Securities And ERISA Suits: A Fatal Combination

Protracted litigation and quick settlements have left these ERISA side car suits without clear precedent to answer many of the difficult questions they raise.

William Blake wrote: "If the doors of perception were cleansed, every thing would appear to man as it is." While the doors to ERISA perception have long been blurred, in late September, Hon. Melinda Harmon, the United States District Court justice presiding over the Enron litigation, cleansed some of these doors with a 300-page order. This article will address the recent insight to some of these questions.

ERISA contains three statutorily defined levels of fiduciary involvement: (a) management or administration; (b) rendering investment advice; and (c) actually investing the plans assets. (29 U.S.C. 1002(21)(A)). If a person exercises control or discretionary authority over the plan in any of these ways, they are considered fiduciaries under ERISA, even if they are not named ERISA fiduciaries.

Side car ERISA suits attempt to hold directors and officers who are not named ERISA fiduciaries liable for their alleged misstatements or omissions regarding the desirability of the companys stock as a retirement plan asset. An important question that the courts continually have to address is: when will a person who is not a named ERISA fiduciary be liable to the retirement plan, and on what grounds?

For example, in In re WorldCom Inc. ERISA Litigation, the court stated: "[W]hen a corporate insider puts on his ERISA hat, he is not assumed to have forgotten adverse information he may have acquired while acting in his corporate capacity."

Though helpful in clarifying the responsibilities of those with insider information, the court did little to explain what actions will incur liability. The court did provide some guidance, however, by refusing to grant motions to dismiss from those who "exercised day-to-day authority" over the plans.

Similarly, in Tittle, et. al. v. Enron Corp., et. al. (S.D. Texas), the plaintiffs assert that various Enron directors and officers violated their ERISA duties of loyalty and care. The plaintiffs further assert that Enron itself violated these duties in its capacity as a fiduciary and as a participant.

Although the directors and officers named had no direct involvement in the management or administration of Enrons ERISA plans, they are still facing liability under ERISA. The question of their ultimate liability will likely turn on the extent to which an ERISA fiduciarys responsibility is predicated upon discretionary control over plan investments.

It is therefore crucial for courts to determine what types of actions will trigger ERSIA fiduciary responsibility for people not directly involved with ERISA administration. While the answer remains unclear, two cases provide a framework to aid courts in making this determination.

In the first case, Varity Corp. v. Howe (1996), the company allegedly knew of its subsidiarys indebtedness. Notwithstanding that knowledge, the company encouraged its employees to invest in the failing subsidiarys stock. Even though the disclosure in question was not mandated by ERISA, the Supreme Court held that the statements encouraging the employees to invest were sufficiently within the framework of communications about the plans benefits to make the company an ERISA fiduciary.

In the second case, Hull v. Policy Management Systems Corp. (D.S.C. Feb. 9, 2001), the defendants allegedly issued misleading information about company stock in order to artificially increase its value. In response, employees of the company, who had purchased its stock for their retirement plans, brought a securities action as well as a side car ERISA action. The plaintiffs claimed that the defendants knew or should have know that the stock was artificially inflated by their misinformation and that the defendants should have informed the ERISA investors of the risk.

The court in Hull held that the executives not involved with administration of the retirement plan had no affirmative duty to inform the plaintiffs of the inflated stock value. Moreover, the court held that the named ERISA fiduciaries had no affirmative duty to investigate within the company to determine whether the stock value was inflated.

As these cases illustrate, courts have recognized a distinction between actions conducted in a corporate capacity and actions conducted in an ERISA fiduciary capacity. Courts have maintained this distinction, even where company executives knew of the corporate misdeeds and failed to report them to the proper ERISA representatives. Moreover, the courts have not imposed a fiduciary responsibility upon the named ERISA fiduciaries to take active steps to seek out information regarding the types of corporate fraud discussed above.

Some of the more difficult questions that the courts will have to answer include:

Will ERISA side car suits expand the purview of ERISA to incorporate those not directly responsible for the administration or management of the plan?

Exactly which actions of the employer will be characterized, ex post, as fiduciary and which actions will be characterized as corporate; and is there a way for companies to insulate themselves from the former?

Will employers have an affirmative duty to disclose essential information to ERISA fiduciaries; and will they be able to do so in a manner that does not violate insider trading restrictions?

Will an ERISA fiduciary have a duty, in a plan that requires an account to be invested primarily in employer securities, to violate that requirement if the fiduciary learns of corporate misdeeds?

In a participant directed plan, might the fiduciary have to ignore the participants direction to continue to invest or to invest more of the plans assets in company stock?

As these questions illustrate, this area of the law is still developing. ERISA side car suits create far more interesting questions than they currently yield definitive answers. None of the post-Enron corporate scandal cases have resulted in conclusive authoritative final orders, thus, it would be premature to speculate as to the answers to these questions.

One very recent case, however, has provided an answer to an important procedural question that ERISA side car suits raise. Corporate defendants have worried that ERISA side car suits might be used as an end-run around the protective provisions of the Private Securities Litigation Reform Act in order to quickly gain access to a broad scope of discovery, which would otherwise be stayed in securities litigation while motions to dismiss were pending.

In the case, In re AOL Time Warner Inc. Securities and "ERISA" Litigation (Sept. 26, 2003, S.D.N.Y.), the court limited discovery to ERISA-specific discovery and enforced the PSLRA automatic stay on all other discovery. The court noted that "[a] stay of all non-ERISA-specific discovery is efficient, nonprejudicial and best comports with the purposes of the PSLRA."

Turning to insurance matters, we note that the ERISA side car suits inevitably contain breach of fiduciary duty claims. As such, they often trigger fiduciary insurance coverage for named ERISA fiduciaries as well as directors and officers who are acting in a fiduciary capacity. Accordingly, insurers may have to cover the cost of defending those accused of fiduciary breaches, even if all of the nonfiduciary duty claims are ultimately dismissed by the court.

What is even more troubling is the scenario where the court holds in favor of the plaintiffs both in the ERISA side car suit and the securities suit. In that scenario, insurance companies may find themselves paying awards from both the fiduciary liability policies and the directors and officers policies, even though the claims are nearly identical and arise out of the same set of facts.

"Tie-in" endorsements, which would prevent the stacking of the limit under each coverage, have yet to become the norm.

Without clear precedent, many of these questions remain, for the moment, unanswered. What is clear is that directors and officers who are not directly involved with ERISA plan management or administration nevertheless may be acting as plan fiduciaries when they make materially misleading financial disclosures in the context of plan administration. The more difficult question of whether named plan fiduciaries, who do not discover materially misleading facts (or omissions) about their companys securities, will be liable under ERISA remains to be resolved.

Attorneys John D. Hughes and Jason M. Rodriguez practice in the Insurance and Reinsurance Department of Edwards & Angell, LLP, a 300-attorney national law firm that focuses on financial services, private equity and technology. They can be reached at jhughes@edwardsangell.com and jrodriguez@edwardsangell.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 26, 2003. Copyright 2003 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.