Directors and the Duty to Monitor under ERISA (Part II)

In a previous post, I discussed the development of case law around this important question: to what extent are directors fiduciaries under ERISA and charged with monitoring the appointment of fiduciaries under ERISA?

Recent cases provide some insight into how the courts are dealing with this ongoing issue as it relates to 401(k)/company stock cases which are making their way through the courts. There are now a whole host of recent cases (stemming from the economic turmoil of the past few years) which have made it past the motion to dismiss phase, two of which have seemingly reached opposite results on the issue and are worthy of discussion:

(1) In re: CMS Energy ERISA Litigation: Plaintiffs brought suit against “Employer Named Fiduciaries,” “Plan Administrator Fiduciaries” and “Insider Director Fiduciaries.” With respect to the directors, plaintiffs alleged a breach of fiduciary duty on account of failing to monitor the other fiduciaries of the plan. Regarding the facts of the case, there were two plans, a 401(k) Plan and an ESOP, which were heavily invested in CMS stock which had, of course, dropped in value. In the plan documents, the employers were designated as the Named Fiduciaries and were charged with the “general administration of the Plan.” The Board of Directors was given the power to “appoint such persons, who may be Members under the Plan, as it determines at any time to act as Plan Administrator in all dealings under the Plan.”

As to whether or not the directors could be considered fiduciaries under ERISA, the Court ruled that the discretion given to the employer under the Plan provisions was broad enough to support a finding that they were fiduciaries under ERISA:

“[W]here the Board of [Directors] may choose a Plan administrator, and the Employers may choose an Investment Manager, but the Plan does not delegate investment policy or decision making power to such manager, administrator, or any other individual or committee, but in fact reserves the broadest administrative and management responsibility to the Employers, the court is convinced that it is premature to dismiss inside directors of the Employers as non-fiduciaries absent specific findings on what responsibilities were actually assumed by them.”

Regarding the duty to monitor, the court stated:

. . .[T]he allegations are that the Employer Named Fiduciaries and the Insider Director Defendants breached their fiduciary duties by failing to adequately monitor the Plan Committees, the Plan Administrators, and other persons, if any, to whom management of Plan assets was delegated. These Defendants knew or should have known that the other fiduciaries were imprudently allowing the Plan to continue offering CMS stock as an investment option and investing Plan assets in CMS stock when it no longer was prudent to do so, yet failed to take action to protect the participants from the consequences of the other fiduciaries’ failures.

As a result, plaintiffs’ allegation survived the defendants’ motion to dismiss on the issue.

(2) In the In re: Dynegy, Inc. ERISA Litigation, the Profit Sharing/401(k) Savings Plans allowed participants to invest in Company Stock. The Benefits Plan Committee was the Administrator of the Plan and also the named fiduciary with respect to the general administration of the Plan, having the authority to control and manage the operation and administration of the Plan. The Board of Directors had the sole authority to appoint and remove the Plan Trustee. Plaintiffs in the lawsuit brought allegations against the Company, the Board of Directors, the Human Resources Committee of the Board of Directors (“HRC”), and the Benefit Plans Committee (“BPC”).

Regarding the claims against the Board of Directors, the plaintiffs had alleged that the Company, Board of Directors and members of the Human Resources Committee of the Board of Directors had (1) breached their duty to disclose and inform the BPC incident to their duty to appoint and monitor their members, and (2) failed to monitor the BPC.

The court dismissed both claims pertaining to the duty to monitor issue, although other claims on other issues survived. The difference in the result in this case from the CMS case seems to stem from the plan fiduciary structure as set forth in the Plan document as well as a different interpretation of the law as it relates to the duty to monitor. In the Dynegy case, the court points out that “[n]either Dynegy nor the HRC were designated as fiduciaries in the Plan or mentioned in the fiduciary provisions of the Plan” and that directors were only mentioned in the Plan as having “the sole authority to appoint and remove the Trustee.”

Plaintiffs had alleged that the Board of Directors were fiduciaries because they had the power to appoint members of the HRC, which in turn had the power to appoint members of the BPC. In making this argument, they alleged that the Board’s fiduciary duty to the Plan was derived from the power given to it in the company’s bylaws to appoint a compensation committee [the HRC] to review “the salaries, compensation and employee benefits” for the employees. They further argued that the HRC’s fiduciary duty to the Plan was derived from the power given to it by a 2002 Proxy Statement and resolutions of a predecessor compensation committee authorizing and directing the HRC “to review all aspects of the company’s benefit and welfare plans and programs, administer the plan, and appoint a person or persons to oversee the administration and operation of the benefit plans.”

Despite this language, the court basically said “no dice” to the argument, and held that because the directors were not named as fiduciaries in the governing plan documents, the test of whether or not they achieved fiduciary status was purely functional in nature. Because the directors had not exercised “de facto control” over the BPC or been on notice of any possible misadventure by their appointees, the court held that claims against them should be dismissed.

It is very interesting to note that the plaintiffs unsuccessfully relied on the Enron case in support of their allegations that the directors had breached their fiduciary duties by failing to monitor the BPC and the HRC. The court in Enron had held that because certain directors had been given the power to appoint the fiduciaries of the plans under the plan document, and because they had, in fact, exercised that “discretionary power of appointment”, they also had the responsibility of monitoring the Committee which had control over the Plan’s investments and that plaintiff’s allegations should not be dismissed.

However, the Dynegy court didn’t seem to buy the argument that the Dynegy directors could be held to have breached their duties through a failure to monitor unless something more was present. The court made it clear that that “something more” would have included such things as the directors “actively and knowingly” participating in the dissemination of misleading information, the directors encountering “red flags” which might have alerted them to the fact of “possible misadventure by their appointees” or allegations that, if the directors had investigated Dynegy’s regulatory filings, they would have discovered accounting improprieties and/or financial problems leading them to take action. The court distinguished the Enron case by stating that that “something more” was present in the Enron case, but not in the Dynegy case.

(In the Enron case, the plan documents had given the Enron Corporation the duty to appoint members of the committee which served as Plan administrator and Enron was designated as the named fiduciary with respect to general administration of the Plan, except for investment of the assets in the trust fund. The plan document also stated that Enron was obligated to provide the Administrative Committee with “any information that the Committee determines is necessary for the proper administration of the Plan” and to the Trustee any such “facts as are deemed necessary for the Trustee to carry out the Trustee’s duties under the Plan.”)

Commentary: All of these cases should be of great interest to those involved in plan documentation and those involved in seeking to insulate Board members from ERISA liability. They demonstrate how the fiduciary structure set forth in the plan documents plays a critical role in determining whether the courts are willing to hold the directors personally liable under the fiduciary responsibility rules of ERISA, if investments go sour and plan participants sue. The Department of Labor has in its Amicus Briefs, as well as publicly, been fairly vocal about its view that directors should be held responsible under ERISA when they are vested with the power to appoint fiduciaries, but fail to be actively involved in monitoring the appointed fiduciaries through prudent processes and procedures. However, some courts have been more reluctant to hold them responsible, absent a finding of “something more” in the way of imprudent conduct on the part of directors that goes beyond the mere duty to appoint.

Until the issue is resolved, there will continue to be uncertainty surrounding this particular area of the law. However, directors and those who represent directors should be aware of the following:

(1) Approving or adopting plan documents willy-nilly without giving thought to plan fiduciary structure is foolish in today’s legal environment, with the threat of lawsuits from participants being a real risk as plaintiff’s lawyers now view ERISA as a fertile ground for recovery. Many employers have in the past taken a rather lackadaisical approach to plan documentation, trying to cut costs by utilizing “canned” documents supplied by vendors and record-keepers. However, it is hard to imagine that such a casual attitude towards plan documentation will continue as these cases play out in the courts and the case law develops.

(2) For those seeking to limit director liability, there seems to be two distinct approaches developing:

  • The DOL’s view supported by some courts which states that, if directors have the duty to appoint fiduciaries, they must establish prudent practices and procedures which will involve “active” monitoring of those fiduciaries appointed on an ongoing basis. If they fail to engage in such monitoring activities, the DOL, and some courts, have held that they should be personally liable under ERISA for losses caused by their failure to monitor. This view is set forth by the DOL in this “ancient” Interpretive Bulletin at Reg. section 2509.75-78:

    D-4 Q: In the case of a plan established and maintained by an employer, are members of the board of directors of the employer fiduciaries with respect to the plan?

    A: Members of the board of directors of an employer which maintains an employee benefit plan will be fiduciaries only to the extent that they have responsibility for the functions described in section 3(21)(A) of the Act. For example, the board of directors may be responsible for the selection and retention of plan fiduciaries. In such a case, members of the board of directors exercise “discretionary authority or discretionary control respecting management of such plan” and are, therefore, fiduciaries with respect to the plan. However, their responsibility, and, consequently, their liability, is limited to the selection and retention of fiduciaries (apart from co-fiduciary liability arising under circumstances described in section 405(a) of the Act). In addition, if the directors are made named fiduciaries of the plan, their liability may be limited pursuant to a procedure provided for in the plan instrument for the allocation of fiduciary responsibilities among named fiduciaries or for the designation of persons other than named fiduciaries to carry out fiduciary responsibilities, as provided in section 405(c)(2).
    . . .
    FR-17 Q: What are the ongoing responsibilities of a fiduciary who has appointed trustees or other fiduciaries with respect to these appointments?

    A: At reasonable intervals the performance of trustees and other fiduciaries should be reviewed by the appointing fiduciary in such manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan. No single procedure will be appropriate in all cases; the procedure adopted may vary in accordance with the nature of the plan and other facts and circumstances relevant to the choice of the procedure.

  • The other, less prevalent view, seems to almost encourage inaction by directors, holding that directors must actually “do something,” i.e. cross over the line, that is, into additional fiduciary activity (beyond the mere authority to appoint and duty to monitor) before they will be held personally liable under ERISA. This view was espoused in the WorldCom case in which the plan document designated WorldCom as the plan administrator, but provided that if WorldCom did not appoint fiduciaries, then any officer had the authority to carry out on behalf of WorldCom the duties of the administrator. According to the court, because the Board did not exercise its authority to appoint fiduciaries, it did not engage in “functional” fiduciary activity, and therefore, a holding that directors could be ERISA fiduciaries when they never actually did the appointing was just going “too far,” in the words of District Judge Denise Cote.

    The same type of theory was advanced in the Dynegy case discussed above where, even though the duty to appoint fiduciaries was vested in certain directors, allegations against them for failure to monitor were dismissed where they were not involved in any additional “functional” activity which would have made them fiduciaries.

All of this raises a very interesting, and somewhat disturbing, question as to whether or not directors who actually engage in the prudent processes of monitoring contemplated by the DOL could in jurisdictions holding to the latter view, actually find themselves in a Catch 22 position of “crossing over the line” into fiduciary functionality, meaning that if they then could be found to have “failed” somehow in their activities of monitoring, they would be held personally liable under ERISA (i.e. whereas total inactivity in such jurisdictions would likely have achieved a different result.)

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