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.
 

This is not, at this point, a novel idea, but I do take credit for being one of the first to blog regularly on the thesis that we are approaching, if haven’t by now already hit, a perfect storm when it comes to retirement benefits and ERISA. The perfect storm consists of a series of elements all coming together in the same place and time, which in this instance consists of the following. First, a move from pensions to 401(k) plans, with the corresponding shift of two key risks – investment performance and capital accumulation – from plan sponsors to participants, a change which most people paid little attention to for a long time, because pensioners were still the majority of people accessing retirement benefits, while the vast numbers who would have to instead rely on defined contribution accounts to fund retirements were still working; this kept both the impact of, and the fear of the impact of, that change relatively hidden for quite some time. Second, the impending boom (pun intended) in retirements of a generation whose retirements will be funded – or, actually, more often than not won’t be funded, if you believe the numbers – solely by 401(k) plans. Third, the swooning of the stock market contemporaneously with these events. Add it all up and you end up with a retirement crisis.

For ERISA litigation, you are already seeing some of the changes that this storm is rendering, and will continue to render, as legal rulings and regulatory initiatives occur that are making it and will continue to make it, roughly speaking, easier to sue for breach of fiduciary duty under ERISA and to recover under ERISA if you are a plan participant. Doctrinal development of case law does not happen in a vacuum, and the easing of the restrictions against suing and recovering in ERISA cases is not happening in a vacuum either, but is instead being firmly influenced by the changes in the retirement industry and environment that are causing this perfect storm.

This occurs in a number of influential but indirect ways, which includes more cases being filed, often by more sophisticated lawyers, providing more opportunities for the legal principles at issue to evolve. One manner in which you see this is the shifting, sometimes almost glacially, of principles created in the case law during the days of pensions, when – in my view – courts paid less analytical attention to certain issues because most disputes concerned problems between sponsors and outsiders to the system, such as vendors or lenders, and did not directly affect the ability of participants to be paid their pensions; this is because, absent outright collapse of the sponsor, the obligation remained to pay those benefits regardless of the dispute at issue. The same, of course, cannot be said with regard to defined contribution plans, and thus courts are looking more closely at disputes in this environment than they did when confronted with similar, pension based cases 20 years ago. Indeed, we have clear direction from the Supreme Court that lower courts should reconsider doctrines established back in the long ago days of pensions when they arise in the context of defined contribution plans. Another manner in which this occurs is regulatory change – clearly, the Department of Labor’s flurry of regulatory initiatives related to fee disclosure and fiduciary status concern the need to tighten up the legal structure with regard to defined contribution plans in a manner that was not needed back when pensions walked the earth, as they increasingly no longer do. Each of these regulatory changes, in turn, opens up greater avenues for litigation and fiduciary liability, further changing the legal environment concerning 401(k) plans and ERISA itself. In this way, the perfect storm comes to affect ERISA litigation and liabilities.

Now here is a new wrinkle to add to the perfect storm, one that if true will just add to the impetus towards change described above: the possibility that the impending boom in 401(k) funded retirements will in and of itself depress stock prices. This will in turn simply accelerate the cycle, described above, by increasing the investment risk and capital accumulation risks that the systemic changeover from pensions to defined contribution plans has transferred to participants. The more risk of this nature passed to participants, and the more they suffer as a result of the outcome of those risks running against them, the more litigation, the more recoveries, and the more doctrinal changes you will see.

Put this one in a blog time capsule, and come back and see me in 20 years. I bet I will be right on this one.
 

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.
 

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.
 

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.

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.
 

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.
 

Well, its 2012 and its time to pay close attention to fee disclosure involving 401(k) plans, for those of you who weren’t thinking about it already. The Wall Street Journal caught the bug yesterday, in this article that got wide play. I will tell you what about it caught my attention, which was the quote that the prospect of fee disclosure alone is already "putting downward pressure on fees." I have written on many occasions that the point of the fee disclosure regulations is to create marketplace pressure, driven by sponsors who are worried about the liability risk of failing to target fees and by participants challenging the amount of fees, that will reduce the costs inherent in plans. As I have written before, this approach will affect fees and benefit participants to a far greater degree than the hit or miss excessive fee litigation that has been targeting these issues to date. If the Wall Street Journal says this is already having this effect, then how much more proof do we need?

You know the old saying “let a thousand flowers bloom”? Its long been a shorthand way (ironically enough, given its origin) of referring to the idea of letting state governments and programs serve as testing grounds for different approaches to the same problem, rather than having the federal government dictate one definitive solution, in the form of a particular program. What’s this have to do with ERISA? Well, in all the years I have been writing this blog, people have complained that the Supreme Court, perhaps inadvertently, granted plan administrators too much power by authorizing the application of discretionary review so long as the plan’s authors remembered to grant that to them in the plan documents. Eventually, the carping at the federal level – predominately by means of arguments made in litigation in the federal courts – resulted in some minor changes at the margins, such as rules regarding structural conflicts of interest that are at least slightly more favorable to participants than they are to plans. This approach to date has still not resulted in any great gains in favor of participants, or weakening of the system of arbitrary and capricious, or discretionary, review that governs decisions under most plans. With much less fanfare, however, certain state regulators have targeted this problem by banning the use of the operative language that generates this type of review in insurance policies affecting residents of their states. I have not made a careful study, but the cases that cross my desk from time to time clearly show that these regulatory initiatives are being upheld by the courts, are not preempted, and are serving to impose de novo review – instead of discretionary review – on plans. Why this is working in this way is perfectly summed up in this decision out of the United States District Court for the Northern District of Illinois, Curtis v. Hartford.

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.