Texas Chapter Presents:
Fiduciary Liability Trends
May 10, 2007~ Houston, Texas
Seminar Goals
• Identify exposures faced by employers who offer
employee benefit plans
• Understand the management liability products
available to address these exposures
• Discuss how the market is reacting to new
exposures
• Explore how employers make decisions with
respect to fiduciary liability coverage
• Identify current trends in ERISA litigation
History of Fiduciary Liability
Coverage
• ERISA: Employee Retirement Income Security
Act
– Enacted in 1974 in response to:
 Funding shortages
 Vesting abuses
 Studebaker case
Goals of ERISA
• Protect plan participants and beneficiaries from
abuses
• Establish strict minimum standards of conduct
for those who run pension plans
• Eliminate exculpatory provisions
• Provide exclusive access to Federal Courts
• Ensure financial soundness of plans
ERISA Applies to Employee
Benefit Plans
• Pension benefit plans
− Sole sponsored and multi-employer
− Defined benefit and defined contribution
− ESOPs
• Welfare benefit plans
ERISA Applies to Plan Fiduciaries
• Any person who exercises discretionary
authority or control in management, or
• Anyone named in the Plan
ERISA Mandated Standards of
Conduct for Fiduciaries
• Exclusive Benefit Rule – investments must be
selected and managed “solely for the benefit of
plan participants”
• Prudence Rule – fiduciaries must act in the
same manner as a prudent expert would under
like circumstances
ERISA Mandated Standards
of Conduct for Fiduciaries
• Diversification Rule – assets must be diversified
to avoid risk of large losses
• Plan Target Rule – fiduciaries must follow the
plan terms to the extent they are consistent with
ERISA
Plan Fiduciaries are Subject
to Personal Liability
• Fiduciaries shall be personally liable to restore
to the Plan any losses resulting from a breach of
fiduciary duty and to restore to such Plan any
profits made by the fiduciary through the use of
Plan assets.
ERISA Enforcement
• Participants or beneficiaries
• Department of Labor
• Fiduciaries
• The Plan
Sources of Claims Against Plan
Fiduciaries
• How do fiduciaries get into trouble?
− Making false or misleading statements
− Imprudent investments
− Lack of diversification
− Non-compliance with Plan documents
− Errors in Plan administration
The Cost of a Claim
• Tillinghast Survey
− $1.9 million average indemnity payment of a
fiduciary claim
− $121,000 average defense cost
− Public companies and companies involved in
M&A activity have higher incidences of
claims
Available Insurance
• EBL
• ERISA Bond
• D&O
• Fiduciary Liability Coverage
Fiduciary Liability
Insurance
What is covered? / Who is covered?
• Common coverage provisions
• Common coverage exclusions
• Potential coverage enhancements
Fiduciary Liability
Insurance
What is covered?
Common policy provisions
• Breach of duties imposed by ERISA or COBRA
• Negligence, error or omission in the administration
of employee benefits
• Definition of Claim usually includes written
demands for monetary or non-monetary relief, civil
proceedings, criminal proceedings, formal
administrative or regulatory proceedings, and
alternative dispute resolution proceedings
Fiduciary Liability
Insurance
What is covered?
Administration means….
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Giving counsel, advice or notice
Interpreting plan benefits
Handling records
Effecting enrollment, termination or
cancellation of plan participants in
benefit plans
Fiduciary Liability
Insurance
What is covered?
Loss/Damages
• Compensatory damages and defense
expenses
• Punitive damages – “most favorable
venue”
• ERISA 502(i) and 502(l) penalties
Fiduciary Liability
Insurance
Who is covered?
• Benefit plan (scheduled to policy or
omnibus)
• Merged/terminated/sold plans
• Plan sponsor and subsidiaries
• Fiduciaries/trustees of the plans and plan
sponsor and subsidiaries (D&Os and
employees)
• Spousal extension
Fiduciary Liability
Insurance
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Common Coverage Exclusions
Benefits due
Deliberate fraud/willful violation of statute
Personal profit
BI/PD
Prior and pending litigation; notice given to
prior carrier
Discriminatory hiring or firing, retaliation,
and wrongful termination, other than claims
under ERISA Section 510
Fiduciary Liability
Insurance
Potential Enhancements
• Additional defense coverage
• Coverage for HIPAA violations
• IRS and DOL voluntary compliance
settlement fees
• Coverage for benefit plans not subject to
ERISA Title I
• Amended settlement provision (“hammer
clause”)
Pension Protection Act
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What is it?
Why was it enacted?
What does it do?
Possible effects on fiduciary liability?
Pension Protection Act
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What is it?
Signed into law August 16, 2006
Modified dozens of ERISA and Internal
Revenue Code provisions
Major changes to defined benefit plan
funding rules
New reporting and disclosure requirements
New safe harbors for certain plan features
and plan types
Pension Protection Act
Why was it enacted?
• Improve funding of defined benefit plans
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2000 – 2003 “Perfect Storm”
Record PBGC deficit in 2004
• Funding relief requested by plan sponsors
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Improve accuracy of valuing plan liabilities
Limited ability to overfund plans during good
years
• Response to collapse of Enron
Pension Protection Act
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What does it do?
Modifies defined benefit plan funding rules
Improves disclosure and reporting of defined
benefit and defined contribution plans
Creates a safe harbor for cash balance plans
Creates new diversification rights for certain 401(k)
participants
Creates safe harbors for 401(k) plan automatic
enrollment, default investments, and investment
advice
Increases bonding requirements
Miscellaneous changes to ERISA and Internal
Revenue Code
Pension Protection Act
What does it do?
• Modifies defined benefit plan funding rules
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Increases minimum funding target
Requires more rapid payment of funding deficits
Imposes benefit restrictions on poorly funded
plans
• Improves disclosure of defined benefit plan
funding and benefits
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Triennial benefit statements
Annual funding notices
Pension Protection Act
What does it do?
• Creates a safe harbor for cash balance plans
against age discrimination claims
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Prospective relief only (post-June 28, 2005)
Accelerated vesting
Prohibits “wearaway” after a traditional DB plan conversion
Annual interest credits must be the same for similarly
situated employees
Eliminates the “whipsaw” issue
Pension Protection Act
What does it do?
• Creates new diversification rights in plans with
employer securities
• Creates safe harbors for 401(k) plan automatic
enrollment, default investments, and investment
advice
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Express preemption of state payroll laws
Qualified Default Investment Alternative (QDIA)
Eligible Investment Advice Arrangement
• Improves disclosure of defined contribution plan
rights and benefits
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Annual benefit notices (quarterly for participant-directed
account plans)
Pension Protection Act
What does it do?
• Increases bonding requirements
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Maximum bond limit increased from
$500,000 to $1,000,000 for plans that
hold employer securities
• Miscellaneous changes to ERISA and
IRC
Pension Protection Act
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Implications for plan fiduciaries?
Numerous changes to existing administrative practices
New safe harbors contain a laundry list of new rules
Defined benefit plan funding requirements are more onerous
Possible increase in the number of defined benefit plan
amendments, conversions, freezes and terminations
Greater plan transparency may prompt more comments,
inquiries and complaints from plan participants
Plan fiduciaries may be on their own until additional technical
guidance is issued by the DOL and IRS
Possible need for a corrections bill from Congress
How Are Claims Handled?
• Duty to defend
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Insurer pays first dollar defense
Defense covered for all counts
• Reimbursement
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Flexibility to choose defense counsel
Coverage must be determined prior to
reimbursement
• Reporting of Claims
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Reported during policy period (or within ERP)
“as soon as practicable” language
Claim Trends
Cost of a Claim
$858,000 Legal action brought by employees alleged the wrongful
elimination of a profitable investment option and improper
selection of another and FAILURE TO MONITOR the actions of
the outside investment manager. Defense costs were $358,000
and the jury awarded the plaintiffs $500,000 in damages.
$400,000 Plan participants alleged that the fiduciaries of a 401(K)
PLAN had failed to divest the plan of an investment option that
was not keeping pace with the performance of the comparable
index and RESULTED IN POOR RETURNS. The case settled
for $250,000 after $150,000 in legal fees had been spent.
$530,000 Participants of a health plan sued the plan’s trustee
alleging that the TRUSTEE DID NOT MONITOR the performance
of its third party administrator (TPA) and paid excessive fees.
Damages and defense expenses totaled $530,000.
Texas Trends
• Claim Trends
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Failure to send Cobra Notices
Failure in HR to properly enroll
employees in life and health plans
Texas Specific- Non Subscriber
Worker’s Compensation Claims
Fee Sharing and Pension Protection Act
(to be discussed later)
Claims Breakdown
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Denial of benefits – 32%
Misleading representations – 10%
Administrative error in benefit plan – 9%
Communication of plan benefits – 9%
Imprudent investment – 2%
Civil rights/human rights, including
discrimination – 2%
• Inadequacy of plan assets – 2%
• 2003 Survey
Stock Drop Litigation
Stock Drop Litigation:
Overview
• Focus is on defined contribution plans: participant
directed eligible individual account plans (“EIAP”)
• EIAP is a profit sharing or stock ownership plan that
allows for the acquisition and holding of stock
issued by the plan sponsor.
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At least 19% of all 401(k) assets are invested in employer
stock
2,000 companies feature company stock in their plans
• When the stock declines, participants allege ERISA
based complaints that plan fiduciaries breached
their duties
Stock Drop Litigation:
Plaintiffs’ Claims
• The company stock declined as a result of wrongdoing by the
company or insiders.
• The corporate insiders are ERISA fiduciaries.
 Even if the employer is not designated as the fiduciary, ERISA
imposes fiduciary status if a party undertakes certain
discretionary actions with respect to a plan or its assets
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A plan sponsor usually delegates its fiduciary responsibilities to
the Board of Directors and an Administrative Committee
• Directors: limited fiduciary status with responsibility only over those
activities for which they are responsible
• Administrative Committee: general ERISA fiduciaries who are
charged with the highest care
Stock Drop Litigation:
Plaintiffs’ Claims
The insiders breached ERISA fiduciary duties:
prudence, failure to monitor, and disclosure.
Specifically, corporate insiders:
• Failed to provide adequate information, such as accurate financials
• Acted imprudently by failing to close company stock as an investment
option or failing to divest the plan of company stock
• Acted imprudently in offering company stock as an investment option
• Labored under a conflict of interest and violated duties by failing to retain an
independent fiduciary
• Improperly encouraged participants to invest in company stock while
knowing it was a bad investment
• Breached duties by failing to disclose to participants material inside
information regarding the company
• Failed to disclose illegal business practices at the company
• Breached duties by insider trading
• Breached fiduciary duties by freezing company stock as an investment
alternative
Stock Drop Litigation:
Prevention
• Draft plan documents to reflect that the sponsor has
appointed the board as the responsible fiduciary
• Set forth a simple fiduciary structure in the plan documents
• Invoke section 404(c) and appropriate risk language in the
plan documents
• Communication with participants should be confined to
written materials
• Companies should warn about the risks of investing in
company stock in every communication and should warn
that forward looking statements may not be accurate
• Communicate adverse news aggressively to participants
• More communication is better
Stock Drop Litigation:
Lessons
• Do not appoint senior corporate officers to the
fiduciary committee
• The committee must be prepared to establish
procedural prudence
401(k) Expense Litigation
401(k) Expense Litigation:
Overview
• Plan fees have received attention and are subject
to debate and scrutiny
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Labor Department provided a fact sheet for plan sponsors to use
in selecting pension consultants and for monitoring plan fees
Labor Department proposed changes to the Form 5500 to require
plan administrators to disclose indirect plan fees
GAO recommended that legislation be considered that would
require tax code 401(k) plan sponsors to disclose the total fees
charged to plan participants
• Recently filed lawsuits: Actions filed on behalf of
employees of Boeing Co., Caterpillar Inc., Exelon
Corp., General Dynamics Corp., International Paper
Co., Kraft Foods Inc., Lockheed Martin Corp.,
Northrop Grumman Corp., and United Technologies
Corp. and others
401(k) Expense Litigation:
Why?
• “There has been increased literature regarding
excessive plan fees and potential breaches of
fiduciary duties by plan fiduciaries, which
reflects an increasing amount of dissatisfaction
among plan participants that their ability to have
a secure retirement is being harmed by plan
fiduciaries who are ailing to make sure fees are
reasonable.”
Jerome J. Schlicter of Schleinter, Bogard &
Denton (filed class actions involving plan fees)
401(k) Expense Litigation:
Plaintiffs’ Claims
• Plan fiduciaries breached their duties of
loyalty and care by permitting providers to
charge excessive and improper fees
• Specifically, Plaintiffs claim that they are
charged “hidden fees” from revenue sharing
payments that are not accounted for or
disclosed by plan fiduciaries
401(k) Expense Litigation:
Plaintiffs’ Relief under ERISA
• 502(a)(2): participant or a fiduciary in an ERISA
covered plan can bring a civil action for relief
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Defendants are liable to restore to the 401(k) plan the
losses that arose from the alleged fiduciary breach
• 502(a)(3): participant or a fiduciary in an ERISA
covered plan can obtain equitable relief
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Plan participants are entitled to an equitable accounting of
excess fees and expenses
• Expenses constitute prohibited transactions under
ERISA sections 406 and 408
401(K) Expense Litigation:
Safeguards by Plan Sponsors
• Document the plan fiduciary’s review and
negotiation of all plan service arrangements
• Review and revisit fee arrangements and
investment alternatives on a regular basis
• Review the plan’s fiduciary governance structure to
make sure that plan fiduciaries are clearly identified
• Implement and review the plan’s investment policy
statement
• Ensure that the plan does not obligate the sponsor
• Regularly review and document decisions regarding
the liquidity targets
Disclaimer
• The views expressed in these materials are those
of the authors and do not necessarily reflect the
views of The Travelers Companies, Inc., Beazley,
Westfield or any of their subsidiary companies.
These materials are for general informational
purposes only. None of it constitutes legal advice,
nor is it intended to create any attorney-client
relationship between you and the author. You
should not act or rely on this information concerning
the meaning, interpretation, or effect of particular
contractual language or the resolution of any
particular demand, claim, or suit without seeking
the advice of your own attorney.