Golden Gate CPCU and Northern California PLUS Chapter Present: Fiduciary Liability – Trends &...

Golden Gate CPCU Golden Gate CPCU and and

Northern California PLUS Chapter Northern California PLUS Chapter

Present: Present: Fiduciary Liability – Fiduciary Liability –

Trends & IssuesTrends & Issues

October 10, 2007

SpeakersSpeakers• Christopher Rillo is a partner with Groom Law Group

Chartered and has a national practice representing defendants in ERISA class actions. Chris has represented defendants in company stock actions, cash balance cases, 401k fee actions and ESOP claims. Chris has won several precedential decisions in company stock, cash balance, 401k fee and ESOP actions. Chris' clients include The Boeing Company, El Paso Corporation, Northwest Airlines, General Motors Corporation and The Home Depot. Chris has been recognized recently by The Legal 500 as leading national expert in ERISA litigation.

• Blake Rea, Assistant Vice President responsible for managing the Western Region of RLI Insurance's Executive Products Group, underwriting Directors & Officers , Fiduciary , and Employment Practices Liability. Blake began his insurance career with Chubb in 1981 . Blake spent a number of years as a broker as a Senior Vice President with AON and Marsh specializing in management liability . Blake has been with RLI for six years.

Seminar GoalsSeminar Goals

• Identify exposures faced by employers who offer employee benefit plans

• Understand the management liability products available to address these exposures

• Discuss how the market is reacting to new exposures

• Review current trends in ERISA litigation

FIDUCIARY STATUSFIDUCIARY STATUS

• Definition of a “Fiduciary”

1. Employee Retirement Income Security Act of 1974 ("ERISA") includes a code of conduct for individuals known as fiduciaries. The primary purpose for identifying fiduciaries is to determine who has responsibility and liability for each aspect of plan administration and management. Under ERISA § 3(21), a fiduciary includes any person who –

a. Exercises discretionary authority or control with respect to the management of a plan,

b. Exercises any authority or control respecting management or disposition of plan assets,

c. Has discretionary authority or responsibility in the administration of the plan, or

d. Provides investment advice for a direct or indirect fee with respect to money or property of the plan. 29 C.F.R. 2510.3-21(c).

GENERAL FIDUCIARY DUTIESGENERAL FIDUCIARY DUTIES

• Duty of Loyalty A fiduciary must discharge his duties "solely in

the interest of the plan's participants and beneficiaries" and "for the exclusive purpose" of providing benefits and defraying reasonable expenses of administration.

A fiduciary does not violate this duty of loyalty if his actions incidentally benefit the fiduciary or another party so long as the actions are taken solely with the interests of the participants and beneficiaries in mind.

GENERAL FIDUCIARY DUTIES GENERAL FIDUCIARY DUTIES (con’t)(con’t)

• Duty of Prudence Prudent Professional Standard: A fiduciary

must discharge his duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." ERISA § 404(a)(1)(B). a. The investing fiduciary will be held to the

standard not of a prudent layman, but of a "A pure heart and an empty head are not an acceptable substitute for proper analysis."

GENERAL FIDUCIARY DUTIES GENERAL FIDUCIARY DUTIES (con’t)(con’t)

• Duty of Diversification A fiduciary must diversify the plan's investments

"so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so."

ERISA's legislative history indicates that a fiduciary should not invest an "unreasonably large percentage" of plan assets in a "single security," in "one type of security," or in "various types of securities that are dependent upon success of one enterprise or upon conditions in one locality."

Some courts have found non-diversification to be "clearly prudent" under certain circumstances.

GENERALGENERALFIDUCIARY DUTIES FIDUCIARY DUTIES (con’t)(con’t)

• Duty to Follow the Plan Documents A fiduciary must discharge his duties "in

accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions" of ERISA. ERISA § 406(a)(1)(D).

The plan sponsor must ensure that plan and trust documents accurately reflect current investment practices.

PROHIBITED TRANSACTIONSPROHIBITED TRANSACTIONS

• Party In Interest Transactions ERISA § 406(a) absolutely prohibits certain categories of

transactions between a plan and a "party in interest.“ Parties in Interest: Include any employer of or union

representing covered employees, any service provider to the plan (e.g., record keepers, attorneys, actuaries, brokers), any fiduciary to the plan (e.g., investment managers, trustees, plan administrator), as well as a broad range of affiliates of each of these entities. ERISA § 3(14).

Prohibited Transactions: Absent an exemption, the following transactions are absolutely prohibited under ERISA § 406(a):

a. A sale, exchange or lease of property between a plan and a party in interest.

Example: The plan's purchase of stock from the employer in a private (non-exchange) transaction.[2]

PROHIBITED TRANSACTIONS - PROHIBITED TRANSACTIONS - examplesexamples

* A loan or other extension of credit between a plan and a party in interest. Example: The plan record keeper's advance to a plan in order to affect daily securities transactions.[3]

* The transfer of plan assets to a party in interest. Example: The Plan makes a gratuitous payment to a plan service provider.

* The use of plan assets by or for the benefit of a party in interest. Example: The plan fiduciary causes the plan to purchase the plan sponsor's stock from an unrelated party in order to assist the plan sponsor in blocking a takeover attempt.

PROHIBITED TRANSACTIONS PROHIBITED TRANSACTIONS (con’t)(con’t)

• Prohibited Conflicts of Interest

In addition to transactions between the plan and "parties in interest," ERISA also prohibits self-dealing and other conflicts of interest by plan fiduciaries.

1. Self-Dealing: A fiduciary may not deal with the plan's assets in his own interest or for his own account. ERISA § 406(b)(1).

a. DOL believes that a fiduciary should not even act in any transaction in which he has an interest that could affect his best judgment as a fiduciary. 29 C.F.R. § 2550.408b-2(e)(1).

Example: Plan sponsor fiduciary chooses a custodian bank for the plan because the bank will provide, in exchange, advantageous banking arrangements for the sponsor's assets.

Special Issues for Participant-Special Issues for Participant-Directed PlansDirected Plans

• Section 404(c) Compliance with regulations under ERISA § 404(c) will relieve a

plan fiduciary of responsibility for most of the investment decisions of plan participants who exercise control over assets in their defined contribution plan accounts.

The fiduciary is not completely relieved of liability under a Section 404(c) plan.

a. The fiduciary is fully responsible and liable for prudent selection of the investment alternatives offered to plan participants;

b. Relief is not provided for certain participant transactions including:

i. any transaction inconsistent with the governing plan documents,

ii. any transaction that could jeopardize the tax status of the plan, and

iii. certain transactions with the plan sponsor

Available InsuranceAvailable Insurance

• Employee Benefits Liability

• ERISA Bond (mandated)

• Directors &Officers Liability

• Fiduciary Liability Coverage• Fiduciary Liability Underwriting considerations

• Type of plan

• Plan Assets & Funding

Fiduciary Liability Fiduciary Liability InsuranceInsurance

What is covered? / Who is covered?

• Common coverage provisions

• Common coverage exclusions

• Potential coverage enhancements


What is covered?

Common policy provisions• Breach of duties imposed by ERISA or COBRA

• Negligence, error or omission in the administration of employee benefits

• Definition of Claim usually includes written demands for monetary or non-monetary relief, civil proceedings, criminal proceedings, formal administrative or regulatory proceedings, and alternative dispute resolution proceedings


What is covered?Administration means….• Giving counsel, advice or notice• Interpreting plan benefits• Handling records• Effecting enrollment, termination or

cancellation of plan participants in benefit plans


What is covered?Loss/Damages

• Compensatory damages and defense expenses

• Punitive damages – “most favorable venue”

• ERISA 502(i) and 502(l) penalties


Who is covered?• Benefit plan (scheduled to policy or

omnibus)• Merged/terminated/sold plans• Plan sponsor and subsidiaries• Fiduciaries/trustees of the plans and plan

sponsor and subsidiaries (D&Os and employees)

• Spousal extension


Common Coverage Exclusions• Benefits due• Deliberate fraud/willful violation of statute• Personal profit• BI/PD• Prior and pending litigation; notice given to

prior carrier• Discriminatory hiring or firing, retaliation,

and wrongful termination, other than claims under ERISA Section 510


Potential Enhancements• Additional defense coverage• Coverage for HIPAA violations• IRS and DOL voluntary compliance

settlement fees• Coverage for benefit plans not subject to

ERISA Title I• Amended settlement provision (“hammer

clause”)

Sources of Claims Against Sources of Claims Against Plan FiduciariesPlan Fiduciaries

• How do fiduciaries get into trouble?

−Making false or misleading statements

−Imprudent investments

−Lack of diversification

−Non-compliance with Plan documents

−Errors in Plan administration

ERISA CLAIMSERISA CLAIMS• Defined Contribution Plan Claims

Company Stock Litigation: Plaintiffs contend that participants were damaged because the plan held company stock as a permitted investment and the stock declined in value. Plaintiffs allege that fiduciaries violated their fiduciary duties in 3 ways:

a. Prudence b. Failure to Communicate c. Failure to Monitor

1. 401(k) Fee Litigation: Plaintiffs have filed approximately 17 lawsuits alleging that sponsors and service providers have violated their purported fiduciary duties by causing plans to pay excessive fee and failing to disclose fully those fees. There are several issues raised by these new claims:

a. Revenue Sharing b. Procedural Process

ERISA CLAIMS ERISA CLAIMS (con’t)(con’t)

• Defined Benefit Claims Cash Balance Plans: Plaintiffs have filed a rash of claims

attacking conversions of defined benefit plans to cash balance arrangements as age discriminatory. Despite a landmark ruling by the Seventh Circuit that such conversions do not violate ERISA's prohibition against age discrimination, such suits have continued. Cooper v. IBM Personal Pension Plan, 457 F.3d 659 (7th Cir. 2006).

a. Age Discrimination b. Backloading c. Wearaway d. PPA Changes

1. Defined Benefit Plans: Traditional defined benefit plans attract litigation, often centered on whether an amendment constitutes an illegal cutback or vesting issues, such as whether a break in service permits a participant to recover benefits.

a. Plan Term Litigation, e.g. COLAs

ERISA CLAIMS ERISA CLAIMS (con’t)(con’t)

• Worker Classification Issues With the advent of the new workforce, employers utilize

more temporary employees often for prolonged periods of time. These temporary employees have brought claims that they should be considered employees entitled to benefits. Microsoft settled one such claim.

• Welfare Litigation Health plans and coverage under these plans are

increasingly being raised in litigation. • Multiemployer Plans

The Cost of a ClaimThe Cost of a Claim

• Tillinghast Survey

−$1.9 million average indemnity payment of a fiduciary claim

−$121,000 average defense cost

−Public companies and companies involved in M&A activity have higher incidences of claims

• Duty to defend Insurer pays first dollar defense Defense covered for all counts

• Reimbursement Flexibility to choose defense counsel Coverage must be determined prior to

reimbursement• Reporting of Claims

Reported during policy period (or within ERP) “as soon as practicable” language

How Are Claims Handled?How Are Claims Handled?

Claim TrendsClaim TrendsCost of a ClaimCost of a Claim

$858,000 Legal action brought by employees alleged the wrongful elimination of a profitable investment option and improper selection of another and FAILURE TO MONITOR the actions of the outside investment manager. Defense costs were $358,000 and the jury awarded the plaintiffs $500,000 in damages.

$400,000 Plan participants alleged that the fiduciaries of a 401(K) PLAN had failed to divest the plan of an investment option that was not keeping pace with the performance of the comparable index and RESULTED IN POOR RETURNS. The case settled for $250,000 after $150,000 in legal fees had been spent.

$530,000 Participants of a health plan sued the plan’s trustee alleging that the TRUSTEE DID NOT MONITOR the performance of its third party administrator (TPA) and paid excessive fees. Damages and defense expenses totaled $530,000.

Major SettlementsMajor Settlements

• Royal Dutch/Shell $90 million • Enron $85 million In addition to other

consideration, plaintiffs also received a $356.25 million unsecured claim in Enron’s bankruptcy proceeding.

• Global Crossing $79 million • Lucent $69 million • Williams Companies $55 million • WorldCom $51 million • Household International $46.5 million • Dynegy $30.75 million • AT&T $29 million • HealthSouth $25 million • Morrison Knudson $21 million • McKesson HBOC $18.2 million

Claims BreakdownClaims Breakdown

• Denial of benefits – 32%• Misleading representations – 10%• Administrative error in benefit plan – 9%• Communication of plan benefits – 9%• Imprudent investment – 2%• Civil rights/human rights, including

discrimination – 2%• Inadequacy of plan assets – 2%

• 2003 Survey

Future Trends - Future Trends - Pension Protection ActPension Protection Act

• What is it?

• Why was it enacted?

• What does it do?

• Possible effects on fiduciary liability?

Pension Protection ActPension Protection Act

What is it?• Signed into law August 16, 2006• Modified dozens of ERISA and Internal

Revenue Code provisions• Major changes to defined benefit plan

funding rules• New reporting and disclosure requirements• New safe harbors for certain plan features

and plan types


Why was it enacted?• Improve funding of defined benefit plans

2000 – 2003 “Perfect Storm” Record PBGC deficit in 2004

• Funding relief requested by plan sponsors Improve accuracy of valuing plan liabilities Limited ability to overfund plans during good

years

• Response to collapse of Enron


What does it do?• Modifies defined benefit plan funding rules• Improves disclosure and reporting of defined benefit

and defined contribution plans• Creates a safe harbor for cash balance plans • Creates new diversification rights for certain 401(k)

participants• Creates safe harbors for 401(k) plan automatic

enrollment, default investments, and investment advice

• Increases bonding requirements• Miscellaneous changes to ERISA and Internal

Revenue Code


What does it do?• Modifies defined benefit plan funding rules

Increases minimum funding target Requires more rapid payment of funding deficits Imposes benefit restrictions on poorly funded

plans

• Improves disclosure of defined benefit plan funding and benefits Triennial benefit statements Annual funding notices


What does it do?• Creates a safe harbor for cash balance

plans against age discrimination claims Contains "no-inference" provision which states

that its provisions are prospective only from the date of enactment August 16, 2006.

Accelerated vesting Prohibits “wearaway” after a traditional DB plan

conversion Annual interest credits must be the same for

similarly situated employees Eliminates the “whipsaw” issue


What does it do?• Creates new diversification rights in plans with

employer securities• Creates safe harbors for 401(k) plan automatic

enrollment, default investments, and investment advice Express preemption of state payroll laws Qualified Default Investment Alternative (QDIA) Eligible Investment Advice Arrangement

• Improves disclosure of defined contribution plan rights and benefits Annual benefit notices (quarterly for participant-directed

account plans)


What does it do?

• Increases bonding requirements Maximum bond limit increased from

$500,000 to $1,000,000 for plans that hold employer securities

• Miscellaneous changes to ERISA and IRC


Implications for plan fiduciaries?• Numerous changes to existing administrative practices• New safe harbors contain a laundry list of new rules• Defined benefit plan funding requirements are more onerous • Possible increase in the number of defined benefit plan

amendments, conversions, freezes and terminations• Greater plan transparency may prompt more comments,

inquiries and complaints from plan participants• Plan fiduciaries may be on their own until additional technical

guidance is issued by the DOL and IRS • Possible need for a corrections bill from Congress

QUESTIONS?QUESTIONS?

DisclaimerDisclaimer

• The views expressed in these materials are those of the authors. These materials are for general informational purposes only. None of it constitutes legal advice, nor is it intended to create any attorney-client relationship between you and the author. You should not act or rely on this information concerning the meaning, interpretation, or effect of particular contractual language or the resolution of any particular demand, claim, or suit without seeking the advice of your own attorney.

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