Morgan, Lewis & Bockius, LLP

1. Morgan, Lewis & Bockius, LLP • Recent Developments in ERISA Litigation • 401(k) Stock Drop Litigation • Fee and Expense Litigation • Cash Balance Litigation Presented by Jeremy P. Blumenfeld

2. ERISA Fiduciary Duties • Duty of Loyalty • Duty of Prudence • Duty of Diversification • Duty to Follow Plan Documents • Duty not to Mislead/Misinform Plan Participants • Prohibited Transactions

3. Enforcement of ERISA Fiduciary Duties • Personal liability under ERISA § 209(a), 29 U.S.C. § 1109(a) • “Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties . . . shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets. . . .” • Fiduciary Status • It is possible to be a fiduciary for some purposes, but not for others. • Courts apply a functional test for fiduciary status.

4. ERISA Civil Enforcement Provisions • 502(a)(1) – Claims for benefits under the plan. • 502(a)(2) – Claims for monetary damages for breaches of fiduciary duty under section 409. • LaRue v. DeWolff – “although §502(a)(2) does not provide a remedy for individual injuries distinct from plan injuries, that provision does authorize recovery for fiduciary breaches that impair the value of plan assets in a participants account.” • 502(a)(3) – Catchall provision for “other appropriate equitable relief.”

5. Stock Drop Litigation Defined Benefit Plan v. Defined Contribution Plan • Defined Benefit Plans • Fixed retirement benefit paid out over course of retirement • Based on formula established in plan documents • Defined Contribution Plans • Provide participants with individual accounts • Value of individual account at retirement determined by amount of contributions and investment performance (less fees and expenses) • ESOP – features investment option in plan sponsor stock

6. 401(k) Stock Drop Fiduciary Breach Claims • Imprudence Claims – Company stock became an imprudent investment alternative because of circumstances adversely affecting sponsor company • Misrepresentation/Omission Claims – Plan fiduciaries affirmatively mislead or failed to warn of risks associated with sponsor company stock

7. 404(c) • ERISA § 404(c)(1)(B), 29 U.S.C. §1104(c)(1)(B). • “In the case of a pension plan which provides for individual accounts and permits a participant or beneficiary to exercise control over the assets in his account: . . . no person who is otherwise a fiduciary shall be liable under this part for any loss or by reason of any breach, which results from such participant’s or beneficiary’s exercise of control.”

8. 404(c) • 404(c) plans must: • Offer a diversified array of investments • Provide adequate information concerning the investments to the participants • Authorize flexible and autonomous control by the participants

9. The Circuit Split over 404(c) • Third and Fifth Circuit believe 404(c) means what it says: “any loss” and “any breach.” • In re Unisys Sav. Plan Litig., 74 F.3d 420 (3d Cir. 1996) • Langbecker v. Elec. Data Sys. Corp, 476 F.3d 299 (5th Cir. 2007) • Fourth Circuit (in dicta) and the Department of Labor (“DOL”) have expressed that 404(c) does not apply to a fiduciary’s decisions to select and maintain certain investment options within a participant-driven 401(k) plan. • DiFelice v. U.S. Airways, 497 F.3d 410, (4th Cir. 2007)

10. Pre-2007 Lead Stock Drop Cases • Company stock is a presumptively prudent investment; to state a fiduciary breach claim, plaintiffs must plead and prove a precipitous decline in stock price coupled with evidence of serious mismanagement. • Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) • Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995) • Wright v. Oregon Metallurgical Corp., 360 F. 3d 1090 (9th Cir. 2004) • Plaintiffs must plead and prove that stock fund participants were subjected to “excessive risk,” as manifested by an increasing debt-equity ratio and evidence that participants’ other assets are not diversified. • Summers v. State Street Bank & Trust Co., 453 F.3d 404, 410 (7th Cir. 2006) • Coupled with a (very) large majority of District Court decisions denying Motions to Dismiss.

11. 2007 Decisions • Langbecker v. Electric Data Sys. Corp., 476 F.3d 299 (5th Cir. 2007) • Opinion suggests that class certification may never be appropriate in a stock drop case because 404(c) contemplates individualized defenses. • Coupled with Summers’ notion of individual risk/return, Langbecker may present a new avenue for attacking class actions.

12. 2007 Decisions Harzewski v. Guidant Corp.,489 F.3d 799, 808 (7th Cir. 2007) • Economically Irrational Claim • “It is unlikely that [plaintiffs] would have done better from whatever substitute investment Guidant would have put them in.” • Seventh Circuit instructed on remand “as its first order of business” to “take a very careful look at the plaintiffs’ theory of how they were injured.” • Fiduciary Duty v. Insider Trading • “It probably would have been unlawful, moreover, for Guidant to sell the Guidant stock held by the pension plan on the basis of inside knowledge of the company’s problems. If so, there are no damages, and indeed no breach of fiduciary duty; for the fiduciary’s duty of loyalty does not extend to violating the law.”

13. 2007 Decisions Two New Takes on Standing • Graden v. Conexant Systems, Inc., 496 F.3d 291 (3d Cir. July 31, 2007) • Where a plaintiff alleges that his benefit payment was deficient on the day it was paid under the terms of the plan, he states a claim for benefits, which (if colorable) makes him a participant with standing to sue. • Harzewski v. Guidant Corp.,489 F.3d 799, 808 (7th Cir. 2007) • Whether an ERISA plaintiff is a “participant” entitled to recover benefits under the Act should be treated as a question of statutory interpretation fundamental to the merits of the suit rather than as a question of the plaintiff’s right to bring the suit. • “So the question comes down to whether, if the plaintiffs win their case by obtaining a money judgment against Guidant, the receipt of that money will constitute the receipt of a plan benefit. It will.” • In a footnote in LaRue, the Supreme Court suggests that Harzewski gets it right.

14. 2007 Decisions • DiFelice v. US Airways, 497 F.3d 410 (4th Cir. 2007) • Upholds defense verdict in “stock drop” trial. • “Employees cannot succeed in this lawsuit simply by demonstrating that U.S. Airways offered the Company Fund during a time of grave uncertainty for the company, no matter how significant the Employees’ ultimate financial losses.”

15. 2007 Decisions • De Felice provides a roadmap to plan sponsors and fiduciaries of 401(k) plans containing employer stock: • Company offered twelve diversified and less risky alternatives for investment; • Company allowed participants to transfer freely between funds; • Company warned participants of the risks in plan documents; and • Company sought and obtained two outside legal opinions regarding the continuation of company stock as an investment option.

16. 2007 Decisions • The other side of DiFelice • Limits application of 404(c) defense in dicta. • Backs away from the district court’s zealous application of modern portfolio theory • Provides an example of breach of loyalty, e.g. "that high-ranking company officials sold company stock while using the Company Fund to purchase more shares, or that the Company Fund was being used for the purpose of propping up the stock price in the market”

17. 2007 Decisions • Edgar v. Avaya, Inc.,503 F.3d 340 (3d Cir. Sept. 26, 2007) • Presumption of prudence owed to investments in employer stock applies to all eligible individual account plans (“EIAPs”), not just ESOPs, if the investment is more than just “permitted” under the Plan documents. • Presumption of prudence applies at the pleading stage and requires the plaintiff to allege facts that, if proven, could overcome the presumption of prudence. • A 25% decline in share price following earnings announcement is insufficient as a matter of law to maintain suit. • Offering of company stock was hard-wired into plan document. • Not “the type of dire situation which would require defendants to disobey the terms of the Plans by not offering the Avaya Stock Fund as an investment option, or by divesting the Plans of Avaya securities.”

18. Best Practices • “Hard” wire company stock investment • Consider the objectives of the plan and whether employer stock meets those objectives • Consider plan structure – Who should serve as fiduciary? • Fiduciaries should monitor employer stock and every other investment in the Plan (“procedural prudence”) • Advise participants about risks of employer stock and diversification • Use of independent fiduciaries ???

19. Fee and Expense Litigation • Plan Administration Fees – The day-to-day costs of operation • Individual Service Fees – Fees for optional services • Investment Fees • Sales Charges • Management Fees – Actively and Passively Managed Funds • Other Fees

20. Claims Against Plan Sponsor Fiduciaries • Direct and indirect compensation paid to service providers was not reasonable. • No reasonable investigationinto the payments that service providers receive from mutual funds, i.e., revenue sharing. • Fiduciaries failed to discloserevenue sharing. • Actively managed funds v. index funds (with lower cost) • Retail shares v. institutional shares (with lower cost)

21. Claims Against Service Providers • Service provider is a fiduciary because it exercises some control over the selection and offering of particular mutual funds. The fiduciary breach issues may be even more acute where “bundled” provider insists on inclusion of its own funds on the “platform.” • 404(a) • Plaintiffs allege that revenue-sharing paymentsare plan assetsfor purposes of prohibited transaction rules. They advocate a “functional test” for defining plan assets: whether the item in question may be used to benefit the fiduciary at the expense of plan participants. E.g., Haddock v. Nationwide, 419 F. Supp. 2d 156 (D. Conn. 2006). • 406(a); 406(b)(1)

22. Claims Against Service Providers • Service provider engaged in prohibited transaction because it received consideration (revenue sharing) from a party dealing with the plan (the mutual funds) in connection with a transaction involving assets of the plan. • 406(b)(3) • 408(b)(2) – OK if reasonable compensation is paid

23. Disclosure Claims • Required Disclosures • Section 103(b)(2): Annual Report • Section 104(b): Summary Plan Description • Section 404(c): Participant must be provided certain information, either directly or upon request (but only to satisfy affirmative defense – this is not a separate duty) • Where are revenue sharing agreements reported?

24. Defending Fee and Expense Cases • Highlight efforts to investigate and evaluate fees. • Fees charged to plan were reasonable. • Service provider’s compensation was reasonablein light of the quality and quantity of services and industry standards. • ERISA does not require disclosure of revenue sharing fee and expense cases. • Participants are told the fees they pay in the expense ratio • 404(c)?

25. Best Practices? • Review compliance with 404(c), especially disclosure provisions. • Hire independent consultants to evaluate service providers fees. • Document the review and negotiation of all service arrangements.

26. Best Practices? • Periodic RFPs that request detailed fee breakdowns. • Consider gathering mutual fund fee and service provider compensation information into one document for participants. • Ensure plan expenses are disclosed in 5500s at the master trust level and plan level.

27. Cash Balance Litigation • Cash Balance (“CB”) Plans are defined benefit plans modeled after defined contribution plans. • Participants have hypothetical individual accounts, but they do not control them. • Ultimate retirement benefits are determined by “pay credits” (% of pay earned each year) plus “interest credits” as a percentage of the account balance • Benefits are expressed as lump sum payments of the account balance.

28. Age Discrimination in Defined Benefit Plans – Pre-PPA • “[A] defined benefit plan shall be treated as not satisfying the [benefit accrual] requirements of this paragraph if, under the plan, a participant’s benefit accrual is ceased, or the rate of a participant’s benefit accrualis reduced, because of the attainment of any age.” • 204(b)(1)(H)

29. Age Discrimination v. Time Value of Money • The Circuit Courts agree: CB plans are not per se violations of ERISA’s anti-discrimination provision. • Drutis v. Rand McNally & Co., 499 F.3d 608 (6th Cir. 2007) • Register v. PNC Fin. Servs. Group, Inc., 477 F.3d 56 (3d Cir. 2007) • Cooper v. IBM Personal Pension Plan, 457 F.3d 636 (7th Cir. 2006) • But some District Courts in the Second Circuit think otherwise. • See e.g., In re Citigroup, 470 F. Supp. 2d 323 (S.D.N.Y. 2006)

30. Whipsaw Claims • Pre-PPA ERISA required “normal retirement benefits” in a defined benefit plans to be expressed as an annuity. • CB plans, however, frequently call for lump sum payment of account balance. • The not so simple solution: The Whipsaw Calculation. • Convert account balance to annuity by using plan-provided interest rate, determine future value of annuity at age 65; • Discount future annuity back to present value using statutory discount rates • 2nd, 6th, and 7th Circuits have all considered these issues, and ruled in favor of Plaintiffs – but they haven’t considered all of the issues

31. “Wear-Away” • Pre-PPA, ERISA did not require a participant’s opening balance in a CB plan to equal the accrued benefit under the old defined benefit plan. This allowed for Wear-Aways. • Freeze on benefits accrued under traditional plan, until cash balance account catches up. • Old benefits are protected, but participants could earn benefits under new formula without seeing any net benefit increase • But not any more.

32. Congress to the Rescue . . . • Pension Protection Act of 2006 (PPA) brings much needed guidance to the courts, fiduciaries, and attorneys. • Provides safe harbor for CB plans from the ERISA anti-discrimination provision. • Eliminates the Whipsaw Calculation. • Eliminates intentional Wear-Aways.

33. . . . or maybe not. • PPA does not apply retroactively. • Only applicable to periods beginning on or after June 29, 2005 and to distributions made after its enactment. • In many situations, the old rules still apply.