Nine former employees of Signet Banking Corp. are testing the limits of laws and regulations designed to protect plan sponsors from litigation as fiduciaries. Their class-action lawsuit on behalf of 5,000 former Signet workers was filed in May against First Union Corp. of Charlotte, North Carolina, which acquired Signet Banking in 1997.
As the first prominent court battle since the Department of Labor adopted 404(c) regulations in 1992, the court's decision may set guidelines for handling pension assets in the wake of mergers and acquisitions. Particulars are confined to First Union and perhaps financial institutions that offer proprietary options in 401(k) plans, but ramifications could set a broader precedent. "It's an important case," says Alan Lebowitz, deputy assistant secretary of the Pension and Welfare Benefits Administration. At issue are critical questions about the nature of fiduciary status, the scope of the Employee Retirement Income Security Act (ERISA) regulation, and the trade-off between consolidating pension assets and keeping new workers happy and productive.
The nine plaintiffs charge First Union with violating its fiduciary duty when it liquidated assets in the Signet plan and transferred them to proprietary funds at First Union. At Signet, a big portion of plaintiffs' 401(k) assets had been invested in Capital One, a high-flying spin-off whose stock price has more than tripled since First Union transferred the stake to its handful of mutual funds. Adding insult to injury, plaintiffs complain, First Union tacked on administrative fees it does not require some of its corporate clients to pay.
When First Union announced its intention to replace former Signet employees' stake in Capital One with shares of its own stable value fund, the plaintiffs bristled — not least because, after helping to build Capital One's lucrative credit card business from scratch, they felt they deserved to participate in its roaring success.
"We all got on the phone and tried to learn the reasoning behind the decision," remembers Sue B. Franklin, one of the plaintiffs. The bank's alleged reply: "We don't feel it's wise for you to have so much invested in a single stock."
Some ERISA attorneys believe the case may clarify key aspects of pension regulation. It may define the extent to which employers are sheltered from fiduciary liability when they design pension plans, when they are seen to be acting as employers, not fiduciaries. It may also define the extent of an employer's protection from fiduciary liability under Section 404(c) regulations, which govern participant-directed defined contribution plans.
Two Important Protections
To David Wray, president of the Profit Sharing/401(k) Council of America, the potential seems somewhat more limited. "It is unlikely to clarify any murky areas of the law," he says. The facts in this case are unique to First Union, he says, and the final ruling likely limited in its impact only to First Union. Its impact on financial institutions, if any, would depend on what the court states in its final opinion, Wray says.
The case should nevertheless remind all plan sponsors that it is necessary to: (1) design a process to make fiduciary decisions on behalf of pension beneficiaries and (2) be able to prove adherence to that process. Wray's advice, meanwhile, for plan sponsors when they act as fiduciaries on any matter, including mergers and acquisitions: "Sit down and think about it and put a note in your file." In other words, create a paper trail.
The most obvious implications are for financial institutions that provide proprietary funds in their 401(k) plans for their own employees. The First Union case could become a cautionary tale in this regard. "Financial institutions have to exercise the same level of prudence as managers to select investments for employees as they do when they manage other pension plans," says Steve Saxon, an ERISA attorney and a partner with Groom Law Group, in Washington, D.C. "They still have to evaluate the fund and have a diversified selection of investments that are performing reasonably well," he says.
Following its standard practice after mergers, First Union liquidated $250 million in investments by 5,000 Signet plan participants invested in eight different options. It shifted them to four of the seven investment options available in the First Union plan. (After a brief transition period, former Signet workers were able to invest in all seven First Union options.) In doing so, plaintiffs contend, First Union deprived them of collective gains that would have exceeded $150 million.
The plaintiffs' charge in the First Union lawsuit identifies the lion's share of the $150 million as foregone returns on a $50 million stake in the shares of Capital One Financial. Between December 1997, when First Union liquidated the pension assets, and the date the lawsuit was filed this past May, Capital One's shares more than tripled — to $170 million, a $120 million gain. Additional lost returns stem allegedly from $50 million that had been invested, premerger, in two of Signet's nonproprietary funds — the Vanguard Index Trust 500 Portfolio and the American Century/Twentieth Century Ultra Investors Fund. These two funds combined grew in value to $67 million by May 1999. This represents respective gains of 37 percent and 33 percent. During the same period, First Union's Stable Value Fund supplied modest returns consistent with similar funds.
Reader Comments» Post a comment