Securities lending programs involving assets held by retirement plans have become the latest target of litigation under ERISA. In a series of recent lawsuits – including several putative class actions – involving major custodial banks and their affiliates, plaintiffs have challenged securities lending practices as violating ERISA’s fiduciary prudence and prohibited transaction provisions, among other laws.
Securities lending typically involves the loan of a security by its owner to a borrower who needs the security for short-term purposes. Commonly, the borrower provides cash collateral, which can be invested in short-term instruments or funds (cash collateral pools) to achieve investment returns for the lender. The specific terms of the lending arrangement are governed by contract and will vary. When the loan is terminated, the borrower returns the security to the lender, which is obligated to transfer to the borrower the value of the collateral (along with agreed-upon interest). Thus, the lender bears the risk of loss on collateral investments.
Historically, ERISA plans and collective trusts holding ERISA plan assets have been significant lenders of securities – through programs managed by custodian banks or other securities lending fiduciaries – and have generally benefited from the incremental income securities lending added to their portfolios. However, due to recent substantial disruptions in the fixed income market, some securities lending cash collateral investments have suffered losses and/or a sudden erosion of liquidity. This in turn has caused some fiduciaries of collective trusts and other funds that have loaned securities to implement restrictions on redemptions to avoid further impairment of value and harm to non-redeeming clients, who could otherwise be left with disproportionate investments in illiquid securities.
On fact patterns such as this, at least a dozen lawsuits have been filed across the country alleging, among other claims, violations of ERISA. Among other claims, these suits allege that investment managers and advisers to retirement plan assets acted imprudently in participating in securities lending programs, that securities lending programs were not administered as agreed, and/or that fees collected by securities lending fiduciaries were excessive. The plaintiffs claim violations of ERISA sections 404 (duty of prudence) and 406 (prohibited transactions), and seek equitable as well as monetary relief.
These cases are still in the early stages of litigation, with a number having only recently been filed (see, e.g., Diebold v. Northern Trust Investments, No. 09-cv-1934 (N.D. Ill. filed Mar. 30, 2009) and Fishman Haygood Phelps Walmsley Willis & Swanson L.L.P. v. State Street Corp., No. 09-cv-10533 (D. Mass. filed Apr. 7, 2009)), and no class has been certified to date. Early decisions have gone to both plaintiffs and defendants. For example, defendants successfully defeated a request for a preliminary injunction in BP Corp. North America Inc. Savings Plan Investment Oversight Committee v. Northern Trust Investments, N.A., No. 08-cv-6029 (N.D. Ill. Dec. 16, 2008). The fiduciaries of the BP pension plans filed suit against the funds’ investment managers and their securities lending agents, alleging that the defendants breached ERISA fiduciary duties by exposing retirement fund assets to inappropriate risk in connection with the securities lending practices of index funds in which the plans’ assets were invested. The funds’ collateral pools allegedly were adversely affected by market conditions, resulting in collateral deficiencies that caused the lending agent to impose withdrawal limitations on the index funds. The plaintiffs sought a preliminary injunction requiring the defendants to distribute the BP plans’ assets in cash or as liquid securities. The court denied the plaintiffs’ request for a preliminary injunction, finding no danger of irreparable harm where the damages the plaintiffs sought could be measured at any point, if they prevailed. The court also rejected the assertion that an injunction was uniquely warranted where the plaintiffs made no showing that an individual pensioner needing to withdraw his or her pension assets was at risk.
Just last month, the Western District of Tennessee in FedEx Corp. v. The Northern Trust Co., No. 08-cv-2827 (W.D. Tenn. May 20, 2009), denied the defendant’s motion to dismiss a suit filed by a plan administrator asserting claims against the plan’s trustee and custodian for ERISA breach of fiduciary duty and other common law causes of action in connection with the defendant’s lending of the plan’s securities. The defendant moved to dismiss the common laws claims for breach of contract and breach of a settlement agreement on the ground, among others, that such claims are preempted by ERISA. Denying the motion, the court stated that the scope of ERISA preemption is not entirely settled, but that the agreement that formed the basis for the plaintiffs’ allegations – a compromise agreement regarding the redemption of plan assets invested in funds that engaged in securities lending – had only a tenuous connection to ERISA and was not preempted.
While most of the suits challenging securities lending practices have been filed by plan fiduciaries, the issues targeted in these suits also raise the specter of a new wave of participant-filed class actions. The recently filed case of Diebold v. Northern Trust Investments, No. 09-cv-1934 (N.D. Ill. filed Mar. 30, 2009), was brought by a retirement plan participant who invested in only a single index fund among the many options available in his plan. Nevertheless, the plaintiff seeks to assert claims on behalf of a putative class of participants not only in his plan but in other plans that invested in any defendant-sponsored collective trust or other fund that engaged in securities lending. The defendants have moved to dismiss the Diebold complaint on several grounds, including the plaintiff’s lack of standing to pursue claims on behalf of plans he did not participate in and funds in which he did not invest. That motion is pending.
Some financial institutions have been targeted in a number of these suits, in some instances by the same plaintiffs’ firm. The Southern District of New York recently consolidated three such related putative class actions against the same defendant stemming from losses allegedly incurred by securities lending cash collateral pools. See Board of Trustees of the AFTRA Retirement Fund v. JP Morgan Chase, N.A., No. 09-cv-686, (S.D.N.Y. filed Jan. 23, 2009); Board of Trustees of the Imperial County Employees’ Retirement System v. JP Morgan Chase, N.A., No. 09-cv-3020, (S.D.N.Y. filed Mar. 27, 2009); and The Investment Committee of the Manhattan and Bronx Service Transit Operating Authority Pension Plan v. JP Morgan Chase Bank, N.A., No. 09-cv-4408 (S.D.N.Y. filed May 7, 2009). Further consolidation of cases may be seen if the same institutions continue to be targeted.
Target Date Funds
The Securities and Exchange Commission (“SEC”) and the Department of Labor (“DOL”) held a joint hearing on June 18, 2009 in which they received testimony relating to target date funds. The hearing served as a forum for industry professionals to educate the SEC and DOL about the nature and design of target date funds and to opine as to whether regulatory action is necessary to help ensure that target date funds align with long-term financial expectations.
Target date funds are investment funds that automatically rebalance their asset allocations as the investor’s “target date” approaches. The fund’s manager selects an allocation plan, typically called a “glide path,” which is designed to become increasingly conservative, often reflected by an increased focus on cash and fixed-income investments as opposed to equity investments, as the fund approaches the target date. Target date funds have become increasingly utilized investment alternatives for retirement plans over the past several years, with plan participants choosing funds that have a target date corresponding with the participant’s expected retirement. In particular, these funds have become significantly more popular since the DOL issued regulations under the Pension Protection Act of 2006 (“PPA”) allowing target date funds that satisfy certain requirements to serve as Qualified Default Investment Alternatives (“QDIAs”), with target date fund assets increasing from $66 billion at the end of 2005 to $152 billion in March, 2009.1 QDIA rules provide retirement plan fiduciaries with some relief from liability under the fiduciary duty provisions of ERISA if a participant’s retirement plan account is invested in a QDIA as a default investment, even without an affirmative election by the participant.
Increased Regulatory Scrutiny
Target date funds have recently come under increased regulatory scrutiny. In particular, concerns have been raised regarding the use of target date funds in various types of accounts and recent declines in average target date fund performance. Average losses in 2008 for 31 target date funds with a target date of 2010 were around 25%, with returns ranging from negative 3.6% to negative 41%. In a speech last month before the Mutual Fund Director’s Forum, SEC Chairman Mary Schapiro told the audience that the SEC will be considering “whether additional measures are needed to better align target date funds’ glide paths and asset allocations with investor expectations.” She also noted that the SEC will be reviewing “whether the use of a particular target date in a fund’s name may be misleading or confusing to investors and whether there are additional controls the SEC should impose to govern the use of a target date in a fund’s name.”2
Potential Regulatory Initiatives Discussed at the Hearing
The following potential regulatory initiatives were discussed at the June 18 hearing: (i) enhanced disclosure; (ii) mandated asset allocation; (iii) fund name requirements; and (iv) review of QDIAs. Neither the SEC nor the DOL provided any indication at the hearing as to its position on adopting any or all of these suggestions.
Enhanced Disclosure. According to the Investment Company Institute (“ICI”), many in the industry concede a gap exists in the general public understanding of target funds. The ICI proposed that a fund should: (i) explain that the target date used in a fund name represents the actual year when an investor is assumed to retire and stop making new investments to the funds; (ii) explain whether it is designed for an investor who expects to spend all or most of his or her money at retirement, or is designed for an investor who plans to withdraw money gradually over a long period; (iii) clearly disclose the age group for whom the fund is designed; (iv) provide investors with an illustration of the glide path that the target date fund follows to become more conservative over time; and (v) be accompanied by a statement that the risks associated with a target date fund include the risk of loss near, at or after the target date, and that there is no guarantee that the fund will provide adequate income at and through the investor’s retirement.3
Mandated Asset Allocation. At the June 18 hearing, regulators and presenters discussed the potential for large variation in the percentage of equity holdings among different funds with the same target date, which in turn can expose investors’ retirement savings to very different risks that they might not anticipate based on the stated target dates. There was discussion during the hearing about the possibility of future regulation of target date funds being aimed at mandating specific asset-composition requirements. As an alternative to mandated asset allocation, witnesses suggested potential innovations to target date funds, including (i) offering risk profile choices to retirement plan sponsors and investors considering such funds, (ii) incorporating investment vehicles that would provide minimum distributions upon an investor’s retirement and (iii) greater diversification of asset classes.
Fund Name Requirements. The target date in a fund’s name typically refers to an investor’s expected retirement date. That is the date an investor is assumed to stop making contributions to the fund – a key event that is taken into account in the design of all target date funds. As noted in the ICI’s recommendations, some of the investor confusion about target date funds seems to be centered around whether the use of a particular target date in the fund’s name is misleading or confusing. This is due in large part to the disparity in investment allocations at the stated target date among different target date funds with the same target date. Although specific suggestions for name modifications were not discussed at the hearing, industry testimony urged the SEC and DOL not to create any labels to identify funds as “conservative,” “moderate” or “aggressive.”
Review of QDIAs. Numerous panelists noted that the public policy behind QDIAs is sound, and industry sentiment expressed at the hearing appeared to support target date funds as being well-suited as QDIAs. However, one panelist suggested that unless changes to the names of target date funds were implemented, in their current incarnation, it may not be appropriate to continue allowing them protection under QDIA.
During the hearing on target date funds, neither SEC nor DOL representatives indicated their intentions with respect to adopting or modifying regulations relating to target date funds. Witnesses generally applauded target date funds as a means of ensuring that investors consistently maintain both equity and fixed income investments in their retirement portfolios, while recognizing that 2008 was an unusually volatile year resulting in investment losses across all asset classes. The SEC and DOL did not announce their next steps, if any, with respect to target date funds.
A number of states – including New York, Massachusetts, Michigan, New Hampshire and Iowa – have recently formed task forces directed at identifying and prosecuting companies that misclassify workers as independent contractors rather than employees, thereby escaping the responsibilities to withhold taxes from the workers’ wages, contribute to workers’ compensation, pay for unemployment insurance and provide benefits such as health care and retirement. On a parallel track, the plaintiffs’ bar has continued to bring lawsuits alleging that workers were misclassified as independent contractors and wrongfully denied employee benefits – including benefits under plans governed by ERISA.
In Curran v. FedEx Ground Package System, Inc., 593 F. Supp. 2d 341 (D. Mass. 2009), the plaintiffs brought a putative national class action, claiming that the defendant misclassified them as non-employees and wrongfully denied them benefits. Based solely on this allegation of misclassification, they sought to enforce their rights to ERISA benefits “in whatever [employee benefit] plan for which they were eligible.” Id. at 343 (quoting Compl. 5). The defendant, represented by Goodwin Procter in this matter, argued that employment status alone could not establish the plaintiffs’ entitlement to relief under ERISA, and that the plaintiffs were required to plead facts establishing they were entitled to benefits under an identifiable benefits plan. The court agreed and dismissed the case. The court stated that while participants in a plan are employees, not all employees are necessarily participants in a plan. “Consequently, the plaintiffs must set forth sufficient factual allegations to make plausible a conclusion that they fall within the terms of a particular ERISA plan and, thus, are entitled to seek to enforce those terms under § 1132(a)(1)(B). They have not done so.” Id. (emphasis added).
In Estate of Suskovich v. Anthem Health Plans of Virginia, Inc., 553 F.3d 559 (7th Cir. 2009), the estate of a worker brought an action requesting a declaration that the decedent was an “employee” of the company and not an independent contractor, and seeking recovery of overtime pay and employment benefits. The estate sought damages for the company’s failure to enroll the decedent in retirement benefit plans for which he was eligible. The court examined the employee benefit plans at issue, which provided that “anyone not treated as an employee who is later ruled to be a common law employee in a lawsuit remains ineligible for benefits.” Id. at 571-72. The court noted that the company had always treated the decedent as an independent contractor, and he had signed an independent contractor agreement. Though the court did not reach the issue because it found that the decedent was an independent contractor, it noted that this alternative ground would also provide a basis for entering summary judgment in the defendants’ favor. Id. at 572. See also Martin v. Public Service Utility Electric & Gas Co., 2008 WL 857934 (3d Cir. 2008) (where a plan’s definition of employee carved out independent contractors since at least as early as 1998, a complaint claiming independent contractors were wrongfully denied participation in pension and employee welfare plans is time-barred); Olpchenski v. Parfums Givenchy, Inc., 2009 WL 440959 (N.D. Ill. Feb. 19, 2009) (granting summary judgment, in part, as to so much of independent contractors’ claim that sought retirement plan benefits, where the retirement plan’s definition of employee excluded those who did not receive W-2 Forms and who were treated as independent contractors).
These cases address issues of broad concern to all employers sponsoring employee benefit plans, and also shed light on how courts evaluate claims against any entity under ERISA. Consistent with the statute, courts put great emphasis on the plan documents and the plan definitions. The caselaw is quite clear that ERISA does not provide a right to benefits for all employees; it merely provides a mechanism for an eligible participant under the terms of the plan to enforce his or her rights. Where the plan strictly defines the participants to exclude those whom the employer did not treat as an employee, the courts respect and apply that definition. The commitment of interpreting plan terms strictly will have an impact on many cases involving ERISA claims. See, e.g., Bauer v. Summit Bancorp., 325 F.3d 155, 166 (3d Cir. 2003) (upholding plan administrator’s denial of retirement benefits for time an employee spent as an hourly worker, where the plan limited participation to salaried workers, stating, “[b]arring a contrary directive, we are required to enforce the Plan as written . . . .”).
ALI-ABA Annual Conference on Insurance and Financial Services Litigation
Date: July 9-10, 2009
Location: Langham Hotel, Boston, MA
Jamie Fleckner will be presenting at this ALI-ABA conference on ERISA litigation. This annual conference covers the latest developments and trends in litigation involving the insurance and financial services industries. A faculty of experts focuses on changes affecting the marketing, sale and administration of financial and insurance products, including annuities, life insurance, variable products, retirement plan contracts, mutual funds, health insurance, disability insurance, long term care, and other consumer and commercial financial and insurance products.
ERISA Litigation – The Evolving Landscape and the Fiduciary Quagmire
Date: September 17, 2009
Location: MCLE Conference Center, Boston, MA
This MCLE seminar will offer practical solutions to the litigation problems plaintiffs and defendants face in ERISA-related cases. It will provide information and commentary on cutting-edge issues in employee benefits law to keep attendees up-to-date on recent developments. Jamie Fleckner will serve as a faculty member for this seminar and will present on a panel discussing current trends in ERISA litigation.