Morgan, Lewis & Bockius, LLP
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Recent Developments in ERISA Litigation
401(k) Stock Drop Litigation
 Fee and Expense Litigation
 Cash Balance Litigation
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Presented by
Jeremy P. Blumenfeld
ERISA Fiduciary Duties
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Duty of Loyalty
Duty of Prudence
Duty of Diversification
Duty to Follow Plan Documents
Duty not to Mislead/Misinform Plan
Participants
Prohibited Transactions
Enforcement of ERISA Fiduciary
Duties
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Personal liability under ERISA § 209(a), 29 U.S.C. §
1109(a)
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“Any person who is a fiduciary with respect to a plan who
breaches any of the responsibilities, obligations, or duties . . .
shall be personally liable to make good to such plan any
losses to the plan resulting from each such breach, and to
restore to such plan any profits of such fiduciary which have
been made through use of assets. . . .”
Fiduciary Status
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It is possible to be a fiduciary for some purposes, but not for
others.
Courts apply a functional test for fiduciary status.
ERISA Civil Enforcement Provisions
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502(a)(1) – Claims for benefits under the plan.
502(a)(2) – Claims for monetary damages for
breaches of fiduciary duty under section 409.
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LaRue v. DeWolff – “although §502(a)(2) does not
provide a remedy for individual injuries distinct from
plan injuries, that provision does authorize recovery
for fiduciary breaches that impair the value of plan
assets in a participants account.”
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502(a)(3) – Catchall provision for “other
appropriate equitable relief.”
Stock Drop Litigation
Defined Benefit Plan v. Defined Contribution Plan
 Defined Benefit Plans
 Fixed retirement benefit paid out over course of retirement
 Based on formula established in plan documents
 Defined Contribution Plans
 Provide participants with individual accounts
 Value of individual account at retirement determined by
amount of contributions and investment performance (less
fees and expenses)
 ESOP – features investment option in plan sponsor stock
401(k) Stock Drop
Fiduciary Breach Claims
 Imprudence Claims – Company stock became
an imprudent investment alternative because of
circumstances adversely affecting sponsor
company
 Misrepresentation/Omission Claims – Plan
fiduciaries affirmatively mislead or failed to warn
of risks associated with sponsor company stock
404(c)
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ERISA § 404(c)(1)(B), 29 U.S.C. §1104(c)(1)(B).
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“In the case of a pension plan which provides for
individual accounts and permits a participant or
beneficiary to exercise control over the assets in his
account: . . . no person who is otherwise a fiduciary
shall be liable under this part for any loss or by
reason of any breach, which results from such
participant’s or beneficiary’s exercise of control.”
404(c)
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404(c) plans must:
Offer a diversified array of investments
 Provide adequate information concerning the
investments to the participants
 Authorize flexible and autonomous control by the
participants
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The Circuit Split over 404(c)
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Third and Fifth Circuit believe 404(c) means what it
says: “any loss” and “any breach.”
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In re Unisys Sav. Plan Litig., 74 F.3d 420 (3d Cir. 1996)
Langbecker v. Elec. Data Sys. Corp, 476 F.3d 299 (5th Cir.
2007)
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Fourth Circuit (in dicta) and the Department of Labor
(“DOL”) have expressed that 404(c) does not apply to a
fiduciary’s decisions to select and maintain certain
investment options within a participant-driven 401(k)
plan.
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DiFelice v. U.S. Airways, 497 F.3d 410, (4th Cir. 2007)
Pre-2007 Lead Stock Drop Cases
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Company stock is a presumptively prudent investment; to state a
fiduciary breach claim, plaintiffs must plead and prove a precipitous
decline in stock price coupled with evidence of serious
mismanagement.
 Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995)
 Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995)
 Wright v. Oregon Metallurgical Corp., 360 F. 3d 1090 (9th Cir. 2004)
Plaintiffs must plead and prove that stock fund participants were
subjected to “excessive risk,” as manifested by an increasing debtequity ratio and evidence that participants’ other assets are not
diversified.
 Summers v. State Street Bank & Trust Co., 453 F.3d 404, 410 (7th Cir.
2006)
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Coupled with a (very) large majority of District Court decisions
denying Motions to Dismiss.
2007 Decisions
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Langbecker v. Electric Data Sys. Corp., 476
F.3d 299 (5th Cir. 2007)
Opinion suggests that class certification may never
be appropriate in a stock drop case because 404(c)
contemplates individualized defenses.
 Coupled with Summers’ notion of individual
risk/return, Langbecker may present a new avenue
for attacking class actions.
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2007 Decisions
Harzewski v. Guidant Corp., 489 F.3d 799, 808 (7th Cir.
2007)
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Economically Irrational Claim
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“It is unlikely that [plaintiffs] would have done better from whatever
substitute investment Guidant would have put them in.”
Seventh Circuit instructed on remand “as its first order of business” to
“take a very careful look at the plaintiffs’ theory of how they were
injured.”
Fiduciary Duty v. Insider Trading
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“It probably would have been unlawful, moreover, for Guidant to sell the
Guidant stock held by the pension plan on the basis of inside knowledge
of the company’s problems. If so, there are no damages, and indeed no
breach of fiduciary duty; for the fiduciary’s duty of loyalty does not
extend to violating the law.”
2007 Decisions
Two New Takes on Standing
 Graden v. Conexant Systems, Inc., 496 F.3d 291 (3d Cir. July 31, 2007)
Where a plaintiff alleges that his benefit payment was deficient on the day
it was paid under the terms of the plan, he states a claim for benefits,
which (if colorable) makes him a participant with standing to sue.
Harzewski v. Guidant Corp., 489 F.3d 799, 808 (7th Cir. 2007)
 Whether an ERISA plaintiff is a “participant” entitled to recover benefits
under the Act should be treated as a question of statutory interpretation
fundamental to the merits of the suit rather than as a question of the
plaintiff ’s right to bring the suit.
 “So the question comes down to whether, if the plaintiffs win their case
by obtaining a money judgment against Guidant, the receipt of that
money will constitute the receipt of a plan benefit. It will.”
 In a footnote in LaRue, the Supreme Court suggests that Harzewski gets
it right.
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2007 Decisions
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DiFelice v. US Airways, 497 F.3d 410 (4th Cir.
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2007)
Upholds defense verdict in “stock drop” trial.
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“Employees cannot succeed in this lawsuit simply by
demonstrating that U.S. Airways offered the
Company Fund during a time of grave uncertainty
for the company, no matter how significant the
Employees’ ultimate financial losses.”
2007 Decisions
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De Felice provides a roadmap to plan sponsors and
fiduciaries of 401(k) plans containing employer stock:
 Company offered twelve diversified and less risky
alternatives for investment;
 Company allowed participants to transfer freely
between funds;
 Company warned participants of the risks in plan
documents; and
 Company sought and obtained two outside legal
opinions regarding the continuation of company stock
as an investment option.
2007 Decisions
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The other side of DiFelice
Limits application of 404(c) defense in dicta.
 Backs away from the district court’s zealous
application of modern portfolio theory
 Provides an example of breach of loyalty, e.g. "that
high-ranking company officials sold company stock
while using the Company Fund to purchase more
shares, or that the Company Fund was being used
for the purpose of propping up the stock price in
the market”
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2007 Decisions
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Edgar v. Avaya, Inc., 503 F.3d 340 (3d Cir. Sept. 26, 2007)
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Presumption of prudence owed to investments in employer stock applies
to all eligible individual account plans (“EIAPs”), not just ESOPs, if the
investment is more than just “permitted” under the Plan documents.
Presumption of prudence applies at the pleading stage and requires the
plaintiff to allege facts that, if proven, could overcome the presumption
of prudence.
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A 25% decline in share price following earnings announcement is insufficient
as a matter of law to maintain suit.
Offering of company stock was hard-wired into plan document.
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Not “the type of dire situation which would require defendants to disobey
the terms of the Plans by not offering the Avaya Stock Fund as an investment
option, or by divesting the Plans of Avaya securities.”
Best Practices
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“Hard” wire company stock investment
Consider the objectives of the plan and whether
employer stock meets those objectives
Consider plan structure – Who should serve as
fiduciary?
Fiduciaries should monitor employer stock and every
other investment in the Plan (“procedural prudence”)
Advise participants about risks of employer stock and
diversification
Use of independent fiduciaries ???
Fee and Expense Litigation
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Plan Administration Fees – The day-to-day costs
of operation
Individual Service Fees – Fees for optional
services
Investment Fees
Sales Charges
 Management Fees – Actively and Passively Managed
Funds
 Other Fees
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Claims Against Plan Sponsor
Fiduciaries
A. Direct and indirect compensation paid to service
providers was not reasonable.
B. No reasonable investigation into the payments that
service providers receive from mutual funds, i.e.,
revenue sharing.
C. Fiduciaries failed to disclose revenue sharing.
D. Actively managed funds v. index funds (with lower
cost)
E. Retail shares v. institutional shares (with lower cost)
Claims Against Service Providers
A. Service provider is a fiduciary because it exercises some
control over the selection and offering of particular mutual
funds. The fiduciary breach issues may be even more acute
where “bundled” provider insists on inclusion of its own
funds on the “platform.”
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404(a)
B. Plaintiffs allege that revenue-sharing payments are plan
assets for purposes of prohibited transaction rules. They
advocate a “functional test” for defining plan assets:
whether the item in question may be used to benefit the
fiduciary at the expense of plan participants. E.g.,
Haddock v. Nationwide, 419 F. Supp. 2d 156 (D. Conn.
2006).
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406(a); 406(b)(1)
Claims Against Service Providers
C. Service provider engaged in prohibited
transaction because it received consideration
(revenue sharing) from a party dealing with the
plan (the mutual funds) in connection with a
transaction involving assets of the plan.
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406(b)(3)
D. 408(b)(2) – OK if reasonable compensation is paid
Disclosure Claims
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Required Disclosures
 Section 103(b)(2): Annual Report
 Section 104(b): Summary Plan Description
 Section 404(c): Participant must be provided
certain information, either directly or upon request
(but only to satisfy affirmative defense – this is not
a separate duty)
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Where are revenue sharing agreements
reported?
Defending Fee and Expense Cases
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Highlight efforts to investigate and evaluate fees.
Fees charged to plan were reasonable.
Service provider’s compensation was reasonable in
light of the quality and quantity of services and
industry standards.
ERISA does not require disclosure of revenue sharing
fee and expense cases.
Participants are told the fees they pay in the expense
ratio
404(c)?
Best Practices?
 Review compliance with 404(c), especially
disclosure provisions.
 Hire independent consultants to evaluate service
providers fees.
 Document the review and negotiation of all
service arrangements.
Best Practices?
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Periodic RFPs that request detailed fee
breakdowns.
Consider gathering mutual fund fee and service
provider compensation information into one
document for participants.
Ensure plan expenses are disclosed in 5500s at
the master trust level and plan level.
Cash Balance Litigation
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Cash Balance (“CB”) Plans are defined benefit
plans modeled after defined contribution plans.
Participants have hypothetical individual accounts,
but they do not control them.
 Ultimate retirement benefits are determined by “pay
credits” (% of pay earned each year) plus “interest
credits” as a percentage of the account balance
 Benefits are expressed as lump sum payments of the
account balance.
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Age Discrimination in Defined
Benefit Plans – Pre-PPA
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“[A] defined benefit plan shall be treated as
not satisfying the [benefit accrual]
requirements of this paragraph if, under the
plan, a participant’s benefit accrual is ceased,
or the rate of a participant’s benefit accrual
is reduced, because of the attainment of any
age.”
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204(b)(1)(H)
Age Discrimination v. Time Value of
Money
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The Circuit Courts agree: CB plans are not per se
violations of ERISA’s anti-discrimination
provision.
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Drutis v. Rand McNally & Co., 499 F.3d 608 (6th Cir. 2007)
Register v. PNC Fin. Servs. Group, Inc., 477 F.3d 56 (3d Cir. 2007)
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Cooper v. IBM Personal Pension Plan, 457 F.3d 636 (7th Cir. 2006)
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But some District Courts in the Second Circuit
think otherwise.
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See e.g., In re Citigroup, 470 F. Supp. 2d 323 (S.D.N.Y. 2006)
Whipsaw Claims
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Pre-PPA ERISA required “normal retirement benefits”
in a defined benefit plans to be expressed as an annuity.
CB plans, however, frequently call for lump sum
payment of account balance.
The not so simple solution: The Whipsaw Calculation.
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Convert account balance to annuity by using plan-provided
interest rate, determine future value of annuity at age 65;
Discount future annuity back to present value using statutory
discount rates
2nd, 6th, and 7th Circuits have all considered these issues,
and ruled in favor of Plaintiffs – but they haven’t
considered all of the issues
“Wear-Away”
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Pre-PPA, ERISA did not require a participant’s
opening balance in a CB plan to equal the
accrued benefit under the old defined benefit
plan. This allowed for Wear-Aways.
Freeze on benefits accrued under traditional plan,
until cash balance account catches up.
 Old benefits are protected, but participants could
earn benefits under new formula without seeing any
net benefit increase
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But not any more.
Congress to the Rescue . . .
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Pension Protection Act of 2006 (PPA) brings
much needed guidance to the courts, fiduciaries,
and attorneys.
Provides safe harbor for CB plans from the ERISA
anti-discrimination provision.
 Eliminates the Whipsaw Calculation.
 Eliminates intentional Wear-Aways.
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. . . or maybe not.
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PPA does not apply retroactively.
Only applicable to periods beginning on or after
June 29, 2005 and to distributions made after its
enactment.
In many situations, the old rules still apply.