For those of you interested in the developing law pertaining to ERISA fiduciary responsibility of directed trustees, please note this recent federal district court opinion from the Eastern District of Virginia--DeFelice v. US Airways. Plaintiffs in the case had brought a class action lawsuit against US Airways and Fidelity, the directed trustee, seeking to recover losses to the Plan resulting from the diminution in value of US Air Group stock between August 1, 2001 and August 11, 2002, the date of the bankruptcy filing.
One of the key facts of the case as cited by the court was that "the Company Stock Fund remained an investment option available to Plan participants throughout the period of US Airways' descent into bankruptcy." The court noted that "[d]uring most of the pre-bankruptcy period, in fact, the Company Stock Fund regularly increased its holdings in US Air Group stock." Also, of note, was the fact that the Company hired an independent fiduciary in 2002 which immediately upon appointment ceased purchasing the stock and began liquidating the "shares then held to the extent possible without adversely affecting the stock's market value stock."
The court framed the issue before the court as "whether a directed trustee under ERISA § 403(a) has a duty to challenge the continued inclusion of company stock as one of several investment choices in the company’s 401(k) plan where, as here, publicly available information indicated that the company was considering filing for bankruptcy protection, but had not yet done so."
The court held that § 403(a) of ERISA should not be read as imposing on directed trustees a duty to second guess the wisdom of the named fiduciary's directions as to Plan investment options. The court reasoned that to hold otherwise would "effectively eviscerate § 403(a) by eliminating any distinction between the duty of a directed trustee under § 403(a) and the duty of the ERISA named fiduciary with investment authority, who has the duty of ordinary care and prudence prescribed by § 404(a)." The court noted that § 403(a) of ERISA was plainly meant by Congress "to create a subset of ERISA fiduciaries with a statutorily defined duty different from and more narrowly circumscribed than the general duty of ordinary care imposed on other ERISA fiduciaries by § 404(a)."
The court expounded further on the issue as follows:
To sum up, then, § 403(a), by its terms and context, plays an appropriately distinctive role in the ERISA scheme: It prescribes the duties of an ERISA fiduciary acting as a directed trustee. Specifically, § 403(a) requires a directed trustee to comply with the directions of a named fiduciary. And importantly, a directed trustee under § 403(a) has no duty to assess the merits of a named fiduciary's direction and to reject that direction, if, in the exercise of the directed trustee's independent judgment, the direction is imprudent. Indeed, the directed trustee has no discretion to do so and hence incurs no liability for complying with a direction simply because it may arguably be imprudent. To be sure, Section 403(a) makes unmistakably clear that a directed trustee must implement the named fiduciary's direction provided the directions are proper, i.e., that they meet certain formal requirements and hence are identifiably genuine or valid directions from an authorized fiduciary, and provided further that they are not violative of the plan or ERISA. Nor do either of these provisos import into § 403(a) a duty of ordinary care to second guess the financial wisdom of the named fiduciary's directions. Rather, the provisos merely insure (i) that a direction is valid, as distinguished from some spurious order or suggestion from an unauthorized source and (ii) that a direction is not patently violative of ERISA or the plan, for example, by requiring the directed trustee to engage in an explicitly prohibited transaction or where the direction is the product of collusive and fraudulent acts based on non-public information. To hold otherwise- to impose on directed trustees a duty to second guess the prudence of a named fiduciary's proper directions-would negate the purpose and function of § 403(a) and invite wasteful disputes and litigation between named fiduciaries and directed trustees over the wisdom of each direction. Given the construction of § 403(a) reached here, it follows that Fidelity, as a directed trustee, incurred no liability when it did not countermand US Airways' continuing direction to retain the Company Stock Fund as an investment option for Plan participants despite a reasonable basis for pessimism about the US Air Group's financial prospects.
Also of interest was the court's reference to the DOL's Field Assistance Bulletin 2004-03 in which the DOL had stated that in certain circumstances [i]t might not be imprudent to purchase or hold stock in a distressed company in bankruptcy." The court held that where "the directed trustee possesses only publicly available information" that the DOL's standard imposes liability on a directed trustee "only after the named fiduciary has filed for bankruptcy" and even then only "under circumstances which make it unlikely that there would be any distribution to equity-holders with any value . . . ." The court went on to conclude that "in the view of the DOL, a direction to retain company stock as a plan investment option is not contrary to ERISA until the shares are worthless as a matter of fact, and not as a matter of conjecture or investment judgment about the future."
PlanSponsor.com discusses the opinion here.
The DOL has issued some important guidance on the subject of "Fiduciary Responsibilities of Directed Trustees" in Field Assistance Bulletin 2004-03 ("FAB"). This article from PlanSponsor.com--"EBSA Issues Directed Trustee Responsibility Guidance"--gives some history behind the FAB:
The FAB was a response to Groom Law Group Chartered's advisory opinion request filed by Stephen M. Saxon and Jon W. Breyfogle, on behalf of a dozen banks and other financial institutions early in 2004. The request was endorsed by the American Bankers Association.
The FAB retains the DOL's controversial "knows or should know" standard:
Under section 403(a)(1), a directed trustee is subject to proper directions of a named fiduciary. For purposes of section 403(a)(1), a direction is proper only if the direction is “made in accordance with the terms of the plan” and “not contrary to the Act [ERISA].” Accordingly, when a directed trustee knows or should know that a direction from a named fiduciary is not made in accordance with the terms of the plan or is contrary to ERISA, the directed trustee may not, consistent with its fiduciary responsibilities, follow the direction.
Regarding the subject of following a direction that is "made in accordance with the terms of the plan", the FAB makes it clear that directed trustees must read and follow the plan documents as well as the investment policy statement and if ambiguities exist, seek clarification from the "plan's named fiduciary."
Regarding following a direction that is "not contrary to ERISA", the FAB provides that the "directed trustee cannot follow a direction that the directed trustee knows or should know would require the trustee to engage in a transaction prohibited under section 406 or violate the prudence requirement of section 404(a)(1)":
The FAB provides guidance on how directed trustees can satisfy their fiduciary responsibility in avoiding prohibited transactions. The DOL states that the directed trustee "must follow processes that are designed to avoid prohibited transaction" and can "satisfy its obligation by obtaining appropriate written representations from the directing fiduciary that the plan maintains and follows procedures for identifying prohibited transactions and, if prohibited, identifying the individual or class exemption applicable to the transaction."
With respect to "prudence determinations", the FAB makes it clear that:
The FAB then divides its remarks into two parts: (1) Where directed trustees possess "material non-public information" and (2) where directed trustees merely possess "public information."
The FAB provides that if "the directed trustee possesses material non-public information regarding a security" that is necessary for a prudent decision, the directed trustee, prior to following a direction that would be affected by such information, "has a duty to inquire about the named fiduciary’s knowledge and consideration of the information with respect to the direction." The FAB provides this example:
For example, if a directed trustee has non-public information indicating that a company’s public financial statements contain material misrepresentations that significantly inflate the company’s earnings, the trustee could not simply follow a direction to purchase that company’s stock at an artificially inflated price.
If the directed trustee has no more than public information, the FAB makes it clear that the directed trustee "will rarely have an obligation under ERISA to question the prudence of a direction to purchase publicly traded securities at the market price solely on the basis of publicly available information." The FAB goes on to say that where there are "clear and compelling public indicators, as evidenced by an 8-K filing with the Securities and Exchange Commission (SEC), a bankruptcy filing or similar public indicator, that call into serious question a company’s viability as a going concern, the directed trustee may have a duty not to follow the named fiduciary’s instruction without further inquiry."
While there is a great deal more here that one could write about from the FAB, I found some of the following footnotes to the FAB to be most interesting:
From Footnote 2: "The Department expresses no view as to whether, or under what circumstances, other procedures established by an organization to limit the disclosure of information will serve to avoid the imputation of information to a directed trustee."
From Footnote 4: "We note that section 409 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. 78(m)(l), requires public companies to disclose “on a rapid and current basis” material information regarding changes in the company’s financial condition or operations as the SEC by rule determines to be necessary or useful for the protection of investors or in the public interest. The SEC has recently updated its disclosure requirements related to Form 8-K, expanding the number of reportable events and shortening the filing deadline for most items to four business days after the occurrence of the event triggering the disclosure requirements of the form. 69 FR. 15594 (Mar. 25, 2004). Not all 8-K filings regarding a company would trigger a duty on the part of a directed trustee to question a direction to purchase or hold securities of that company. Only those relatively few 8-Ks that call into serious question a company’s ongoing viability may trigger a duty on the part of the directed trustee to take some action."
From Footnote 5: "A directed trustee’s actual knowledge of media or other public reports or analyses that merely speculate on the continued viability of a company does not, in and of itself, constitute knowledge of clear and compelling evidence concerning the company sufficient to give rise to a directed trustee’s duty to act."
From Footnote 7: "Nothing in the text should be read to suggest that a directed trustee would have a heightened duty whenever a regulatory body opens an investigation of a company whose securities are the subject of a direction, merely based on the bare fact of the investigation."
Also, this quote from the Plan Sponsor article noted above:
In response to the FAB, Groom's Saxon said in a statement, "We appreciate the Department's guidance and are still analyzing it. The guidance did not go as far as we would have liked, and certainly we would never concede that a directed trustee is a fiduciary. The case law here is not clear. Notwithstanding this, the FAB sends a message, loud and clear, to the plaintiffs' bar that ordinary directed trustees are no longer fair game for class action lawsuits. The Department agrees with us that directed trustees who by contract have no investment responsibilities will not be liable for losses that arise simply because of a drop in stock prices. That game is over,” Saxon added.