Interestingly, when I wrote yesterday on the question of imposing discipline on public pension financing, the NY Times had not yet published – at least on the on-line version that I skim each day – this detailed, and frankly harrowing, article on the pension obligations faced by San Jose and the problems it is causing for the municipal budget. As the article notes, in an almost scare mongering opening:

San Jose now spends one-fifth of its $1.1 billion general fund on pensions and retiree health care, and the amount keeps rising. To free up the money, services have been cut, libraries and community centers closed, the number of city workers trimmed, salaries reduced, and new facilities left unused for lack of staff. From potholes to home burglaries, the city’s problems are growing.

What is more interesting, in some ways, is the discussion of what caused the problem – excessive pension promises of a kind that one would never see from an employer forced to account, in real time, for future pension promises – and the proposed solutions. The proposed solutions mirror what has occurred in the private sector, which is changing future benefits (read reducing them) beyond those already accrued for current participants, reducing the retirement benefits outright for new employees, and  changing overall to a defined contribution type system. Interestingly, the latter is what I predicted, in yesterday’s post, would almost certainly occur if municipalities, like private employers, were placed in a position that they must account, in the here and now, to at least some degree for promises to provide pensions in the future.
 

I am not sure there is anything in this article that will surprise anyone who is a regular reader of this blog, or who follows the issues raised by public and private pensions, including their financing. More than that, I doubt there is anything in it that anyone knowledgeable about the subject will disagree with: writing about the crisis in public pensions, the author suggests that the proper response is to impose a legal structure, possibly similar to ERISA, that will force municipalities to fund their pensions as they go, rather than promising benefits and leaving them for future taxpayers (many, frankly, too young to vote – or even read – when the pensions are promised) to fund. Nothing too shocking there, although, in truth, I think what you would see in the public sector if that were enacted is exactly what you have already seen in the private sector: the replacement of pensions with some type of defined contribution type structure.

The article is aptly titled “The Long, Sorry Tale of Pension Promises,” and, despite the somewhat lukewarm introduction above to the article, I have to say that I liked the article and greatly enjoyed it, including its excellent presentation of the history of pension busts that led up to ERISA’s enactment. Its certainly worth a few minutes of your morning.
 

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.
 

I absolutely love this story on the Fifth Circuit asking the Texas Supreme Court to consider the scope of insurance coverage for claims arising out of the Deepwater Horizon oil spill loss; the case itself is fascinating as well. The reason is that insurance coverage law is an odd little area, in that massive numbers of decisions in that area are issued each year, and yet most do little more than move the chains a little bit in terms of refining or redefining the law in this area. This point is well-illustrated, for those of you who like support for a proposition, by Randy Maniloff’s on-going series of excellent coverage newsletters, aptly titled Coverage Opinions, which details the continuing flow of judicial decisions in this area.

At the same time, though, the history of insurance coverage law is written in big letters, by the big dollar cases that bring out the best lawyers and arguments that the industry and the policyholder bar have to offer; it is these cases that drive the development of the case law in new directions, and often rewrite the framework in which insurance coverage disputes are analyzed and decided for the next few decades. It was the big money exposures of asbestos and Superfund – issues now so old that they could have been referenced in a retro-movie like Argo, in the same way it featured rotary phones to add period authenticity – that gave rise to much of the case law that currently governs most disputes over trigger and allocation. Likewise, the issues at the heart of the Deepwater Horizon coverage dispute are additional insured and coverage for contractual indemnity obligations that have been floating around insurance coverage law for the entire length of my career, with often inconsistent results; a major decision in a high profile case like Deepwater Horizon is almost certain to reframe those discussions for many years going forward.
 

Here’s a great piece – and not just because I am complimented in it – by Susan Mangiero on the continuing problem of workforce participation, and the impact on retirement financing of a less than robust job market. As Susan has pointed out in other posts, less workers, in a nutshell, equals fewer taxpayers and current employees to support social security and private company retirement packages, thus hastening the cycle towards funding problems on those fronts. In a way, this gives rise to a hidden and subtle bias towards 401(k) and similar programs that, despite complaints about them such as their fees, at least have the virtue of being one worker/one funder/one beneficiary systems. I know that is a gross simplification, when you consider such issues as company matches, spousal distributions, etc., but the point is simple: such retirement plans rely on the participant in the workforce to plan ahead and fund it, and not on a shrinking labor pool to fund it in the future for that worker.

There are a lot of costs to a shrinking and/or severely curtailed job market, from the personal costs to those who can’t get jobs, to the long term reduction in earnings for those who must wait years beyond graduation to really get started on a profitable work life, to the inability of many to retire after job losses and stock market losses struck them in the latter part of their work lives. There is no getting around the fact, however, that, as Susan points out, a shrunken workforce puts financial pressure on the retirement structure across the board, from a reduction in tax rolls for the funding of public pensions to a distortion of the worker/retiree leverage upon which social security rests.

It is, in the end, important to remember the linkage between jobs and the retirement scheme, whether that is pensions, social security, 401(k)s or some as yet undreamed of replacement. The latter does not exist in a vacuum and, as Susan has pointed out, is closely tied to the former.
 

Eric Berkman’s article in this week’s Massachusetts Lawyers Weekly on Gross v. Sun Life, in which I am quoted, does an excellent job of explaining the case, particularly to those readers who do not have years of experience with ERISA cases, benefit litigation, or the long history of the law in this circuit governing benefit cases. I have written before of my thoughts on the Court’s opinion in Gross, but I realized, in reading Eric’s article, that his questions when he interviewed me for his article were astute enough to draw out some additional thoughts on the case, which I had not yet thought of when I posted about the case on my blog.

Eric presents those additional ideas of mine very well in his article and, citing my own personal interpretation of the fair use doctrine, I thought I would pass them along here:

Stephen Rosenberg, a Boston ERISA lawyer who typically represents insurers and employers, described the case as a “natural culmination of years of judicial approach” in this circuit.

“Whether or not it’s shown up in decisions, there’s been a certain level of skepticism on how best to apply standards of review to medical evidence in these circumstances,” said Rosenberg, who practices with the McCormack Firm and was not involved in the case. “It was only a matter of time before they deviated from Brigham and established a higher bar for obtaining discretionary review. The court makes clear — as do other circuits — that they really want to see a clear statement that ‘we retain discretion’ to decide the issues.”

He also said the ruling extends beyond long-term disability insurance plans. In many contexts, the employer itself, rather than an insurer, provides an ERISA plan and wants to maintain discretion to determine benefits eligibility, Rosenberg explained.

“These plans are often written by an in-house benefits person or an in-house attorney who has no ERISA expertise,” Rosenberg said. “Years later, when a dispute arises, the company will always want to claim discretionary review, and I think they’ll have to learn from this decision that they need to use the proper language in these types of plans as well.”
 

Great, great decision out of the First Circuit a few days ago on ERISA benefits litigation, covering, in no particular order: what language is necessary to establish discretionary review; when does the safe harbor exception to preemption apply; when is an LTD policy part of an ERISA governed plan; the proper weight and mode of analysis to be given to video surveillance in the context of an LTD claim; and when to remand to a plan administrator for further determination as opposed to the court ordering an award of, or denial of, benefits.

I can’t say enough about the Court’s analysis of each one of these issues, particularly if, like me, you have been carefully reading all of the ERISA decisions out of the First Circuit and the district courts in this circuit over the past decade or more. On each one of the issues I noted above, the opinion builds quite carefully, and persuasively, on the evolution on each of these issues that has taken place in this circuit, quite slowly, over many years. I will give you two examples. First, the Court raises the bar for establishing discretionary review, and in so doing, gives a careful presentation of exactly why this is the normal and logical result of years of jurisprudence. Here’s a second example. It wasn’t that long ago that we all expected the district court to either affirm a denial of benefits by an administrator or to instead overturn that denial and order an award of benefits. At one point in time, though, the case law shifted towards an analysis of whether, if a denial would not be upheld by the district court, the entire issue should be remanded to the plan administrator for further evaluation of evidentiary concerns identified by the court, so that the plan administrator could determine whether an award of benefits was warranted given those concerns; further litigation could thereafter ensue if the administrator maintained a denial and the plan participant wanted to challenge that determination in court. In this latest decision out of the First Circuit, however, you see something very interesting: the pure application of the need for remand to the administrator, as though this is simply the basic rule in this circuit (which, in fact, is what it has become).

The decision is Gross v. Sun Life. To echo a comment I made on Twitter about it, I don’t think you can litigate ERISA cases in this circuit unless and until you have both read it and thoroughly incorporated its lessons. And a side note: one of the plaintiff’s lawyers was Jonathan Feigenbaum, who, as I discussed here, takes exception to the very idea that discretionary review is even constitutional.
 

Attorneys Jonathan Feigenbaum and Scott Riemer, who represent claimants in long term disability cases, have published a fascinating article, titled “Did the Supreme Court Flunk Constitutional Law when it Permitted Discretionary Review of Insured ERISA Benefits Cases?” In it, they argue, not surprisingly given the title, that it is unconstitutional for courts to apply discretionary review. In short form, their argument is that it deprives claimants of their constitutional right to have their cases adjudicated by an Article III court, by giving initial decision making, subject to a limited scope of review, to an outside, non-judicial party, without allowing for a full trial in court. This is a simplification of their well-developed thesis, which is more subtle and complicated than that, which is what makes it fun.

The response to their argument, though, rests in the proper response to a gauntlet the authors throw down at the outset of their paper, in which they challenge readers to:

identify any litigation in the federal courts between private litigants, other than discussed in this paper, where the Article III Judge must defer to the decision of the defendant without conducting a full trial on the merits. We bet you can’t.

This isn’t really what discretionary review does, however. Instead, it is simply a presumption running in favor of the private decision maker – who is best understood as a party to a contract who made a decision that is now being challenged in court by the other party to the contract – under which the other party must rebut the presumption by showing that the decision was not based on substantial enough evidence to support it. The American legal system is rife with these types of presumptions. What is the Moench presumption in stock drop litigation, if not a presumption running against the claimants that they can overcome with the right type of evidence? Employment law, with its burden shifting evidentiary rules, historically was rife with similar examples, in which one party bears a burden of proof only after another party makes a certain showing. The business judgment rule applies a gloss in favor of directors and officers in certain types of cases, which must be overcome by a plaintiff. Patents are presumed valid when challenged in court, and a holder of a registered copyright is presumed to have a valid copyright, unless and until proven otherwise in court.

One could go on like this for hours, making such a list. The point, though, is simple: discretionary review is not an unconstitutional removal from the court system of decision making authority over a claim, but rather the creation by the courts of an evidentiary presumption and a burden of proof, no different than what occurs in numerous other areas of the law.
 

Just what more is there to say about Sun Capital at this point? The decision, out of the First Circuit, concerns the withdrawal liability for a multiemployer pension plan of the private equity owners of a portfolio company that was a member of the pension plan, with the First Circuit finding that, while a certain claim against the private equity owners could not proceed for technical reasons, they could nonetheless be liable for the pension obligations of the portfolio company. The decision has been written on by almost every large firm with a significant private equity practice (either in actuality or hoped for down the road), with much more haste than they often display in getting out client alerts.

And of course that is completely understandable, as the short form take away from the decision is that private equity ownership can be liable for the pension obligations of portfolio companies. This is of course a tremendously significant issue for investment shops of that nature, and it raises highly technical questions going forward for structuring acquisitions, in terms of examining whether it is possible to legally structure the acquisition and ownership of a portfolio company in a manner which will insulate the acquirer from unfunded pension obligations or, if it is not certain whether that can be achieved, will at least make it as hard as possible for potential plaintiffs to recover, thus hopefully dissuading future lawsuits of the type at issue in Sun Capital. Of course, as those of us who often represent investors, emerging companies, start ups and other oft targeted defendants know, dissuading lawsuits is almost as good as having a highly defensible legal position in the courtroom itself.

Among the many, many good client alerts out there on Sun Capital are this one, and this one, which can provide you with the details of the decision itself. If you are engaged in structuring corporate acquisitions and need to be concerned about protecting yourself or a client against pension liabilities, frankly, you need to read the decision itself, which you can find here.

Perhaps the more interesting issue, though, is to step away from the legal questions, which really concern how best to structure a transaction to insulate the acquirers after the acquisition has been settled on, and to look instead at the more fundamental issue that an excessive focus on the technicalities of the decision in Sun Capital itself can mask. As Susan Mangiero notes – almost uniquely among prominent bloggers writing about the decision, perhaps because she is a business expert, rather than a lawyer, and approaches the world from that vantage point – the most important take away from the opinion concerns the decisions made long before the legal structuring of the transaction, which concern valuing the pension exposures of the target company and accounting for that exposure financially in the purchase price. Do that correctly, and you have already accounted for the possibility of being forced to cover the portfolio company’s exposure; do that incorrectly, and you may have – as occurred in Sun Capital – doubled down on a losing proposition.
 

I have written and spoken on a number of occasions about the extent to which courts will enforce the exhaustion doctrine with regard to benefit claims, and about the exceptions that exist to exhaustion; I have litigated those disputes as well, in a number of contexts running from top-hat plans involving substantial deferred compensation to old fashioned LTD benefit denials.

Many lawyers and courts start out from the premise that the exhaustion requirement should be strictly applied, and that exceptions should be granted infrequently. This is all true, but the reality is that the dividing line between when to require exhaustion and when to allow an exception should be fact based: when a claimant simply alleges the elements needed to establish an exception, exhaustion should be strictly enforced, but an exception should be allowed where the plaintiff can demonstrate that the factual elements of a particular exception exist.

The United States District Court for the District of Puerto Rico just captured this distinction nicely, in an opinion addressing whether the futility exception to exhaustion could be invoked, when the Court explained that:

a plaintiff’s belief that bringing administrative remedies would be futile is insufficient to call the futility exception into play. If, however, the plaintiff’s belief is accurate—as demonstrated by factual evidence—and exhausting the administrative remedies would, in fact, be futile, then the futility exception is called into play.

Perfectly said.