ERISA Litigation Update - September 2010

In Diebold, et al. v. Northern Trust Investments N.A., et al., No. 09-c-1934 (N.D. Ill. Sept. 7, 2010), the U.S. District Court for the Northern District of Illinois granted in part and denied in part a motion to dismiss ERISA breach of fiduciary duty and prohibited transaction claims involving an investment manager’s securities lending program.  This is one of a number of recent cases challenging such programs in light of the recent credit crisis, as previously reported in Goodwin Procter’s June 25, 2009 ERISA Litigation Update.

The case was filed in 2009 by two employees who participated in defined contribution plans that invested in funds managed by the defendant investment manager.  The funds engaged in securities lending under a program that involved the lending of securities held by the funds to borrowers who posted collateral equal to 102% of the value of the borrowed securities.  The collateral was placed into collateral pools, which were then invested in longer-term fixed income instruments in accordance with investment guidelines established for each pool.  The collateral pools generated investment income to the funds participating in the program, a portion of which was paid to the securities lending program manager – also a defendant. 

The plaintiffs alleged that the defendants imprudently managed the collateral pools, causing the funds in which the plaintiffs were invested through their defined contribution plans to lose money.  Specifically, the plaintiffs alleged that the defendants took no steps to amend the securities lending program or change the investment strategy for the collateral pools even after becoming aware that the liquidity crisis in the credit market would make it difficult to sell fixed-income investments like those held by the collateral pools.  The plaintiffs alleged that, as a result, the collateral pools incurred tremendous losses in the wake of the financial crisis.  On these allegations, the plaintiffs asserted claims for ERISA breach of fiduciary duty and prohibited transactions.

The defendants moved to dismiss the breach of fiduciary duty claim on the ground that the plaintiffs “offered nothing but conclusory allegations and 20/20 hindsight” in support of their imprudence allegations.  The court held that while the plaintiffs did not identify a single investment that was indicative of an imprudent investment strategy, they put forth sufficient allegations in their complaint regarding “a set of circumstances . . . that would have caused a prudent investor to amend its securities lending program to protect the assets of the collateral pools” to state a claim under Federal Rule of Civil Procedure 8.  The court also rejected the defendants’ assertion that the plaintiffs’ prudence claim was based on hindsight where the plaintiffs adequately pleaded that the defendants ignored “warning signs.”  While the court sustained plaintiffs’ breach of fiduciary duty claim as posing a fact-intensive question not appropriate for a motion to dismiss, it cautioned that the plaintiffs, to support a judgment, “may well have to demonstrate more than just the fact that [d]efendants knew that the asset-based securities market faced stress.” 

The plaintiffs’ second claim, that the defendants engaged in prohibited transactions, was based on the allegation that the securities lending agreements at issue constituted a “lease of property” between the plans and parties in interest, including the securities lending program manager.  The court dismissed the claim, holding that the plaintiffs’ conclusory allegations that the securities lending program operated as a lease failed to state a plausible claim for relief.  The court noted that the lending agreement attached to the complaint made clear that the lending arrangements did not constitute a lease of plan property.  

Lastly, the court addressed the defendants’ arguments that the plaintiffs lacked standing to assert claims because they failed to plead that they had suffered individual losses, and in any event could not assert class claims on behalf of participants in other plans that they purported to represent.  The court found the complaint’s allegations that the plaintiffs participated in various plans and that the defendants breached duties in managing the securities lending program sufficient to state an actionable loss, and rejected the assertion that the plaintiffs’ class claims failed on the pleadings.  The court stated that any argument regarding the plaintiffs’ ability to represent participants in other plans would be addressed at the class certification stage.  This holding stands in contrast to a decision earlier this year by a different federal court dismissing at the pleading stage claims against the defendants with respect to a securities lending program where the plaintiff lacked standing because no losses resulted from the alleged conduct.  Fishman Haygood Phelps Walmsley Willis & Swanson L.L.P. v. State Street Corp., No. 1:09-10533-PBS, 2010 WL 122377 (D. Mass. Mar. 25, 2010).

After years of litigation, the handful of ERISA fee cases that have survived dismissal at the pretrial stages are starting to wend their way to trial. Judgment was entered on August 9, 2010 in the first trial decision of this wave of cases, in Tibble v. Edison, No. 07-5359 (C.D. Cal.).  The court awarded judgment, in part, for the plaintiffs – participants in the Edison 401(k) Savings Plan (“Plan”) – and in part for the defendants – the plan sponsor, various of its subsidiaries, and numerous officers and employees who served on various plan committees.  In terms of monetary recovery, while the plaintiffs claimed losses in excess of $335 million, judgment of only $370,732 was awarded in their favor (though their lawyers have sought over $2.4 million in fees and costs). Each party took an immediate appeal. 

The Edison suit was brought by Plan participants on behalf of a class of all current or former Plan participants. Claims were similar to those brought in other ERISA fee cases that have been described in this newsletter and Goodwin Procter’s Financial Services Alert, including, most recently, the June 22, 2010 Alert. In short, the plaintiffs alleged that the defendants violated ERISA’s fiduciary duties of prudence, loyalty and compliance with plan documents, and committed prohibited transactions, by allowing payments of revenue sharing between the Plan’s investment options and the Plan’s recordkeeper, selecting allegedly imprudent investments, and allowing the Plan’s trustee to retain “float.” A class of Plan participants and beneficiaries was certified on June 30, 2009.  

In rulings dated July 16 and 31, 2009, the trial court denied the plaintiffs’ motion for summary judgment and granted in large part the defendants’ motion for summary judgment. The court dismissed core claims challenging revenue sharing, the general selection of retail mutual funds and an employer stock fund, and the trustee’s retention of float. After trial on the remaining issues, the court ruled in the defendants’ favor on all claims, except one. The only issue it found in the plaintiffs’ favor was that, under the facts adduced at trial, the defendants breached ERISA’s duty of prudence (but not loyalty) by selecting three retail mutual funds (out of approximately 40 offered through the Plan) where institutional share classes of the identical funds were available. The court’s decision hinged on two facts found at trial: (i) there was “no evidence that Defendants even considered or evaluated the different share classes” (emphasis in original) and (ii) the defendants offered no “credible explanation for why the retail share classes were selected instead of the institutional share classes.”  The court was clear in holding, though, that “ERISA does not require the [] plan fiduciary [to] select the cheapest fund available,” only one that is within the “reasonable range of fees charged by other comparable funds” (citing, among others, Hecker v. Deere & Co., 556 F.3d 575, 586 (7th Cir. 2009)) (reported in Goodwin Procter’s June 25, 2009 ERISA Litigation Update).   

Last month, in George, et al. v. Kraft Foods Global, Inc., et al., Case No. 08-c-3799 (N.D. Ill. Aug. 25, 2010) (“Kraft II”), the U.S. District Court for the Northern District of Illinois granted a motion to certify as a class action a lawsuit filed by several plan participants challenging the prudence of including two actively managed mutual funds in their employer’s defined contribution plan (the “Plan”).

In their Second Amended Complaint, the plaintiffs asserted claims for ERISA breach of fiduciary duty against the plan sponsor and other plan fiduciaries alleging, among other claims, that the defendants caused the Plan to be charged excessive administrative fees and imprudently included actively managed mutual funds in the Plan’s investment lineup when low cost index options were readily available. An earlier case against some of the same defendants asserting similar claims, George et al. v. Kraft Foods Global, Inc. Administrative Committee, et al., No. 07-1713 (N.D. Ill.) (“Kraft I”), had been dismissed when the court granted the defendants’ motions for summary judgment. In Kraft II, the allegations against the defendants had been narrowed first by the court granting in part a motion to dismiss in December 2009, and second, by the parties’ subsequent stipulation that certain counts would be dismissed. The only count that remained in Kraft II by the time the court ruled last month on class certification was the plaintiffs’ claim for alleged imprudent investment selection based on the defendants’ inclusion in the Plan of two actively managed retail mutual funds instead of passively managed separate accounts and/or commingled pools.

In opposing the plaintiffs’ motion for class certification, the defendants argued that two of the named plaintiffs lacked Article III standing because they did not invest in the funds at issue. The defendants further argued that the plaintiffs’ claims did not meet the typicality requirement for class certification under Federal Rule of Civil Procedure 23 insofar as the named plaintiffs’ claims could not be typical of putative class members who actually invested in the challenged funds.  The court rejected this argument, stating that the plaintiffs’ imprudent investment selection claim is, at bottom, a challenge to the defendants’ alleged “deficient investment policies” and “not tied to actual investment in any particular fund.”  Accordingly, the court held that the fact that the proposed class representatives did not invest in the two funds at issue did not deprive them of standing to pursue class claims because the “[p]laintiffs and their proposed class share the same injury: the invasion of their legally protected interest in a prudent fiduciary.”  Other courts have reached opposite conclusions given similar challenges. See, e.g., Hans v. Tharaldson, No. 05-cv-115, 2010 WL 1856267 (D.N.D. May 7, 2010) (in ERISA suit arising out of a plan’s purchase of company stock, proposed class representatives whose plan assets were invested in options other than the challenged stock fund did not meet typicality requirement necessary to represent a class including participants invested in the stock fund).

As the Supreme Court recently observed, “[p]eople make mistakes. Even administrators of ERISA plans.”  Conkright v. Frommert, 130 S.Ct. 1640 (2010). Sometimes those mistakes result in erroneous payments to (or on behalf of) plan participants. Not surprisingly, plan administrators and service providers may seek to recover those mistaken payments through litigation. However, there is conflicting case law regarding the types of claims that can be brought to accomplish that goal. The recent court decisions discussed below illustrate some of the challenges facing parties who file suit to recover mistaken plan payments.

While some courts have permitted the use of state law to recover mistaken payments, others have held that state law causes of action are preempted by ERISA Section 514(a), which provides that (subject to exceptions not relevant here) ERISA supersedes all state laws that “relate to” a plan.  For example, in ING Investment Plan Services, LLC v. Barrington, No. 09-cv-3788, 2010 WL 3385531 (N.D. Ill. Aug. 24, 2010), an administrative service provider for a pension plan miscalculated the lump sum value of a distribution due a participant, resulting in an overpayment of more than $143,000. After reimbursing the plan for the overpayment, the service provider sued the participant in federal district court, asserting state law claims of quantum meruit and money had and received. The participant moved to dismiss the complaint, arguing that these state law claims were preempted by ERISA. The district court agreed, holding that the state law causes of action were preempted because they implicated the relationship between two “principal ERISA entities,” the plan and the participant. The court also noted that adjudicating the service provider’s claims would necessarily require consulting the plan’s terms. However, the court granted the service provider leave to amend the complaint to add claims under ERISA.

The ability to bring a claim to recover plan overpayments under ERISA will depend on the specific facts of the case and the court’s view of the scope of the remedies available under the statute. The relevant statutory provision is ERISA Section 502(a)(3), which authorizes (among other claims) actions by plan fiduciaries for “appropriate equitable relief” to enforce plan terms. In Great West Life & Annuity Insurance Co. v. Knudson, 534 U.S. 204 (2002), the Supreme Court indicated that a restitution action to recover a plan payment will be considered to be a claim for “equitable” relief within the meaning of ERISA Section 502(a)(3) only if it seeks recovery of a specific fund held by the defendant and traceable to payments made by the plan. However, in Sereboff v. Mid-Atlantic Medical Services, Inc., 527 U.S. 356 (2006), the court determined that a claim for recovery of a plan could be “equitable” for Section 502(a)(3) purposes – even if it was not a claim against assets specifically traceable to the plan payment – so long as the claim was based upon an “equitable lien by contract.”  In Sereboff, the court held that such an equitable lien arose from provisions of a medical plan requiring a participant who had received plan benefits to reimburse the plan if he received payments from a third party (e.g., recovery from a tortfeasor with regard to an accident which resulted in the medical services for which the plan paid).

The lower courts have had to apply the lines drawn by Great West and Sereboff to varying fact patterns in cases seeking recovery of plan payments. For example, in Cusson v. Liberty Life Assurance Co. of Boston, 592 F.3d 215 (1st Cir. 2010), a participant in a long-term disability (LTD) program received a retroactive, lump-sum Social Security disability award that, under the plan terms, constituted an offset against plan payments he had already received. In an action filed in federal district court, the disability insurer relied on ERISA Section 502(a)(3) in seeking recovery of the amount of the previous plan payments subject to the retroactive offset.¹  The participant, relying on Great West, argued that the insurer’s claim was not for “equitable” relief, within the meaning of Section 502(a)(3), because it did not seek recovery from a specific, identifiable fund. The district court rejected this argument and the First Circuit affirmed, holding that the case was controlled instead by Sereboff. The Cusson court decided that the relevant language of the LTD plan was sufficient to grant the insurer an equitable lien by contract in the amounts paid to the participant which should have been offset by the Social Security disability award.

Other claims for recovery of plan payments have been denied by courts – even where plan language granted the plan a right to recover – because, in the court’s view, the action fell outside the scope of Section 502(a)(3). For example, in Kolbe & Kolbe Health and Welfare Benefit Plan v. Medical College of Wisconsin, Inc., 09-cv-205, 2009 WL 3245108 (W.D. Wisc. Oct. 6, 2009), a medical plan sought recovery of $1.6 million it had paid to a hospital for services provided to a child. After it had made the payments, the plan determined the child was not eligible for coverage under the plan. The plan sued the hospital in federal district court under Section 502(a)(3), relying on Sereboff, and asserting that the plan language gave it the right to recover any payments made in error. The court, however, held that the plan language could not constitute a basis for an “equitable lien by contract” claim against the hospital, because the hospital was not a party to the relevant contract – i.e., the plan.

As illustrated by these cases, plan administrators and service providers seeking to recover mistaken plan payments must review closely the specific facts and circumstances to determine the proper basis for their claims.

“The Case for a Presumption of Prudence”
BNA Pension & Benefits Daily
September 29, 2010
Author: James O. Fleckner