Now, More than Ever for Fiduciaries, No Good Deed Goes - AIG.com

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1 Now, More than Ever for Fiduciaries, No Good Deed Goes Unpunished By: Rafael Droz Vice President, Claims, Financial Lines AIG On June 25, 2014, the United States (Supreme Court) issued its decision in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (U.S. 2014), (Fifth Third Bancorp), wherein it unanimously decided to eliminate the long-standing presumption of prudence for fiduciaries of an employer stock ownership plan (ESOP), in cases alleging the fiduciaries should have divested the plan of company stock instead of holding it. Just weeks later, the U.S Court of Appeals for the Fourth Circuit issued its post-Fifth Third Bancorp decision in Tatum v. RJR Inv. Comm., 2014 U.S. App. LEXIS 14924 (4th Cir. Aug. 4, 2014) and made it clear that fiduciaries can be liable even when they do divest the plan of company stock. Although fiduciary liability is not something new, it continues to present new challenges to fiduciaries. Fiduciaries can be liable for, among other things, not negotiating the best deal possible with third parties providing record- keeping services to a plan, and the costs of defending and settling such cases have been increasing. Many directors and officers assume that they are protected by an indemnity agreement with their company in the event a lawsuit is filed against them; however, we have seen courts deny indemnification where a pension plan owns a substantial percentage of the outstanding stock. And recently a new theory of liability has surfaced in the context of traditional defined-benefit plans where plaintiffs allege that the fiduciaries investment strategy is so excessively risky that that it is imprudent to implement it. This paper will briefly address some of the increased risks and exposures facing todays fiduciaries.

2 Now, More than Ever for Fiduciaries, No Good Deed Goes Unpunished The Stock-Drop Playing Field Has Changed Liability, I Presume? For almost 20 years, most courts have dismissed claims against plan fiduciaries arising from alleged imprudence in buying and holding company stock. Although such cases could be costly to defend, most judges applied the presumption of prudence originally set forth by the U.S. Court of Appeals for the Third Circuit Court in 1995 in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) (Moench) to dismiss cases based on pre-discovery motions. Pursuant to the Moench presumption courts generally presumed that a fiduciarys decision to buy and hold company stock in a pension plan whose documents provide for such investment was prudent, absent plausible allegations that the company was in dire circumstances. Then, in the Fifth Third Bancorp decision, the Supreme Court reasoned that ERISA makes no reference to a special presumption in favor of employee stock ownership plan (ESOP) fiduciaries and that it does not require plaintiffs to allege that the employer was on the brink of collapse, under extraordinary circumstances or the like. The Supreme Court also noted that ERISA modifies the duties of fiduciaries in a precisely delineated way, exempting ESOP fiduciaries from the duty of prudence only to the extent that [prudence] requires diversification. In all other respects, the Supreme Court held that the fiduciaries must comply with the duty of prudence. The good news, if any, lies in hints dropped by the Supreme Court as to how future judicial analysis should be conducted. With respect to claims based on public information, it was concluded that: 1.a fiduciary usually is not imprudent to assume that a major stock market provides the best estimate of the value of the stocks traded on it; and 2.in the absence of special circumstances, a plaintiff cannot plausibly allege that a fiduciary was imprudent by failing to recognize from public information that a stock was incorrectly valued by the market. Regarding claims based on non-public information, the Supreme Court held that a plaintiff must allege that: 1.a prudent fiduciary under similar circumstances would have taken a specific alternative action that does not violate the securities laws against insider trading (which might include ceasing employer stock purchases or pre-disclosing negative information) and 2. it was not possible for the fiduciary to conclude that such action would do more harm than good. Time will tell whether fiduciaries may take any comfort from the hurdles these hints may impose upon plaintiffs. For now, at least, there is no reason to expect such hurdles will decrease defense costs or foreclose future claims. How will parties address special circumstances? No guidance was provided on what actually constitutes special circumstances in public information cases, leaving open for discussion whether special circumstances existed. Some commentators have suggested that plaintiffs may now need potentially costly expert analysis at the pleading stage. If Fifth Third Bancorp compels plaintiffs to establish that the market price of the company stock was not efficient and the fiduciaries should have known that it was not reliable, we will likely see a spike in early defense costs. In non-public information cases, expert costs seem unavoidable. How else can the arguments around losses likely to have stemmed from alternative actions be evaluated? Further, because the Supreme Court did not address the question of whether references to SEC filings in a Summary Plan Description transform such public filings into fiduciary communications, the claim that the plan fiduciaries breached their duties in transmitting false information is still alive. In addition, the Supreme Courts decision may encourage plaintiffs previously reluctant to bring a claim to bring one now in the absence of the presumption, testing the contours of the decision for leverage in settlement. This point is amplified by the fact that with a six-year statute of limitations, it may still not be too late for plaintiffs to file lawsuits based on the markets implosion in 2008 and its aftermath. Hard on the heels of the Fifth Third Bancorp decision relating to potential liability for holding company stock in a pension plan, the Fourth Circuit decided in Tatum v. RJR Inv. Comm., 2014 U.S. App. LEXIS 14924 (4th Cir. Aug. 4, 2014) that fiduciaries can also be liable if they go the other way and decide to divest a plan of company stock. In this case, RJR spun-off Nabisco in a corporate transaction to separate the tobacco business (RJR) from its food business (Nabisco) on the theory that there was tobacco taint on the RJR Nabisco stock. RJR then sold the Nabisco Holdings stock from its 401(k) plan after the spin-off because it was thought to be imprudent to have a single-stock fund of non-employer stock. The amended plan documents did 2

3 G LO B A L S O LU T I O N S C U S TOM IZ E D not mandate that the Nabisco stock be sold nor did they forbid it. Of course, after the stock was sold, the price increased dramatically and plaintiffs sued (the case was filed in 2002). The Fourth Circuit held that after a plaintiff makes a prima facie case of breach of fiduciary duty (by showing deficient procedures in place for evaluation of the investment) then the defendant must prove that its decision was the best decision, which is obviously a very high hindsight-oriented burden to meet. 401(k) Fee Cases Getting More Expensive Over the last few years, settlement amounts and defense costs have increased in cases alleging, among other things, that plan fiduciaries engaged in revenue-sharing agreements and failed to obtain the lowest fees for servicing the 401(k) accounts. One of the reasons these cases are more expensive is due to the increased willingness of plaintiffs counsel to take such cases to trial. A sample of some of the cases brought and settled by Jerome Schlichter, of Schlichter Bogard and Denton, the most well-known plaintiffs lawyer in this area, shows that, if a company is sued, the suit is likely to cost eight figures to settle (and considerably more than $10 million to defend): CASE NAME DATE SETTLED SETTLEMENT AMOUNT Martin v. Caterpillar, Inc. (C.D. IL) 11/2009 $16.5M Will v. General Dynamics Corp. (S.D. IL) 11/2010 $15.15M Kanawi v. Bechtel (N.D. CA) 03/2011 $18.5M George v. Kraft Foods (N.D. IL) 06/2012 $9.5M Beesley v. International Paper (S.D. IL) 10/2013 $30M Nolte v. Cigna Corp. (C.D. IL) 10/2013 $35M What Are You Complaining About? Theres Plenty of Money and the Check Is Not Due for Another 15 Years. It must have been quite a surprise for the plan fiduciaries of Weyerhaeusers defined-benefit pension plan to learn that they might be breaching their fiduciary duties even though the plan met minimum funding standards by essentially making too much money. In a defined-benefit plan, the company bears the risk of investment loss. The plaintiffs in Palmason v. Weyerhaeuser Co., No. 11 Civ. 00695 (W.D. Wash. April 25, 2011) alleged that Weyerhaeusers investment strategy for its defined benefit plan was an imprudent breach of fiduciary duty, even though there were no allegations that the plan was not paying benefits or that it was in any danger of defaulting or terminating. During 2003-2007, the fiduciaries used alternative investments such as hedge funds, private equity funds and real estate, in an effort to beat market benchmarks, overfunding the plan by 80%. However, then came 2008 when many investments lost some value, causing the plaintiffs to allege the previously successful investment strategy was too risky. The defendants moved to dismiss the complaint on the basis that the plaintiffs did not have standing to sue because they had not suffered any injury and were still receiving their benefit payments. The judge ruled that there was no direct injury to plaintiffs because, for example, retirees were getting their checks, the plan was not in danger of default and was at most 1.5% underfunded at the time of the filing of the action. As a result, plaintiffs had no standing to sue for money damages. However, if plaintiffs could prove a deprivation of a specific statutory right or protection (e.g., right to a prudent investment strategy without regard to whether the strategy makes money), they would be entitled to injunctive relief. Immediately after the judge issued his decision, the parties engaged in settlement discussions. Ultimately, Weyerhaeuser settled the matter by, among other things, making a $5 million payment to plaintiffs counsel and agreeing to the appointment of an independent expert to the plan for the purpose of reviewing the companys master retirement trust statement of investment policies and principles. This theory of liability lives on, and less-funded plans may have more difficulty in defending such cases. For example, in Abrams, et al. v. U.S. Bank, 0:13-cv-02944-MJD-AJB (filed in October 2013), plaintiffs allege that the fiduciaries of the defined benefit plan engaged in an excessively risky investment strategy causing loss to the plan. Although it is too early to speculate on the cases resolution, one thing is for certainmillions of dollars will be spent defending it. Continued on back > 3

4 You Thought You Had an Indemnity Agreement In Johnson v. Couturier, 572 F.3d 1067 (9th Cir. 2009), plaintiffs complained of the CEOs alleged excessive compensation package and sought to void the CEOs indemnity agreement with the company. The Ninth Circuit concluded that the district court did not abuse its discretion in granting a preliminary injunction against the advancement of defense costs from the corporation to the CEO on the theory that where an ESOP owns all, or substantially all of the stock of the company, the companys assets are the plans assets because ERISA section 410 provides that any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability from any responsibility, obligation, or duty under this part shall be void as against public policy. The argument against indemnification set forth in the Couturier case has recently been made by both sides in litigation regarding an ESOP and the indemnification provision contained in the employment agreement of a corporate officer/alleged plan fiduciary. The plaintiffs in Spear, et al. v. Fenkell, et al., Case No. 2:13 -cv-02391-RK (E.D. Pa. May 1, 2013) allege that because the ESOP owns all of the companys stock, the indemnification agreements between the company and Fenkell are null and void. Fenkell, in his counter-claims, alleges that if he is not entitled to indemnification on that basis then the individual plaintiff, also a corporate officer and the ESOPs trustee, is not entitled to indemnification on counter-claims. See also Schafer v. MultiBand Corp., 2013 WL 607910 (E.D. Mich. Feb. 19, 2013) (affirming arbitrators decision that [a contractual] indemnification agreement is void and noting that fiduciary liability insurance does not violate ERISA section 410); Fernandez v. K-M Indus. Holding Co., 646 F. Supp. 2d 1150 (N.D. Cal. 2009) (no indemnification in situation involving an ESOP which only partially owned the company). The good news is that the Ninth Circuit has made it clear that ERISA does not bar the purchase of liability insurance by a plan, fiduciary or employer. Couturier. This harkens back to a similar statement from the Ninth Circuit in finding a fiduciary personally liable for failing to prevent the breaches of other fiduciaries in Barker v. American Mobil Power Corporation, 64 F.3d 1397, 1404 (9th Cir. 1995): While we are not unsympathetic to his burden, we note that fiduciaries may be insured for this type of liability. It would appear that prudent fiduciaries would have their plan or employers secure such insurance. Conclusion The Supreme Court threw the ERISA bar a curve ball with its decision in Fifth Third Bancorp such that there is a new playing field to which both plaintiffs and defendants will need to adjust. Given the need for expert testimony and analysis to more fully develop the facts in the absence of a presumption of prudence, risks and costs to fiduciaries have increased. Claims that were not brought for fear of the presumption may now be filed. And given the decision in RJR, fiduciaries will continue to face liability for any decisions they make regarding the use of company stock in their plans. 401(k) defined-contribution plans are not going away. Given the increased amounts needed to defend and settle (or go through trial and subsequent appeals of) cases alleging that fiduciaries should have negotiated a better deal with service providers, plan fiduciaries face increased exposure. Though traditional defined-benefit plans are less prevalent now, the plaintiffs bar is spending time second-guessing the fiduciaries investment decisions and nothing precludes the Department of Labor from doing the same. Further, where the plan owns all or substantially all of the company stock, nothing precludes the Department of Labor or an adversary from asserting that no indemnification is available from the company leaving the fiduciary on his or her own (unless and to the extent there is sufficient insurance). It is a brave new world of ERISA liability and the costs to live in it have increased. About the Author: Rafael Droz is a Vice President in Financial Lines Claims at AIG. Rafael manages the claims group that handles all Fiduciary Liability (ERISA) claims, in addition to certain complex Directors and Officers Liability and Employment Practices Liability claims. He is also involved in new policy creation. Prior to joining AIG in 2006, Rafael was a litigation associate at Brown Raysman Millstein Felder and Steiner LLP and was a law clerk to Justice Alex O. Bryner of the Alaska Supreme Court and Magistrate Judge A. Harry Branson of the United States District Court, District of Alaska. Rafael has spoken concerning ERISA and insurance issues at various conferences sponsored by American Conference Institute (ACI), Practicing Law Institute (PLI), and Thomson Legalworks, among others. Rafael graduated magna cum laude from Albany Law School of Union University in 1997 and was admitted to the New York State Bar in 1998, the Alaska State Bar in 2001, and the Connecticut State Bar in 2007. American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in the United States. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. Additional information about AIG can be found at www.aig.com | YouTube: www.youtube.com/aig | Twitter: @AIGinsurance | LinkedIn: www.linkedin.com/company/aig AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. For additional information, please visit our website at www.aig.com. All products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Products or services may not be available in all countries, and coverage is subject to actual policy language. Non-insurance products and services may be provided by independent third parties. Certain property-casualty coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds, and insureds are therefore not protected by such funds. American International Group, Inc. All rights reserved. 09/14 SP1106

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