0Sixth Circuit Holds That ERISA Preempts State Law Claims Against Nonfiduciary Plan Custodian
In McLemore v. Regions Bank, No. 10-5480 (6th Cir. June 8, 2012), a divided panel of the U.S. Court of Appeals for the Sixth Circuit ruled that ERISA preempted state law claims brought against a custodian that allegedly failed to prevent a plan fiduciary from stealing plan funds.
In McLemore, a third-party administrator (the “TPA”) for a number of ERISA plans directed the plans to send funds to depository accounts with a bank (the “Bank”) that were held in the name of the TPA. Over a four-year period, the TPA effectively stole over $19 million from these accounts through numerous withdrawals and transfers. After the TPA became bankrupt and its theft of the plans’ funds was discovered, the trustee of the TPA’s bankruptcy estate sued the Bank on behalf of the plans in federal district court, asserting fiduciary claims under ERISA § 502(a)(2) as well as claims under state law. On the Bank’s motion, the district court dismissed both sets of claims, ruling that the complaint failed to allege adequately that the Bank was an ERISA fiduciary and that the state law claims were preempted by ERISA. On appeal, the Sixth Circuit (in an opinion authored by Judge Cook) affirmed the district court ruling in a 2 – 1 decision that addressed four issues.
First, the Court of Appeals determined that the trustee of the TPA’s bankruptcy estate had standing as a fiduciary to bring claims on behalf of the plans under ERISA § 502(a)(2). In this regard, the court concluded that the bankruptcy trustee had adequately pleaded its fiduciary status, in light of the complaint’s allegations that – as “successor fiduciary” of the TPA – the bankruptcy trustee exercised control over assets of the plans.
Second, the Sixth Circuit rejected the Bank’s arguments that, because the bankruptcy trustee asserted it was “step[ping] into the shoes of [the TPA]” to sue as fiduciary, its claims should be barred by the equitable doctrines (in pari delicto and unclean hands) that in certain situations prevent culpable parties from bringing suit. The court emphasized that, in suing on behalf of the plans, the bankruptcy trustee was “stepping into the shoes of the plans” and was not attempting to recover funds for the TPA’s bankruptcy estate.
Third, the court affirmed the dismissal of the ERISA fiduciary claims against the Bank, agreeing with the district court’s conclusion that, under the complaint’s allegations, the Bank was not an ERISA fiduciary of the plans. In this regard, the complaint alleged: that the Bank knew that the TPA’s accounts held plan assets; that the Bank had assisted the TPA in opening the accounts in its own name in order to circumvent banking rules; and that the Bank had withdrawn over $500,000 in fees and other charges from the accounts for its own benefit. In the court’s view, these allegations did not establish the requisite “authority or control” over management or disposition of plan assets within the meaning of ERISA’s definition of fiduciary, because they indicated that the Bank acted only as a nondiscretionary custodian that followed the TPA’s directions and collected its “contractually owed fees” from the accounts.
Lastly, the Sixth Circuit ruled that ERISA preempted the complaint’s state law claims. The court noted that, in the circumstances of this case, applicable state law limited the claims that could be brought to allegations of knowing or bad faith conduct by the Bank (effectively eliminating claims based on, e.g., negligence). The court observed further that state law claims alleging the Bank had knowingly, or in bad faith, permitted the TPA to steal funds from the plans would effectively constitute state law claims that the Bank had knowingly participated in the TPA’s actions that constituted breaches of the TPA’s fiduciary duties under ERISA. The court reasoned that such state law claims would be preempted by ERISA, which itself provides a cause of action against nonfiduciaries who knowingly participate in breaches of fiduciary duties by ERISA fiduciaries. The court stressed that the remedies for such a “knowing participation” claim under ERISA would be limited to equitable relief (such as the restitution of plan funds in the Bank’s possession), while remedies for state law knowing participation claims could provide for broader relief (such as damages to make the plans whole for their losses). It found that the state law claims were preempted because they would impermissibly supplement the remedies established by ERISA’s remedial scheme, which Congress intended to be exclusive.
Judge Merritt dissented from the majority’s conclusion that the state law claims were preempted, arguing that, before ERISA was enacted, the plan participants could have had state law remedies against the Bank in the circumstances of this case, and that Congress intended ERISA to be protective of participants. He asserted in dissent that he “would not adopt a construction of preemption that perversely deprives [plan] participants of rights they previously possessed.”
0Sixth Circuit Dismisses Stock Drop Claim for Failure to Allege “Actual Injury”
The U.S. Court of Appeals for the Sixth Circuit recently rejected a breach of fiduciary duty claim in connection with a participant’s investment in a company stock fund on the ground that the plaintiff failed to establish an actual injury. The case is Taylor v. KeyCorp, No. 10-4163, 2012 WL 1889283 (6th Cir. May 25, 2012). In her complaint, the plaintiff alleged that the price of the company stock had been artificially inflated as a result of the sponsor’s inappropriate lending and tax practices, among other breaches. She alleged that plan fiduciaries violated ERISA by failing to prudently manage the plan’s investment in company stock, failing to adequately inform plan participants about the risk of investing in the company stock, failing to adequately monitor the management and administration of plan assets, and failing to avoid impermissible conflicts of interest. The plaintiff brought her claim on behalf of herself and similarly situated participants and beneficiaries.
Having lost an early motion to dismiss on the pleadings for failure to state a claim, the defendants moved again to dismiss the complaint in the district court on the ground that the court lacked subject matter jurisdiction over the claims because the plaintiff had sustained no “actual injury.” The defendants argued that the plaintiff did not experience a net loss in investing in company stock through the plan. They pointed out that she had sold 80% of her company stock at a time she alleged its price was inflated. The plaintiff countered that she sustained an injury, either based on an alternative investment theory of damages or based on the loss sustained on 20% of her holdings. The district court dismissed the claim, finding that the plaintiff had benefitted from any inflation of the stock’s price and therefore had alleged no actual injury sufficient to establish the subject matter jurisdiction.
The Sixth Circuit reviewed the dismissal de novo and similarly concluded that the court lacked subject matter jurisdiction where the plaintiff could establish no actual injury. The appeals court relied on the Supreme Court’s reasoning in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), that, in the context of securities fraud allegations, to establish economic loss based on an alleged inflation of stock price, the plaintiff must have purchased her stock at an inflated price and sold at a loss. Mere allegations of an inflated purchase price are insufficient.
The Sixth Circuit rejected the plaintiff’s argument that an alternative investment theory of damages, as opposed to an out-of-pocket loss theory of damages, was appropriate. It held that allowing plaintiffs to pursue damages on that theory was inappropriate for a claim alleging artificial inflation of stock value because allowing such a measure of damages would not advance the purpose of ERISA, noting that “[t]he purpose of the ERISA safeguards was not to obtain windfalls for the participants but [to] ensure that the rights promised by a company were fulfilled.”
The court also rejected an argument advanced by both the plaintiff and by the Department of Labor in an amicus brief that the plaintiff’s loss on her later sales should not be netted against her gains on her earlier sales. Relying on the Restatement (Second) of Trusts § 213, the court held that netting of gains and losses is required where both stem from a single breach of fiduciary duty.
0Eleventh Circuit Affirms Dismissal of Stock Drop Suit
In Lanfear v. Home Depot, Inc., Case No. 10-13002 (11th Cir. May 8, 2012), the U.S. Court of Appeals for the Eleventh Circuit adopted the presumption of prudence for the holding of employer stock in a retirement plan (the “Moench presumption”) in affirming dismissal of a putative class action complaint filed by participants in an eligible individual account plan (“EIAP”) and employee stock ownership plan (“ESOP”).
Lanfear involved a retirement plan sponsored by The Home Depot, Inc. (the “Company”). The complaint alleged that plan fiduciaries breached ERISA fiduciary duties by (i) continuing to purchase and failing to sell the Company’s stock even though they knew based on nonpublic information that the stock price probably was inflated; (ii) providing inaccurate information to plan participants in fiduciary communications; and (iii) failing to disclose to plan participants certain Company business practices that had inflated the Company’s stock price. The plaintiffs’ allegations arose from certain losses that the Company’s stock suffered in 2005 and 2006 due to an announcement that Company executives had engaged in stock-options backdating practices that resulted in an underestimation of compensation expenses and improper accounting of product chargebacks to vendors.
While the appeals court affirmed dismissal of the complaint, it disagreed with the district court’s reasons for dismissal. First, it disagreed with the district court’s conclusion that the plaintiffs’ prudence claim was a diversification claim barred by ERISA Section 404(a)(2), which exempts EIAPs and ESOPs from ERISA’s diversification requirement. The Eleventh Circuit held that the plaintiffs’ claim was not a diversification claim, but rather was a prudence claim.
Second, the appeals court disagreed with the district court’s assertion that the decision to invest in Company stock was immune from judicial review because the plan required the investment. The appeals court noted that the fiduciaries “retained limited discretion over investment decisions,” so judicial review was appropriate.
0District Court Dismisses Claims of Alleged Imprudence of Securities Lending Investments
On April 20, 2012, Judge Barbara Jones of the U.S. District Court for the Southern District of New York dismissed a putative class action alleging that it was imprudent for a securities lending manager to invest cash collateral held for ERISA plans in Lehman Brothers Inc. notes (the “Notes”). The case is Bd. of Trustees of Operating Engineers Pension Trust v. JPMorgan Chase, 2012 WL 1382274 (S.D.N.Y. Apr. 20, 2012).
The suit was brought by trustees of a multi-employer pension plan. The trustees had entered into a written securities lending agreement (“Agreement”) with the defendant bank, pursuant to which the plan participated in the bank’s securities lending program. Through the program, the bank facilitated loans of securities owned by the plan and those loans were secured by collateral posted by the borrowers. The bank had full discretion under the Agreement to invest some of the cash collateral on behalf of the plan. The Agreement also specified the terms of the bank’s compensation, allowing it to retain 30–40% of any investment profits but any losses would be borne solely by the plan. In addition to investing the collateral of the securities lending program in the Notes, the bank separately acted on its own behalf as a Lehman creditor and in that capacity in early 2008 began demanding additional collateral from Lehman. When Lehman filed for bankruptcy in September 2008, the value of the plan’s investment in the Notes dropped by 85%.
The trustees brought suit, asserting class claims of breach of ERISA duties of prudence and loyalty, and prohibited self-dealing, concerning investments in the Notes. The court dismissed the allegations of imprudence, holding that a claim is not sufficiently stated based solely “on news articles selected after the fact and references to financial modeling that reflected a supposed ‘market consensus’ that Lehman was headed for default.” It emphasized that “the fiduciary duty to act prudently under the circumstances at the time of the decision precludes any judgment of a fiduciary’s actions from the vantage point of hindsight” (internal citation omitted). The court concluded that allegations that the bank was separately seeking additional collateral from Lehman on its own behalf (as creditor) were insufficient evidence that the bank knew continued investments in the Notes were “unduly risky,” so it did not need to reach the bank’s argument that information barriers existed between its various operations.
The court also held that the fee arrangement between the plan and the bank was not actionable against the bank because a bank is not a fiduciary as to compensation that was agreed upon by it and the plaintiffs “freely and after arms’-length negotiations.” The court further concluded that the bank was not acting in its ERISA fiduciary capacity when it made additional demands for collateral from Lehman, on its own behalf (as creditor), and thus could not have committed a prohibited transaction as to the plan with respect to such conduct.
After the case was dismissed, a further amended complaint was filed on May 14, 2012, purporting to cure the defects identified by the court.
0New Disclosure Obligations for Sponsors of ERISA Plans and Service Providers with ERISA Clients
ALI-ABA Conference on Life Insurance Industry Class Actions and Complex Litigation
September 20-21, 2012
Jamie Fleckner will present on the latest developments in ERISA litigation at this conference.
Thomson Reuters 25th Annual ERISA Litigation Conference
New York, NY
Jamie Fleckner will provide an ERISA litigation update at this conference.
James S. DittmarRetired Partner
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