Stock market declines and the financial collapse of companies such as Enron, Global Crossing and WorldCom have generated numerous shareholder class-action lawsuits against directors and officers alleging violations of federal securities law for issuing false and misleading public statements that failed to disclose the company’s true financial condition and various accounting improprieties.
At the same time, a significant number of ERISA class-action lawsuits have reportedly been filed by employees whose retirement and stock savings plans were heavily invested in their companies’ now worthless stock.
As a result, there is reportedly a startling increase in fiduciary liability class actions, which are wreaking havoc on the fiduciary liability line, according to panelists who spoke at the recent PLUS Employment and Fiduciary Issues Symposium.
“These cases are pretty straight up,” Greg Braden, partner, Alston & Bird LLP, said. “A typical case is not going to get into a lot of coverage issues. Looking at the selection of counsel, the question is whether you have to get separate council for inside and outside directors. Generally the answer is going to be no,” he said. “Unlike securities fraud, you don’t have these conflicts in the ERISA cases in the various defendants. Usually they are all indemnified by the company. Usually cases are going to be pretty similar and one counselor can usually defend all of them.”
With the enactment of the Employee Retirement Income Security Act (ERISA) in 1974, fiduciaries assumed new responsibilities relating to the management and administration of employee benefit plans.
ERISA mandated that fiduciaries may be personally liable for breach of certain responsibilities or duties imposed upon them under the law. Today, more and more, companies and its directors and officers are reportedly breaking their fiduciary duties under ERISA by knowingly issuing false and misleading public statements about the company’s financial condition, which induces employees to invest and maintain their plan assets in company stock at artificially high prices, according to panelists.
“The first issue is whether the defendants are fiduciaries and if not, there should be a motion to dismiss,” Braden said. “Sometimes all of them are not fiduciaries and all of them are dismissed.” Braden noted that directors and officers are not named as fiduciaries but they do have authority to appoint or remove a fiduciary for custody and control. “In order for D&Os to be fiduciaries, they have to have some authority to oversee custody and control. Fiduciaries have the kind of information that they can’t sit on their hands,” he added. “The courts are all over the map on this issue. Some say it’s a breach if the fiduciary says no but financial statements are false.”
Marc Machiz, partner, Cohen, Milstein, Hausfeld & Toll P.L.C., noted that a responsive plaintiff’s council has an obligation to look at all the claims that they’ve got. “Typically in these cases there is a committee which is responsible for appointing that entity. Sometimes it’s the directors, sometimes it’s the company. If it’s the company, who do you sue, the company? You probably also sue the board of directors. It’s actually a pretty well established principal in the law that directors and officers have a responsibility for fiduciary responsibility,” he said. “It’s not a question if they have responsibility, but how much responsibility. Responsibility to pass on the information to the committee.”
Howard Shapiro, partner, Shook Hardy & Bacon, and panel moderator, noted that there are separate sets of defenses in a fiduciary lawsuit. “What does the plan say? The plan doesn’t say these folks have all this responsibility. One of the fights in these initial battles is in the area of motions to dismiss. You’re constantly saying look at how narrow the plan document is drawn,” he said.
“From an underwriting standpoint, how well is the document defined. Look at the document. They don’t have the responsibilities that the plaintiff is seeking to foist on these folks,” he said, adding, “The more concise, to the point, the better case we have on the defense side. Look at one section of the plan. Figure out the simple questions. Where’s the power to do what. Who has the power and what kind of power do they have?”
Looking at the plaintiff’s view, Machiz noted that the structure of ERISA requires that somebody be responsible for everything. “ERISA creates a default that the trustee is at fault. There are only two other people who are responsible, an investment manager or a fiduciary committee. It’s in the plan document. It’s a matter of plan design. How a plan’s invested is inherently a fiduciary document,” he said.
The question of whether corporate fiduciaries with knowledge will be found liable for failing to affirmatively inform either plan participants or other plan fiduciaries, of the true state of the company’s financial difficulties, panelists explained.
While courts may be reluctant to require a full public disclosure of insider information that would result in a drop in share price, and thus damage to the company and plan assets, they may require affirmative disclosure to other plan fiduciaries so as to allow investigation and consideration into the appropriateness of further investment in company stock.
“The identity of the fiduciaries is very important,” Braden said. “One thing you don’t want to see is insider trading. If you’re on the 401k plan committee and have information, you have an obligation to use that information. Who are the fiduciaries? Do they have insider information?”
Shapiro noted that there is a dichotomy of function with the CFO of a company. “There’s got to be a distinction between wearing the fiduciary hat from the CFO hat. This is one of the major issues to be battled out. When are you acting as an employer and when are you acting as a fiduciary?”
Machiz said that the securities laws have taken a position that there isn’t a contradiction. “You have an obligation not to trade on inside information on securities laws. There’s nothing in the securities laws that says you have to buy. What they prohibit is purchasing or holding for inside information. A large part of the allegations are that you continued to purchase stock while you were privy to information that the stock was overpriced. You know the stock is overpriced, so what’s a fiduciary to do? You can just cause the plan to dump the stock, that doesn’t mean that you sit on the information either.”
Shapiro said it was not as simplistic as that. “How much do you disclose? When do you disclose? In what forum do you disclose? The securities laws should control this. This is going to be a major battleground,” he said. “The decisions that say that the securities law and ERISA can live harmoniously don’t work. It’s not how business works and will lead to a lack of standards.”
Another problem with disclosure is efficient market theory, according to Braden. “Efficient market theory means once you disclose, the market instantly adjusts for the information you disclosed. It says you can avoid a loss by disclosing and selling.”
Machiz noted that efficient market is just a theory. “It’s an opinion that the market is not so spontaneous. If the fraud had been disclosed very early on in that case, it would have prevented the Enron stock from going as high as it did. I don’t think it’s going to be as simple as that,” he added.
Shapiro noted there was a real problem with the ERISA cases. “The damages that we have are $1 billion. These damages pale in comparison to the securities losses. Companies don’t like to settle one case and still have something pending,” he said. “When that happens, the ERISA case goes to the back of the line compared to the securities case. There’s a double-dipping issue.”
Another area of concern was the cash balance trade issue, according to Mike Pollard, partner, Baker & McKenzie. “Today you hear about stock drop cases and 401K plans. Cash balance plan and a defined benefit plan and defined contribution plan and how it fits in,” he said. “A defined contribution plan is often borne by the individual. A defined benefit plan promises, at retirement age, a specific benefit, and most deliver on that. A cash balance plan is a defined benefit plan that promises a hypothetical contribution. So people will derive benefits on 5 percent of salary for the year. One of the issues that arises when somebody retires before normal retirement age is how do you value that interest rate?”
According to Pollard, in the Burger case, the Seventh Court of Appeals affirmed a verdict of $300 million with some offsets. “They settled for $200 million. What was at issue was the interest rate. How do you value the interest rate? In that particular case it was the Treasury rate plus one. Take a look at the language of these plans. If you think the plan is unclear, the statutory plan is unclear. The court will also look at the economic realities.”
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