Month: November 2003

Don’t miss Ernie the Attorney‘s response to this article from the the November edition of Litigation News, a publication of the ABA Section of Litigation, discussing blawgs (law version of “blog”) and the impact they are (or are not) having on the legal profession. He concludes with this comment that “a caveman wouldn’t regard a cellphone as a particularly significant tool, unless maybe he could use it to smash rocks.”

Regarding the mutual fund industry scrutiny going on, you can access testimony from the hearing entitled “Mutual Funds: Trading Practices and Abuses that Harm Investors” held yesterday by the Senate Committee on Governmental Affairs at this link. The Wall Street Journal reports on the hearing: “Regulators Testify to Abuses In Mutual-Fund Arena.” (Subscription required.) The article states that “securities regulators are planning to bring enforcement actions against about two dozen brokerage firms for overcharging customers who bought large amounts of mutual-fund shares.” Quote of Note: “In conducting recent checks, the Securities and Exchange Commission said it found that 25% of brokerage firms allowed clients to place potentially illegal “late” orders for mutual-fund shares and that three fund companies appeared to have arrangements that allowed such late trading. In addition, the SEC said that about 30% of the brokerage firms may have actively assisted some investors in conducting improper trading.”

Today, a hearing entitled “Mutual Funds: Who’s Looking Out for Investors?” is being held by the House Committee on Financial Services:

• Press Release on the Hearing is here.
• Today’s prepared testimony is here.
• You can actually listen to today’s hearing at this link. (Scroll down, on the left under “Capital Markets.”)

Also, the 401khelpcenter.com has a very helpful article entitled “Recapping the Mutual Fund Scandal Fund by Fund” for those looking for information regarding the different funds involved in the mutual fund scrutiny.

The LAtimes.com is reporting in this article–“Senate Banking Panel to Examine Fund Abuses“–that the Senate Banking Committee will also hold a hearing tentatively set for November 13th.

The Wall Street Journal today has this article: “Weighing the Alternatives For Frazzled Fund Investors.” Another good article that someone should write is: “Weighing the Alternatives for Frazzled ERISA Plan Fiduciaries.” Michael H. Rosenthal for Pepper Hamilton LLP has tried to do just that in an article entitled–“What ERISA Fiduciaries Should Do About the Mutual Funds Investigation.” The article drew my attention to remarks made by Assistant Secretary Ann L. Combs before the Annual Conference of The National Defined Contribution Council where she stated:

And as you know, another front has been opened in the war against fraud. New York Attorney General Eliot Spitzer and the SEC have recently launched investigations into alleged late trading and market timing by mutual funds.

I recognize that the practice of short-term trading is discouraged by mutual funds, but in certain cases, the fund managers have overlooked or agreed to short-term trading by certain investors in return for investments that would increase their fees.

How do these allegations impact defined contribution plans? Market timing would disadvantage long-term investors, including 401(k) plans, by increasing fund administrative expenses. The problem with late trading is obvious – it’s illegal. What should plan fiduciaries do in light of the allegations?

ERISA requires that plan investment decisions, including the selection of mutual funds, must be prudent and solely in the interest of the plan’s participants and beneficiaries.

Allegations of improper mutual fund practices where a plan is invested must be factored into the fiduciary’s determination of the continuing appropriateness of that investment. The plan fiduciary may need to contact the mutual fund’s management for information regarding the trading practices and take appropriate action.

We expect that fiduciaries will be attentive to activities that materially affect the plan’s investment in the mutual fund or expose the plan to additional risk. Therefore, plan fiduciaries should have more active communication with mutual fund management in order to meet their obligations under ERISA.

Fiduciaries may also ultimately have to decide whether and how to participate in lawsuits or settlements arising from improper mutual fund activities. Of course, a plan fiduciary must weigh the cost of participating in a lawsuit against the likelihood and amount of potential recovery.

Perhaps one of the beneficial side effects of the unfortunate spate of corporate fraud and mutual fund investigations is a renewed emphasis on good corporate governance and good plan governance. I hope that the issues raised by Enron and similar cases have focused corporate officials on the important role fiduciaries play in protecting plan participants and has provided a necessary wake up call for people to take their fiduciary responsibilities seriously. In the long run, a renewed focus on fiduciary responsibility will benefit us all.

The U.S. Supreme Court is in session today and has issued its order list which apparently includes review of the following ERISA case which was consolidated: Aetna Health Inc. v. Davila and Cigna Healthcare of Texas Inc. v. Calad.

“Supreme Court to Rule on Patients’ Rights“: Anne Gearan for the Associated Press reports via Yahoo! News. David Savage for the LATimes also has this: “U.S. Courts Rule Patients Have Right to Sue HMOs: Two appeals verdicts go against interpretation of a 1973 law that has shielded health-care groups from damages.“

As you may recall, this post discussed Third Circuit Court Judge Edward Becker’s plea in a concurring opinion in the case of DiFelice v. Aetna for Congress and the Supreme Court to “revisit what is an unjust and increasingly tangled ERISA regime.” Judge Becker states that “[e]ven if Congress refuses to act, however, the Supreme Court, in its interpretive capacity, is capable of effecting salutary change in many ways. The Court has no crystal ball, and twenty years ago it could not have foreseen the radical changes that have overtaken the health care system, and the difficulties that its preemption decisions would create. The time might be right to reconsider . . .”

One of the reoccurring themes here at Benefitsblog is the need for ERISA fiduciaries to become educated and trained about their fiduciary duties and responsibilities under ERISA. A 2002 case from the Central District of California district court, Springate v. Weighmasters Murphy, Inc. Money Purchse Pension Plan, 217 F. Supp. 2d 1007, illustrates how some ERISA fiduciaries are “in a fog” about their status and duties. In fact, at a conference I attended, one litigator commented that some individuals do not even realize that they are ERISA fiduciaries until they are having their deposition taken. A similar situation occurred in this case as the opinion states: “Until the time of his deposition, [Defendant 3] did not understand that one of his obligations was to tell the trustee “how to invest Plan assets.&#8221”

The case involved a money purchase pension plan which had lost significant value in a short period of time. A plan administrative committee comprised of family members who also ran the business served as the “named fiduciaries” of the plan.

The court’s discussion of how the three individuals serving on the plan administration committee failed to fulfill their fiduciary duties under ERISA is a lesson in itself:

4. What the fiduciaries did not know about their duties and obligations as fiduciaries
[Defendant 1] does not know the meaning of the word “fiduciary.” [Defendant 1] did not understand the Plan when he read it. [Defendant 1] never read the entire Plan document. [Defendant 1] does not know the meaning of the word “trustee” and never made any inquiries as to what his role as a trustee was. [Defendant 1] does not know the meaning of the words “plan participant.” [Defendant 1] does not know the meaning of the words “plan beneficiary.” [Defendant 1] does not know the meaning of the expression “party in interest.” [Defendant 1] does not know the meaning of the expression “exclusive benefit rule.” [Defendant 1] does not know the meaning of the expression “plan year.” [Defendant 1] does not know the meaning of the expression “plan asset.” [Defendant 1] does not know the meaning of the expression “a prudent man.” [Defendant 1] does not know the meaning of the expression “a prudent fiduciary.” [Defendant 1] does not know the meaning of the expression “diversification of assets.” [Defendant 1] does not know the meaning of the acronym “ERISA.”

By the way, the portion of the opinion which I have quoted here is taken from the District Court case. The case was affirmed on appeal on August 22 of this year by the 9th Circuit. (No link available.)

Continue reading for more excerpts from the case . . .

[Defendant 2] does not know the meaning of the word “fiduciary.” [Defendant 2] does not know the meaning of the word “trustee.” [Defendant 2] does not know the meaning of the words “plan participant.” [Defendant 2] does not know the meaning of the words “plan beneficiary.” [Defendant 2] does not know the meaning of the expression “party in interest.” [Defendant 2] does not know the meaning of the expression “prohibited transaction.” [Defendant 2] does[*pg. 1018] not know the meaning of the expression “exclusive benefit rule.” [Defendant 2] does not know the meaning of the expression “plan year.” [Defendant 2] does not know the meaning of the expression “plan asset.” [Defendant 2] does not know the meaning of the expression “a prudent man” as applied to the obligations of a trustee. [Defendant 2] does not know the meaning of the expression “a prudent fiduciary” as applied to a trust of any type. [Defendant 2] does not know the meaning of the expression “diversification of assets.” [Defendant 2] is not familiar with the expression “ERISA.” [Defendant 2] has not taken any steps to educate himself as to the role of a fiduciary. [Defendant 2] does not know if he read the Plan. [Defendant 2] does not know the meaning of the expression “plan sponsor.” [Defendant 2] is the Secretary Treasurer of Weighmasters Murphy, Inc. [Defendant 2] does not know the source of funding for the Plan.

[Defendant 3] defines “trustee” as “somebody who is responsible.” [Defendant 3] states that within the context of a pension plan, the “trustee” is only responsible for choosing someone to handle the responsibility and money. [Defendant 3] has been a “trustee” only once. [Defendant 3] was a “trustee” for his brother’s estate. [Defendant 3] defines “fiduciary” within the context of a pension plan as meaning that “you will be faithful in seeing that the assets are in good hands and administered well ….” [Defendant 3] cannot properly define the expression “plan participant.” [Defendant 3] has not read the Plan document. [Defendant 3] is not familiar with the expression “party in interest.” [Defendant 3] defines the expression “prohibited transaction” as “not filing the papers correctly.” [Defendant 3] is not familiar with the expression “exclusive benefit rule.” The named fiduciaries did not consult with a financial advisor concerning any aspect of the Plan assets. [Defendant 3] has taken no steps to ensure that he had a proper level of knowledge when attempting to act as a Named Fiduciary. [Defendant 3] does not have any understanding of the expression “prudent man” within the context of a pension plan. [Defendant 3] contends that as a Named Fiduciary he does not have any responsibility for the monitoring whomever he hired to insure they were diversifying the Plan’s assets. [Defendant 3] contends that as a Named Fiduciary he had no obligation to do anything with regard to the assets of the Plan. [Defendant 3] does not have an understanding of the expression “independent trustee.” [Defendant 3] is not familiar with the expression “named beneficiary.” [Defendant 3] is not familiar with, and has no understanding of, the expression “named fiduciary.” Until the time of his deposition, [Defendant 3] did not understand that one of his obligations was to tell the trustee “how to invest Plan assets.”

5. What the Defendant fiduciaries did not know concerning the composition and value of the Plan’s assets
[Defendant 1] was never aware that the Plan owned stock in UNUM Corporation. [Defendant 1] never knew UNUM’s stock price. The value of the Plan assets declined after Decedent’s death. [Defendant 1] took no steps to interrupt the decline in value of the Plan’s assets. [Defendant 1] did nothing to determine the value of [Decedent]’s interest in the Plan at the time of [Decedent]’s death. [Decedent]’s interest in the Plan dropped 40% in the 14 months after her death. [Defendant 1] does not know if any participant, other than [Decedent], sustained a 40% decline in the same period of time. [Defendant 1] does not know why [Decedent]’s interest in the Plan dropped from over $1.5 million to $915,000.00 in the 14 months following her death. [Defendant 1] never found out why [Decedent]’s interest in the Plan dropped from over $1.5 million to $915,000.00 in the 14 months following her death. [Defendant 1] does not know the value of the Plan’s assets for any year in which he was a Named Fiduciary. [Defendant 1] does not know the composition of the assets of the Plan for any year in which he was a named Fiduciary. Despite the fact that he had no experience in investing in the stock market, [Defendant 1] never consulted with a financial advisor to determine if any asset owned by the Plan was an appropriate asset to be owned by a pension plan. [Defendant 1] never consulted with a financial advisor about the Plan’s assets at all. [Defendant 1] did not know what assets the Plan held as of May 31, 1999, the end of the Plan year in which Decedent died. [Defendant 1] did not know the value of any individual asset held by the Plan on May 31, 1999, the end of the Plan year in which Decedent died. [Defendant 1] never took any steps to inform himself as to what assets the Plan held as of May 31, 1999. [Defendant 1] never took any steps to inform himself as to what assets the Plan held at any time. . . . [Defendant 1] was never aware that the Plan owned 22,852 shares of UNUM stock. [Defendant 1] does not know what UNUM does. [Defendant 1] did not know that UNUM’s stock price had dropped from $55.5625 per share on May 31, 1998, to $13.375 per share on February 29, 2000. [Defendant 1] did not know that UNUM’s stock price had been reduced by 80% between May 31, 19998 and February 29, 2000. [Defendant 1] does not know what an “asset” is.

[Defendant 2] does not know the composition of the Plan’s assets. [Defendant 2] does not know what types of assets a Plan may hold under ERISA. [Defendant 2] does not know what types of assets a Plan may not hold under ERISA. [Defendant 2] never took any steps to determine what the Plan’s money was invested in, whether it was stocks, bonds, cash or anything else. [Defendant 2] never consulted with a financial advisor concerning what types of assets and investments were appropriate for a plan to hold. Since becoming a Named Fiduciary in May 1999, [Defendant 2] has done nothing to fulfill his obligations he may have had except attend one or two meetings of the Committee. [Defendant 2] has never known what the assets of the Plan consisted of. [Defendant 2] does not know if the Plan ever owned UNUM stock. [Defendant 2] never reviewed the performance of UNUM stock to determine if it was an appropriate investment for the Plan. [Defendant 2] never knew the Plan owned 22,852 shares of UNUM stock. [Defendant 2] does not know what “MFB NORTHRN INSTL FDS Diversified Growth Portfolio” is.

[Defendant 3] is not aware of any Named Fiduciary consulting with a financial advisor. [Defendant 3] has taken no steps to ensure that he fulfills his fiduciary duties. [Defendant 3] never understood until his deposition that it was his obligation to tell the trustee how to invest Plan assets. [Defendant 3] does not know who was responsible for choosing the Plan’s assets since May of 1999. [Defendant 3] never chose any asset to be owned by the Plan. [Defendant 3] does not know the value of the assets held by the Plan at the end of the 1999 Plan year. [Defendant 3] does not know the value of the assets held by the Plan at the end of the 2000 Plan year. [Defendant 3] does not know the composition of the Plan assets at the 1999 Plan year end. [Defendant 3] does not the composition of the Plan’s assets in the 2000 Plan year end. [Defendant 3] does not know if the assets owned by the Plan were appropriate investments. [Defendant 3] never investigated UNUM stock at all. [Defendant 3] never concerned himself with what assets were in the Plan. As a Named Fiduciary, [Defendant 3] did nothing to minimize the losses suffered by the Plan and its Participants. [Defendant 3] had previously retired from Weighmasters Murphy, Inc. and received his interest in the Plan in a lump sum distribution. [Defendant 3] never reviewed the investments made by the Plan. [Defendant 3] never reviewed the investment returns or losses made by the Plan’s assets. [Defendant 3] admits he is not competent to choose stocks for the Plan. [Defendant 3] never consulted with anyone concerning how to properly run or administer the Plan. [Defendant 3] never paid attention to whether the Plan’s investments were going up or down in value. [Defendant 3] did nothing to determine if UNUM stock was an appropriate investment of Plan assets. The Plan’s investment in UNUM stock constituted of two thirds of the Plan’s assets. [Defendant 3] did nothing to determine if it was appropriate to keep two thirds of the Plan’s assets in UNUM stock. [Defendant 3] does not know what MFB NORTHRN INSTL Diversified Growth Portfolio is. [Defendant 3] did not know the Plan owned over 30,000 shares of MFB NORTHRN INSTL Diversified Growth Portfolio. [Defendant 3] took no steps as a Named Fiduciary to determine if the Diversified Growth Portfolio was a wise investment of Plan Assets. [Defendant 3] never looked at the Plan’s assets in 1999 or 2000 to determine why their value was dropping. [Defendant 3] was not aware that UNUM stock dropped from $55.00 per share to $13.00 per share between May 31, 1999 and February 29, 2000. [Defendant 3] concedes that it was not prudent to “ride it [the UNUM stock] down” 75%. [Defendant 3] never thought that in order to protect the Plan participants and beneficiaries, the Named Fiduciaries should sell the UNUM stock and invest in something else.

This article this week from the Wall Street Journal–“Arbitrations Over Funds Reach Record Levels Irate Investors Challenge Brokers On Sales Practices, High Costs; Going It Alone vs. Class Actions–caused me to wonder how many of the lawsuits that are predicted to be brought over the current mutual fund scrutiny will involve ERISA fiduciary claims. The article notes that regulators are investigating “whether investors paid higher-than-necessary sales charges when buying mutual funds” and discusses how this summer, “the NASD issued an investor alert relating to the sale of so-called B shares, which carry no upfront sales charge, but carry higher annual fees and back-end loads that are imposed if the investors sells within a few years.” According to the article, for investors who remain in a fund for more than a few years, these shares can be more costly than shares with an upfront sales charge. The article goes on to say that “the NASD expects to see more arbitration complaints involving B shares and fund sales practices next year, after regulators complete their investigations.”

The questions that come to mind from reading this article are: in the retirement plan arena, when can a broker become an ERISA fiduciary? And, are arbitration clauses enforceable under ERISA? And is it prudent for plan fiduciaries to enter into contracts with financial services firms which contain mandatory arbitration clauses?

When can a broker-dealer become an ERISA fiduciary?

Yesterday, the Wall Street Journal carried this report: “Mutual Funds Vow To Fix Their Clocks: Earlier Deadlines Are Proposed For Investors to Place Orders; Will New Fees Frustrate ‘Timers’?” Reuters also reports via Yahoo! News: “Mutual Fund Reform Proposals Draw Fire.” Both articles discuss changes to share-trading practices endorsed by the Investment Company Institute as reported here at their website. Under the proposal, fund orders would have to be in the hands of the fund companies themselves by 4 p.m. — a move that would require deadlines several hours earlier at intermediaries such as brokerage firms and 401(k) plans. Apparently, the ICI’s proposal is an endorsement of the late trading action plan laid out by SEC Chairman Donaldson a few weeks ago. Quote of Note:

Institute Chairman Paul Haaga said the ICI Executive Committee “was aware that this decision, if embraced by the SEC, would substantially alter longstanding business practices. We also recognize that it will affect millions of fund shareholders, thousands of intermediaries, and hundreds of fund companies.” Haaga said the ICI would nevertheless urge the SEC to move as rapidly as possible given the practical challenges associated with implementation. “The ICI Executive Committee was presented with a range of policy options. We considered but rejected exceptions to the deadline for entities subject to full SEC regulation. We considered but rejected several procedural options that would have closed the late trading window substantially, but not all the way. Finally, we considered but rejected reliance on accelerated technological developments.”

The Wall Street Journal article notes:

The change could be most dramatic for participants in 401(k) plans. Currently, some orders placed by retirement-plan participants don’t make their way to the fund companies for processing until early the next morning, but still get the price the day the order was placed. With a firm 4 p.m. order deadline, by contrast, many 401(k) orders might have to be executed at the next day’s price and not the current day’s price, ICI president Matthew Fink said in a conference call Thursday.

The Society of Professional Administrators and Recordkeepers (“SPARK”) Institute, a 401(k) industry trade organization, had this to say:

We stressed the adverse implications of a proposed 4:00 PM deadline for placement and processing of orders, making it clear that imposing such a deadline would not only be unworkable, but also would have a negative effect on participant investment accounts in the nearly 400,000 U.S. 401(k) plans

In this press release, you can read about how members of SPARK were invited to meet with the SEC on Tuesday to discuss proposed rulemaking initiatives dealing with late trading and market timing in mutual funds.

You can read the Profit Sharing/401(k) Council of America’s thoughts on the issue here.

The 401khelpcenter.com has this to say in a press release via Benefitslink.com entitled–“A Strictly Enforced Trading Deadline Will Not Threaten Retirement Plans“:

Already industry lobbying groups have begun to cry that such a requirement on retirement plan trades will create additional costs which may have the unintended consequence of actually lowering retirement savings and will cause other undesirable consequences to plan participants. . . This simply is not true. Many of the nation’s 401k plans operate in just such an environment today with no “adverse implications” for plan participants. Further, these late trade submission arrangements that intermediaries have with the mutual fund companies only became common in the 1990’s. 401k retirement plans operated perfectly well long before there advent. Making an easily enforceable absolute 4:00 pm deadline is the right thing to do. The retirement industry should put aside their own self interest in order to help rebuild investor confidence in the mutual fund industry.

UPDATE on 11/2: The Philadelphia Inquirer today has a great article by Jeff Brown which discusses in detail why the SEC should adopt the ICI’s proposals: “Changes would end unfair fund trading.”