United States: The Rise Of ERISA Litigation And Its Impact On Collective Trusts – Goodwin Procter To Hold A Webinar On Recent Trends, February 7, 2008
(Financial Services Alert - Developments of Note)

Originally published December 25, 2007

The past year has seen a dramatic rise in litigation under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). As more of the nation’s wealth has moved into retirement savings vehicles - in 2007, over $17 trillion are invested in U.S. retirement assets, according to the latest statistics from the Investment Company Institute - retirement savings plans governed by ERISA have increasingly become targets for plaintiffs’ lawyers, and are receiving increased regulatory scrutiny from the Department of Labor ("DOL"). Neither the plaintiffs’ bar nor the DOL has shown any intention of slowing their respective efforts. The rise of these suits and investigations coincides with a movement in the financial services industry to offer collective investment trust products along with registered mutual funds as investment options designed for the retirement savings market-place. Unlike mutual funds, however, collective investment trusts are not statutorily exempt from ERISA’s provisions. Certain plaintiffs’ lawyers have indicated that these unregistered products are the latest targets of their litigation efforts.

This article traces the dramatic increase in capital market and financial services ERISA litigation since the collapse of Enron in 2001. It addresses three primary types of such litigation: (1) the stock drop cases; (2) excessive fee cases; and (3) the recent emergence of collective trust litigation. As evidenced by the OCC’s recent publication of a handbook entitled "Retirement Plan Services" banks and other financial institutions are heavily involved in retirement products. The objective of this article is to analyze the trends we are seeing in this area, so that financial services firms can begin to take steps to identify areas where litigation may occur and begin planning preventative measures. This article does not attempt to address all the various types of litigation that may be brought, or each type of measure that may be taken to avoid litigation or to aid in the defense of any suit. Goodwin Procter will be hosting a webinar on February 7, 2008 to address these topics in greater detail. Look for more information about this program in upcoming issues of the Financial Services Alert.

First, there were the "stock drop" suits, in which plaintiffs’ lawyers targeted (and continue to target) public companies that required and/or allowed the investment of retirement savings plan assets in a non-diversified company stock fund offered as part of a defined contribution retirement plan, such as a 401(k) plan. When the price of the employer’s stock fell significantly, suits were filed, and this trend is continuing. These suits typically assert ERISA causes of action for imprudence alongside parallel securities fraud litigation relating to the same stock drop. Since 2001, over 100 of these ERISA stock drop suits have been filed.

These cases target a wide range of defendants. Defendants often include the corporation that sponsors an ERISA plan; corporate officers, employees and committees responsible for administering the plan; and the corporation’s directors. Financial service providers have not been immune. Some publicly traded financial service companies have been named in suits where they themselves sponsor retirement plans for their employees that included investment of plan assets in their own stock. Other financial service providers have been named in suits involving the drop in an unrelated public company’s stock where they served as directed trustee for the public company’s plan. However, more recently, directed trustees have not generally been named in stock drop suits brought by private plaintiffs’ lawyers. This is primarily due to Field Assistance Bulletin 2004-03 issued by the DOL on December 17, 2004 (the "FAB") and a series of favorable decisions by courts that dismissed the directed trustee defendants, including several cases that were subsequently affirmed at the appellate level. The cases favorable to directed trustees include: LaLonde v. Textron, 270 F. Supp. 2d 272 (D.R.I. 2003) (granting motion to dismiss), aff’d on other grounds, 369 F.3d 1 (1st Cir. 2004); Wright v. Oregon Metallurgical Corp., 360 F.3d 1090 (9th Cir. 2004) (affirming dismissal); In re Cardinal Health, Inc. ERISA Litigation, 424 F. Supp. 2d 1002 (S.D. Ohio 2006) (granting motion to dismiss); DiFelice v. U.S. Airways, Inc., 397 F. Supp. 2d 735 (E.D. Va. 2005) (same); In re Worldcom, Inc. ERISA Litigation, 354 F. Supp. 2d 423 (S.D.N.Y. 2005) (granting motion for summary judgment). Goodwin Procter represented the directed trustee in three of these cases.

It should be noted many of these courts dismissed directed trustees in reliance on the FAB. We reported on the issuance of the FAB in the December 21, 2004 issue of the Financial Services Alert. To summarize, in the FAB, the DOL laid out what it viewed to be the proper role of a directed trustee under ERISA in this context. The DOL stated that there were two instances where a directed trustee was required to question a direction to invest in employer stock under ERISA’s duty of prudence: (i) when there are "clear and compelling public indicators, as evidenced by an 8-K filing with the Securities and Exchange Commission ("SEC"), a bankruptcy filing or similar public indicator that call into serious question a company’s viability as a going concern" and (ii) when the directed trustee "possesses material non-public information that is necessary for a prudent decision". The issuance of the FAB, with its articulation of a relatively narrow duty, has led to fewer directed trustees being named as defendants in stock drop cases.

ERISA stock drop suits nevertheless continue to be filed against employers and their officers and directors. These cases have generated mixed results. Recently, on September 26, 2007, the Third Circuit Court of Appeals held in Edgar v. Avaya, Inc., 503 F.3d 340 (3d Cir. 2007), that (i) it is appropriate to apply a presumption of prudence to the continued holding of employer stock in an ERISA plan that qualifies as an "eligible individual account plan" as defined in ERISA § 407(d)(3), 29 U.S.C. § 1107(d)(3), and (ii) this presumption may be applied at the pleading stage to dismiss stock drop claims. The test to be applied under Edgar is whether "the ERISA fiduciary could not have believed reasonably that continued adherence to the . . . direction [to invest in employer stock] was in keeping with the settlor’s expectations of how a prudent trustee would operate". While the Edgar decision is bound to shape future litigation in the Third Circuit and elsewhere, the contours of its long-term impact on stock drop cases is not yet clear. In this regard, the Edgar case involved a situation where the applicable plan document directed the availability of the company stock fund.

A second, and relatively newer, wave of litigation has been focused more broadly on the role of financial service providers to defined contribution plans. In the last fifteen months, over 20 so-called "excessive fee" cases have been filed, challenging in one form or another the fees charged by service providers to 401(k) and other defined contribution plans and their participants as breaches of ERISA’s duty of prudence and/or prohibited transaction rules. These cases challenge, among other things, the use of retail mutual funds as investment options for defined contribution plans, the use of actively managed investment products, payments received under sub-transfer agency and other agreements between record-keepers and investment options, and the disclosure practices with respect to fees and so-called "revenue sharing". Suits have been brought on behalf of participants of large 401(k) plans against plan sponsors, fiduciaries, and, in some cases, service providers to those plans, along with investment advisers to the funds offered as investment vehicles to plan participants. More recently, some plan sponsors and fiduciaries have filed suit against their own record-keepers and, in at least one case, against a plan consultant. These latter cases have generally been styled as class actions on behalf of all similarly-situated plan sponsors and fiduciaries.

We reported in the July 3, 2007 issue of the Financial Services Alert about the first significant victory defendants obtained in early motion practice in these cases, in Hecker et al v. Deere & Company, et al., 496 F. Supp. 2d 967 (W. D. Wis. 2007), now pending appeal to the Seventh Circuit Court of Appeals. In Hecker, the court made three principal holdings in granting motions to dismiss on behalf of the plan sponsor, trustee/record-keeper, and mutual fund investment adviser.

First, the court held that ERISA does not require specific disclosure of so-called "revenue sharing". The court concluded that to require disclosures of "revenue sharing" would "require judicial expansion of the detailed disclosure regime crafted by Congress and the DOL pursuant to its statutory authority". Indeed, since Hecker was decided, the DOL has taken further steps to clarify the disclosure obligations relating to payments between service providers and investment advisers, as well as bundled service providers. On November 16, 2007, the DOL amended its instructions for the disclosure of fees required on Form 5500. See 72 Fed. Reg. 64824. On December 13, 2007, it issued its proposed regulation under ERISA § 408(b)(2), 29 U.S.C. § 1108(b)(2), to provide regulatory guidance relating to disclosure of service provider arrangements. See 72 Fed. Reg. 70988. The 408(b)(2) proposed regulation will be discussed in greater detail in the January 1, 2008 issue of the Financial Services Alert.

Second, the court rejected as a matter of law plaintiffs’ claims that defendants breached their ERISA fiduciary duties by offering retail mutual funds as investment options, where such funds had expense ratios ranging from seven (7) to one hundred and one (101) basis points - all of which were fully disclosed on the funds’ prospectuses.

Third, the court found that neither the trustee/recordkeeper nor the investment adviser to the plan investment options possessed relevant fiduciary authority such that they could be liable under ERISA for any alleged failure to disclose or any imprudent choice of investment options.

While Hecker marks an early-stage win for service providers and sponsors sued for breaching ERISA fiduciary duties with respect to allegedly excessive fees, other cases have reached different results in their early stages. For example, in Haddock v. Nationwide, 419 F. Supp. 2d 156 (D. Ct. 2006), the court denied the defendants’ pre-trial motions to have all claims dismissed as to them. In Haddock, the court denied the motion for summary judgment of Nationwide Financial Services, Inc. and Nationwide Life Insurance Company (collectively, "Nationwide"), entities that offered variable annuity products to defined contribution plans. The court held that the evidence produced during discovery was sufficient to allow a trial as to whether Nationwide breached ERISA fiduciary standards or engaged in prohibited transactions by accepting allegedly excessive "revenue sharing" payments from the advisers of mutual funds serving as investment options for the variable annuity products. Similarly, the court found that there was sufficient evidence to proceed to trial as to whether Nationwide’s status as the plan’s investment provider made it a fiduciary and whether, as a result, the payments with respect to the mutual fund investment options made to Nationwide were "plan assets".

Cases in this area, including cases in which Goodwin Procter is significantly involved, continue to be actively litigated. Clear trends in the judicial decisions have not yet emerged.

Most recently, the ERISA plaintiffs’ bar has begun to focus on collective investment trusts. Unlike registered investment products, the assets of these vehicles are generally plan assets. As a result, the management of these vehicles is subject to ERISA. So, while these trusts often are desirable as retirement plan investment alternatives because they are exempt from SEC oversight, and the requirements of the Investment Company Act of 1940 (assuming they are bank-maintained), they are nevertheless subject to ERISA. As such, the managers of these vehicles will be ERISA fiduciaries.

As an ERISA fiduciary, the manager of a collective investment trust must "discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and (A) for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan". ERISA § 404(a)(1), 29 U.S.C. § 1104(a)(1). The fund manager must also act prudently, diversify plan investments, and act in accordance with the documents governing the plan insofar as following the plan documents does not otherwise result in a violation of ERISA. ERISA § 404(a)(1)(B)-(D), ), 29 U.S.C. § 1104(a)(1)(B)-(D).

The dramatic changes in the mortgage and housing markets have led to increased litigation against the managers of collective investment trusts under ERISA and a number of investigations by the DOL. Suits brought by plan sponsors against their investment managers for allegedly imprudent management of plan assets and/or misleading disclosures regarding their investment products appear to be on the rise. Plaintiffs’ lawyers have indicated that this may merely be the "tip of the iceberg". 34 BNA Pensions & Benefits Reporter, at 2915, December 11, 2007.

Goodwin Procter has been at the forefront of each of these types of ERISA suits and regulatory investigations. The firm’s litigators work closely with our ERISA attorneys in both defending those of our clients who find themselves in litigation or regulatory investigations relating to the discharge of ERISA duties, and also counseling clients as to how to structure their products and actions in light of these recent developments. As noted above, Goodwin Procter is sponsoring a webinar on February 7, 2008 to discuss the impact of these new trends. Look for more information on our webinar in upcoming editions of the Financial Services Alert.

Goodwin Procter LLP is one of the nation’s leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.

This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. © 2008 Goodwin Procter LLP. All rights reserved.