For many employers, underfunded defined benefit pension plans present significant ongoing challenges. These challenges arise not only because of the underfunding itself, but also because of the significant volatility that the underfunding can create on its balance sheet due to changes in interest rates and other key assumptions over time. An employer has always had the ability to seek to improve its longer-term financial profile by “de-risking” its pension plan through the purchase of an annuity from a suitable annuity provider that commits to pay benefits to plan participants without further financial support from the employer. The transfer of pension obligations in this manner, which may include the termination or partial termination of the pension plan, can significantly improve an employer’s financial profile. De-risking transactions have become more prominent in recent months because of two transformative transactions, one involving General Motors and the other involving Verizon. We are pleased to report that the first judicial test of these transactions in court under ERISA, the Federal benefits statute, has resulted in a victory for the parties involved in the transaction. And, while the decision was based only on a request for preliminary injunctive relief, and while future litigation will be based on the manner in which future de-risking transactions are structured (including on the key issue of annuity provider selection and suitability), the decision validates the central thesis of pension de-risking and provides an important and helpful roadmap through some of the potential ERISA challenges to these transactions.

…continue reading: Court Rejects ERISA Challenge to Pension De-Risking Transaction

Private equity funds (PE funds) and their advisors long have been concerned that a fund (or its other portfolio companies) may be liable for unfunded pension plan liabilities of one of its portfolio companies. However, in a decision published last month, the U.S. District Court of Massachusetts held that three PE funds sponsored by Sun Capital were not liable for any portion of the withdrawal liability incurred by a portfolio company in which the funds collectively held a controlling interest. In reaching this decision, the court expressly rejected the analysis contained in a 2007 Pension Benefit Guaranty Corporation (PBGC) Appeals Board opinion, which found that the investment activities of a PE fund constitute a “trade or business” and thus subjected the PE funds to joint and several liability under Title IV of the Employee Retirement Income Security Act (ERISA) for a portfolio company’s unfunded pension liabilities.

Although the Sun Capital Partners case provides a foundation for cautious optimism on the issue of whether PE funds can be held jointly and severally liable for the pension-related liabilities incurred by portfolio companies in which they invest, it remains to be seen whether its analysis will be adopted by other courts and whether the district court’s decision will be upheld on appeal to the First Circuit. PE funds should continue to view control group liability as a potential risk in the acquisition context and, in order to minimize exposure to unfunded pension liabilities, PE funds should consult counsel when encountering these issues.

…continue reading: PE Funds Are Not Subject to “Controlled Group” Liability

In the past decade, numerous lawsuits have been brought under ERISA against the fiduciaries and sponsors of 401(k) and other defined contribution retirement plans. Many of these lawsuits have been pled as class actions on behalf of all or many participants of the plan. The most common lawsuits have involved declines in the value of employer stock offered in the plans and allegations that decisions to maintain employer stock in the plans were imprudent. There have also been some lawsuits over other investment options, as well as lawsuits over the management of collateral from securities lending programs run by plan trustees. Another substantial category of litigation has involved allegations of excessive fees. Many of these cases, both investments and fees, have also involved allegedly inadequate disclosure of information to plan participants.

Economic analysis plays an important role in many of these cases. The purpose of this paper is to discuss some of the important economic issues that arise in ERISA litigation, both in establishing liability and in calculating damages.

…continue reading: Economic Analysis in ERISA Litigation over Fiduciary Duties

In companion decisions issued recently, the United States Court of Appeals for the Second Circuit has ruled that retirement-plan fiduciaries should have the benefit of a “presumption of prudence” when faced with claims by employees concerning losses on their employer’s stock.  The cases are In re Citigroup ERISA Litigation, No. 09-3804-CV (2d Cir. Oct. 19, 2011), and Gearren v. McGraw-Hill Cos., No. 10-792-CV (2d Cir. Oct. 19, 2011).

The two cases involved the same basic facts.  The retirement plans at issue mandated that employees have as one of their investment options a fund consisting mainly of their employer’s stock — Citigroup in one case, McGraw-Hill in the other.  After each company suffered a stock-price decline, plan participants complained that the fiduciaries should have seen the decline coming and either should have eliminated the employer stock fund as an option under the plan, or else sold the company’s stock out of the fund.  The plaintiffs claimed that the fiduciaries, by failing to do so, violated their duties of prudence and loyalty under the Employee Retirement Income Security Act.

…continue reading: “Presumption of Prudence” for Fiduciaries in ERISA Litigation

My co-author, Atanu Saha, and I have recently posted three papers dealing with securities damage issues. The first paper, Forward-Casting 10b-5 Damages: A Comparison to Other Methods, discusses and critiques two commonly used methods for calculating securities fraud damages under Rule 10b-5: constant dollar back-casting and the allocation method. We also present the forward-casting method, our proposed alternative to these other methods. Not only is the forward-casting method well-grounded in academic literature, but has the advantage of incorporating market expectations when determining what the stock price would have been “but for” the alleged fraud. Neither the constant dollar back-casting nor the allocation method takes these market expectations into account. We also address other issues that can arise by virtue of using these various methods. These three methods can generate substantially different 10b-5 damage estimates. We use a real world example to demonstrate these differences in the three methodologies.

The methodology used to estimate Rule 10b-5 damages is extremely important when estimating potential liability exposure and the determination of settlement value. In addition, these estimates, because they speak to the extent to which securities prices were distorted by fraudulent misinformation, can also be useful in determining whether the misinformation was “material,” an element of a Rule 10b-5 cause of action. Moreover, our analysis has implications for other causes of action, including Sections 11 and 12(2) of the Securities Act of 1933 and common law fraud actions.

…continue reading: New Insights into Calculating Securities Damages

Comply-and-Explain: Should Directors Have a Duty to Inform?, published recently in Duke Law School’s Journal of Law and Contemporary Problems, argues that the directors of publicly held companies in the United States should be subject to a new state law duty requiring them to explain to shareholders how the board is exercising business judgment and acting in the best interests of the corporation.

The duty is derived from: (1) the Model Business Corporation Act (MBCA) Section 8.30 that requires directors to act in the best interest of the corporation and to share information material to the exercise of the board’s decision-making or oversight functions; (2) Section 3.C.4 of the American Bar Association’s Corporate Director’s Guidebook, that sets forth a director’s “duty of disclosure”; and (3) the Department of Labor ERISA requirements governing the fiduciary duties of institutional investors and their exercise of proxy votes. The duty to inform also builds on concepts from the UK’s principles-based, comply-or-explain governance system that gives directors wide discretion to customize governance policies provided that they explain how their decisions are intended to achieve business goals and serve the best interests of the company and its shareholders.

…continue reading: The Directors’ Duty to Inform

For more than half a century, traditional investment funds (mutual funds) and alternative investment funds (hedge funds) occupied separate and distinct segments of the investment market.  They employed different investment strategies, were subject to different regulatory standards, and mostly catered to different classes of investors.  Increasingly, however, these two types of funds have found themselves converging toward common investing ground.

Recent changes to the capital markets, to investor preferences, and to industry regulations have caused investors to seek out investment products that contain the characteristics of both mutual funds and hedge funds.  Investment managers have responded by introducing a new breed of hybrid funds that combine the exotic strategies of hedge funds with the transparency and relative stability of mutual funds.  Because mutual funds and hedge funds operate within different logistical and regulatory frameworks, investment managers desiring to operate in this new hybrid space must familiarize themselves with the elements of each.

…continue reading: The Convergence of Traditional and Alternative Investment Products

On October 21, 2010, the Department of Labor (“DOL”) proposed regulations (the “Proposed Regulations”) that would, if adopted, significantly expand the circumstances in which a person will be treated as a fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”) by reason of providing investment advice for a fee to an employee benefit plan. A fiduciary under ERISA is subject to strict prudence and conflict of interest standards and it is the DOL’s expressed intention in making the changes to enhance its “ability to redress service provider abuses that currently exist in the market, such as undisclosed fees, misrepresentations of compensation arrangements, and biased appraisals of the value of employer securities and other plan investments.” Because many financial institutions have regular interactions with employee benefit plans and their fiduciaries—as counterparties, service providers, agents, and so forth—the Proposed Regulations are widely relevant for the financial services industry.

…continue reading: Proposed Regulations Would Expand ERISA Fiduciary Exposure

The Dichotomy between Institutional Investing and Institutional Voting

Over the past 30 years, institutional investing and institutional voting of portfolio shares have separated to the point that in most institutions the persons charged with making investment decisions have relatively little or no responsibility for voting the institution’s portfolio shares. While this is not universally the case, it is by far the prevailing paradigm. It has become rare for those charged with making investment decisions to buy or sell stock also to be important players in the share voting process. [1]

The reasons for the divorce of investing and voting at institutional investors are:

• The law of large numbers (too many portfolio companies with too many ballot votes at annual shareholder meetings), and
• Two seminal decisions by government agencies that regulate our institutional investor community — the US Securities and Exchange Commission (SEC) and the US Department of Labor in its administration of ERISA.

…continue reading: The Parallel Universes of Institutional Investing and Institutional Voting