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.

Fee shifting provisions, such as the one in the ERISA statute, that authorize a court to award attorney’s fees to a prevailing party, are facially neutral, and allow for an award in favor of the prevailing party, whomever that may be, and against the losing party, again whomever that may be. But should attorney’s fees be awarded to a large plan or administrator, such as a multimillion or billion dollar pension plan, from a plan participant who has lost a case seeking benefits that he or she believed was owed under the plan’s terms? In essence, does a facially neutral fee shifting statute really require David to pay Goliath?

The elements that are to be considered in ruling on an award of attorney’s fees under ERISA are, like the statute’s fee shifting provision itself, facially neutral; they do not presuppose that any particular type of party is more or less entitled to an award of attorney’s fees than any other party, nor that any particular type of party is entitled to protection against being hit with such an award. But the devil, as always, is in the details or, perhaps more accurately when, as in this case, broad open ended standards in the law are applied to a particular case, in the application of the standard to the concrete facts before the court. And as this case here, and Roy Harmon’s discussion of it shows, the application of those elements to this type of scenario tends to end up with a finding that the individual plan participant who has lost a case against a large plan does not have to pay attorney’s fees to the prevailing defendant.

A couple of different things from my desk today that are worth passing on.

First, for those of you interested – as I am and have often discussed in these electronic pages – in the need to balance effective litigation tactics with the costs of litigation, particularly given discovery and e-discovery issues, I pass along this article here, which I truly enjoyed. In many ways, it mirrors what I said in my own article on the subject, which you can find here.

Second, the Supreme Court delved back into the ERISA world yesterday with an argument on what, from a practical perspective, is a particularly vexing problem that bedevils plan administrators: namely, who is entitled to plan proceeds when a plan participant has divorced and thereafter a dispute arises as to who should rightly get plan proceeds after the parties thought they had negotiated resolution of the issue as part of the divorce proceedings? The prototypical circumstance, which seems straight out of television but actually happens all the time, is the death of a plan participant who changed the beneficiary, post- divorce, to a new boy or girlfriend, in ways that contradict the agreed division of property made as part of the divorce. For those of you interested in this question, here is a terrific article on the details of the particular case before the Court, and here is the Workplace Prof’s analysis of the argument yesterday before the Court. My own general sense of the case is that it really revolves around the question of whether ERISA’s QDRO provisions, which are directed at this issue, are to be strictly construed and treated as the only manner in which payments in accordance with the plan’s express terms and the operative beneficiary designation can be avoided, or whether, instead, the issue can be handled in a more loosey-goosey fashion that, even if the QDRO provisions aren’t technically satisfied, effectuates the apparent intent of the divorcing parties. Me, I am betting the Court’s opinion ends up at the former.

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.

Disparate thoughts. Connect the dots. Or maybe more unintended consequences. Take your pick. While many advocates of health care reform cheer the Ninth Circuit’s conclusion that ERISA does not preempt all state pay or play laws, I am a little dubious as to whether this represents anything more than a Pyrrhic victory for anyone actually interested in ensuring that everyone is insured. Report after report, many of them credible, tell us that employers, who provide most of the country’s health insurance, are aghast at the idea of losing ERISA preemption, and would consider it one more reason not to continue to provide health insurance to employees and to instead pull back from that role. I am hardly inclined to think that, should employers relinquish that role, state or federal governments are prepared fiscally or intellectually to step into the breach and effectively fill that hole well. I thought this before, in the past, and wrote about it in a number of postings (such as here), when we saw the financial costs of Massachusetts’ reform plan balloon, supposedly unexpectedly; I thought it again when we saw the effectiveness of federal government regulation of Wall Street; and I thought it for sure when I read Paul Krugman this morning.

Perhaps this obsession among health reform advocates with defeating ERISA preemption is a case of putting the cart before the horse; maybe we should first have effective non-employer health insurance structures in place, before we go trying to dismantle the preemption structures on which employers rely in choosing to provide health insurance to their employees.

Well, my trial this week is over, and I return to the blog with a – cue self-congratulatory, self-promoting note here – win in my back pocket. Last time I tried a case, I complained, tongue firmly in cheek, about the courts insisting on issuing major ERISA decisions while I was not available to discuss them, and they did it again this time around as well, with court decisions and legal developments in this area of the law pouring into my in-box all week. Its exactly as one of my favorite philosophers once wrote: “the wheel is turning and you can’t slow down, you can’t let go and you can’t hold on, you can’t go back and you can’t stand still.”

Among the most prominent decisions issued while I was in court was, obviously, the Ninth Circuit’s ruling finding that San Francisco’s pay or play law was not preempted by ERISA. Can’t say I buy that one. Whatever is the scope of preemption in the field of ERISA, it logically reaches state efforts that result in a multi-jurisdictional company having to comply, with regards to its employee benefit plans, with a differing web of regulation that varies from one state to the next.

Of more interest, perhaps, is the wide ranging group of consequences, some predictable and others unintended, that the Ninth Circuit ruling likely unleashes. The first that jumps out at me is predictable, and the same that immediately occurred to every other commentator: that with the direct conflict it creates between the Fourth and Ninth Circuits on this issue, in combination with the political impetus in numerous states and localities to legislate on this issue, Supreme Court review seems certain. What is less predictable, or at least less widely predicted at this point, is what I fear may be the unintended consequences of that occurring; much as the LaRue decision did little, if anything, to clarify the law in the area of 401(k) losses going forward, but instead opened up a Pandora’s box of not yet addressed and still to be resolved legal issues (as commented on here, for instance), I suspect a ruling in this area by the Court will have the same effect on the question of the legal validity of state action in this area. I am disinclined, given the number of differing approaches to ERISA law and interpretation applied by the differing opinions in LaRue, to think that Supreme Court review of this issue will result in one coherent, uniform theory that can easily be interpreted and applied prospectively to these types of statutes, and suspect that such a ruling is instead more likely to open up a range of issues that will have to be litigated if and when such statutes are challenged as preempted. I could be wrong, but recent history in this area of the law suggests I am not; we may know more after the Supreme Court rules on the ERISA cases currently on its docket, as to how uniform an approach in this field of law and how much helpful guidance will come down from the Court. Bear in mind on this question though, that the Court’s decision in LaRue alone already has courts and litigants thinking that every issue (“every” may be a little bit of an overstatement, but you get the point) that was previously thought resolved is up for grabs in cases filed involving 401(k) plans, if those issues were originally resolved only in cases involving defined benefit plans.

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.

Who knew what and when did they know it?

No, I am not talking about the Wall Street bailout; I am talking about something really interesting, prior knowledge exclusions in insurance policies (well, interesting to me anyway). Prior knowledge exclusions basically work like this: they say that there is no coverage under a liability policy if the insured knew or should have known, prior to commencement of the policy period, that activity it was involved in would result in a claim against it. But how much knowledge the insured must have had, and how certain it must have been that its activities would lead to a claim in the future, have always been the tricky questions in applying these types of exclusions. Set the standard too low and the exclusion encompasses too many prior events, deleting coverage for losses that the insured may have literally had to be prescient to have anticipated; set the standard too high and the exclusion loses its intended effect of preventing insureds from buying policies to protect itself from things that it, but not the insurer selling the policy, knows is lurking in the closet.

This story here concerns the interesting case of a large law firm that apparently knew a client was engaged in misconduct with regard to securities, thereafter bought a professional liability policy, and wanted coverage under that policy for the claim eventually made against it as a result of its legal work for the client engaged in the misconduct. A New York appeals bench concluded that the standard for denying coverage on the basis of a prior knowledge exclusion had to require more than just knowledge of the client misconduct and the ability to anticipate that claims against the insured might possibly arise as a result, but also some level of participation in the misconduct by the insured law firm itself that would justify a belief on its part that it might be subject to liability. As the article describes the court’s conclusion:

Here, while evidence strongly suggests that defendant Gagne and other firm members subjectively either believed or feared that the firm might be subjected to professional liability claims by entities claiming injury as a result of SFC’s conduct, his or the firm’s subjective belief that a suit may ensue based upon SFC’s misconduct is not enough," Saxe wrote.

"In our view, the policy cannot be properly read to require Pepper Hamilton to notify its potential insurers of its client’s misconduct and its own recognition that it may be subjected to legal claims brought by those insureds as a result of its client misconduct," the judge added.

However, the panel held that "if it is ultimately established that the law firm participated in the misconduct, such as by preparing documents on behalf of the client knowing that the documents contained false or insufficient information, or by knowingly creating the forbearance payment mechanism … then application of the prior knowledge exclusion could be justified."

Frankly, from where I sit, that finding seems to put the bar a little high, essentially concluding that evidence of an active role by an insured in actual wrongdoing is necessary to invoke this bar to coverage. The exclusion itself, which is contained in a policy purchased by a quite sophisticated and knowledgeable insured, does not state that it only applies to active wrongdoing before the policy period that leads to a claim, but is instead written more broadly and for broader purposes. Moreover, this interpretation leaves coverage in place for losses, such as this one, where it is fair to say that the insured could have foreseen the exposure before issuance of the policy but it does not appear that the insurer could have done so and thereby built the risk of it into the premium charged for the policy.

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.

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?