ERISA Litigation Update - March 2012 March 29, 2012
In This Issue

Federal District Court Holds That Investment Advice to a Plan Assets Fund May Make Advisor a Fiduciary to Plans Invested in the Fund

In a case involving losses arising from investments with Bernard Madoff, the U.S. District Court for the Southern District of New York recently held that a firm that advised an ERISA plan assets fund to invest with Madoff could, by reason of that advice, be considered an ERISA fiduciary with respect to each ERISA plan holding an interest in that fund. In re: Beacon Associates Litigation, 09 Civ. 777 (LBS) (S.D.N.Y. March 14, 2012).

In Beacon, certain union pension plans (the “Plans”) purchased interests in an investment fund (the “Fund”) that was considered to hold “plan assets” under the Department of Labor’s plan assets regulation, 29 C.F.R § 2510.3-101 (the “Plan Assets Regulation”). The Fund invested its assets with investment managers selected by the entity that operated the Fund (the “Operator”). The Fund invested over $350 million with Madoff, all of which was lost when Madoff’s Ponzi scheme was uncovered in 2008. Alleging violations of ERISA’s fiduciary rules, the Plans filed a class action complaint against a number of defendants, including the Operator and a firm that provided research and advice to the Operator regarding the Fund’s investment managers (the “Advisor”). (This case also includes a number of non-ERISA claims brought against the Operator and other defendants by the Plans and certain individuals who had invested in the Fund.)

After surviving a motion to dismiss and engaging in discovery, the Plans moved for class certification. The Advisor opposed the motion, arguing (among other things) that the class should not be certified because the Plans could not prove an essential element of their ERISA claims against the Advisor – that the Advisor had acted as an ERISA fiduciary with respect to the Plans and other members of the putative class (that is, other ERISA plans that had invested in the Fund).

The Plans asserted that the Advisor was a fiduciary under Section 3(21)(A)(ii) of ERISA, which confers fiduciary status on a person to the extent that he renders investment advice to a plan for a fee. The Advisor countered that, under the DOL regulation explaining Section 3(21)(A)(ii), a person can be an ERISA fiduciary based on the provision of advice only when he “render(s) individualized investment advice to the plan based on the particular needs of the plan.”  See 29 C.F.R § 2510.3-21(c) (the “Advice Regulation”). The Advisor argued that it had provided advice to the Fund itself – not to the Plans invested in the Fund – and that advice could not be “individualized” within the meaning of the Advice Regulation with respect to a pooled vehicle like the Fund and with respect to the Plans that invested in the Fund. The Advisor asserted that a finding of an obligation to provide individualized advice to both the Fund and each Plan would result in a conflict of duties since the Advisor could not provide advice for the exclusive benefit of the Fund as a whole while at the same time providing advice to the Fund that would have to be tailored to the particular needs of each Plan investing in the Fund.

The court rejected this argument, concluding that the Advisor’s advice to the Fund could make it a fiduciary with regard to each of the Plans that invested in the Fund. In the court’s view, this situation did not raise the type of conflict cited by the Advisor, because when plans invest in pooled funds they pursue certain common investment goals, meaning that (to the extent of the plans’ investments in the fund) the interests of the plans are necessarily aligned with those of the fund. In addition, the court noted that the Plan Assets Regulation indicates that a person who provides fiduciary investment advice to a pooled fund that holds ERISA plan assets is a fiduciary with respect to the plans invested in that fund. Reading the relevant statutory and regulatory provisions together, the court reasoned that “individualized advice with respect to the needs of a pooled investment fund should be considered individualized advice with respect to the plans that invest in it” for purposes of the Advice Regulation. Consequently, the court concluded that the issue of the Advisor’s fiduciary status did not preclude certification of the class.

Bank Securities Lending Settlement for $150 Million

The past few years have seen a number of class claims brought against banks in connection with securities lending programs (reported in the June 2009 ERISA Litigation Update).

One of these cases settled earlier this month, when a bank agreed to pay $150 million to resolve a certified class action alleging breach of ERISA fiduciary duties in connection with the bank’s securities lending program. The case is a consolidation of claims asserted on behalf of all plans and entities for which the bank invested cash collateral directly or indirectly in one or more debt securities issued by Sigma Finance, Inc. (“Sigma”), a structured investment vehicle.

Securities lending involves the loan of a security by its owner to a borrower who uses the security for short-term purposes. In this case, the plaintiffs alleged that the bank had a practice of lending securities held by the plans and using the cash collateral to invest in notes and other debt securities issued by Sigma, whose subsequent liquidation resulted in losses to participants in the bank’s securities lending program. The plaintiffs alleged that the bank breached its fiduciary duties by (i) investing cash collateral obtained from securities lending in the Sigma notes, which they alleged were “inappropriate and unsuitable for the investment of cash collateral,” (ii) maintaining investments in the notes in light of “the excessive risks” from Sigma’s inability to pay the notes as they matured and (iii) imprudently maintaining the investments in the Sigma notes despite warnings from analysts about their lack of liquidity. The plaintiffs further alleged that the bank had a conflict of interest because it separately earned fees from the cash collateral investments. (An earlier decision in the litigation had granted summary judgment to the bank on allegations of disloyalty stemming from its alleged separate transactions as a lender to Sigma.) 

According to the plaintiffs, the settlement of $150 million represents between 30% to 100 % of the losses that they would have been able to prove had the case gone to trial. The parties had been engaged in both formal and informal settlement discussions since December 2009. Their submission to the court explains that the parties had engaged in extensive direct and third-party discovery, including 40 fact and expert depositions and 21 expert reports, as well as briefing on cross motions for summary judgment and other motion practice.  

The settlement still requires court approval because it affects the interests of absent class members. If approved, it will release all claims against the bank and also contemplates releases of third-party claims brought by the bank against trustees of certain of the plans.

The case is Board of Trustees of the AFTRA Retirement Fund v. JPMorgan Chase Bank N.A. (S.D.N.Y. 09-cv-00686).

Sixth Circuit Holds Safe Harbor Defense Does Not Apply to Selection of Investment Funds, and Moench Presumption Does Not Apply at Pleadings Stage

The U.S. Court of Appeals for the Sixth Circuit held that the presumption of prudence for the holding of employer stock in a retirement plan (the “Moench presumption”) does not apply at the pleadings stage. It also held that ERISA’s safe harbor defense for losses caused by a participant’s exercise of control does not apply to the selection of investments a plan offers. The decision, Pfeil v. State Street Bank and Trust Company, No. 10-2302 (6th Cir. Feb. 22, 2012), is available here.

Pfeil involved two 401(k) plans sponsored by General Motors Co. (the “Company”), each of which allowed participants to invest in a fund comprised of Company stock. According to the court’s decision, the plan documents directed the bank trustee to divest the plans’ holdings of Company stock if it “determines from reliable public information that (A) there is a serious question concerning [the Company’s] short-term viability as a going concern without resort to bankruptcy proceedings; or (B) there is no possibility in the short-term of recouping any substantial proceeds from the sale of stock in bankruptcy proceedings.”  After various public disclosures by the Company in 2008, the trustee suspended purchases of Company stock. The participants sued under ERISA because, allegedly, the trustee did not divest the plans’ Company stock holdings until the following year. The district court dismissed the complaint. It held that while the complaint pleaded sufficient facts to overcome the presumption of prudence in holding Company stock, the complaint failed to demonstrate that the trustee’s actions caused any losses to the plans given that participants remained free to move their plan holdings to investments other than the Company stock fund at any time.

The Sixth Circuit began its opinion by holding that the Moench presumption “is not an additional pleading requirement and thus does not apply at the motion to dismiss stage,” even though the court noted that it was not necessary to decide that question to rule on the appeal. The court nonetheless held that the presumption was an evidentiary one. The court recognized that other circuits, most notably the Second and Third, take a different approach and apply the presumption at the pleading stage – with the Second Circuit in its recent Citigroup decision (reported in the December 2011 ERISA Litigation Update) holding that the presumption was not simply an evidentiary one. The Sixth Circuit explained that under its articulation of the Moench presumption, the evidence required to rebut the presumption is broader than the evidence needed to rebut the presumption in other circuits. Given this difference, the court held that it was not appropriate to apply the presumption at the pleadings stage in its circuit.

The court then reversed the lower court’s holding as to causation. The Sixth Circuit held that a “fiduciary cannot avoid liability for offering imprudent investments merely by including them alongside a larger menu of prudent investment options.”  It went on to address ERISA’s safe harbor provision, Section 404(c), which provides that a fiduciary shall not be liable for losses that result from a participant’s exercise of control. The court held that the defense (i) was not applicable at the pleadings unless the plaintiff anticipates the defense and addresses it in the pleadings, and (ii) “does not relieve fiduciaries of the responsibility to screen investments.”  In this later holding, the court followed the decision last year of the Seventh Circuit (reported in the March 2011 ERISA Litigation Update) and the view of the Department of Labor that Section 404(c) “does not serve to relieve a fiduciary from its duty to prudently select and monitor any service provider or designated investment alternative offered under the plan.”

Upcoming Conferences

FTI Consulting ERISA Litigation and Compliance Breakfast Series
May 3, 2012
Boston, MA

Jamie Fleckner will present on ERISA litigation at this seminar, where leading industry and regulatory experts will discuss the changing legal and financial landscape for ERISA fiduciaries, counsel and asset managers. The seminar will examine the impact of new rules and regulations, lessons learned from the courts and ways to mitigate personal and professional liability at a time when fiduciary litigation is soaring.

ALI-ABA Conference on Collective Trust Funds: Current Banking, SEC, and ERISA Regulatory and Compliance Issues
May 16, 2012
Sutherland Asbill & Brennan LLP, New York, NY

Jamie Fleckner will present at this ALI-ABA conference on ERISA regulatory and compliance issues relating to collective trust funds. A faculty of leading banking, SEC and ERISA lawyers will be joined by other leading professionals in the area to provide updates on all of the regulatory developments affecting collective trust funds. It will also review marketplace developments and new product design features.