When you approach the Moakley federal courthouse in Boston from the direction of Boston proper, your eye is invariably drawn to a series of quotes engraved on the courthouse wall. I have walked to that courthouse an untold number of times, and still, each time, I read the quotes as I go by as though I have never seen them before. One of the quotes is Holmes’ famous comment that law is the “witness and external deposit of our moral life.” I thought of this after reading this Washington Post article which tries to give a moral dimension to a fact of which ERISA lawyers – both those who represent plans and those who represent participants – are well aware, which is that retirement funding is woefully inadequate in comparison to most people’s retirement goals. As most of us know and as I have discussed in this blog numerous times, pension funding is a substantial problem, to the extent that pensions are the dinosaurs of the retirement plan world, while underfunding of defined contribution plans by participants is the new normal.

For most ERISA lawyers, including myself, the response to this typically falls in the category of yup, what else is new, followed by a shrug and an assertion that plan requirements, funding issues, age limitations and other retirement plan issues have to be managed in a way that recognizes and accepts this reality. The Washington Post article, however, points out that there is a moral element to this evaluation, which is that a correlation exists (or appears to exist, as I am always skeptical of any statistical claims unless and until I am satisfied about the underlying data, as per my discussion here) between wealth at retirement age and life expectancy. I highly doubt that there is much that ERISA really has to say or can do about this phenomenon: the reality is that plans are only required to provide what the plans say they are required to provide, and ERISA basically (and very generally speaking) requires only that. But to the extent this correlation truly exists, then perhaps ERISA, and how it is interpreted and applied by courts, has a role to play, at least at the margins, when it comes to this problem, in the sense that it warrants courts holding plans and their authors to high standards of excellence and competence. This is probably the least, and may well be the most, that ERISA can bring to the table in addressing this issue.
 

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;
•Inflated projections;
•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.
 

This is interesting, right on the heels of all the discussion about the Second Circuit, in Kirkendall, not requiring a participant to exhaust administrative remedies by appealing a benefit determination before filing suit. As I noted in my discussion the other day about Kirkendall, the Court did not require an appeal because the plan did not clearly impose such an obligation. But what if the plan did, in clear language, provide a right and obligation to appeal? Well, the Eighth Circuit has just reminded us that, in that case, an appeal is necessary, and the failure to do so precludes filing suit. The case is Reindl v. Hartford Life and Accident Insurance Co., discussed in this excellent post by the entertainingly named (and entertainingly written) Boom blog.

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.
 

There are limits, though vast, to the degree to which words, even in the hands of the most careful draftsperson, can accurately capture concepts, particularly when those concepts concern future events and possibilities. There are likewise limits, though vast, to the degree to which people can anticipate future events. I have written more than once about the impact of these limits of both language and foresight on insurance policies. Because of these fundamental realities, no matter how much effort is put into drafting an insurance policy and anticipating the scope of potential exposures, there will inevitably be losses that either were never anticipated when the policy language was written or that, even if anticipated, were not accurately captured within the chosen wording. It is this phenomenon that constitutes the source of much insurance coverage litigation: either an event occurs that neither the policyholder nor the insurer anticipated and included within the policy language, or one party or the other thinks it bought coverage for or excluded a particular future possibility, only to find out later that the words they chose to use didn’t capture it.

This is true for plan documents, LTD policies, and essentially any contract – words and anticipation aren’t always enough to create a document that fully provides for everything that might happen in the future, leaving the parties to dispute how the document applies when a novel event eventually occurs. This has never been so evident as in this new decision from the First Circuit Court of Appeals, in which the issue arose as to whether the future risk of a relapse by an anesthesiologist who had been diagnosed with addiction rendered the physician disabled for purposes of an LTD policy. The case itself is fascinating, as is, to some extent, the question at its heart: if the currently disabling event has passed, but the participant may become again disabled, is the participant still disabled for purposes of the policy? The question itself sounds like a Zen koan and, phrased as I just have, almost as unanswerable. Almost, but not quite, because the First Circuit found an answer, rooted in the limitations on language and foresight I noted above. The Court found that the risk of relapse rendered the participant still disabled, because the LTD policy did not specifically exclude this risk. So there you have it: if you don’t want to cover the currently rehabilitated participant whose risk of relapse means he can’t go back to work, you better write that down somewhere in the plan or the policy.

 

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.
 

I am, for a change, flabbergasted and struck dumb: most people who know me will tell you I am seldom either. Luck, though, just landed me on ERISA Pundit, Warren von Schleicher’s well-written and insightful blog. Warren’s writing reminds me of a dirty, not really secret, secret about lawyers, especially litigators, which is that all lawyers think they are good writers, but very few demonstrate an actual foundation for that belief. Even a quick read of ERISAPundit makes clear that Warren isn’t among the latter; his writing brought a smile to my face on a cold January morning. If you haven’t read his blog yet, it is worth following this link.

I have to say, I had an amazingly busy 2012, but I still can’t believe I didn’t stumble across his blog until this morning.
 

These are two oddly complimentary stories, that tie closely to topics I have discussed regularly on this blog, including, among others, the difficulty faced by smaller shops of running a pension or other benefit plan, and the fact that no one at all wants to run a pension anymore. The first story is about a law firm in Detroit which is in the process of turning its pension plan over to the PBGC. What’s interesting about it is the sheer impracticality running a pension plan is for even a decent sized – but not massive – professional services firm. As the article notes, the coming and goings of partners, and the length of pension obligations, resulted in a plan in which “"you have people in the firm who aren’t in the plan and people in the plan who aren’t in the firm." Think about that for a minute. A law firm or other service entity isn’t really in the position of predicting out its obligations and future work force in the same way that a company with a large unionized or otherwise reasonably predictable workforce is; partners come, partners go, and you end up with the ones who stay funding a pension plan for the ones who have left. Heck, the routine collapses of law firms these days, even the biggest ones, make clear the folly of predicting that firms whose sole real assets are their intellectual capacity will be around long enough for a pension plan to survive and thrive.

And of course, as I have discussed in numerous posts, things aren’t much different even for companies with hard assets, most of whom have either gotten out of the pension business already or are now looking to do so by means of de-risking, which is the process of pursuing “options for transferring some or all of a sponsor’s plan risk” to third-parties. This is a broad, deep and complicated topic that touches on a wide range of issues and disciplines, from finance to litigation risks to fiduciary prudence to ERISA. One of the best descriptions in a nutshell I have seen on this topic can be found in the second story I wanted to pass along today, which is Susan Mangiero’s excellent post on this subject on her blog, Pension Risk Matters. I highly recommend it as a starting point for understanding this topic.
 

We – meaning lawyers who do civil side work involving ERISA plans – mostly think about the rules against prohibited transactions from two perspectives. The first concerns whether clients can structure certain transactions or engage in specific plan actions without running afoul of the prohibited transaction rules. The second arises in litigation, where we either challenge certain plan actions as prohibited transactions or defend plan fiduciaries against claims that they engaged in prohibited transactions. What we don’t normally think of, though, is the idea that if a fiduciary goes just way too far over the line between prohibited and appropriate actions, a whole heck of a lot of hurt is coming down the pike; this isn’t typically on our radar screens because most plans and fiduciaries not only don’t want to get into the kind of trouble that would come from taking such a step, but also because most plans and fiduciaries, in my opinion (even if they are ones I am suing, rather than ones I am defending), have an overall bias towards generally trying to do the right thing. Here’s a very good story illustrating what happens when that dynamic isn’t in play, though, and a fiduciary invokes significant DOL action over prohibited transactions.

What do these two stories have in common, the first about a claims administrator not being allowed to change the basis for a denial of benefits during the internal appeal and the second about an administrator not being allowed to deny benefits based on factual investigation during litigation? They both highlight the importance, for the parties on both sides of the “v” in any denial of benefits case, of the administrative claim process. Under the court decisions discussed in both stories, the record, and the grounds for denying benefits, were effectively frozen thereafter. In one of the two cases, in fact, the administrator was not even allowed to shift the grounds for denial during the processing of the appeal of its initial denial of claim, before the case even moved to litigation, and was forced to stand on the basis for denial contained in its original, initial denial.

From a practical perspective, there are lessons to be learned here about the need to stake out your position, and back it up, very early on in the claim process in an ERISA denial of benefits dispute. From a more philosophical perspective, the cases raise a serious question, about what the rule should be if, in fact, there is new evidence or analysis that would invoke a new plan term limiting coverage or otherwise affect the outcome of a claim, that is learned by the natural course of the claim’s progression. For instance, it may well be that an administrator denies a claim on one ground under the plan, but evidence submitted during an appeal of the initial denial taken by the participant demonstrates the applicability of another plan term as a basis for denial. Should the plan or the administrator be frozen out of raising that plan term as a ground for denial on the final decision, after the appeal of the initial decision, just because it wasn’t raised in the initial denial of benefits?