0Third Circuit Holds Nonfiduciary Who Is Not a “Party in Interest” May Be Liable For Participation in Fiduciary’s Violation of ERISA Section 406(b)(3)

In National Security Systems, Inc. v. Iola, No. 10-4154, 2012 WL 5440113 (3d Cir. Nov. 8, 2012), the U.S. Court of Appeals for the Third Circuit held that a nonfiduciary who knowingly participates in a fiduciary’s breach of ERISA’s anti-kickback provision, Section 406(b)(3), may be subject to appropriate equitable relief under ERISA Section 502(a)(3), even though that nonfiduciary is not a “party in interest” under the statute’s prohibited transaction rules.

The relevant facts of National Security Systems are as follows. Ronn Redfearn created a tax avoidance scheme (known as “EPIC”) under which employers would establish ERISA-covered welfare plans and would make tax deductible contributions to a trust maintained for the plans.  The trust in turn would pay premiums under life insurance policies selected by a company established by Redfearn to administer EPIC (the “Administrative Company”). The insurance policies would fund tax-free, annuity-like payments for the employer’s owners after their retirement. The insurance company that issued the policies would pay commissions to the Administrative Company.

James Barrett, a financial planner, induced a number of his clients to become participating employers in EPIC, and Barrett became the contact person for their communications with, and contributions to, EPIC. The Administrative Company compensated Barrett for his services with payments from the commissions it received from the insurance company. After a number of years, the Internal Revenue Service audited the employers and determined that EPIC’s structure did not satisfy applicable requirements under the Internal Revenue Code. The IRS disallowed the deductions the employers had taken for contributions to EPIC and assessed penalties against the employers. The employers then brought suit in federal district court in New Jersey against a number of entities and persons associated with EPIC, including Barrett, asserting violations of various laws, including ERISA.

As part of a decision resolving numerous claims and defenses (under ERISA and other laws), the district court ruled that Barrett had not acted as an ERISA fiduciary in connection with the plaintiff employers’ participation in EPIC, but could be held liable for appropriate equitable relief as a nonfiduciary who had knowingly participated in the Administrative Company’s violation of ERISA Section 406(b)(3), which prohibits a fiduciary from receiving consideration from a third party dealing with a plan in connection with a transaction involving plan assets. The district court concluded that the Administrative Company breached Section 406(b)(3) when it acted as a fiduciary in selecting the insurance policies in which contributions would be invested and received commissions from the insurance company issuing those policies. The court ruled that Barrett knowingly participated in this breach and ordered him to disgorge to the plaintiffs one half of the payments he had received from the Administrative Company. The court ordered this remedy under ERISA Section 502(a)(3), which authorizes appropriate equitable relief to remedy violations of the statute.

On appeal, Barrett argued that, under the leading case on nonfiduciary liability -- Harris Trust and Savings Bank v. Salomon Smith Barney, Inc., 530 U.S. 238 (2000) --  only nonfiduciaries who are “parties in interest” under ERISA’s prohibited transaction rules may be subject to liability for knowingly participating in a fiduciary’s breach. Barrett noted that just last year, in Renfro v. Unisys Corp., 671 F.3d 314 (3d Cir. 2011), the Third Circuit had indicated that Harris Trust had “authorized suits for nonfiduciary participation by parties in interest to transactions prohibited under ERISA.” Id. at 325 n.6. He asserted that, because he was not a party in interest, he could not be subject to knowing participation liability under Section 502(a)(3).

The Third Circuit panel in National Security Systems rejected this argument and affirmed this aspect of the district court’s decision. It reviewed the underlying analysis of the Supreme Court in Harris Trust, and concluded that, while the defendant in Harris Trust happened to be a party in interest, that fact was not critical to the Supreme Court’s holding that nonfiduciary liability was authorized by Section 502(a)(3). The Third Circuit noted that the Supreme Court had emphasized that, in authorizing appropriate equitable relief to remedy violations of ERISA, the text of Section 502(a)(3) does not limit the persons who can be subject to liability. The panel in National Security Systems determined that the suggestion to the contrary by a different Third Circuit panel in Renfro was dicta — and, in any event, it was not bound to follow its own precedent that was inconsistent with the Supreme Court’s reasoning in Harris Trust.

0Summary Judgment Decided in Suit Challenging Insurer’s Use of Retained Asset Account to Settle Group Life Insurance Benefits

The U.S. District Court for the District of Massachusetts entered an order on cross summary judgment motions in one of the many cases challenging the use in group insurance benefit plans of retained asset accounts, denying the beneficiary’s motion and granting, in part, the insurer’s motion in Vander Luitgaren v. Sun Life Assurance Company of Canada, No. 09-11410, 2012 WL 5875526 (D. Mass. Nov. 19, 2012).

The litigation was brought by a beneficiary of a group life insurance plan whose sponsor had purchased group life insurance contracts from the insurer defendant. The insurer paid benefit claims under the group contract through interest-bearing accounts backed by funds that the insurer retained until the account holders wrote checks or drafts against the account. The plaintiff challenged the practice, which he claimed constituted a breach of fiduciary duty and a prohibited transaction under ERISA. The plaintiff purported to sue on behalf of a class of beneficiaries under contracts issued by the insurer defendant who had received their benefits through a retained asset account.

In 2011, the insurer’s motion to dismiss the complaint was denied because, among other reasons, the court found that the plaintiff had adequately alleged that the insurer was an ERISA fiduciary with respect to retained assets.

In its recent order, the court granted summary judgment to the insurer on the plaintiff’s prohibited transaction claim under ERISA § 406. The court found that nothing in the insurance contract suggested an ongoing property interest by the plan or participants in the insurer’s assets that back retained asset accounts. Accordingly, the assets were not ERISA-governed plan assets. In this regard, the court distinguished the First Circuit’s decision in Mogel v. Unum, 547 F.3d 23  (1st Cir. 2008), in which the appeals court held that sums due retained asset accountholders remained plan assets subject to ERISA fiduciary duties until “actual payment.”  The Vander Luitgaren court stated that Mogel should not be interpreted to hold that assets held in an insurer’s general account – which are not plan assets – are “transformed into plan assets” once a defendant establishes a retained asset account. In rejecting the plaintiffs’ fiduciary self-dealing claim, the court held that, unlike in Mogel, where the insurance contract required payment by lump sum, the contract at issue in Vander Luitgaren did not. The insurer therefore discharged any fiduciary obligations that it had with respect to the management and disposition of plan assets when it set up the account.

With respect to the plaintiff’s claim for breach of fiduciary duties under ERISA § 404, the court denied the insurer’s motion for summary judgment. The court followed the First Circuit’s holding in Mogel that disposition of benefits to beneficiaries falls squarely within the insurer’s fiduciary responsibilities with respect to plan administration, holding that the insurer was acting as a fiduciary with respect to plan administration when it paid the plaintiff’s benefits claims. In particular, the court concluded that the insurer exercised discretionary fiduciary authority (i) in selecting to pay benefits via retained asset accounts; and (ii) in determining the crediting rates.

The court declined to decide the issue of whether the insurer breached its duty, noting that discovery was required to determine if the insurer was acting to optimize its own earnings when it established the retained asset accounts, and to determine if the interest rate that the insurer paid was competitive.

0District Court Refuses to Dismiss Challenge to Financial Services Company’s Use of Proprietary Product for Its Own Retirement Plan

On November 20, 2012, the U.S. District Court for the District of Minnesota denied a motion to dismiss ERISA claims in a case challenging the use by a financial services company of affiliated investment products as options for its 401(k) plans. The case is Krueger v. Ameriprise Financial, Inc., No. 11-cv-02781, 2012 WL 5873825 (D. Minn. Nov. 20, 2012).

Krueger involves the 401(k) plan sponsored by a financial services company. The plan makes available as investment options proprietary mutual funds and collective trusts, along with a company stock fund and a brokerage window. Until last year, the brokerage window was managed by the sponsor. And until a 2007 sale, the plan’s record-keeper was also an affiliate of the sponsor. The case was brought by seven current and former participants of the plan. Plaintiffs raised seven counts under ERISA, alleging breaches of fiduciary duty, prohibited transactions, co-fiduciary liability, and knowing participation in other’s alleged breaches of duty. Plaintiffs asserted one claim alleging unjust enrichment under supposed federal common law.

Plaintiffs alleged that the investments managed by the sponsor or its affiliates were selected as options for the plan because they generated profits to the sponsor and its affiliates. Plaintiffs alleged that, as to some of those investment options, the sponsor used the plan’s investments to “seed new and untested mutual funds,” which had the alleged effect of making those funds more marketable outside of the plan. Among other things, the complaint also: (i) alleged the improper use of two tiers of fees in the proprietary target date funds made available on the menu, when supposedly comparable funds charged one tier of fees; (ii) challenged purported limitations on the funds available on the affiliated brokerage window — limitations which they allege were imposed because of “kickbacks” paid to the sponsor or its affiliates; and (iii) asserted that various fees charged in connection with the brokerage window and trust and recordkeeping services were improper.

The court followed the holdings in other “excessive fee” cases in its district — the Eighth Circuit Court of Appeals decision in Braden v. Wal-Mart, 588 F.3d 585 (8th Cir. 2009), and an earlier decision by the U.S. District Court for the District of Minnesota (Gipson v. Wells Fargo, 2009 WL 702004 (D. Minn. Mar. 13, 2009)) — to deny defendants’ motion to dismiss. The court held that, like in those cases, plaintiffs’ allegations plausibly alleged that the defendants selected affiliated funds “to benefit themselves at the expense of participants” and that the selection process was “flawed,” each of which it found sufficient to support a claim of breach of ERISA fiduciary duty.  The court also held that the fact that defendants included a range of investment options under the plan — which included investments managed by unaffiliated entities — did not shield defendants from liability. It further found that defendants could be liable for allegedly excessive record-keeping fees and for profits derived from the sale of its record-keeping and trust business if, as plaintiffs alleged, defendants used the plan’s relationship to “prop up” the trust and record-keeping business for sale.

The Krueger court further held that (i) the plaintiffs’ allegations sufficiently stated a claim for prohibited transactions given the affiliation between the plan sponsor and the fund managers; and (ii) exceptions to the prohibited transaction rules did not apply on a motion addressed to the pleadings as a procedural matter because such exceptions are of the nature of an affirmative defense. Largely on the basis of its rulings as to fiduciary breach and prohibited transactions, the court also allowed claims of failure to monitor and co-fiduciary liability to proceed. The only claim the court dismissed was a claim for common law unjust enrichment, which the court found to be preempted by ERISA.