ERISA Fiduciary Process: Moving Beyond a Pure Heart and Good Intentions to Rigorous Due Diligence

Transcription

1 ERISA Fiduciary Process: Moving Beyond a Pure Heart and Good Intentions to Rigorous Due Diligence Richard I. Loebl, Seyfarth Shaw LLP (New York, NY) September 25, 2009

2 Introduction

3 Concerns for Fiduciaries arising from the Current Economic Climate The economic crisis, collapse of some financial institutions and accompanying market downturns have resulted in fiduciaries focusing on issues such as: Safe investments no longer viewed as free of risk Money market funds ( breaking the buck ) Fixed income vehicles Insurance company guarantees Stable Value fund investments Securities Lending Investment of collateral Return of securities Assuring the integrity of alternative investments Seyfarth Shaw LLP

4 Increased Risk of ERISA Fiduciary Litigation The ERISA plaintiffs bar has become more sophisticated and aggressive, with nearly 9,000 ERISA cases filed every year The most significant exposures come from cases alleging violation of the fiduciary s ERISA Section 404 duties, resulting in plan-wide losses Plaintiffs counsel claim that exposures in these cases are in the hundreds of millions to billions of dollars Already in 2009, one settlement of $75 million In 2008, two stock drop cases settled for in excess of $35 million The trend in ERISA fiduciary settlements is down from the early part of this decade, but the numbers still are significant The increased sophistication of the ERISA plaintiffs bar has made fiduciary insurance more important; plaintiffs demands generally assume the presence of significant insurance policies Seyfarth Shaw LLP

5 Effect of Current Economic Climate on ERISA Fiduciary Litigation Market Conditions Lead to Litigation Turmoil in the markets has aroused the interest of plaintiffs lawyers Plaintiffs lawyers who previously filed securities law class actions often now pursue ERISA class actions Market conditions have tested even commonly accepted types of investments, exposing weaknesses and highlighting risk The shift away from defined benefit plans has brought costs and investment returns into sharper focus a reduced return may be alleged to be a loss to the plan More suits between fiduciaries, as well as by plan fiduciaries against trustees, investment managers and other service providers Seyfarth Shaw LLP

6 Enhanced Litigation Risks for ERISA Fiduciaries Increased litigation risk with respect to: Stock drop Revenue sharing/administrative fees Securities lending Investments with exposure to mortgage- or asset-backed securities Use of derivatives Selection of investment alternatives in ERISA Section 404(c) plans Allegations of insufficient due diligence of investment alternatives Default funds Target and life cycle funds Fixed income investments Alternative investments Style drift Valuation (e.g., non-public employer stock) Seyfarth Shaw LLP

7 Fiduciary Breach Allegations: The 401(k) Fee Cases Began as claims regarding investment and administrative fees Alleged failure to understand the many ways in which service providers can be compensated, and allowing service providers to receive unreasonable compensation (e.g., float and revenue sharing) Alleged failure to negotiate/monitor compensation to ensure that no more than reasonable compensation is paid by the plan Allegedly misleading disclosures to participants regarding plan fees and expenses Through discovery, plaintiffs may develop evidence to support other claims such as: Inappropriate investment types (e.g., actively managed v. passively managed) Inappropriate investment vehicles (mutual funds v. separate accounts; retail v. institutional share classes; unitized v. non-unitized company stock funds) Offering shadow index funds that assess actively-managed fund fees for what is essentially passive management Securities lending Failure to recapture float revenue Seyfarth Shaw LLP

8 Other Common Fiduciary Breach Allegations Stock Drop Litigation Company stock is imprudent (either inherently or at that price ) Failure to disclose material financial ( insider ) information Failure to disclose material information regarding business risks Failure to monitor fiduciaries Securities Lending Claims Failure to capture securities lending revenues Undue risk with invested collateral, and failure to return securities Subprime Mortgage Exposure Stock drop claims Failure to disclose that money market or stable value products had substantial exposure to mortgage-backed securities Seyfarth Shaw LLP

9 Considerations for ERISA Fiduciaries in the Current Economic Climate Same fiduciary duty standards under ERISA, including: Prudence fiduciary to act with the care, skill, prudence, and diligence under the circumstances that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character with like aims Loyalty ( exclusive purpose ) and avoidance of self-dealing PROCESS is critical Not a mere paper trail Substantive engagement Review of, and compliance with, applicable documents Due diligence in appointment of service providers and other fiduciaries Monitoring of appointees Seyfarth Shaw LLP

10 Why Implement a Prudent Process? Cases focus on process rather than result therefore, it is helpful, although not necessarily dispositive, to have a well-documented process Plan governance procedures Document your analysis Consult experts and follow their advice (or document why you do not) Monitor your service providers and other appointees on a regular basis Recent Defense Victories in Stock Drop Cases In some cases, even without any clear evidence of a conscious process to evaluate prudence of company stock as an investment Plaintiffs are unable to show that removal of the company stock investment would have been more prudent than keeping it Investment in company stock is hard-wired and plaintiffs are unable to overcome the presumption that the fiduciary must follow the terms of the plan in that regard No material omissions or misrepresentations; thus, no ERISA disclosure claim Seyfarth Shaw LLP

11 How Do Courts Evaluate Prudence? Monitoring and use of independent advisors Fiduciaries met four times per year and retained two independent advisors to opine on the propriety of maintaining the company stock fund. DiFelice v. U.S. Airways, Inc., 497 F.3d 410 (4 th Cir. 2007) Fiduciary monitored the performance of the funds and reviewed written information regarding the funds. Jenkins v. Yager, 444 F.3d 916 (7th Cir. 2006) Investment choices are evaluated based upon the evaluation made, and the information known, at the time the decision was made Taylor v. United Technol. Corp., 46 EBC 1935, 2009 WL (D. Conn. 3/3/2009) That plaintiffs may have been able to enjoy better performance is insufficient to support a claim of fiduciary breach where defendant has engaged in prudent analysis of its decision. Cf. the Executive Life cases, where some courts held that issues of fact existed as to whether fiduciaries had fulfilled their duties in selecting the annuity providers An objectively reasonable investment is unlikely to give rise to liability for damages, even if there is no prudent process. However, the better the process, the less need to defend the merits of the particular investment Seyfarth Shaw LLP

12 How Do Courts Evaluate Reasonableness? Compliance with statutory and regulatory requirements Comparison to other similar plans/vendors Use of consultants and experts during the evaluation process Use of comparative data and benchmarking Thoroughness of process If a reasonable process is used to negotiate a fee, courts normally will not question the fee Seyfarth Shaw LLP

13 Considerations for Investment Fiduciaries Courts expected to apply fiduciary standards based on the circumstances at the time the investment action was taken (or not taken), as opposed to application of hindsight Appropriate factors for an investment fiduciary to consider include: Diversification of investments to minimize the risk of large losses unless, under the circumstances, it is clearly prudent not to do so Risk of loss Opportunity for gain Compliance with investment and funding policies Liquidity and return of portfolio Suitability of investments given participant demographics An investment fiduciary also may need to consider: Review of current investments and managers Possible selection of new investments or managers An investment fiduciary needs to act based on the current status, but with a long-term view Seyfarth Shaw LLP

14 The Importance of Participant Control over Investments ERISA Section 404(c) provides a defense to claims of imprudence if participants exercise control over investments Numerous regulatory criteria DOL takes the position that ERISA Section 404(c) protection does not apply to selection of investment vehicles (the menu ) Extensive litigation over scope/applicability of Section 404(c) Given the language of the statute, courts are willing to place responsibility for poor investment selection on plan participants, rather than on plan fiduciaries Unbiased, independent investment advice would support application of an ERISA Section 404(c) defense Seyfarth Shaw LLP

15 Participant Control over Investments: Investment Advice Many DC plans rely on protection of fiduciaries under ERISA Section 404(c), but there may be discomfort regarding whether participants have knowledge adequate to manage their accounts Employers may be reluctant to assist participants because of the risk of liability DOL regulations on providing investment advice to participants were issued on January 21, 2009, to be effective March 22, These required: Advice to be provided by a fiduciary adviser under an eligible investment advisory arrangement Must use computer modeling or a fee-leveling arrangement Annual audit of the adviser Implementation of regulations delayed until at least November 18, 2009 Many groups objected to the regulations, primarily asserting that participants must be able to receive conflict-free advice Legislation has been introduced that would require such advice to be provided either pursuant to computer modeling or by an independent fiduciary Seyfarth Shaw LLP

16 The ERISA Fiduciary s Response to the Current Economic Climate The current economic climate has not changed a fiduciary s duties, but it has increased the scrutiny of a fiduciary s actions or inactions Fiduciaries should: Review existing governance documentation Is it accurate? Are changes appropriate? Review documentation of fiduciary process Have the documents considered by the fiduciary been preserved? Have the meetings concerning fiduciary issues been documented? Consider a compliance audit or risk assessment Review contracts with service providers Review target asset allocations Review existing investment guidelines, asset allocations, menu of investment alternatives, etc Seyfarth Shaw LLP

17 The ERISA Fiduciary s Response to the Current Economic Climate (con t.) Fiduciaries should: Determine exposure to troubled assets Consider increasing communication From plans to managers and consultants From plans to participants Increase monitoring of managers and service providers, including their compensation arrangements Consider whether the plan has legal claims that should be asserted Be cognizant of discovery obligations and risks, including the fiduciary exception to the attorney-client privilege Consider whether use of an independent fiduciary is advisable Consider how documents and communications would look as trial exhibits Review their fiduciary insurance policies and fidelity bond arrangements Seyfarth Shaw LLP

18 The ERISA Fiduciary s Response to the Current Economic Climate (con t.) Training for ERISA Fiduciaries Who should undergo training? Named fiduciaries, including members of boards of directors, trustees, and plan committee members Senior management who will have plan sponsor authority over plans Employees who support and assist with plan administration and pension investments Training should be held periodically To train new personnel/fiduciaries To reflect new laws and best practices To reinforce concepts Seyfarth Shaw LLP

19 Plan Governance Considerations Identifying Fiduciaries Named fiduciaries and de facto fiduciaries Co-fiduciaries Directors and officers as fiduciaries The two hats doctrine Corporate insiders and company stock Appointment of fiduciaries Establishing a plan committee Administrative, appeal and investment subcommittees Best practices for the board of directors: appointment and monitoring of fiduciaries Seyfarth Shaw LLP

20 Plan Governance Considerations (con t.) Fiduciary Compliance Fiduciary duties Avoiding prohibited transactions Statutory and class exemptions Individual exemptions Review of plan documents, policies and procedures The terms of the plan Policies and procedures (e.g., loan, QDRO, QMCSO) Contracting with service providers and monitoring of service providers Fiduciary training Personal liability and civil actions Fidelity bond Fiduciary liability insurance Errors and omissions insurance Corporate indemnification of fiduciaries Best practices for fiduciary compliance Seyfarth Shaw LLP

21 Checklists of Persons, Documents and Topics to be Considered, Reviewed or Monitored

22 EBSA Form 203A, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Plans I. Predication (State the reason for the case opening and for conducting an investigation.) II. Background Plan Sponsor: Plan Type: As of / / : Assets: Participants: Period Covered by Investigation: / / to / / Other Plans Reviewed: III. Areas Examined Bonding Other Loans Income / Earnings Rptg. & Disclosure ER Sec. / Real Prop. Expenses Contributions Ptrships. / Jt. Venture Valuations Stocks & Bonds Other Investments Cash Real Estate Receivables / Payables Insurance Mortgages Liabilities Benefits Other: Seyfarth Shaw LLP

23 EBSA Form 203A, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Plans (continued) IV. Records Reviewed (For each item checked, supporting documentation obtained during the investigation should be retained in the case file.) Trustee / Corp Minutes Forms 5500 Real Estate / Mortgage Correspondence Files Financial Stmts Appraisals / Valuations Service Prov Contracts Rcpts./Disbs. Partnership / Joint Venture Insurance Contracts Bank / Inv Stmts. Stock Records Plan/Trust Documents Loan Records Participant Records Bond Liability Ins. SPD/SAR Other: V. Interviews Conducted (Supporting documentation for each interview conducted should be retained in the case file.) NOTE: Parts I-V of Forms 203D, 203E and 203F, used under Program 53 (limited review of cases with the highest potential for abuse), are substantially similar to the corresponding checksheets shown here. Program 53 is an expedited inquiry into one or more specific facts in order to determine whether further investigation is merited Seyfarth Shaw LLP

24 EBSA Form 203B, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Financial Institutions I. Predication (State the reason for the case opening and for conducting an investigation.) II. Background Type of Financial Institution: As of / / : No. of ERISA Client Plans: Managed Assets: Period Covered by Investigation: / / to / / Other: III. Areas Examined Scope of Fid. Respon. Pooled Investments Annuities Proxy Voting Real Estate Fees / Commissions Cash Management Insurance Rebates Stocks & Bonds Other Investments Cash Equity Investments Commercial Side Bonding Fixed Income Investments Transactions Rptg. & Disclosure Other: Seyfarth Shaw LLP

25 EBSA Form 203B, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Financial Institutions (continued) IV. Records Reviewed (For each item checked, supporting documentation obtained during the investigation should be retained in the case file.) A. Financial Institution Records ERISA Client List Regulatory Filings Organizational Chart Fee Schedules Officers / Directors List Financial Internal Audits Client Complaints / Litigation Investment Performance Written Procedures & Guidelines Marketing Materials Approved Securities List Trust / Inv. Committee Minutes Master Securities List Asset Valuations Investments Contracts Other: B. Plan Records Financial Institution Agreements Billing Invoices Correspondence Files Participant Records Financial Plan / Trust Documents Insurance Asset Holdings Transaction Ledgers Investment Contracts Confirmation Slips / Order Tickets Other: V. Interviews Conducted (Supporting documentation for each interview conducted should be retained in the case file.) F.I. Officials Plan Sponsor Attorney Plan Trustee Plan Administrator Accountant Other: Seyfarth Shaw LLP

26 EBSA Form 203C, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Service Providers I. Predication (State the reason for the case opening and for conducting an investigation.) II. Background Type of Service Provider: Health Pension Other As of / / : No. of ERISA Covered Plans: Participants Period Covered by Investigation: / / to / / Services: Claims / Benefit Determination COBRA Administration Claim / Benefit Payments Benefit Consulting Prep/Maintenance Partic. Records Investment Prep./Maintenance Accounting Records Insurance Bonding Utilization Review Legal Actuarial Doc Prep: 5500 Plan SPD SAR Other: III. Areas Examined Scope of Fid. Respon Contributions COBRA Administration Claim / Benefit Processing Commissions Investment Claim / Benefit Payments Ins. Arrngmnt. Actuarial Services Unnec'y / Duplicate Svcs. Fees Rebates Other: Seyfarth Shaw LLP

27 EBSA Form 203C, Checksheet Report of Investigation, Program 48 (general investigation of ERISA, Title I, Part 4) Service Providers (continued) IV. Records Reviewed (For each item checked, supporting documentation obtained during the investigation should be retained in the case file.) A. General Service Provider Records Client List Marketing Materials Financial State License Receipt / Disbursement Rec. Bank / Investment Org. Chart Fee Schedules / Compensation SP Contracts Other: B. Plan/Client Records Administration Agreement Plan/Trust Doc Trustee/Corp. Minutes Billing / Invoices Form 5500 Financial Statements Contributions / Premiums Benefits / Claims Bank / Invt Statements Participant Records Correspondence Pended Claims Other Contracts Insurance Contracts Reports to Plans and/or Clients Other: V. Interviews Conducted (Supporting documentation for each interview conducted should be retained in the case file.) Service Provider Plan Administrator Accountant Personnel Plan Sponsors Attorney Plan Trustee Other: Seyfarth Shaw LLP