Fiduciary Afterthought Now A Hot Topic

For Professional Liability Underwriters, Buyers

Securities class-action tag-alongs, as wellas cash-balance issues raise red flags

TheWall Street Journal

Gone are the days when the greatest worries for fiduciaryliability insurers were claim payouts that fell in the $5-to-$10million range, mainly for defense costs, and when fiduciaryliability placements for brokers were an afterthought to directorsand officers liability coverage.

Fiduciary liability insurance, often written by D&Ounderwriters, basically covers employee benefit plan fiduciaries(people who exercise control over the management or administrationof pension, health plans, and the like) for breaches of theirfiduciary duties and errors they make. Fiduciary duties areprescribed by the Employee Retirement Income Security Act.

"Let's hope my crystal ball's not clear," Mr. Coonan, vicepresident and fiduciary product manager for Chubb & Son inKansas City, Mo., told National Underwriter in a recentinterview as he described possible fiduciary liability implicationsof a Journal article he'd just finished.

The article reported that a public interest group is suing a largepublic retirement system to get information on management fees paidfor alternative investments in venture-capital funds. Suggesting acorollary that could impact fiduciary insurers, he said regulators,public interest groups and unions might start challenging feearrangements that fiduciaries have with various investmentmanagement parties they bring in to manage retirement planinvestments.

"We haven't seen activity to any great extent, but I can see itcoming," he said, attempting to forecast the next potentialnightmare for insurers.

However ominous Mr. Coonan's prediction might be, it wasn't thescariest issue on his mind when he and other experts spoke at theProfessional Liability Underwriting Society Employment andFiduciary Issues Symposium in April. Then, underwriters bemoanedthe fact that their crystal balls weren't clear enough a few yearsago to foresee an onslaught of "tag-along securities suits," eachwith alleged damages in the hundreds of millions of dollars theynever priced for.

Essentially, the suits arise from the same situations that promptstandard D&O securities cases filed on behalf of shareholderswhen a company's stock drops in the wake of some adverse financialdisclosure. The tag-alongs are repackaged to allege breaches offiduciary duty, Mr. Coonan said, explaining that the typicalallegations have two forksthat company stock is not an acceptablechoice for employees to have in a retirement plan, and thatmanagement breached its fiduciary duty by failing to adequatelydisclose matters having to do with the company's fortunes.

"Far and away, that's the big animal that's come out of the junglein the last two years," he said during the PLUS meeting, notingthat such suits were "really kicked off by Enron situation."

"This is a whole new ballgame here and we're talking aboutmega-bucks," he said. "How do you deal with severity?" he asked. "Iwish it was the $64 million question, but that doesn't even comeclose to covering itand that's just on my book."

And while tag-along suits may be the "claims du jour"focusing the attention of fiduciary liability underwriters, anothersource of fiduciary claimspension plan conversionsshould not bedismissed lightly, according to Rhonda Prussack, vice president andproduct manager for fiduciary liability at AIG's National Union inNew York, issuing a warning to her co-panelists at PLUS.

Ms. Prussack told NU that her concerns were triggered bythe Cooper vs. The IBM Pension Plan decision last July, inwhich the judge "basically indicted all cash-balance conversions"saying they were inherently discriminatory toward older employeesin the way they accrued benefits and that this discriminationviolates ERISA.

(Many companies have converted from traditional defined benefitpension plans to cash-balance plans in recent years. Under atraditional defined benefit plan, the employer guarantees aspecified benefit at retirement. In a cash-balance plan like IBM's,each employee has a hypothetical account to which contributions andinterest payments are credited. See NU, Aug. 11, 2003, formore on the IBM decision.)

At the time of the decision, "I expressed concerns to clients andunderwriterseven about plans that converted years ago. I wasconcerned that this [decision] would reopen those issues" and thatlawyers would interpret the statute of limitationwhich startsrunning when a plan participant has knowledge of a breach of afiduciary dutyto start running on the date that the IBM decisioncame down.

"Sure enough, while there hasn't been a flood of them yet, we'vestarted to see claims related to cash-balance conversions thathappened seven year ago, nine years ago," she said.

Ms. Prussack also said she's seen claims arising out of the mutualfund investigations by New York Attorney General Eliot Spitzer andsecurities regulators. "In particular, we're seeing financialinstitutions being targeted in lawsuits. These are financialinstitutions that offered their own product to employees withintheir 401(k) plans [and] had issues related to market timing andlate trading," she said. "This is the next big thing that we'revery concerned about."

"What's interesting is that we've never really had this many hottopics in fiduciary liability coverage up in the air to worryabout," said Carrie Brodzinski, vice president of St. PaulTravelers Bond's executive liability group in Hartford, Conn.,noting, for example, that the IBM case is currently onappeal.

In addition, a trend toward settlements in tag-along cases iskeeping another key issue from being sorted out. "Really whatyou've got is a conflict between two bodies of law," she said."ERISA law says that the first and foremost obligation of a planfiduciary is to the plan participant. However, that might be inconflict with securities laws [provisions] about when and how youcan make certain types of disclosures."

"In some of these cases, the issue is that there are planfiduciaries, who were also insiders of the company, who knew orshould have known that the employer stock in the benefit plan wasgoing to drop. So [to comply with ERISA], they needed to dosomething about it," she said.

While Ms. Brodzinski said she hadn't seen any claims frompre-IBM cash-balance plan conversions, "there are a lot ofdifferent ways companies can get in trouble in making conversions,"she said"not the least of which is all the calculations to mapaccrued and vested benefits of old system into new plan. Some suitsallege that companies did it wrong."

Mr. Coonan also said cash-balance conversion cases haven't "been abig activity" for Chubb. "We've had some, but not a big crush ofcases."

But "the danger there is that hundreds of companies have done thesecash-balance conversions in the last four or five years, includingour own company, Chubb," he said. "Should the [next] ruling go thewrong way, it could lead to a new fresh front of litigation."

Mr. Coonan also said the mutual fund wildcard hasn't turned into abig ERISA liability issue yet, "but obviously the plaintiffs' barhas its binoculars out at that neighborhood," he said, noting thata section on the Web site of a plaintiffs' firm specializing inERISA liability casesthe erisafraud.com site of Seattle-basedKeller Rohrbackalludes to the possibility.

Information on the site specifically names eight mutual fundcompanies the law firm is investigating for breaches of fiduciaryduty. The companies served as trustees or investment managers forhousehold name companies like Whirlpool and Coca-Cola, the sitesays, adding that the funds "may have offered their own proprietarymutual funds as plan investment options even though they allowedinstitutional investors to engage in trading activities that wereimproper and potentially illegal, [perhaps benefiting] theinstitutional investors to the detriment of planparticipant[s]."

The site also lists a sampling of 20 tag-along suits the firm isinvolved in, including Enron, Lucent, Tyco, WorldCom, and Xerox, aswell as information on a $69 million Lucent settlement and an $85million partial Enron settlement.

"When you're looking at that site, you're looking at a lot of mycustomers. I have some layer on the vast majority of them," Mr.Coonan revealed at the PLUS conference. "A lot of the cases arestill open," he added, noting that Chubb has had to put upsubstantial reserves on those.

In a recent interview, he said that there was some slowdown intag-along cases late last year and early this year, relative to thetwo prior years. But the coast isn't yet clear, he said, noting:"I've got four or five brand new cases since this spring."

Reproduced from National Underwriter Edition, September 16,2004. Copyright 2004 by The National Underwriter Company in theserial publication. All rights reserved.Copyright in this articleas an independent work may be held by the author.