Federal appellate courts in the last year have reached different conclusions as to whether the incorporation into an ERISA Summary Plan Description by 401(k) plan fiduciaries of (allegedly untruthful) company SEC filings, thus potentially misleading participants about the risk of investing retirement money in the plan’s employer stock fund, is a breach of ERISA fiduciary duty.
A 401(k) plan is an employee benefit plan in which employees may make tax deductible contributions to be invested on a tax deferred basis and paid out when the employee retires or terminates employment. Publicly traded companies typically offer an employer stock fund as one of the available investment options under the plan. If the 401(k) plan is voluntary and employee contributions may be invested in employer stock, an offer and sale occurs which must be registered under the Securities Act of 1933. See SEC Release No. 33-6188.
SEC Registration of 401(k) Plans
There is a simplified form for registration of employee benefit plans. Form S-8 permits much of the information that is required to be contained in the prospectus, such as information about the issuer’s operations and its financial statements, to be incorporated by reference from the issuer’s filings under the Securities Exchange Act of 1934 – Forms 10-K and 10-Q.
401(k) Plans are also governed by the Employee Retirement Income Security Act of 1974 (ERISA). ERISA requires that companies sponsoring 401(k) plans prepare and distribute to participants a Summary Plan Description (SPD). The SPD is required to describe, in laymen’s terms, information about the plan, such as who is eligible to participate, amount of contributions, vesting, when distributions are made from the plan, available investment choices for participants and identification of the plan trustee and administrators. There is much overlap in the information required in the prospectus and the SPD. It has become common for many issuers to combine the prospectus and the SPD into one document for reasons of efficiency, consistency and cost. This means, however, that the issuer’s 1934 Act filings are incorporated by reference into the ERISA SPD.
ERISA imposes fiduciary duties on plan administrators. In the "stock drop" litigation of the last decade, plaintiffs’ lawyers realized that they did not have to be limited to securities law claims. If the defendant company maintained a 401(k) plan with a company stock fund, an ERISA breach of fiduciary duty claim could be asserted. The claim is that the plan fiduciaries breached their fiduciary duty by continuing to maintain the deteriorating company stock fund for investment of 401(k) contributions and failed to advise the employee participants about the true condition of the company.
The plaintiffs’ lawyers also discovered that the ERISA document, the SPD, was incorporated by reference and therefore contained the allegedly false and misleading SEC filings. Thus it was easy to allege that an ERISA plan fiduciary had distributed to plan participants an ERISA document containing false data on which the participants relied to their detriment in continuing to invest in the company stock fund thereby resulting in a breach of fiduciary duty. As a result, plaintiffs have converted a cause of action for deficient SEC reporting into an ERISA breach of fiduciary duty.
There are some important things to note about ERISA fiduciary liability:
- ERISA is a personal liability statute. Plan fiduciaries are personally liable for ERISA fiduciary breaches. ERISA prohibits a plan from indemnifying fiduciaries for breach of fiduciary duty although liability insurance coverage or indemnification by the employer is permitted.
- Companies typically maintain ERISA insurance in addition to their D&O insurance. Plaintiffs see the ERISA insurance as another deep pocket.
- Plan fiduciaries are often company officers who sit on the plan investment and administrative committees and who are potentially liable for these breaches.
ERISA Disclosure Litigation
Some United States district courts addressing the issue of ERISA liability for SEC documents have ruled in favor of the defendants but others have held for plaintiffs or at least have refused to grant defendants motions for dismissal or summary judgment. See Shirk v. Fifth Third Bancorp., No. 05-049, 2009 U.S. Dist. LEXIS 24490 (S.D. Ohio Jan. 29, 2009); AEP ERISA Lit. 327 F.Supp. 2d 812 (S.D. Ohio 2004); Benitez v. Humana Inc., No. 08-211, 2009 U.S. Dist. LEXIS 92323 (W.D. Ky. Sept. 30, 2009); and In Re Lehman Brothers SEC & ERISA Lit., 683 F.Supp. 294 (S.D. N.Y. 2010).
Two federal circuit courts of appeal have now addressed the issue. A Second Circuit case held there was no cause of action based on incorporation of SEC filings in the SPD. The court stated that the SEC filings were prepared by the corporate officers in their officer capacity and not as ERISA fiduciaries. A Sixth Circuit case reached the opposite conclusion and stated that the ERISA breach came from the decision to incorporate the SEC filings into the SPD and was a basis for a breach of liability.
The Sixth Circuit case has been appealed to the United States Supreme Court. In a somewhat unusual step, the Supreme Court has asked for the views of the Solicitor General of the United States as to whether certiorari should be granted based on an interest of the federal government in the issue. This enhances the likelihood that the appeal will be heard.
Companies should consider whether the SPD and prospectus should be delivered as separate documents. The duplicate disclosures may still be avoided by incorporating the SPD into the prospectus. This would result in the incorporation by reference of the SEC filings only into the prospectus but not the SPD which is the ERISA document. Thus, the claim upheld by the Sixth Circuit may be avoided