The 7th Circuit’s Big ERISA Day: On January 21, 2011, the 7th Circuit Court of Appeals handed down two ERISA opinions, both by Judge Diane Wood, covering four cases and dealing with three significant issues:

  • How does ERISA’s prudence standard apply to a fiduciary’s decision to offer plan participants the opportunity to invest their accounts in employer stock?
  • What are the standards for certifying a class action alleging imprudent conduct by the fiduciaries of an individual account plan?
  • Does a terminating employee’s release of claims against his employer preclude him from bringing an action alleging a fiduciary breach concerning a plan in which he was a participant?

The next three sections of this ERISA Advisory discuss these issues individually. Each is of considerable importance to plans that allow participants to direct the investment of their accounts, particularly when the possible choices include investment in employer stock.

Allowing participants to invest in employer stock passed prudence muster, court holds. Two cases involved Motorola’s 401(k) plan, presenting identical claims that the company, the plan committee, and various corporate officers had breached their fiduciary duties by retaining employer stock as a plan investment option during a period when undisclosed business developments allegedly rendered it imprudently risky. One case, discussed in the section after next, was dismissed for reasons unrelated to the merits. Remaining was Lingis v. Dorazil, 2011 WL 183966 (7th Cir., 1/21/11), in which the district court had granted summary judgment for the defendants. The 7th Circuit affirmed, though on narrower grounds than the court below.

The impetus for the lawsuit was a drop of about 50 percent in the value of Motorola stock between May 2000 and May 2001, not due to general market conditions but rather allegedly due to an unfavorable business transaction. The essence of their complaint (which included other, less noteworthy counts that will not be discussed here) was that under these facts the plan fiduciaries had a fiduciary duty to keep participants’ accounts out of Motorola stock.

The district court dismissed the suit on the broadest conceivable theory: that ERISA, §404(c), which relieves fiduciaries from liability for the investment decisions of a participant who “exercises control over the assets in his account,” applied. Since participants were free to invest or not invest in employer stock, the lower court reasoned, fiduciaries could not be liable to those whose decisions turned out badly.

The appellate court was unwilling to go that far. Instead, it agreed with the reading of Section 404(c) urged by the Department of Labor’s amicus brief:

In short, the statute ensures that the fiduciary will not be held responsible for decisions over which it had no control. . . The language used throughout section 404(c) thus creates a safe harbor only with respect to decisions that the participant can make. The choice of which investments will be presented in the menu that the plan sponsor adopts is not within the participant’s power. It is instead a core decision relating to the administration of the plan and the benefits that will be offered to participants.

Thus, we agree with the position taken by the Secretary of Labor in her amicus curiae brief that the selection of plan investment options and the decision to continue offering a particular investment vehicle are acts to which fiduciary duties attach, and that the safe harbor [§404(c)] is not available for such acts.

Having said that, the court went on to hold that the plaintiffs’ evidence of imprudence was “fatally thin.” It amounted to no more than unsupported assertions regarding the problematic business transaction at issue and the fact that Motorola shares did in fact decline in value. In explaining why these facts did not raise enough of an issue to avoid summary judgment for the defendants, the opinion lays strong emphasis on the availability of other investment choices:

The very existence of the three other investment options (until July 1, 2000) or eight other options (after that date), in the absence of any challenge to [the prudence of] any of those other funds, offers assurance that the Plan was adequately diversified and no participant’s retirement portfolio could be held hostage to Motorola’s fortunes.

The implied principle is important: that prudence should be evaluated on the basis of the entire menu of investments offered to participants, not by scrutinizing each one in isolation. That this is the proper line of analysis ought to be obvious, but it has received little attention from in 401(k) plan “stock drop” cases.

Court nixes class action certifications in two stock drop/§401(k) fee cases. In two cases the Seventh Circuit examined grants of class action status for lawsuits against Boeing and International Paper. In each case, 401(k) plan fiduciaries allegedly failed in their ERISA duties in a variety of ways: by imprudently offering employer stock and “risky” mutual funds as investment options, by paying excessive fees to investment providers, and by concealing material information on these matters from participants. The Southern District of Illinois had certified classes consisting of all “participants or beneficiaries of the Plan and who are, were or may have been affected by the conduct set forth in this Complaint, as well as those who will become participants or beneficiaries of the Plan in the future.” The district court had certified the class under Federal Rule of Civil Procedure 23(b)(1)(B), which meant that no member of the class can opt out of the class. On appeal by defendants the appellate court consolidated the two cases for decision. Spano v. The Boeing Company, 2011 WL 183974 (7th Cir., 1/21/11); Beesley v. International Paper Company, 2011 WL 183974 (7th Cir., 1/21/11).

Gaining class action certification is a key step in cases like Spano and Beesley; otherwise they are rarely attractive to plaintiffs' counsel.

Though cautiously phrased, the 7th Circuit’s opinion sets standards for class certification that the plaintiffs in these and similar cases will find hard to meet. The Seventh Circuit found that the classes certified by the district court in the cases at hand suffered two fatal flaws: the representative plaintiffs had failed to show that their circumstances were typical of all plan participants, and it was not clear that their interests were adequately aligned with those of the class as a whole. Both are required findings in order for a case to proceed as a class action. The court of appeals observed that it is not enough that plaintiffs claim they are seeking relief for the plan as a whole, because there may well be plan participants swept into the class that have no complaints about the investment options they selected over a particular period of time or may be content to absorb higher fees associated with an investment option if that option has an outstanding track record or fits particularly well into their overall retirement planning strategy. Thus, a remedy that limited the plan to the cheapest possible funds or eliminated investment options that performed well for some participants would not necessarily serve their interests.

Court agrees that ex-employee’s general release covered ERISA claims. The final case in this set, Howell v. Motorola, Inc., 2011 WL 183966 (7th Cir., 1/21/11), presented the same claims as Lingis v. Dorazil, with which it was consolidated for decision by the appellate court. Its twist was that the plaintiff was laid off a few months after the events that gave rise to the suit, and in return for a severance package, signed a general release of claims against Motorola and all of its officers, directors, and affiliates, specifically including claims under ERISA, but not “claims for benefits under the Motorola employee benefits plan” or “claims or rights which cannot be waived by law.” The district court viewed this release as a complete bar to suing Motorola and its officers for breach of fiduciary duty under ERISA.

On appeal, neither of plaintiff's arguments for disregarding the release impressed the court. First, the plaintiff tried to recharacterize the action as a “claim for benefits,” extrapolating from the Chief Justice’s concurring opinion in LaRue v. DeWolff, Boberg & Associates, Inc., 552 U.S. 248 (2008). There the Supreme Court held that a participant could sue for breach of fiduciary duty when his account balance was invested in a manner contrary to, and less profitable than, his elections. Justice Roberts, in a concurring opinion, questioned the fiduciary analysis and suggested that it might be preferable to treat the action as a claim for benefits. The 7th Circuit, however, looked to the meaning of the language in the release, didn’t see any need to consider LaRue and held that based on a sensible reading of the release, plaintiff had intended to release the claims at issue.

Second, the plaintiff contended that claims against ERISA fiduciaries cannot legally be waived, because ERISA §410(a) declares void as against public policy “any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under” the statute’s fiduciary standards. The court responded that a release in exchange for compensation “merely settles a dispute that the fiduciary did not fulfill its responsibility or duty on a given occasion” and that to hold otherwise “would make it impossible, as a practical matter, to settle any ERISA case.”

Determination Letters: Cycle A rolls around again. Five years ago, the IRS divided all qualified retirement plans into five groups and mandated that, in the future, each would have to apply for an updated determination letter every five years. On January 31, 2011, the first complete series of Determination Letters (DL) cycles for individually designed plans came to a close. Now the second series begins.

The determination letters issued during the previous Cycle A “open window,” which ended on January 31, 2007, will expire on January 31, 2012, unless they are renewed through the timely filing of a new application. The window for these applications opened on February 1, 2011, and will continue through January 31, 2012. Simultaneously, the IRS raised the “user fees” that it charges for processing applications. The base fee has increased from $1,000 to $2,500, while the extra charge for a ruling on whether the plan’s benefits satisfy “nondiscrimination” standards is now $4,500, up from $1,800. Most plans don’t need a “nondiscrimination” ruling, fortunately, because their coverage and benefits fall into “safe harbors” or present only cut-and-dried issues.

A plan falls into Cycle A if either –

  • its sponsor’s Employer Identification Number (EIN) ends in “1” or “6”, or
  • its sponsor is part of a controlled group or affiliated service group that maintains more than one qualified plan and elects to file DL applications for all of its plans in Cycle A.

Special rules cover plans to which the standard ones don’t conveniently apply: A plan covering employees of unrelated employers is in Cycle D if it is collectively bargained and in Cycle B if it is not. A plan maintained by a governmental unit is in Cycle C.

In some cases, pertinent facts, such as the sponsor’s EIN or controlled group status, will have changed since the plan’s last DL. The general rule is that the plan’s cycle changes accordingly. For instance, if the sponsor of a Cycle D plan merges into a company whose EIN ends in “1” or “6”, the plan is now on Cycle A. If the cycle change occurs during the Cycle A submission window, however, the plan automatically gets a 12-month extension, to January 31, 2013.

A plan that has obtained a favorable determination letter is, except in the rarest of circumstances, immune to disqualification if the IRS later discovers defects in the plan document. While there is no protection against disqualification for operational defects, a determination letter is useful insurance against mistakes in plan drafting. The escalating complexity of the qualification rules renders it almost impossible to prepare a perfect document, so a plan without a determination letter is exposed to potential legal jeopardy.

The details of the determination letter process are contained in Revenue Procedure 2007-44 and the new user fees in Revenue Procedure 2011-8.