CHAPTER 29F LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS: 2012 UPDATE TO CHAPTERS 29, 29A, 29B, 29C, 29D AND 29E

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1 CHAPTER 29F LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS: 2012 UPDATE TO CHAPTERS 29, 29A, 29B, 29C, 29D AND 29E Compiled and Edited by Susan D. Lenczewski Authors: Lynn Archer, Theodore M. Becker, Gregory K. Brown, Robert W. Edwards, Matthew Goedert, Julie Govreau, Steven B. Greenapple, Bradley E. Henschen, Tim Jochim, Jeffrey S. Kahn, Susan D. Lenczewski, Stephen P. Magowan, Susan Peters Schaefer, Robert F. Schatz, and Jay Van Heyde II. * The authors and editors have thoroughly updated and edited this chapter from earlier published material. This Chapter 29F was published on the book s website in the fall of The authors and compilers originally published much of this material in a different form in the monthly Legal Update section of the ESOP Report, The ESOP Association s newsletter. Substantially all of this chapter, with permission, appeared in 2012 ESOP Legal Update, An NCEO Issue Brief, which is published by The National Center for Employee Ownership. [ 2014 ESOP Book, Inc.]. This chapter is an addition to Chapter 29 in the printed book, as well as to Chapters 29A, 29B, 29C. 29D and 29E, which can be found on the book website at in the member s area. This issue brief summarizes the 2011 judicial and regulatory developments affecting employee stock ownership plans (ESOPs) and 401(k) defined contribution plans that invest in employer stock. In years past, we have addressed legislative developments, but there was no legislation in 2011 that directly affected these types of plans. The U.S. Supreme Court issued a notable opinion on the status of a summary plan description, as compared to the plan document, and the array of equitable remedies * Susan D. Lenczewski is counsel at Fafinski Mark & Johnson, P.A., in Eden Prairie, Minnesota. Susan has practiced in the area of employee benefits and ERISA for over 20 years and is a specialist in ESOPs and other qualified retirement plans. She is chair of the Legislative and Regulatory Advisory Committee of The ESOP Association (TEA) and is a frequent speaker at conferences sponsored by the National Center for Employee Ownership and TEA. Until April 2012, Susan was a shareholder with Gray Plant Mooty in Minneapolis. Lynn Archer is a partner at Barnes & Thornburg LLP, Minneapolis, MN. Theodore M. Becker is a partner at Drinker, Biddle & Reath LLP, Chicago, IL. Gregory K. Brown is a partner at Holland & Knight, Chicago, IL. Robert W. Edwards is a shareholder at Steiker, Fischer, Edwards & Greenapple, P.C., Providence, RI. Matthew Goedert is an associate at Sedgwick LLP, San Francisco, CA. Julie Govreau is an associate at Morgan Lewis & Bockius LLP, Chicago, IL. Steven B. Greenapple is a shareholder at Steiker, Fischer, Edwards & Greenapple, P.C., Morristown, NJ. Bradley E. Henschen is a consultant at Principal Financial Group, Des Moines, IA. Tim Jochim is a director at Kegler Brown Hill & Ritter, Columbus, OH. Jeffrey S. Kahn is a shareholder at Greenberg Traurig, P.A., Boca Raton, FL. Stephen P. Magowan is CEO at Sunrise Management Services LLC, and formerly a shareholder at Steiker, Fischer, Edwards & Greenapple, P.C., Burlington, VT. Susan Peters Schaefer is a partner at McDermott Will & Emery, LLP, Chicago, IL. Robert Schatz is a partner at Schatz Brown Glassman Kossow LLP (dba ESOP Plus), West Hartford, CT. Joseph Jay Van Heyde II is a shareholder at Dean Mead, Orlando, FL. 29F-1

2 29F-2 ESOPs 29F.1[1][a] available to plan participants and beneficiaries who are harmed as a result of breach of fiduciary duty under ERISA. The case actually dealt with a defined benefit pension plan, but the opinion is relevant to ESOPs and 401(k) plans. The spate of stock drop litigation continued throughout 2011, as the U.S. Court of Appeals for the Second Circuit joined the Fifth, Sixth and Ninth Circuits in adopting the Moench presumption that originated in the Third Circuit. The Internal Revenue Service (IRS) continued its efforts to improve the determination letter program for ESOPs and other qualified retirement plans, but otherwise issued little in the way of regulatory guidance. After throwing down the gauntlet on October 22, 2010, with its proposed regulation that redefines fiduciary, the Department of Labor (DOL) was in the news throughout 2011 on nearly a weekly basis as it defended the new definition to members of Congress and the retirement plan investment community. The DOL withdrew the proposed regulation on September 19, 2011, and has yet to reissue it. The DOL s litigation branch continued to file amicus briefs in stock drop cases in its effort to take down the Moench presumption. Much of the material in this publication originally appeared in a different form in the ESOP Report, The ESOP Association s newsletter. Page 29F.1 CASE LAW... 29F-4 [1] Fiduciary Duties... 29F-4 [a] Court Comments on Summary Plan Descriptions and Equitable Relief Alternatives for Fiduciary Breach Under ERISA... 29F-4 [b] No Breach of Fiduciary Duty for Miscommunicating Reshuffling Policy or for Applying Reshuffling Retroactively... 29F-6 [c] No Prohibited Transactions, So No Breach of Fiduciary Duty... 29F-7 [d] Defendants Motion for Summary Judgment Denied for All Counts Except One... 29F-8 [e] All Defendants Dismissed Except One and Admissibility of Expert Testimony... 29F-10 [f] Court Grants Class Certification and Denies Trustee s Request for Reconsideration; Case Settles... 29F-11 [2] Stock Drop Cases... 29F-12 [a] Second Circuit Adopts Moench Presumption... 29F-12 [b] Stock Drop Involving Closely Held Company Stock in an ESOP... 29F-12 [c] ERISA Section 404(c) Safe Harbor Not a Defense in Stock Drop Cases... 29F-14 [d] Court Denies Motion to Dismiss, Ruling Moench Presumption Does Not Apply and Fiduciaries Are Responsible for Misleading SEC Filings... 29F-15 [e] Motion to Dismiss for Statute of Limitations Denied and Valuation Report Held Not a Plan Document... 29F-15 [f] Court Grants Defendants Motion to Dismiss, Except for Claim of Breach for Imprudent Investment in Stock... 29F-16 [g] Stock Drop Case Survives Motion to Dismiss, as Court Sidesteps Presumption of Prudence... 29F-16 [h] Court Grants Defendant Fiduciaries Motion to Dismiss in Stock Drop Case... 29F-17

3 29F.1[1][a] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-3 [i] Stock Drop Case Dismissed for Failure to Overcome Moench Presumption 29F-17 [j] Court Allows Loss Causation Defense to Stock Drop Claim, but Allows Action to Proceed... 29F-18 [k] Plaintiffs Overcome Presumption of Prudence... 29F-18 [l] Court Concurs with Plaintiffs that Fiduciary Breach Occurred, but Case Moves on to Trial on Other Issues... 29F-18 [m] Stock Drop Case Survives Motion to Dismiss, as Court Sidesteps Presumption of Prudence; Court Reconsiders, Still Denies Motion to Dismiss... 29F-19 [n] Moench Presumption Applied to Dismiss Stock Drop Case... 29F-20 [o] Court Denies Defendants Motion for Summary Judgment; in a Subsequent Decision, Court Denies Motion to Certify Participants as a Class... 29F-20 [p] Applying Moench Presumption, Court Dismisses Stock Drop Case... 29F-21 [q] Class Certified in Stock Drop Case Against Alliance Holdings.. 29F-21 [r] Applying Moench Presumption, Court Dismisses Stock Drop Case... 29F-22 [s] Applying Moench Presumption, Court Dismisses Most of the Plaintiffs Claims... 29F-23 [t] Stock Drop Case Settles... 29F-23 [u] ERISA Section 404(c) Not a Defense to Stock Drop Claim... 29F-23 [v] Court Dismisses Failure to Diversify Claim in an ESOP Stock Drop Case... 29F-24 [w] Court Grants Defendants Summary Judgment Motion... 29F-24 [3] Miscellaneous ESOP Cases... 29F-24 [a] ESOP Amendments... 29F-24 [1] Required Interim Amendments... 29F-24 [b] Disclosure and Communications to Participants... 29F-27 [1] Inadequate Disclosures Did Not Support Claim for Benefits, but Plaintiffs May Be Able to Recover Based on Equitable Surcharge... 29F-27 [2] No Class Certification in Misrepresentation Case... 29F-27 [c] Qualified Replacement Property (Code Section 1042)... 29F-28 [1] Disposition of Floating Rate Notes Was Sale, Not Loan, Triggering Capital Gain Recognition... 29F-28 [d] DOL Litigation Activity... 29F-28 [1] Large Settlement Reached in DirecTECH ESOP Litigation. 29F-28 [2] Amicus Briefs Filed in Second, Sixth, and Eleventh Circuit Stock Drop Cases... 29F-29 [4] Regulatory Developments... 29F-29 [a] Internal Revenue Service... 29F-29 [1] Notice : Readily Tradable Employer Securities... 29F-29 [2] Revenue Procedure : IRS Guidance on Deductibility of Transaction Success Fees... 29F-30 [3] Private Letter Ruling : ESOP Disqualification... 29F-30

4 29F-4 ESOPs 29F.1[1][a] [4] Private Letter Ruling : Waiver of the 60-day Deadline for a Rollover... 29F-31 [5] IRS Form 8955-SSA... 29F-31 [6] Determination Letter Program... 29F-32 [7] IRS Project on ESOP Guidance... 29F-33 [8] 2012 Cost-of-Living Adjustments to Dollar Limitations of Interest to ESOP Companies... 29F-33 [b] Department of Labor... 29F-34 [1] DOL Proposed Regulation Defining Fiduciary... 29F-34 29F.1 CASE LAW [1] Fiduciary Duties CIGNA v. Amara [a] Court Comments on Summary Plan Descriptions and Equitable Relief Alternatives for Fiduciary Breach Under ERISA On May 16, 2011, the United States Supreme Court decided CIGNA Corp. v. Amara, 131 S. Ct (2011), and provided favorable guidance to sponsors of ERISA-governed qualified retirement plans and the participants and beneficiaries in those plans. The opinion clarifies that a summary plan description (SPD) or summary of material modifications (SMM) does not constitute plan language that can be enforced under ERISA as a plan document and discusses in detail the rights of participants to seek equitable relief for harm caused by plan fiduciaries due to incomplete, inaccurate, or misleading disclosures. In 1997, CIGNA decided to convert its traditional defined benefit pension plan to a cash balance pension plan. Over the course of a year, CIGNA delivered to participants and beneficiaries newsletters, SPDs, and other communications about the conversion. The district court found these communications provided no information about significant features of the new plan, were incomplete and inaccurate, and were intentionally misleading. Further, the district court found that the evidence presented by the claimants had raised a presumption of likely harm and allowed the class action to continue without requiring each participant to show particular harm. The district court determined that the communications by the plan administrator violated the notice requirement for cutback amendments at ERISA Section 204(h) and the SPD and SMM requirements at ERISA Sections 102(a) and 104(a). In providing relief to the participants, the district court reformed (i.e., rewrote) the new plan s benefit formula and granted injunctions to force CIGNA to pay claims under the terms of the new plan, as reformed. The district court cited as authority ERISA Section 502(a)(1)(B), which provides plan participants and beneficiaries the right to bring a civil action to recover benefits due under the terms of the plan. The district court s decision was upheld by the Court of Appeals for the Second Circuit. The case actually was accepted by the Supreme Court to review whether a showing of only likely harm was sufficient to entitle plan participants to recover benefits based on faulty disclosures. However, the Supreme Court felt it necessary to address an initial question raised by CIGNA and to respond to the Department of Labor s argument as amicus curiae regarding the role of the SPD as plan language. As an initial matter, in response to CIGNA s assertion, the Supreme Court discussed the scope of ERISA Section 502(a)(1)(B) and whether it could support the reformation of a plan document by a

5 29F.1[1][a] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-5 court. The Supreme Court concluded that ERISA Section 502(a)(1)(B) provides only legal remedies, and legal remedies do not include reformation of a plan document. ERISA Section 502(a)(1)(B) is available only to recover benefits, enforce rights, and clarify rights to future benefits under the terms of the plan. The focus of ERISA Section 502(a)(1)(B) is strictly to enforce the terms of a plan as written, not to change them. In making this determination, the Supreme Court also chose to address the argument of the Department of Labor that the plan s terms include the language of the SPD. The Supreme Court disagreed and held that the SPD is not part of the plan document itself, and its terms cannot be added to the plan and then enforced. In clarifying the role of the SPD, the Supreme Court differentiated between the roles of the plan sponsor and plan administrator. The plan sponsor, as a settlor, has the right to create the plan, provide for its amendment, and approve such amendments. These are not fiduciary functions. However, the plan administrator, which is an ERISA fiduciary, is responsible for the fiduciary duties of providing participants and beneficiaries with SPDs and SMMs that are calculated to be understood by the average participant and beneficiary and that are sufficiently accurate and comprehensive to reasonably apprise them of their rights and obligations under the plan. Given this distinction, if there are problems with the SPD or an SMM regarding an ESOP, a post- CIGNA claim will not be asserted as a claim for benefits against the assets of the ESOP and the employer (in its role as plan sponsor/settlor), but instead will be an action for breach of fiduciary duty by the plan administrator. This is where the language of the case is potentially beneficial to participants and could provide us with years of case law development under ERISA Section 502(a)(3). Section 502(a)(3) authorizes a civil action by a participant, beneficiary, or fiduciary to enjoin any act or practice that violates ERISA or the terms of the plan or to obtain other appropriate equitable relief to redress such violations or to enforce any provisions of ERISA or the terms of the plan. For many years, it was believed that the Supreme Court had severely curtailed the kinds of relief available to participants under ERISA Section 502(a)(3) and its other appropriate equitable relief provision in such cases as Mertens v. Hewitt Assocs., 508 U.S. 248 (1993), and Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204 (2002). In CIGNA, the Court stated that this view of its earlier decisions is misplaced and suggested a number of equitable relief avenues open to claimants. The Court distinguished Mertens and Great-West Life as actions, respectively, against a nonfiduciary for compensatory relief and against a beneficiary for monetary reimbursement. The claims in those cases were said to be legal, not equitable, in nature. However, in CIGNA, the claims were by participants against the plan administrator, which the Court said is a fiduciary (like a trustee) that could be sued by beneficiaries in a traditional equity action. Accordingly, the Court stated that in the right circumstances, participants could rely on ERISA Section 502(a)(3) and seek traditionally equitable relief against a plan fiduciary for breach of fiduciary duty under the terms of the plan or ERISA. Equitable relief could include reformation of the plan document where the plan and SPD differ, injunction, promissory estoppel where there has been detrimental reliance on the incorrect disclosures, and surcharge, which the Court defined as monetary compensation for a loss resulting from a fiduciary s breach of duty or unjust enrichment. To prevail on any of these equitable theories, the Supreme Court said the claimant must show harm. However, it pointed out that neither ERISA nor the law of equity defines a general principle of harm that applies here. Instead, each type of equitable remedy imposes its own requirements of harm. Thus, although the door to equity has been cracked open for participants and beneficiaries to sue under ERISA Section 502(a)(3), it take years and many court decisions before the level and standards of harm, detrimental reliance, and/or causation come into focus. There are many important lessons to be learned from CIGNA v. Amara by ESOP sponsors, fiduciaries, and participants. First, SPDs and SMMs should be written clearly and accurately without exaggeration, misleading statements, or omission of important information. Second, the plan administrator, not the plan sponsor, is charged with preparing and delivering these summaries, which

6 29F-6 ESOPs 29F.1[1][b] are fiduciary acts. Where the ESOP document defines the plan administrator as the plan sponsor, this distinction is not important (although the claim will be in equity for breach of fiduciary duty instead of an action to recover benefits under the plan). However, where the ESOP document defines the plan administrator as a particular person or committee, that person or committee needs to understand that its fiduciary duties include preparation and dissemination of SPDs and SMMs. If there is an amendment of the ESOP document by the plan sponsor, the plan administrator needs to carefully revise the SPD or issue an SMM that is consistent with the changes. Third, if material errors or omissions occur in these employee communications and harm results, the responsible plan fiduciaries may be sued for equitable relief, including monetary damages, under ERISA Section 502(a)(3). This is different than a claim for benefits under the terms of the plan against the ESOP or the employer. Finally, because these equitable claims will be against fiduciaries for breach of fiduciary duty and will not be in the nature of a claim for benefits against the ESOP or plan sponsor, the plan administrator should review its fiduciary liability insurance coverage and indemnification provisions to make sure they cover these situations. Peggy J. Beaston v. The Sundt Companies, et al. [b] No Breach of Fiduciary Duty for Miscommunicating Reshuffling Policy or for Applying Reshuffling Retroactively This lawsuit was brought by a former employee whose stock account in an ESOP was diversified at the direction of the employer and invested in trust assets other than stock after her termination of employment. (This summary uses the term conversion to refer to mandatory diversification or, as the IRS puts it, reshuffling, since that is the term used by the district court.) The conversion of stock to other assets caused the plaintiff s account to miss a significant increase in the value of the stock that occurred during the plan year after the conversion. (The ESOP had an October 1 through September 30 plan year.) As a result, the plaintiff claimed breach of fiduciary duty through misrepresentation, fraud, and discrimination by The Sundt Companies (the Company ); Carol Peabody, a member of the ESOP Advisory Committee ( Peabody ); and the ESOP committee (collectively, the defendants ) for the missed gain in company stock value. The court, in Beaston v. Sundt Cos., 804 F. Supp. 2d 1011 (D. Ariz. 2011), ruled in favor of the defendants on their motion for summary judgment. At the time of the plaintiff s termination of employment, the ESOP s governing documents provided the ESOP committee with the authority to convert former employees stock accounts into other trust assets at any time, provided the conversion was based upon a nondiscriminatory policy and there were sufficient assets in the ESOP trust to do the conversion. The Company s practice, which the Company communicated to all participants every January, was to execute the conversion of former employees stock accounts as soon as the ESOP trust had enough cash to do so. Before making the decision to terminate employment, the plaintiff asked Peabody how long her stock account would remain invested in stock. Peabody informed the plaintiff that historically it was taking approximately two years for the conversion to take place and that the plaintiff s account would remain in stock for approximately two years after her employment ended. After receiving this information, the plaintiff chose to terminate employment on September 23, During the plan year following the plaintiff s termination of employment, the ESOP committee discussed for the first time the possibility of changing the terms for converting terminated employees stock accounts to other assets. After a series of discussions and a repurchase obligation analysis, the ESOP committee decided to retroactively amend the ESOP documents to provide that former employees stock accounts would be effectively segregated and valued on the first day of the [plan year] following the year in which their employment ended. The stock value to be used for the conversion would be the appraised value as of the prior plan year end that is, September 30 of the

7 29F.1[1][c] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-7 plan year in which the plaintiff terminated employment. Even though the plaintiff left employment in the plan year before the plan amendment, the amendment was applied retroactively, and the plaintiff s stock account was converted to other assets effective as of October 1, 2006, using the value as of September 30, 2006, the end of the plan year in which she terminated employment. Had the plaintiff s stock account remained invested in stock for the next plan year, the stock in her account would have gained approximately 51% during that plan year, from $52.96 to $80.33 per share. The plaintiff s claim for breach of fiduciary duty was based upon two events: first, the statement by Peabody that the plaintiff s stock account would remain invested in stock for approximately two years; and second, the retroactive application of the amendment to the conversion policy to employees who terminated employment before the amendment date. For the plaintiff to succeed on the misrepresentation claim, the court stated the plaintiff had to show that either (1) there were affirmative material misrepresentations made to the plaintiff when she inquired regarding possible changes in the plan; or (2) there were inaccurate statements made that were intended to induce the plaintiff to make a certain decision. In this case, the change in conversion policy was not under serious consideration until after Peabody made the statements regarding the plaintiff s account remaining in stock for approximately two years. Since the facts communicated to the plaintiff at the time were an accurate reflection of the current conversion policy and historical experience, no affirmative material misrepresentation regarding any changes in the conversion policy were found to have been made by Peabody. In addition, none of the evidence suggested that Peabody knew that the plaintiff s decision to terminate employment was dependent upon the statements made regarding how long the plaintiff s account would remain invested in stock. The court found that there were no inaccurate statements made by Peabody that induced the plaintiff to terminate employment. The plaintiff claimed that the retroactive implementation of the change in the conversion policy to previously terminated employees stock accounts was a breach of the defendants fiduciary duty. The court found that the original conversion policy already allowed the ESOP committee the discretion to implement the conversion of terminated employees stock accounts at the end of the plan year in which they terminated employment. No evidence was presented that the defendants knew that the company stock price had increased when the conversion policy changes were adopted. The court did not find that any evidence suggested that the company benefited in any inappropriate way by converting the stock accounts of former employees earlier under the new conversion policy. In addition, the court went through an analysis regarding the reasoning of Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) and the Moench presumption regarding the prudence of holding company stock. In the court s analysis, the reasoning behind the presumption of prudence to hold company stock is also applicable to the decision not to hold company stock. Finally, the plaintiff argued that the retroactive implementation of the conversion policy was an impermissible reduction in her accrued benefit. The court rejected this argument by stating that the elimination of future expected accruals of benefit is not a violation in an individual account plan such as this ESOP. In the end, no breach of fiduciary duty was found in implementing the new conversion policy. Middleton v. J. Hoyt Stephenson [c] No Prohibited Transactions, so No Breach of Fiduciary Duty The U.S. District Court for the District of Utah, Central Division, granted summary judgment for the defendant, J. Hoyt Stevenson, as to two of the claims asserted by the plaintiff in Middleton v. Stephenson, No. 2:11-CV-313 TS, 2011 WL (D. Utah Dec. 8, 2011). In this case, the defendant incorporated National Financial Systems Management, Inc., in 2003 and put all of the shares of NFSM into a newly formed ESOP. Stevenson served as trustee of the ESOP. In 2007 and 2008, NFSM purchased the stock of two entities also owned by Stevenson, National Financial Systems, Inc., and Metronomics, by making cash down payments for portions of the purchase price

8 29F-8 ESOPs 29F.1[1][d] and issuing promissory notes to Stevenson for the balance. In 2009, NFSM was in default under both promissory notes and transferred all of the stock in both entities back to Stevenson, who then sold the entities to a third party. The plaintiff brought suit under ERISA, claiming that Stevenson breached his fiduciary duties as trustee of the ESOP by engaging in prohibited transactions with ESOP plan assets when he, as the head of NFSM, bought NFS and Metronomics and when he entered into default agreements returning those entities to himself. Stevenson was granted summary judgment on the plaintiff s claim of a violation of the ERISA prohibited transaction rule against a sale or exchange between a plan and a party in interest. The court held that, although NFSM was wholly owned by an ESOP, the transaction was not between a plan and a party in interest because a business transaction with NFSM was not the same as a business transaction with the ESOP. Additionally, although NFSM stock constituted ESOP plan assets, NFSM s underlying corporate assets were not plan assets. Because no NFSM stock was sold or exchanged in the 2007 and 2008 transactions, they cannot have been between a plan and a party in interest. Likewise, the court dismissed the plaintiff s claim of an ERISA prohibited transaction for self dealing, which prohibits a fiduciary from dealing with the assets of the plan in his or her own interest or for his or her own account, on the basis that the NFSM assets in question were corporate, rather than plan, assets. Note that the decision in this case can be contrasted with the decision of the Ninth Circuit Court of Appeals in Johnson v. Couturier, 572 F.3d 1067 (9th Cir. 2009), which upheld a lower court decision that the plan sponsor could not indemnify a plan fiduciary with company assets because those assets were tantamount to ESOP assets. Kenny Christopher, as Trustee of Embroidery Library, Inc., ESOP and Embroidery Library, Inc. v. Harlan L. Hanson et al. [d] Defendants Motion for Summary Judgment Denied for All Counts Except One This lawsuit revolves around two 2006 transactions between Embroidery Library, Inc. (ELI) and ELI s ESOP (together, the plaintiffs ) on the one hand, and ELI s founder, Harlan L. Hanson, his wife Marcia, and their children Mark and Scott (each referred to by his or her first name, and collectively, the defendants ) on the other hand. ELI and the ESOP each purchased shares from the defendants in January and December The plaintiffs filed suit, alleging that the defendants breached various duties under ERISA and Minnesota law by inflating the stock price and requiring ELI to enter into burdensome restrictive covenants. This decision, Christopher v. Hanson, Civil No (JNE/JJK), 2011 WL (D. Minn. June 6, 2011), addresses the defendants motion for summary judgment dismissing all counts. Before 2000, the defendants owned 100% of ELI s stock. In 2000, the ESOP was formed and acquired 30% of ELI s stock. Harlan acted as trustee of the ESOP from its inception until he resigned from that position in mid-december Three of ELI s executive employees became ESOP trustees at various times through mid-december The defendants made up ELI s board of directors until December 31, Lyndon Steele of Gerald Gray & Associates acted as the independent appraiser for the ESOP. In 2004 Harlan hired Prestwick Partners, an investment banking firm, to market ELI for sale. Prestwick found several potential buyers interested in purchasing ELI for up to $4.4 million plus an earnout. One valuation given during the marketing process valued ELI at $5.6 million. Prestwick disagreed strongly with Steele s valuation of ELI, which appraised ELI at $15.2 million.

9 29F.1[1][d] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-9 On January 25, 2006, the ESOP purchased stock and ELI redeemed stock from the Hansons, both at a price of $ per share, based on Steele s appraisal. After this transaction, the ESOP owned 50.2% of the ELI stock. The transactions were financed entirely by the Hansons. In spring 2006, Harlan told ELI s president and chief operating officer, who was also one of the ESOP trustees, that he intended to sell the rest of the Hansons ELI shares to the ESOP and ELI in December 2006, and that she would be fired if she did not make the transactions happen. The proposed transactions closed on December 31, They involved selling some of the remaining shares to the ESOP in exchange for promissory notes and converting the rest of the shares to sevenyear bonds, both at a price of $275 per share. In connection with financing the transactions, Harlan also insisted that ELI s officers and directors agree to restrictive covenants including a covenant not to sell the company for three years. ELI s attorney advised that these covenants would affect the value of the shares and would make it difficult to reach the targeted price and that applying the restrictions to the shares already owned by the ESOP, without any consideration to the ESOP, would constitute a breach of fiduciary duty. With regard to both 2006 transactions, there was no independent ESOP trustee, and the ESOP was not represented by its own attorney, contrary to the advice of ELI s attorney; there were no arm s-length negotiations between the Hansons, ELI, and the ESOP; and Harlan did not give Steele any information about Prestwick s failed attempts to sell ELI and did not inform Steele of the restrictive covenants. To prevail in a motion for summary judgment, the moving party must show that there is no genuine dispute as to any material fact and that the movant is entitled to judgment as a matter of law. The court denied all but one of the defendants arguments for summary judgment, finding as follows: To the claim that the defendants were not fiduciaries as of the December 31, 2006, transaction because they resigned as board members as of that date, the court responded that (1) there was no evidence that the defendants resignations from the board took place before approval of the transaction that occurred on the same day; and (2) the evidence that Harlan strong-armed ELI s non- Hanson executives, ESOP trustees, and directors into agreeing to the December 31, 2006, transaction and that the other Hansons allowed this to occur could lead to a finding that the defendants breached their fiduciary duties before December 31, To the claim that there was no evidence that the defendants breached ERISA fiduciary duties, the court responded that there was sufficient evidence to find that the defendants, as ERISA fiduciaries, breached the ERISA duties of loyalty and prudence, which caused a loss to the ESOP. The court pointed to the defendants interest in maximizing the share value; the apparent failure to follow the advice of ELI s attorney that the ESOP should be represented by independent counsel and that the negotiations should be arm s-length; the failure to advise Steele of the failed attempts to sell ELI through Prestwick; the lack of evidence that the defendants scrutinized the financial projections given to Steele; evidence that an appraiser other than Steele should have been used for the transactions because of his past history with Harlan, ELI, and the ESOP; and Harlan s failure to inform Steele of the restrictive covenants, instructing ELI s attorney not to communicate with Steele, and threatening ELI s president that she would be fired if the December 31, 2006, transaction was not completed at $275 per share. The court also found that the same facts that support the plaintiffs ERISA fiduciary duty claims also support ELI s state law fiduciary duty claim. To the claim that the transactions fell within the adequate consideration exception to ERISA s prohibited transaction rule, the court responded that there was sufficient evidence showing that the share prices for both transactions were much too high and that Harlan withheld information from the appraiser, thereby raising an issue of fact as to whether the transactions fell within the adequate consideration exception. To the claim that Marcia, Mark, and Scott did not breach their duty to monitor and evaluate Harlan s performance as an ESOP trustee because they did not know or have reason to know of Harlan s alleged misdeeds, the court responded that there was sufficient evidence to find that Marcia,

10 29F-10 ESOPs 29F.1[1][e] Mark, and Scott were liable as cofiduciaries for Harlan s acts because their failure to monitor Harlan enabled his alleged breach of fiduciary duty. To the claim that the plaintiffs state-law claims are preempted by ERISA, the court responded that the state-law claims are not preempted insofar as they are claims by ELI against the Hansons, relating to the redemption of stock by ELI, stating, These claims exist with or without an ERISA plan and assert independent state-law causes of action. To the claim that plaintiffs unjust enrichment claims fail because equitable relief cannot be granted where the rights of the parties are governed by a valid contract the court responded that the plaintiffs allegations are not based upon the contracts, but rather that the contracts were entered into in violation of the defendants duties under state and federal law, and, thus, it could not find, at the summary judgment stage, that there were valid contracts governing the rights of the parties. The court granted the defendants motion for summary judgment only on the aiding and abetting claim against Marcia, Mark, and Scott, finding that there was no evidence that the three individuals had actual knowledge of Harlan s wrongdoing and that the tortuous conduct was not so clearly illegal or unlawful so as to justify imputing constructive knowledge. Tharaldson Motels, Inc., Employee Stock Ownership Litigation [e] All Defendants Dismissed Except One and Admissibility of Expert Testimony In a lengthy opinion in this protracted and complicated litigation, the U.S. District Court for the District of North Dakota entered an order on all pending summary judgment motions and dismissed all defendants except Gary Tharaldson (Hans v. Tharaldson, No cv-00115, 2011 WL (D.N.D. Oct. 29, 2011). The court determined that: (1) the sales of stock of Tharaldson Motels, Inc. (TMI) to the ESOP were part of a single, integrated transaction (the Transaction ); (2) there was no preexisting ESOP debt for Gary Tharaldson, as trustee of the ESOP, to consider when entering into the Transaction; (3) the determination of fair market value of the ESOP notes is a matter for the court to decide at trial; and (4) the plaintiffs have the burden to show breach of fiduciary duty and loss to the ESOP, while Mr. Tharaldson bears the burden of demonstrating that the stock acquisition in the Transaction was for adequate consideration. Additionally, in the court s October 2011 decision, all defendants were dismissed but Mr. Tharaldson. The court, however, found that there remained a number of issues in dispute, including whether Mr. Tharaldson and the selling shareholders, which included several trusts, sold their shares of TMI stock to the ESOP for more than adequate consideration; whether, in light of the conflicting expert opinions and testimony, the ESOP notes were cash equivalents and must be valued at their face amount; and whether Mr. Tharaldson breached his fiduciary duties under ERISA by failing to ensure all conditions set forth in the 1998 stock purchase agreements were met. In an opinion rendered on December 23, 2011, the U.S. District Court for the District of North Dakota entered procedural determinations on the plaintiffs and defendants motions to exclude or strike portions of prior testimony in the case of Hans v. Tharaldson, No cv-115, 2011 WL (D.N.D. Dec. 23, 2011). Several substantive issues remained in the case after the October 2011 decision, including whether the shareholders selling TMI stock to the ESOP in the Transaction received more than adequate consideration, whether the ESOP notes were cash equivalents and must be valued at their face amount, and whether Mr. Tharaldson participated in a prohibited transaction under ERISA and thereby breached his fiduciary duties. This decision serves as a refresher course on Rule of Evidence 702, which allows expert testimony for the purpose of assisting a trier of fact under certain circumstances, as the court discussed the motions brought by both parties with respect to excluding or striking testimony. The

11 29F.1[1][f] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-11 court held that expert testimony regarding the tax consequences of the transaction, the appropriate discount rate to use when determining the fair market value of stock, and opinions as to the standard of care applicable to a fiduciary and how a fiduciary s actions deviated from such standard of care are valid subjects of expert testimony. However, the court held that testimony regarding investment strategies of a hypothetical hotel investor, the post-transaction performance of the TMI hotel portfolio, and the future benefits received by ESOP participants are irrelevant to determine the issues of law in question. Tribune Litigation and Settlement (Neil v. Zell) [f] Court Grants Class Certification and Denies Trustee s Request for Reconsideration; Case Settles On February 28, 2011, the U.S. District Court for the Northern District of Illinois denied a motion by the ESOP trustee (the Trustee ) to cap potential damages in favor of participants in the Chicago Tribune Employee Stock Ownership Plan (the ESOP ). The Trustee s proposal would have limited its liability to between $2.8 million and $15.3 million related to the purchase by the Trustee of Tribune stock at a cost of $250 million. In an earlier decision, on November 9, 2010, the court determined that the purchase by the Trustee of unregistered and restricted Tribune stock when the Tribune had outstanding publicly traded stock constituted a breach of the Trustee s fiduciary duty under ERISA because the unregistered and restricted stock did not constitute employer securities under Code Section 409(l) nor a qualifying employer security under Code Section 4975(e)(8). In subsequently issued decisions, the court issued an order on March 4, 2011, granting class certification to the plaintiffs, meaning that as many as 11,000 employees of the Tribune could be included in the class of participants in the ESOP. The Trustee had objected, arguing that the named plaintiffs, Dan Neil and Eric Bailey, were not representative of Tribune employees because of their personal animosity to Sam Zell, one of the other original defendants. On March 8, 2011, the court denied a motion by the Trustee for reconsideration of the court s December 17, 2009, decision denying the Trustee s motion to dismiss the plaintiffs second amended complaint. The court noted that the primary issue had already been addressed in an earlier proceeding on November 9, 2010, where the court granted a partial summary judgment, finding that the Trustee had breached its fiduciary duty to the ESOP. The court held that the Trustee could address the remaining secondary issues in a motion for summary judgment after the parties had the opportunity to brief the issues. In a Memorandum of Understanding (MOU) filed August 19, 2011, parties to the litigation surrounding the Tribune s going-private transaction using an ESOP agreed to a settlement for a total of $32 million. Subject to approval by the district and bankruptcy courts, the binding MOU settles the ERISA class action lawsuit, Neil v. Zell, 767 F.Supp.2d 933 (N.D. Ill. 2011) and litigation arising in connection with the bankruptcy of the Tribune Company, In re Tribune Co., 464 B.R. 208 (Bankr. D. Del. 2011). The plaintiffs in the class action are former employees of the Tribune Company who sued a number of defendants, including GreatBanc Trust Company, as trustee to the Tribune Company ESOP, and the Tribune Company, as sponsor of the ESOP, for violations of ERISA. Under the terms of the MOU, several insurers will contribute $26.4 million, Tribune Company will pay $4.45 million, and GreatBanc Trust Company will contribute the remaining $1 million. The total sum of the $32 million settlement will cover all costs and fees of the litigation, in addition to any recovery by the plaintiffs class. The Department of Labor has also agreed to drop its objections to the Tribune Company s plan of reorganization in the bankruptcy filing.

12 29F-12 ESOPs 29F.1[2][a] [2] Stock Drop Cases Gray v. Citigroup Inc. (In re Citigroup ERISA Litigation) and Gearren v. McGraw-Hill Companies, Inc. [a] Second Circuit Adopts Moench Presumption The U.S. Court of Appeals for the Second Circuit, in a split decision, adopted a rebuttable presumption of prudence in favor of retirement plan fiduciaries sued for continuing to offer publicly traded stock for investment when the stock sustains a drop in value. The majority, in In re Citigroup ERISA Litig., 662 F.3d 128 (2d Cir. 2011), joined the Third, Fifth, Sixth, and Ninth Circuits in adopting what is known as the Moench presumption. In Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), the U.S. Court of Appeals for the Third Circuit considered when an ESOP fiduciary s duty to act prudently requires taking action to stop purchasing (or to dispose of) employer securities held in the plan, when doing so would conflict with both Congressional intent and language in the plan documents. The district court in Moench held that plan language providing for investment in employer securities trumps a plan fiduciary s obligation to act prudently, and entered summary judgment in favor of the defendant fiduciaries, even though the company stock at issue had declined in value from $18.25 per share to less than $.25 per share before the plan sponsor filed for bankruptcy protection. On appeal, the court held that an ESOP fiduciary is entitled to a presumption that it acted consistently with ERISA by investing in employer securities, but that the presumption can be rebutted by establishing that continued investment under the circumstances amounted to an abuse of discretion. On the facts before it, the Moench court reversed the lower court s decision and remanded the case for further proceedings. In Citigroup, the U.S. Court of Appeals for the Second Circuit upheld a district court decision that dismissed an ERISA class action complaint alleging that Citigroup breached its fiduciary duties when it continued to offer employer stock as a 401(k) plan investment option during a period when Citigroup was incurring substantial losses in connection with the subprime mortgage crisis. In particular, the majority held that the presumption that a fiduciary has acted prudently in investing the assets of an eligible individual account plan in employer stock can be overcome only where there is a dire situation that was objectively foreseeable. Applying an abuse-of-discretion standard of review, the majority found the plaintiffs did not overcome the presumption. Furthermore, the majority also found that the presumption could be applied at the pleadings stage. The majority also affirmed the lower court s dismissal of the plaintiffs claims alleging that Citigroup and other plan fiduciaries breached their duty of loyalty by failing to provide complete and accurate information about Citigroup. This is because plan fiduciaries have no duty to provide participants with nonpublic information that might pertain to the future performance of plan investment options. The facts and claims involved in Gearren v. McGraw-Hill Cos. Inc., 660 F.3d 605 (2d Cir. 2011), were substantially similar to those involved in the Citigroup case and the results and analysis are nearly identical. The majority in these twin cases clearly rejected the amicus brief arguments put forth by the Department of Labor to reject the Moench presumption. Peabody v. Davis [b] Stock Drop Involving Closely Held Company Stock in an ESOP In the interesting case of Peabody v. Davis, 636 F.3d 368 (7th Cir. 2011), the Seventh Circuit affirmed the district court s decision in favor of John F. Peabody, a participant in an eligible

13 29F.1[2][b] LEGISLATIVE, REGULATORY AND CASE LAW DEVELOPMENTS 29F-13 individual account plan, that the fiduciaries had breached their duty of prudence when they failed to divest the participant s account of its stock in a closely held company after the company sustained a significant drop in value, but remanded the case back to the district court for a redetermination of damages. Peabody became employed by Rock Island Corporation (RIC), a closely held firm based in Chicago, in In 1999, Peabody agreed to rollover his external IRA, in the amount of approximately $168,000, into the RIC Savings Plan (the Plan ) and have the rollover funds invested in RIC stock. The Plan was an eligible individual account plan (EIAP) sponsored by RIC s subsidiary, Rock Island Securities (RIS). Peabody and RIC management agreed that if he rolled over his IRA into the Plan and invested it in RIC stock, he could receive his 1999 bonus, as he desired, in cash instead of RIC stock, as had been the company s practice. RIC and RIS were securities trading firms that made profits on the spread in buy and sell prices, primarily on NASDAQ. Changes in SEC regulations derailed the companies method of making money and led to a rapid decline in the companies fortunes. In particular, testimony indicated that changes in SEC regulations crushed RIC s profit margins, such that by 2003 or 2004 profit margins had declined by 70% to 80%. The court observed that a widely known and permanent change in the regulatory environment had undermined the core business model, and consequently, the company stock became an imprudent investment. Sometime in 2005, RIC went out of business, and the RIC stock in Peabody s account became worthless. Peabody filed suit and made the following claims: against the Plan fiduciaries, on behalf of the Plan, to make good the loss to the Plan arising from their breach of the fiduciary duty of prudence; against the Plan, as a participant, to receive his benefits under the Plan; and against the third-party insurance defendants, for other equitable relief. The facts in the court s opinion indicate that the valuation of RIC stock was performed periodically, at times by insiders, and resulted in values ranging from $2,000 per share at the time of Peabody s investment in 1999 to $550 per share in When Peabody left RIC in January 2004, he requested distribution of his benefits and eventually reached an agreement with RIC that RIC would redeem all the shares at $350 per share in exchange for an interest-bearing note for approximately $292,000, payable in a year. RIC was not able to make the payment at the end of the year. The district court ruled that the defendants violated their fiduciary duty of prudence by maintaining the investment in company stock throughout its decline, failing to distribute Peabody s plan benefit, and engaging in a prohibited transaction by offering a loan in payment for the stock. The Seventh Circuit agreed with the district court that defendants RIS and Plan trustees Davis and Kole, who were also co-founders and officers of RIC, violated their fiduciary duty to Peabody under ERISA Section 404(a)(1)(B) and (C) by allowing Peabody s account to remain 98% invested in company stock throughout the company s decline. The court ruled that a prudent investor would not have remained so heavily invested in the company s stock as the company s fortunes declined precipitously over a five-year period for reasons that foretold further and continuing declines. Further, the court found that Peabody s agreement to invest his IRA rollover into the Plan in company stock at the outset did not mean that he had waived his breach of fiduciary claims with respect to the company stock investment, nor did it free the defendants from the exercise of their fiduciary duty. In affirming the district court, the Seventh Circuit observed that the ERISA plan at issue was an EIAP within the meaning of ERISA Section 407(d)(3), as are all ESOPs, and consequently exempted by statute from the ERISA Section 404(a)(1)(C) diversification duty with respect to employer securities (see ERISA Section 404(a)(2)). The court then stated that the exemption from the duty to diversify reflects a congressional judgment that the benefits of broadening employee ownership outweigh the greatly increased risks of an undiversified investment. The court followed this fairly innocuous and reassuring (at least to ESOP companies, fiduciaries, and practitioners) statement with the following alarming comment: [T]hat calculation may have been more plausible at the time ERISA was enacted than it is today, because in 1974 the prevailing form of retirement plan was the defined benefit pension for which the duty to diversify is fully applicable, while today defined