed plans, because employer contributions alone do not in and of themselves render a plan an ERISA governed plan. I have discussed before the totality of factual circumstances that are to be considered in the First Circuit to determine whether a benefit is an ERISA governed plan, and the fact that the source of funding alone is not determinative.
More on 401(k) Fees and ERISA
Permalink | For those of you readers who are interested in the issue of fiduciary liability for excessive 401(k) fees - and who isn't? - here is more on the subject. I posted before about ways to avoid exposure to these types of claims, and Susan Mangiero has more on that topic here. Meanwhile, Workplace Prof has this to say on the upcoming wave of litigation over this issue, and about Congress weighing in on this issue now as well.
401(k) Plan Fees and Breaches of Fiduciary Duty
Some of you hopefully saw my recommendation the other day concerning this morning's webinar on 401(k) plan fees and the attendant obligations of fiduciaries. The webinar discussed in detail the obligations of plan sponsors and other fiduciaries with regard to 401(k) plans and their accompanying fees. On the key issue of how to avoid incurring liability for breach of fiduciary duty as a result of the fees incurred by 401(k) plans and their impact on plan performance, the speakers emphasized a commitment to due diligence. In particular, the speakers favor a systemic and periodic review of the entire issue of the fees affecting the plan, and proper investigation and selection of funds and advisors with the issue of fees firmly in mind. In other words, don’t put the plan together without thinking about the issues of fees and ensuring that the applicable fees are consistent with industry benchmarks, and even after you do that, don’t just forget about the issue, but instead return to the topic regularly and make sure fees and performance remain appropriate. There is no magic wand to protect against liability exposures of this nature, but a documented consistent course of conduct that makes certain that fees remain consistent with relevant benchmarks will go far towards insulating fiduciaries from liability on the basis of excessive plan fees.
In some ways, the entire issue reminds me of a story a well-seasoned money manager told me about his firm’s selection many years ago to manage a portion of the funds of a municipal pension plan. The plan selected multiple advisors, each charged with a different portion of the assets, and each was assigned an appropriate benchmark against which its performance would be measured. Each was also told that after a set period of time, the plan would review all of the managers’ performances as against the applicable benchmarks, and the trailing performers would be replaced, and the others would continue to manage their portions, at least until the next scheduled review, at which point the trailers at that point would be replaced.
Isn’t this exactly what we mean by diligent, reasonable conduct by fiduciaries - a consistent, regular effort to ensure that fund assets are being managed to the advantage of participants, based on a comparison to appropriate benchmarks?
Investment Management Fees, and Contract Geeks
Two things to chew on over the holiday, other than the turducken (I have always wanted to use that word in a sentence), one to know about before it occurs, the other to note before it disappears. I guess I could take that dichotomy a little further, and note that one concerns the first half of the blog’s title, and the other, the other half.
The first: Susan Mangiero, who writes the excellent blog Pension Risk Matters, is hosting a webinar on November 28 covering issues related to investment fees, the management of 401(k) plans, and fiduciary obligations. The webinar, covering “401(k) plan fees - what they are, how they can affect reported performance and the fiduciary practices that address investment management fees” is driven by the fact that:
In the aftermath of the Pension Protection Act of 2006, 401(k) plan sponsors are required to carefully select "fiduciary advisors", identify appropriate default investment choices for participants and comply with more rigorous federal reporting procedures. All of this could spell trouble for retirement plan fiduciaries who fail to realize that regulation, public awareness and employee angst put them in the spotlight as never before. This is especially apropos with respect to plan fees.
You can find more information on the webinar here.
The second: Insurance coverage lawyers, almost by definition, have to be contracts geeks. At the end of the day, what they are really doing is fighting over the language in contracts, a particular type of contract certainly, but contracts nonetheless. And here, before it vanishes from the internet, is the story of how much money there is in not being a contracts geek.
Recoupments and Set Offs Under ERISA Plans
Here's a very interesting decision, Northcutt v. General Motors Hourly-Rate Employees Pension Plan, out of the 7th Circuit, upholding the right of administrators to rely on recoupment language in a plan to set off a lump sum social security payment received by a beneficiary against on-going payment obligations to that beneficiary that would otherwise exist under the plan. The problem is one that arises with extraordinary frequency, namely a beneficiary is awarded benefits under a plan, and then later collects a lump sum retroactive award of benefits from social security covering a period of time during which the individual had been receiving benefits from the plan. What happens when the plan contains language declaring that if the lump sum payment is not paid over to the plan, the plan will reduce the benefits being paid until such time as the withheld amount of the benefits adds up to the amount of the lump sum payment in question?
Well, generally the answer is that what the plan says is exactly what is going to happen. Now as you can imagine, beneficiaries are often none too happy when this occurs. They go from thinking a windfall has landed in their laps, in the form of a large retroactive benefit award from social security, to being dunned for the whole amount. Even worse from the point of view of any sort of amicable resolution of the problem as between the plan and the beneficiary, the scenario is often complicated, as it was in Northcutt, by the fact that beneficiaries have often spent the lump sum award before being notified that they actually owe it back to the plan. (I like, by the way, how the Northcutt court described the problem, as being that the sum was "dissipated by the time [the plan administrator ] made its demand" for reimbursement; I might have chosen the term "spent it like a drunken sailor on shore leave without bothering to find out first if they owed any of the money to someone else" if I were the court.)
The plaintiffs in Northcutt were two beneficiaries confronted by this problem and who tried to get around it by creative lawyering, insisting that the recoupment provisions in the plan were an attempt to create some sort of quasi-judicial right of recovery to which the plan was not entitled because it was contrary to, or at least not expressly part of, the rights to relief and causes of action granted by the express language of ERISA to plan fiduciaries. The court caught an obvious problem in this argument, namely that the recoupment was a right established under the plan and was simply part of the express terms of administration of the plan set forth in the controlling plan documents. The recoupment was simply an administrative act, and was not judicial relief or a court action.
The court rejected the plaintiffs' theory, finding that the sponsor clearly had the right to impose such terms as part of the plan, and that the plan was within its rights to simply apply those terms of the plan.
There is, beyond the holding and the interesting presentation of the reasoning behind it, some interesting language in the decision. One part that I like in particular speaks of the general acceptance in the case law of this type of recoupment mechanism, and of the fact that, although the Northcutt plaintiffs tried a novel theory of argument not already rejected by other courts, they were still subject to this same general acceptance of recoupment provisions. To quote the court:
Although Mr. Northcutt and Mr. Smith advance a novel theory in support of their argument, challenges to the enforceability of similar reimbursement provisions are not new. Before other courts, these challenges generally have focused on whether such reimbursement structures might violate particular provisions of ERISA. In these other suits, the plaintiffs have contended that contractually based recoupment amounts to a breach of fiduciary duty by the plan or to a violation of ERISA's anti-assignment provisions. The district courts appear to have rejected each theory and approved, either explicitly or implicitly, of contractually based recoupment.
401(k) Plans and ERISA Class Actions
Jerry Kalish has a terrific post, drawing on a law firm white paper, about the potential ERISA liabilities of financial advisors and others who manage or otherwise help to run company 401(k) plans. As he discusses, class action lawsuits are being filed alleging ERISA violations in the operation of such plans; the suits stem from the decisions made by plan advisors and others concerning plan investments and the effect of those decisions on plan expenses.
Substantively, these types of suits raise interesting questions as to exactly how much discretion in making investment decisions should be extended to administrators, sponsors and advisors of such plans before second guessing becomes appropriate. On a broader note, these suits also point out the extent to which the simultaneously high and somewhat amorphous standards that govern the actions of fiduciaries under ERISA make the responsibilities and potential liabilities of 401(k) administrators, sponsors and advisors a fertile field for imaginative plaintiffs' lawyers.
And finally, given the number of different advisors and other players involved in the operations of these types of retirement vehicles, there are bound to be plenty of fiduciaries - as that term is understood in the context of ERISA - involved in almost any 401(k) plan, making for plenty of targets for such suits.
401(k)s and ERISA
A terrific paper on the application of ERISA and its fiduciary duty standards to 401(k) plans and to the people who run them is available free right now from the ABA. As employee benefit plans, these retirement plans are within ERISA's ambit and the companies and individuals who operate them are subject to the fiduciary obligations imposed by ERISA. The paper provides a nice overview of the application of ERISA to these types of employee benefit plans. The fiduciary duties and the manners in which they can be breached that are detailed in the paper carry over to the operations of other employee benefit plans as well, and do not apply only to the operators of 401(k) plans. As a result, it is worthwhile reading for fiduciaries of other types of benefit plans as well.
A nod of thanks to BenefitsBlog for noting the availability of this paper. BenefitsBlog discusses tax and other issues related to benefits that are beyond the ambit of this blog, which focuses more on litigation under ERISA.
Equitable Relief under Section 502(a)(3)
Last week, in Sereboff v. Mid Atlantic Medical Services, Inc., http://www.supremecourtus.gov/opinions/05pdf/05-260.pdf, the Supreme Court returned to the question of what particular relief sought by a fiduciary can properly be pursued under the equitable relief provisions of Section 502(a)(3)(B) of ERISA, which provides that:
A fiduciary may bring a civil action under ¬ß 502(a)(3) of ERISA "(A) to enjoin any act or practice which violates any provision of this subchapter or the terms of the plan, or (B) to obtain other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of this subchapter or the terms of the plan."
502(a)(3)(B) is understood, under Supreme Court precedent, to only allow fiduciaries to pursue equitable relief, spawning a class of litigation over the issue of what particular relief sought by a plan or other fiduciary should be deemed to be "equitable" for these purposes. In Sereboff, the Court returned to the specific question of when can the plan obtain reimbursement from beneficiaries who had collected a third party tort recovery. In the case before the Court, the beneficiaries had collected health benefits from the plan and thereafter obtained a tort settlement from those who had caused the injuries that required the health care in question; the plan contained an
"Acts of Third Parties" provision [, which] requires a beneficiary who is injured as a result of an act or omission of a third party to reimburse [the plan] for benefits it pays on account of those injuries, if the beneficiary recovers for those injuries from the third party.
The Court concluded that this issue is not decided by simplistic characterizations of the recovery, such as should it be characterized as restitution, a recovery normally understood at least in casual legal thought as equitable, or instead as compensatory damages, but instead by analyzing the history of equitable relief under Supreme Court precedent and determining whether, on that long history, the relief in question would qualify as equitable.
Who is a Fiduciary?
Still mining Judge Woodlock's summary judgment opinion in Kansky v. Aetna Life Insurance Company and Coca Cola Enterprises, available here http://pacer.mad.uscourts.gov/dc/cgi-bin/recentops.pl?filename=woodlock/pdf/kansky%20may%201%202006.pdf.
Who is a fiduciary under ERISA? According to Judge Woodlock, under 29 U.S.C. section 1002 (21)(A),
"a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan." 29 U.S.C. ¬ß 1002(21) (A).