401(k) Suits Follow Securities Fraud Litigation

Although the underlying facts may have a common nexus in the companys stock performance over a given period of time, the essential premise of the 401(k) litigation lies in a breach of fiduciary duty under the Employee Retirement Income Security Act of 1974. The breach, this type of litigation contends, arises from allowing an overconcentration of the plans investments in the companys own stock, while at the same time restricting or even precluding the participants ability to move the companys matching contribution to alternative vehicles.

From an insurance viewpoint, these suits typically impact two separate liability policies. The securities fraud litigation, of course, implicates the companys directors and officers insurance. The 401(k) litigation, on the other hand, will typically present a claim against any fiduciary liability or pension and welfare benefit fund liability policy that the company may have.

In many, but not all, cases, the same insurer may in fact have issued these policies.

In some cases, the 401(k) suits have been filed pretty much contemporaneously with the securities fraud suits. In others, they have more or less "followed on" the securities fraud suits, in some cases being filed only upon notice of a proposed settlement in the securities fraud litigation.

Delaying the filing of the 401(k) suit in such a manner can give rise to interesting insurance complications for both policyholders and the claimants within the respective plaintiff classes.

First, where there may be a "blended" D&O and fiduciary liability insurance product, there may be a single common aggregate limit of liability or otherwise a "tied-in" limit where the two genres of litigation may be considered a common claim. If the D&O suit is first settled in such cases, that may leave little or no available limits to satisfy the 401(k) claim.

Also, upon knowledge of the onset of securities litigation, the fiduciary liability insurer, appreciating that there may be a potential for "follow on" 401(k) litigation, may elect to non-renew the risk or significantly restrict the coverage.

As large as securities fraud settlements have become in recent years, with at least ten such cases settling at levels above $100 million, the ERISA-based 401(k) litigations have the potential to be even larger. That is largely due to the measure of damages, which in the ERISA litigation will allow for lost opportunity damages essentially measured by the difference between what the plan had gained or lost and what the plan would have earned had it made prudent alternative investments to the company stock.

Because this litigation is a relatively recent phenomenon, we have had little in the way of settlements or judgments to guide us as to the potential exposure. Other high profile claims beside Enron are pending, including litigation involving Rite-Aid Corporation, Lucent Technologies and Reliance Group Holdings. The focus has been largely on 401(k) plans, but the same fiduciary responsibilities would exist with regard to the sponsors and trustees of employee stock ownership plans (ESOPs) and defined benefit pension plans.

Just as the plaintiffs in this litigation can take a proactive protective measure by bringing their suits early and not await resolution of the likely companion securities litigation, fiduciary liability insurers can avail themselves of a number of useful checks during the underwriting process.

First, it should be determined whether and to what extent a plan invests in the common stock and other securities issued by the plans sponsor corporation. If the investments appear to violate certain ERISA guidelines or are otherwise indicative of a lack of prudent diversification, this should present a negative signal to the underwriter.

Of course, if a plan does not invest in the companys own stock or only does so to a minimal extent, the problems discussed in this article become nonexistent and, solely from that viewpoint, the risk becomes an acceptable one.

Second, what discretion do plan participants have to direct how the company match, as well as their own, portion of their account is invested?

In recent weeks, we have seen the introduction of bills in Congress, as well as voluntary initiatives on the part of employers, to allow employee-participants greater discretionary control over their account investments.

Finally, does the plan avail itself of the services of an independent investment advisor?

If it does, and appropriately follows its advice, there should be less likelihood that investment decisions are made with a view toward maintaining a large amount of shares in "friendly hands" (i.e., the 401(k) plan or ESOP). In this situation, it is also less likely that investment decisions are being influenced by the company itself in that funding company contributions to these plans with company stock is relatively painless, in comparison to likely more costly alternative equity or fixed income investment vehicles.

We are still in the embryonic stages of this litigation phenomenon with no demonstrated final outcomes in the form of settlements or judgments. Prudent participants from the various constituencies–insurers, plaintiffs lawyers, plan fiduciaries and corporate interests–should all watch and evaluate legislative and other developments in the coming months to determine whether these claims will in fact rival securities fraud litigation in frequency, severity and the degree of general public and regulatory scrutiny.

Joseph P. Monteleone is Vice President and Claims Counsel at Hartford Financial Products in New York City.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 25, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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