Trustees: Independent vs. Internal and Directed vs. Non-Directed Legal Aspects

Transcription

1 Trustees: Independent vs. Internal and Directed vs. Non-Directed Legal Aspects The 19 th Annual Ohio Employee Ownership Conference Akron/Fairlawn Hilton Akron, Ohio Friday, April 15, 2005 Carl J. Grassi, Esq. McDonald Hopkins Co., LPA 600 Superior Avenue, E. Suite 2100 Cleveland, Ohio

2 LEGAL UPDATE: RECENT RULINGS IMPACTING TRUSTEES I. Duties of Trustee, Generally A. Duties of Trustees/Fiduciaries 1. A fiduciary must exercise his or her duties with respect to the plan: (d) (e) Solely in the interest of the participants and beneficiaries; For the exclusive purpose of providing benefits to such participants and beneficiaries in defraying the administrative costs; With the care, skill, prudence and diligence that the prudent man when acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims; By diversifying the plan s investments, so as to minimize the risk of large losses, unless its clearly imprudent to do so; and [1] In accordance with the plan documents. 2. The fiduciary may not engage in prohibited transactions including the sale of property and the lending of money or any other extension of credit between the plan and a party in interest. ERISA 406 generally prohibits transaction between a plan and a party in interest. It also prohibits a plan from entering into the following transactions: Selling, exchanging, or leasing real property from a party in interest; Borrowing money from or lending money to a party in interest; Obtaining goods, services, or facilities from a party in interest; Transferring plan assets to a party in interest; or Acquiring any of the employer s securities or real property from a party in interest. 3. However, an exemption to the prohibited transaction rules permits an ESOP to purchase employer stock from any party in interest as long as the following two requirements are met: The plan is not charged a commission; and The purchase price is not less favorable to the plan that adequate [2] consideration.

3 (i) Adequate consideration. (1) In the case of securities that are traded in a generally recognizable market, adequate consideration is the fair market value on that [3] exchange. (2) In the case of securities that are not traded in a generally recognizable market, adequate consideration is determined in good faith by the trustee as not less than the amount that the asset [4] would change hands between a willing buyer and willing seller. B. Generally, when fiduciary responsibility is delegated to another person, the named fiduciary is not liable for an act or omission by such person carrying out the responsibility except to the extent that: (1) the named fiduciary violates his fiduciary duties with regard to: the allocation or designation of the responsibilities; the establishment of any procedures maintained for allocating fiduciary responsibilities; or in continuing the allocation or designation; or (2) the named fiduciary would otherwise be liable as a co-fiduciary under ERISA. C. Independent Trustee 1. Armstrong v. Amsted Industries, Inc U.S. Dist. LEXIS (N,D. IL 2004). Participants of the Amsted ESOP sued Amsted Industries, Inc., certain of its officers, directors, members of its ESOP committee (the Amsted Defendants ), and LaSalle Bank, as trustee of the ESOP, for breach of fiduciary duty. Among the claims was that the Amsted Defendants failed to prudently manage the company s repurchase obligations related to the stock holdings in the ESOP. Additionally, the plaintiffs alleged that all of the defendants (including the trustee) had caused a prohibited transaction by causing the repurchase of ESOP shares at a price in excess of fair market value. Plaintiffs lost on summary judgment on all claims. The conclusions reached by the court are significant. The adverse impact, realized by ESOP participants upon a dramatic decline in stock value was not, by itself, a sufficient basis for imposing legal liability for imprudence upon an ESOP trustee. Where a trustee is independent and has experience administering ESOPs, a court should grant deferential review and thus, not substitute its judgment for that of the trustee, unless the trustee s decisions are found arbitrary and capricious. (i) The court discusses the fact that the review should be highly deferential because the trustee was independent and an experienced ESOP trustee. (d) ERISA fiduciaries are not corporate fiduciaries and therefore it is not the responsibility of an ESOP trustee to independently investigate the business

4 decisions of the plan sponsor s management. (e) By its ruling on Amsted s alleged failure to monitor its repurchase obligations, the court reaffirms the principle that the prudence of an ESOP fiduciary s actions are evaluated from the perspective of the time that the actions were taken. D. Directed Trustees 1. A directed trustee is generally one who has custody of plan assets but who is not delegated the discretionary authority over the disposition and management of plan assets. Most often, a directed trustee acts on the instructions of a plan fiduciary that has such authority. 2. Although a directed trustee generally has limited liability when a breach occurs because it lacks the requisite authority over the plan, or its assets, to the extent that the directed trustee exercises authority or control with respect to the management or disposition of trust assets, it is a fiduciary for purposes of ERISA. 3. The primary obligation of a directed trustee is to ensure that directions received from the named fiduciary comply with the terms of the plan document and are not [5] contrary to ERISA, in order to avoid co-fiduciary liability. 4. Based on the foregoing, directed trustees have historically argued that their duties were limited to ensuring that any instructions they received concerning plan assets were properly issued, both under the terms of the plan document as well as under ERISA. Accordingly, directed trustees have historically argued that their liability was limited because they serve in a nondiscretionary capacity. 5. However, dozens of suits have been filed, which involve investments in employer stock held by either an ESOP or a 401(k) plan. Some of these suits name directed trustees as defendants and allege that they owe duties to the plan beyond traditional notions. 6. Field Assistance Bulletin No The Department provides that a directed trustee violates its fiduciary duties if he knows or should know that a direction from a named fiduciary is (1) not in accordance with the terms of the plan, or (2) contrary to ERISA. With regard to whether a direction is in accordance with the terms of the plan, the DOL has formally taken the following positions: A directed trustee has a duty to request and review all documents and instruments governing the [6] plan that are relevant to its duties. A direction is consistent with the terms of the plan if the plan s documents do not prohibit the direction. Additionally, if the plan s documents are ambiguous, the directed trustee may rely on an interpretation of such provision(s) that have been prepared by the

5 fiduciary responsible for interpreting such terms, without violating his fiduciary duty. With regard to whether a direction is contrary to ERISA, the DOL has taken the following positions: A directed trustee must follow processes that are designed to avoid prohibited transactions. The named fiduciary has primary responsibility for determining the prudence of a particular transaction whereas a directed trustee only has an obligation to ensure that the directions were proper, in accordance with the terms of the plan and not contrary to ERISA. The DOL also provides direction on when a directed trustee has a duty to act on non-public information, which he may have concerning a prudent decision. Prior to following a direction that would be affected by such information, the directed trustee has a duty to inquire about the named fiduciary s knowledge and consideration of the information with respect to the direction. (d) With regard to the duty to act on public information, absent material nonpublic information, the Department provides that a directed trustee rarely has an obligation to question the prudence of a direction to purchase publicly traded securities at the market price solely on the basis of publicly available information. In fact, in the Field Assistance Bulletin, the DOL states, even a steep drop in a stock s price would not, in and of itself, indicate that a named fiduciary s direction to purchase or hold such stock is imprudent and, therefore, not a proper direction. (e) The Department also provides the following: Where there are clear and compelling public indicators, the directed trustee may have a duty not to follow the direction without further inquiry. Directed trustees may have a duty to take reasonable steps to remedy a breach if he has knowledge of a fiduciary breach, or face being held liable as a cofiduciary for said breach. 7. Wright v. Oregon Metallurgical Corporation, 360 F. 3d 1090 (9 th Cir. 2004). The company s stock bonus pension plan required that a defined percentage of participant s assets had to be invested in company stock. Following a merger, plaintiffs asked the company to increase the percentage participants were permitted to sell in order to capture the premium generated by the merger. The defendants refused to so amend the plan. Plaintiffs sued the company, former officers, plan administrators and the trustee for breach of ERISA s prudence, exclusive purpose, and prohibited transaction provisions.

6 (d) (e) (f) The appellate court affirmed the district court s dismissal of plaintiffs claims. With regard to the trustee, the court found that the trustee was a directed trustee, thus not a fiduciary, and therefore not liable under ERISA. Plaintiffs contentions against the trustee was that it was liable as a cofiduciary because it participated in, permitted, or failed to remedy the fiduciaries alleged violation of ERISA s exclusivity requirement. The court finds the trustee is a directed trustee and as such is not liable for following the investment instructions provided by a plan s named fiduciary. Plaintiffs, relying on WorldCom, argued that the trustee should be liable because it was aware that the fiduciaries instructions were imprudent and thus the trustee knowingly acted contrary to ERISA. However, the court rejects this argument on the basis that if the underlying fiduciary direction itself is not in violation of ERISA, the directed trustee s compliance with that direction will not serve as a basis for liability. II. Recent Court Rulings A. Horn v. McQueen, 215 F. Supp. 2d 867 (W.D. Ky. 2002) (finding liability), judgment entered by Horn v. McQueen, 353 F. Supp. 2d 785 (W.D. Ky. 2004). 1. U.S. Corrections Corporation ( USCC ) operated private prisons under various government contracts. Shareholder Todd and Defendant Thompson each owned shares of common stock (50% each of the voting power and % each of total stock) and Defendant McQueen owned 15 shares of non-voting common stock.. 2. In late 1993, an ESOP was created to finance the leveraged buyout of Todd s shares. Kerrick, a CPA hired by the trustees, valued the stock at $132,472 per share, with USCC valued in the aggregate at over $52 million. The ESOP borrowed a total of $34,427,353 and the proceeds were used to acquire approximately 66% of outstanding USCC shares. 3. A 10,000-to-1 stock split occurred resulting in 3,935,600 shares outstanding and shares were allocated to participants on a pro rata basis as payments of interest and principal were made on the ESOP loan. 4. In 1996, an investor group agreed to purchase 33% of the stock. As part of that agreement, USCC was required to terminate the ESOP, pay off the ESOP debt and provide the vested participants with the option to cash out their shares or to retain the shares either personally or by rolling them over into the restated 401 (k) plan or an IRA. 5. In March, 1997, the ESOP was terminated and some participants elected to receive cash of $15.49 per share or receive stock having the same per share value. 6. April 1998, USCC was acquired for over $170 million, plus the assumption of millions of dollars in debt.

7 7. Plaintiffs complaint alleged breach of fiduciary duty for: Failing to prudently investigate the ESOPs investment of company stock; and Causing the ESOP to pay more than adequate consideration for the company stock. 8. The court looked at the following issues: The standard by which the court is to judge the fiduciaries actions in the case; Whether a determination that no more than adequate consideration was paid for USCC stock (should the court so find) renders harmless any failure by the trustees to conduct a reasonably prudent investigation into the price of said stock; and The point in time at which any loss to the plan is determined, and the measure of such loss. 9. The court follows Donovan v. Cunningham, 716 F.2d 1455 (5th Cir. 1983) and applies a prudent person standard on the basis that the case applied directly to allegations of payment for stock in excess of adequate consideration. Further, it rejects the approach taken in Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995) and Moench v. Robertson, 62 F.3d 553 (3rd Cir. 1995), distinguishing both on the fact that they were both failure to diversify cases. 10. The court follows the legal framework clarified in Reich v. Hall Holding Co., 990 F. Supp. 955 (N.D. Oh 1998), aff d by Chao v. Hall Holding Co., 285 F.3d 415 (6th Cir. 2002) to conclude that a prudent investigation is required to benefit from the protection afforded under ERISA s prohibited transaction exemptions. 11. Once again, the court follows Chao in concluding that the loss is measured as the difference between what the ESOP paid for the stock and its fair market value at the time of the transaction, plus interest. 12. Finally, the court finds that a prudent investigation into the value of the stock was not performed. 13. Ultimately, the court finds that although the defendants were involved to varying degrees in an investigation into the stock s value, none of them were acting on behalf of the ESOP and certainly not in the interest of plan participants and beneficiaries, as required by ERISA. Such a failure is sufficient to show a breach, and thus a prohibited transaction. B. Horn v. McQueen, 353 F. Supp. 2d 785 (W.D. Ky. 2004). 1. In Horn, 215 F. Supp. 2d 867, the court determined that in the case of a breach of fiduciary duty, loss will be measured as the difference between what the ESOP paid for the employer s stock and its fair market value at the time of the transaction, plus interest.

8 2. Upon receiving the supplemental report from the Special Master, the court concluded that the ESOP overpaid by $8,139,116 and awarded prejudgment interest based on the following analysis. Valuation Factors used in considering the value of a company (DOL Prop. Regs (4)) General approaches in valuation The nature and history of the business The general economic outlook and outlook of the specific industry The book value of securities and financial condition of the business The earning capacity of the company The dividend-paying capacity of the company The firm s goodwill or other intangible value The market price of similar publicly traded corporations The marketability of the firm s securities, and The company s control premium The income approach The market approach The asset approach The court analyzes each parties expert reports and found plaintiffs experts use of the discounted cash flow method appropriate and credible. The court also awarded prejudgment interest. C. LaLonde v. Textron, Inc., 270 F. Supp. 2d 272 (D.R.I. 2003), upheld in part with regard to defendant s motion to dismiss as to trustee by LaLonde v. Textron, Inc., 369 F. 3d 1 (1 st Cir. 2004). 1. The plan included a variety of investment options including a stock fund. 50% and 100% of employee contributions and matching contributions, respectively, were automatically invested in the stock fund. 2. During 2000 and 2001, the stock lost approximately 43% of its value, while restructuring and layoffs occurred. During such time, the company allegedly continued to encourage employees to contribute to their ESOP accounts. 3. Plaintiffs complaint alleged that: Defendants engaged in self dealing, prohibited transactions;

9 (d) Defendants violated anti-inurement provisions of ERISA; Defendants breached fiduciary duties; and Defendants participated knowingly in other fiduciaries breaches. 4. In reviewing the defendants; motion to dismiss, the court looked at the following issues: For each count, the court must determine if the defendants are fiduciaries and if they are, whether plaintiffs have sufficiently alleged facts to support a claim that defendants breached their fiduciary duties. The court assumes fiduciary status and looks solely at the alleged breach: Whether a breach occurred by continuing to purchase stock while it declined in value and failing to sell when it was in the best interests of the participants; and Whether a breach occurred by the company continuing to encourage employees to purchase stock and by restricting the participants ability to sell, despite the declining value. 5. The court, following the 3 rd circuit in Moench v. Robertson, 62 F.3d 553 (3 rd Cir. 1995), and the 6 th circuit in Kuper v. Iovenko, 66 F.3d 1447 (6 th Cir. 1995), finds that an ESOP fiduciary is entitled to a presumption that a decision to remain invested in employer securities is reasonable. Plaintiffs may rebut this presumption by showing an abuse of discretion. 6. The court finds that plaintiffs have not met this burden. Defendant s motion to dismiss is granted with regard to claims against the directed trustee. The trustee argues, with regard to plaintiff s allegations that it violated ERISA by failing to sell the stock, that it was not a fiduciary, but rather, a directed trustee. After looking at the plan document, and determining that it, as well as the trustee agreement, specified that the trustee was a directed trustee, the court concluded that the plan provided the trustee with no authority to override or veto the direction of the plan administrator to invest in stock or reinvest those assets already so invested. D. In re AEP ERISA Litigation, 327 F. Supp. 2d 812 (S.D. Oh. 2004). 1. Defendants motion to dismiss is denied as to all claims. Aside from alleging breach of fiduciary duty by offering an employer stock fund as an investment vehicle in the plan, plaintiffs also allege a breach by defendant for negligent misrepresentation and negligently failing to disclose material information necessary to make informed decisions concerning plan assets and the appropriateness of investing in the stock fund. 2. Defendants unsuccessfully argue that disclosing information regarding the imprudence of AEP stock as an investment would have violated insider-trader

10 laws. 3. The court finds the appropriate authority for the fiduciary to suspend the transfer or exchange of funds to protect the interests of plan participants. E. May v. National Bank of Commerce, 2004 U.S. Dist. LEXIS (W.D.Tn. 2004). 1. ESOP owned 100% of all Company stock. Plaintiff s allege that Defendant caused the Company to redeem all but one share of the stock. Following the redemption, Plaintiff s further allege that Defendant purchased the sole remaining share from the ESOP for $7.78, thereby fraudulently acquiring all shares of Company stock. 2. Defendant filed a counterclaim that, among other things, asserts that, if he did engage in improper conduct, members of the ESOP s administrative committee are liable for negligence and breach of fiduciary duty because they failed to discover the alleged wrongdoing sooner. 3. The court ultimately follows the Ninth Circuit and other District Courts in the Sixth Circuit, which provides that ERISA does not provide for a right of contribution among fiduciaries and further, refuses to create such a right using federal common law. III. Enron Update A. Northern Trust remained in the suit following Defendant s Motion to Dismiss in Further, Northern Trust was not a settling party in the settlement which occurred in the fall of B. Background: 1. Northern Trust, the directed trustee, followed the named fiduciary s direction in locking down the stock. After implementing such direction, the stock price fell from $33.84 to $10.00 per share. The claims against Northern were that they breached a fiduciary duty by following the direction it received. Northern responded generally that it was only required to determine if such direction was facially proper under ERISA and the plan s document, thus leaving no independent fiduciary duty to act loyally or prudently. 2. The court agrees with the plaintiffs. Northern s fiduciary obligations to the ESOP were broader than a mere determination on the face of the direction. 3. Moreover, the court concludes that a directed trustee is still a trustee and thus subject to fiduciary obligations which include certain supervisory and investigative duties beyond simply determining whether the instructions were proper and in accordance with the plan and ERISA. 4. Further, the court concludes that the directed trustee has a separate obligation of prudence and that the same is heightened where the directed trustee knows or should have known that the named fiduciary breached (or was breaching) its fiduciary duties or had conflict that threatens the interests of the plan participants and beneficiaries.

11 [1] ERISA 404. [2] ERISA 408(e) and Code [3] ERISA 3(18)(A). [4] ERISA 3(18)(B) [5] The Department of Labor, in Advisory Opinion 92-23A, provides that the directed trustee has the responsibility to exercise discretion where he has reason to believe that the named fiduciary s directions are not proper (either because they are in contradiction of the plan document and/or ERISA). Additionally, the Department specifies that directed trustees must also be mindful of any existing or potential conflict of interest. [6] As an example, the DOL states that acting contrary to the plan s investment policy may be a breach of the directed trustee s fiduciary duty to follow proper direction.