Today’s economy is looking pretty grim from Joe the Plumber’s perspective. Tough economic times like these mean that a previous trend in Employee Retirement Income Security Act retirement plan litigation – “stock drop” cases – will likely hit a feverish pitch in the near future.
We also will see a new version of the old breach of ERISA fiduciary duty cases take hold in which one plan fiduciary sues the third party investment managers (think Northern Trust) for monumental drops in plan values.
The Employee Retirement Income Security Act of 1974 is a federal law that establishes minimum standards for most voluntarily established, private pension plans and sets the standards that the different fiduciaries managing those plans must operate by.
A fiduciary is someone who has discretionary authority or exercises control over the management of the plan or the management and disposition of plan assets, or gives investment advice to the plan, or who has discretionary responsibility for plan administration.
Employers offering employees retirement plan options often create benefit committees which become cloaked with fiduciary status.
As with other fiduciaries, these benefit committees are required by ERISA to discharge their duties in the sole interest of the participants and beneficiaries of the plan and with the intent of providing benefits and defraying plan expenses.
Because whether a fiduciary has done so is judged under a “prudent man” standard, fiduciaries typically have a duty to diversify plan assets.
Fiduciaries have other specific duties to avoid self-dealing and conflicts of interest.
These duties set the stage for what has become known as “stock drop” litigation. As the name implies, in stock drop cases plan participants sue when the value of the employer’s stock heads south. These plaintiffs usually allege that the benefits committee breached its fiduciary duty by allowing the employer’s stock to be offered or maintained as an investment option in the plan and/or that the disclosures to participants about the stock value were inadequate.
The First Circuit Court of Appeals dealt with a little different scenario in which the benefits committee was accused of acting improperly by selling the stock. Bunch v. W.R. Grace serves as a good illustration of how well-meaning benefits committee members can unwittingly get themselves into trouble, and also provides an example.
In that case, W.R. Grace filed for bankruptcy and in doing so, concluded that its benefits committee – whose members included corporate officers – might have a conflict of interest if it decided to maintain company stock in the plan’s portfolio. In a move intended to ameliorate the conflict, the committee hired State Street Bank to analyze whether the company stock should be retained or sold.
The bank proceeded to study market conditions, the company’s bankruptcy and reorganization plan and litigation involving the company. The bank’s findings led it to recommend that the company stock should be sold.
The plan participants were not happy about the sale and sued the committee, contending that the sale price was artificially low and therefore an imprudent fiduciary act.
The First Circuit thought otherwise. It held that the actions of the fiduciaries unquestionably met ERISA’s prudent man standard because the benefits committee recognized the potential conflict and took action to correct it.
For its part, the bank hired objective third parties for assistance and considered a multitude of factors in its exhaustive analysis of the value of the W.R. Grace stock.
Noting that how well or how poorly the company stock performed is not the standard for judging a fiduciary’s acts and that one factor (i.e., market price) is not given more weight than another, the court concluded that the totality of circumstances mandated the conclusion that the benefits committee met its ERISA obligations.
As this and other stock drop cases show, employer-related fiduciaries must be extremely diligent and cautious when purchasing or selling, or considering whether to purchase or sell, company stock, and especially when the employer’s financial security becomes threatened.
Conflicts of interest are even more easily perceived in financially difficult times because committee members’ loyalty to the employer is theoretically manifested in the purchase or holding of corporate stock. Retaining a reputable, experienced third party which also does a complete investigation of all factors affecting stock-related transactions will go a long way toward satisfying the investment fiduciaries’ ERISA obligations.
Other, non-stock drop losses can occur in retirement plans as well.
A proactive approach to litigation may be available to employer-related fiduciaries to deal with such losses.
Many “fiduciary-on-fiduciary” suits have been filed recently in which plan benefits committees are going after investment advisers and managers whose negligence or fraudulent conduct causes huge plan losses.
In one such case, fiduciary investment managers Northern Trust Co. and Northern Trust Investments are accused of improper securities lending in which stocks owned by retirement plans are loaned and secured with risky investments like mortgage-backed securities.
With an economic climate unlike we have quite seen before, look for litigation to increase in these areas. Given the widespread distribution of federal government bail-out money, however, the biggest losers in this reality show are going to be the citizens of this country.
Kerri J. Atencio is an attorney at Holland & Hart LLP. She can be reached at email@example.com.