Alert December 13, 2012

Third 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.