More US Sugar ESOP and California’s Franchise Tax Board (FTB) Notice 2008-4

The July 1, 2008 Employee Ownership Update is online and discusses the following:

• Florida Agrees to Buy U.S. Sugar; Employees Will Get Windfall
  
• California Offers Settlement for Taxpayers in Abusive ESOPs
  
• NASPP Survey Shows ESPPs Somewhat More Conservative

The Update discusses how Florida is Purchasing U.S. Sugar Land and the latest news related to the U.S. Sugar ESOP Issues:

Laid-off hourly employees will get one year's severance pay, and salaried employees will get two years. Employees will receive incentives to stay on during the transition.

The price offered by the state, which amounts to about $350 per share, is a considerable premium over a previous bid of $293 per share. The approximately 3,800 U.S. Sugar ESOP participants (about 1,700 of which are current employees) own about 35% of the company through an ESOP, so they will divide approximately $650 million among them.

The Update also notes that ESOP valuation practices would have required that participants be paid at a non-control price:

They now say the current offer just proves their point, but ESOP valuation practices would have required these former employees to be paid out at a non-control price, whereas the offers all included a premium for control. The circumstances of the sale to the state, which clearly only had an interest if it could take full control, suggest that a substantial control premium could have been in order.

The Update also covers California's Franchise Tax Board (FTB) Notice 2008-4 – Resolution of Certain ESOP Transactions and notes that taxpayers seeking resolution need to file before September 13, 2008. It also discusses a 2007 equity compensation survey that shows that employee stock purchase plans (ESPPs) have become more conservative since accounting rule changes became fully effective in 2006.

U.S. Sugar ESOP Update: Florida Purchasing U.S. Sugar Land

We recently discussed the U.S. Sugar ESOP Issues. Florida to Buy U.S. Sugar's Land To Aid Everglades discusses how Florida is purchasing land from U.S. Sugar Corp. and leasing it back for the next six years before turning over the land for conservation purposes, effectively shutting down the company:

The state of Florida, stepping up its efforts to restore the Everglades wetlands, offered to purchase 300 square miles of land now used for sugar-cane production for $1.75 billion from U.S. Sugar Corp., effectively moving to shut down the largest grower of the crop in the U.S.

The Clewiston, Fla.-based company and the South Florida Water Management District on Tuesday signed a "statement of principles" that would allow U.S. Sugar, which has farmed the land since 1931, to continue growing cane and producing sugar for the next six years. If final terms are settled as expected in the coming months, the company would then turn over the land for conservation purposes at the end of that period.

The state plans to pay $50 million in cash and finance the rest of the purchase's $1.7 billion through debt.

The article also notes the presence of the ESOP and the fact that the offer was compelling enough for the board of directors to proceed, even if it meant the end of the company:

The private company -- owned by descendents of its founder, Charles Stewart Mott, and an employee-ownership plan -- had invested more than $500 million in recent years to upgrade its facilities on the land and had no intention of shutting down until Gov. Crist, in meetings with executives in recent months, "suggested he buy us out," said Robert Coker, senior vice president of U.S. Sugar.

The terms of the state's offer, he added, were compelling enough for U.S. Sugar's board of directors to authorize moving ahead with the plan, even if it meant the end of the company.

Until the six-year period ends, Mr. Coker added, U.S. Sugar will continue to grow and produce sugar and will provide an incentive plan to retain employees. It currently has 1,700 employees. "It will be business as usual...but then we'll hand over the keys," he said.

Booting US Sugar from the Everglades also discusses the transaction.

Kirschbaum v. Reliant Energy, Inc., No. 06-20157 (5th. Cir. 4/25/2008) (5th. Cir., 2008)

ERISA Class Action Defense Cases–Kirschbaum v. Reliant Energy: Fifth Circuit Affirms Summary Judgment In Favor Of Defense In ERISA Class Action Complaint Holding Class Action Claims discusses Kirschbaum v. Reliant Energy, Inc., No. 06-20157 (5th. Cir. 4/25/2008) (5th. Cir., 2008), a stock drop case that ruled in favor of the defense because the claims that they should not have invested in company stock ran counter to ERISA and because negligent misrepresentations were not made:

Plaintiff filed a class action against his employer, Reliant Energy, Inc. (REI) and the Benefits Committee of his employer's savings plan alleging violations of ERISA (Employee Retirement Income Security Act). The Plan is an Eligible Individual Account Plan (EIAP) under ERISA, and the class action complaint alleged that defendants breached fiduciary duties owed to current and former participants in the Plan in that defendants "had a fiduciary duty to liquidate the Common Stock Fund and cease purchasing REI shares, notwithstanding the Plan's express contrary requirements." Kirschbaum v. Reliant Energy, Inc., ___ F.3d ___, 2008 WL 1838324, *1 (5th Cir. April 25, 2008). The district court granted plaintiff's motion to certify the litigation as a class action, id. Defense attorneys moved for summary judgment on the ground that defendants satisfied their legal duties to the class: The district court granted summary judgment as to all class action claims, and entered judgment in favor of defendants on the class action complaint. Id. Plaintiff appealed, and the Fifth Circuit affirmed.

Kirschbaum v. Reliant Energy: Fifth Circuit Adds to Growing Body of Law Imposing Substantial Hurdles to Fraud-Based Employer Stock Drop Claims discusses how this decision builds on other recent Circuit Court decisions:

Reliant Energy builds on recent Circuit Court decisions that have suggested claims of fraud will not make out a fiduciary breach claim unless the fraud challenges the company's survival. For example, in Edgar v. Avaya, Inc., 503 F.3d 340 (3d Cir. 2007), the Third Circuit recently dismissed a claim that fiduciaries knew or should have known the stock was inflated prior to an earnings warning that resulted in a 25% one-day drop in the stock price, reasoning that this was not the type of "dire circumstance" that would overcome Moench's presumption of prudence. Similarly, in Pugh v. Tribune Co., 2008 WL 867739 (7th Cir. Apr. 2, 2008), discussed in last month's Newsletter, the Seventh Circuit concluded fiduciaries may reasonably rely on the company's investigation and reporting of fraud absent some reason to believe the corporate reporting process was broken. Although ERISA fiduciary suits continue to be filed when a company with an employer stock fund in its 401(k) plan suffers a substantial setback, these cases suggest that there will be substantial defenses to these claims.

Court Gives ERISA Plan Fiduciaries Presumption of Prudence discusses the following:

1. Stock Drop Led to ERISA Claims
2. Investment Policy May Have Created Fiduciary Discretion
3. Plaintiffs Must Bear a "Heavy Burden" to Override Plan Terms
4. Misrepresentation Claim Rejected Because Prospectus Was Not an SPD

It also discusses lessons for plan sponsors:

• Less discretion may be best. Plan sponsors whose 401(k) plan or ESOP features an employer stock fund should consider having their applicable investment policies, as well as the Plan documents, require that company stock be purchased for this fund. Companies that do so may have a stronger defense against claims that their plan's company stock fund should not have invested in company stock.
  
• Bailing out may be necessary when the ship is sinking. ERISA fiduciaries remain bound to override the plan's terms and divest holdings of employer stock when the plan sponsor's existence as a going concern is threatened or the stock is in danger of becoming essentially worthless.
  
• Consider issuing a separate SPD. Plan sponsors and fiduciaries should avoid the shortcut of using a 10(a) Prospectus as a Summary Plan Description. Instead, the plan should issue a separate SPD that does not incorporate by reference the plan sponsor's SEC filings.

The DOL also filed an Amicus Brief for this case.

Recent California Supreme Court Ruling, Definition of Spouse and Marriage, Defense of Marriage Act (DOMA), and the Impact on Plan Administration

California Supreme Court's Decision on Domestic Partnerships May Raise Some Plan Document Issues discusses how last month's California Supreme Court Ruling (In re Marriage Cases, No. S147999 (May 15, 2008)) could create some plan document issues.

When considering these issues, it is important to consider the impact of the Defense of Marriage Act (DOMA) definition of marriage:

SEC. 3. DEFINITION OF MARRIAGE.

(a) In General.--Chapter 1 of title 1, United States Code, is amended by adding at the end the following:

``Sec. 7. Definition of `marriage' and `spouse'

``In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word `marriage' means only a legal union between one man and one woman as husband and wife, and the word `spouse' refers only to a person of the opposite sex who is a husband or a wife.''

The Impact of Same-Sex Marriage on Employee Benefit Plan puts the DOMA definition in context:

Congress adopted DOMA in 1996 in response to a ruling by the Hawaii Supreme Court that cast serious doubt on the constitutionality of a state law that limited marriage to couples of the opposite sex. One of DOMA's two principal provisions, and the one relevant here, reads as follows:

In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word 'marriage' means only a legal union between one man and one woman as husband and wife, and the word 'spouse' refers only to a person of the opposite sex who is a husband or a wife (1 U.S.C. § 7).

All provisions of the Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code ("Code"), and any regulations promulgated under those laws, which reference a person's marital status must be read in a manner consistent with DOMA's definition of marriage. Our initial assessment is that in the two states actually recognizing same-sex marriages, DOMA's biggest impact is on qualified plans under section 401(a) of the Code — pension plans in particular — with only minimal impact on health and welfare and deferred compensation plans.

The article proceeds to address the qualified plan provisions that DOMA governs:

• Qualified Joint and Survivor Annuities and Spousal Consent
• Optional Joint and Survivor Annuities
• Qualified Pre-Retirement Survivor Annuities
• Qualified Domestic Relations Orders
• Incidental Death Benefit and Minimum Required Distribution Rules
• Rollover Rules
• Preference Beneficiary Rules

Definition of Spouse also discusses the impact of the DOMA definition on plan administration.

As we said, the DOMA definition of spouse is applicable to all Federal laws, agencies, and regulations. And although our written plan document is unaffected by DOMA, in practice, the parties to a same-sex marriage are not recognized as spouses for retirement plan purposes. Thus, there are no spousal rights. What does this mean administratively?

Since the DOMA definition of spouse is not met, the Federal laws involving the word spouse do not apply. Therefore:

• No spousal consent is needed to name someone other than the spouse as beneficiary
• No qualified joint and survivor annuity (QJSA) requirements or protections are provided.
• No qualified pre-retirement survivor annuity (QPSA) requirements or protections apply.
• No spousal consent is needed for distributions, loans or hardship withdrawals.
• The joint life tables for required minimum distributions cannot be used if the same-sex spouse is more than 10 years younger.
• No spousal rollover of the deceased participant spouse's plan assets is permitted.
• In certain defined benefit plan designs, if the participant dies before the earliest retirement age under the plan, no benefits will be paid from the plan on that participant's behalf because the qualified pre-retirement annuity would not be enabled.

The article also addresses the following:

• What is a spouse?
• Who is a spouse?
• Who is a spouse under federal law?
• What is a marriage?
• When is one considered married according to IRC Section 417(d)?
• Impact of DOMA on retirement plan administration
• QDRO Quandary
• So, what is a marriage?

Pension and Employee Stock Ownership Plan Administrative Committee of Community Bancshares Inc. v. Patterson, N.D. Ala., No. CV-04-BE-00531-S, 3/31/08

An ESOP Fable with a Drafting Tip discusses Pension and Employee Stock Ownership Plan Administrative Committee of Community Bancshares Inc. v. Patterson, N.D. Ala., No. CV-04-BE-00531-S, 3/31/08, a case that permitted a plan to Use an Account Balance to Offset Damages Resulting from a Fiduciary Breach. We further expanded on this case in Criminal Sentences and Bad Boy Clauses – When ERISA Account Balances Can Be Recovered by the Plan.

The case is centered on Kennon Patterson, who at the time was the Chairman, CEO, and President of Community Bancshares, Inc., as well as a member of the ESOP administrative committee. After Patterson was convicted of "fifteen counts of conspiracy, bank fraud, causing false entries in bank records, and filing false tax returns", the ESOP Committee and Trustee sued:

As early as 1998 and continuing at least through the mid 2000s, Patterson had been defrauding the bank by having contractors bill the bank for construction on his personal farm. He was indicted for bank fraud in 2003 and convicted in 2005. In 1998, during a time that a shareholder derivative suit was pending but before these criminal charges had come to light, the ESOP refinanced its note and purchased an additional 56,682 shares of Bancshares stock. Patterson was a member of the ESOP committee during this period, but did not disclose his fraudulent activity to the committee. Later, a second shareholder derivative suit was filed that did allege the personal construction charges. Other suits followed, and not surprisingly, the value of the stock held by the ESOP declined.

The article notes that the plan document included language permitting the offset of a participant's benefits as allowed by IRC Section 401(a)(13)(C) - Qualified pension, profit-sharing, and stock bonus plans - Requirements for qualification - Assignment and alienation - Special rule for certain judgments and settlements and suggests that the "decision serves as good reminder to include such language in ESOP documents":

The plan document recited the general rule providing that no assignment or attachment can occur against a participant's benefit, but immediately followed that with the following statement: Notwithstanding any provisions of the Section to the contrary, an offset of a Participant's accrued benefit against an amount the participant is ordered or required to pay the Plan with respect to a judgment, order or decree issued, or a settlement entered into, on or after August 5, 1997, shall be permitted in accordance with Code Section 401(a)(13)(C) and (D).

The article also discusses how the opinion differentiated between fiduciary and company officer acts and that a fiduciary "has an affirmative duty to disclose to plan participants facts that would have an "extreme impact" on the plan as a whole."

Applying LaRue to an ESOP Case, CASB Final Rule, and the U.S. Sugar ESOP

The June 2, 2008 Employee Ownership Update is online and discusses the following:

• District Court Says LaRue Does Not Apply in ESOP Case
• Cost Accounting Standards Board Finalizes ESOP Reimbursement Rules
• New York Times Article on U.S. Sugar ESOP Creates Controversy
• Ownership Thinking Conference Set for Denver September 17-18
  

The Update discusses Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), which ruled that an ESOP case could not be reopened based on the LaRue ruling:

In this case, the court had previously denied a claim by the plaintiffs concerning the alleged failure of the fiduciary of an ESOP at Central Alabama Home Health Services to provide for a proper valuation concerning the ESOP's purchase of shares. Now the plaintiffs sought reconsideration in light of LaRue. The court found, however, that even if the plaintiffs' allegations were valid, the actions of the fiduciary would affect the entire plan, not just individual participants. LaRue was premised on the difficulty a plaintiff might have in getting damages when the relief would apply only to that individual and a plan-wide remedy would thus be impractical or inequitable. Here, a plan-wide remedy was already available. Moreover, the court cited the concurring opinion of Chief Justice Roberts expressing concern that LaRue not be read to allow cases to proceed where existing administrative remedies had not been exhausted, as the court found they had not been in this case.

The Update also discusses Accounting for the Costs of ESOPs Sponsored by Government Contractors and the U.S. Sugar ESOP Issues.

U.S. Sugar ESOP Issues

In a complaint filed on January 31, 2008 and amended on May 2, 2008, three former U.S. Sugar Corp. employees and ESOP participants allege that their ESOP accounts were cashed out at prices lower than they should have been. The Complaint was recently discussed in major news publications and has become a major topic of discussion in the ESOP community.

UPDATE 6/25/2008: U.S. Sugar ESOP Update: Florida Purchasing U.S. Sugar Land discusses how Florida is purchasing land from U.S. Sugar Corp. and leasing it back for the next six years before turning over the land for conservation purposes, effectively shutting down the company.

UPDATE 7/2/2008: More US Sugar ESOP and California’s Franchise Tax Board (FTB) Notice 2008-4

Anaylsis

For purposes of our U.S. Sugar ESOP analysis, we will split the issues into ESOP perception issues and legal issues.

ESOP Perception Issues

Sugar workers say company cheated them on pensions was initially was posted Tuesday, May 27, 2008 on the International Herald Tribune, the global edition of the New York Times. On Wednesday the New York Times website posted an online article titled Sugar Workers, Given Shares Instead of Pension, Wonder Why Price Is So Low. Saving the most sensational headline for the print edition,
In Stock Plan, Employees See Stacked Deck appeared on the front page of the Thursday, May 29 edition of the New York Times.

The New York Times Attacks ESOPs discusses how the New York Times piece is an unbalanced article that ignores the Economic Performance of ESOP Companies and the benefits of ESOPs and employee ownership to employees, companies, and society. The post also discusses how the article is "potentially the most damaging we have seen for a very long time" and notes the influence of the New York Times on public policy:

The New York Times is very influential in New York City in shaping the opinions of public policy decision makers, one of whom is Congressman Charles Rangel (D-NY), Chair of the House Ways and Means Committee. We're sure his staff also faithfully read The New York Times.

The post also includes a copy of a letter to the editor from J. Michael Keeling, the President of the ESOP Association.

The media has a history of taking individual incidents and broadly applying them to the entire ESOP universe. A recent example of this is the sale of Bear Stearns. As with Bear Stearns, it is essential that members of the ESOP community Counter the Negative ESOP Coverage with the Facts.

If the media is looking for a balanced story, we often discuss ESOPs In the News. Here are some recent examples:

• In the News: Succession Planning, Empowering Employees, Improving Recruiting, Creating Selling Point, and Improving the Bottom Line
• In the News: More Responsibility and Better Decision-Making
• In the News: A Different Approach to Management and Compensation and Aligning Business Objectives with the Clients’ Objectives
• In the News: 2008 Innovations Award Winner, Three-Tier Reward System, 600 Hours of Management Training, and Two-Day Personal-Development Leadership Training
• In the News: Employee Retention, Distinguishing Themselves from Competition, Using Employee Input for Continuous Improvement

UPDATE 6/3/2008: The ESOP Community Comments on the U.S. Sugar ESOP shares commentary from members of the ESOP community:

• The New York Times Article Continued
• Dispatched With Prejudice
• Some comments on the U.S. Sugar story in The New York Times.

UPDATE 6/6/2008: Published Letter to the Editor Re: U.S. Sugar ESOP shares a Letter to the Editor

Legal Issues

The plaintiffs have created the US Sugar Class Action Lawsuit online case information resource, which includes an amended copy of Johnson, et al. v. White, et al., Case No. 08-80101-Civ-Middlebrooks/Johnson, and other court filings. ESOP not Sweet as Candy for Participants in U.S. Sugar ESOP provides some initial legal thoughts and contains some excellent comments from Corey Rosen, executive director of the National Center for Employee Ownership (NCEO). Rosen has also written The U.S. Sugar ESOP in Context, which discusses four key questions that the New York Times article neglected to ask:

• Should the participants have gotten the same price as the prior offer?
  
• Should the trustee have pushed for a sale of the company?
  
• Was the ESOP a "raw deal" for participants?
  
• Are ESOPs generally a good deal for employees?

Missouri Building LLC v. Clark (In re Seferyn), B.A.P. 10th Cir., No. KS-07-094 (May 15, 2008)

Bankruptcy Appellate Panel Upholds IRA Assets Exclusion discusses how a 10th U.S. Circuit Bankruptcy Appellate Panel ruled that ESOP proceeds rolled into an IRA were excludable from the debtor's bankruptcy estate:

Missouri Building argued the ESOP was not a qualified retirement plan because it did not comply with IRS's Revenue Ruling 2004-4, which meant the IRA assets should be counted among the debtor's bankruptcy estate. "The IRS issued a favorable determination letter specific to the ESOP established by Volo Holdings in its organization form at the time of creation. Missouri Building did not present evidence that the ESOP was established and administered in any way other than the way initially approved by the IRS," the court said.

This is consistent with a 2005 Supreme Court Ruling that exempts IRAs from a debtor's bankruptcy estate.

Related Links:

• IRS Revenue Ruling 2004-4 – Prohibited Allocations of Securities in an S Corporation – This revenue ruling pertains to ESOPs, subchapter S corporations, synthetic equity, nonallocation years, and "listed transactions."
• IRC Section 409(p) Anti-Abuse Testing, History of Regulations, and Private Letter Ruling (PLR) 200804023
• In re Christopher Joseph SEFERYN, Debtor. Missouri Building, LLC, Appellant, v. Carl R. Clark, Trustee, and Christopher Joseph Seferyn, Appellees. , 10th Cir.BAP (Kan.), May 15, 2008
• US Supreme Court Extends Bankruptcy Protection to IRAs

SPD Language Providing Less Plan Benefits Overrules Plan Document Language

In Conflict Between Plan Document and SPD, SPD Prevails to Participant’s Detriment discusses how Kolpacke v. CSX Pension Plan, No. 07-1959 (CA6, May 21, 2008) found that the SPD prevailed in a conflict between the plan document and the SPD, even if the SPD provided less benefits to the participant:

The SPD provided that the plaintiff's benefit under the plan would be reduced by railroad retirement benefits, which are the railroad industry's version of social security benefits. The participant argued that the plan document did not provide for this reduction in benefits, thus the conflict. Plaintiff also argued that CSX was estopped from reducing his benefits by an offset for railroad retirement because CSX provided him with a letter stating that his benefit had already been offset for railroad retirement and would be reduced no further. 9 days after the participant elected to retire, CSX corrected this mistake.

The district court granted summary judgment to CSX. Even though the benefit calculation made according the language in the SPD provided less benefits to the participant than the language in the plan document, the participant did not prevail. In the opinion, the district court cited to Anderson v. Chrysler Corp., 99 F.3d 846 (7th Cir. 1996) for the proposition that where the plan itself gives the employee greater benefits and protection, it should control.

The important takeaway is to make sure your plan document and SPD contain the same plan provisions.

We discussed this topic in detail in Conflicts Between the Plan Document and the Summary Plan Description (SPD), including discussions about the following:

• The plan document and the SPD are written at different times
• The plan document and the SPD are written in different styles
• The plan document and the SPD are written by different people
• Recent court cases provide that the SPD provisions and the interpretation of the provisions overrule the plan document if they benefit the participant
• Recent court case indicates absence of language in the SPD is not fatal if language is in other plan documents
• Do participants even read the SPD?
• How do you resolve a conflict?
• What is a way to minimize the risk of errors?

Cook v. Campbell, 482 F. Supp.2d 1341 (M.D. Ala. 2007)

Court Says LaRue Ruling Doesn't Apply to ESOP Challenge discusses Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), a district court case that rejected an attempt to revive a fiduciary breach case, Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., March 30, 2007), based on the LaRue ruling. The case involved an ESOP, which is “designed to invest primarily in qualifying employer securities”:

"There is no allegation that Plaintiffs could make individual choices as to how the ESOP was funded or that Plaintiffs' losses occurred based on [defendant's] failure to adhere to Plaintiffs' individual directives as to how their accounts (i.e., their proportional share of company stock) were to be maintained," the court said in its opinion.

UPDATED 6/2/2008 to include links to both the original Memorandum Opinion and Order and the Plaintiffs’ Motion to Reconsider.

UPDATED 6/2/2008 to include information from the June 2, 2008 Employee Ownership Update:

"In Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), a district court ruled that a previously decided ESOP case could not be reopened in light of the new legal standard set out in LaRue v. DeWolff, the Supreme Court case that allowed individual defined contribution plan participants to sue for damages to themselves, as opposed to the plan as whole.

In this case, the court had previously denied a claim by the plaintiffs concerning the alleged failure of the fiduciary of an ESOP at Central Alabama Home Health Services to provide for a proper valuation concerning the ESOP's purchase of shares. Now the plaintiffs sought reconsideration in light of LaRue. The court found, however, that even if the plaintiffs' allegations were valid, the actions of the fiduciary would affect the entire plan, not just individual participants. LaRue was premised on the difficulty a plaintiff might have in getting damages when the relief would apply only to that individual and a plan-wide remedy would thus be impractical or inequitable. Here, a plan-wide remedy was already available. Moreover, the court cited the concurring opinion of Chief Justice Roberts expressing concern that LaRue not be read to allow cases to proceed where existing administrative remedies had not been exhausted, as the court found they had not been in this case.

The decision, while hardly surprising in light of the facts of the case, does provide some comfort to those concerned that LaRue would open up another avenue for plaintiffs to plead arguments that would not succeed under prior law."

Nelson v. Hodowal, 512 F.3d 347, 2008 WL 90057, (7th Cir. January 2, 2008)

This abstract discusses Nelson v. Hodowal, 512 F.3d 347, 2008 WL 90057, (7th Cir. January 2, 2008) and affirms that ERISA fiduciaries do not have a legal duty to disclose to participants that they are selling their stock:

In Nelson et al. v. Hodowal et al., the plaintiffs' employer matched employee contributions in company stock. Some months after the company merged with another, the stock value dropped sharply. The plaintiffs sued the original company executives for failing to anticipate the impending drop. They also contended executive fiduciaries intentionally misled workers, withdrawing personal investments in company stock. The executives contended they expected to be replaced by the new company. The Seventh Circuit Appeals Court affirmed the lower court's ruling for the defendants. The court ruled plan fiduciaries are not required to tell participants about their own stock sales, even if they disclose the fact to a third party advisor.

ERISA Class Action Defense Cases-Nelson v. Hodowal: Seventh Circuit Affirms Defense Judgment In ERISA Class Action Holding Plan Fiduciaries Not Required To Disclose "Facts That May Lead To Idiosyncratic Reactions discusses the appeal in more detail:

The sole issue on appeal was "whether the defendants had to tell the participants that the defendants were selling most of their own stock in IPALCO-not only stock held through the Thrift Plan, but also stock that the defendants were able to acquire by exercising vested options that they had received in their roles as managers or directors of Indianapolis Power & Light." Nelson, at *2. In essence, plaintiffs argued that defendants implicitly promoted AES as a good investment "while by divesting their own holdings they demonstrated that their true beliefs were otherwise," a form of implied deceit referred to by the securities law as "scalping." Id. The district court had rejected this argument and expressly found that "the defendants actually (and reasonably) believed everything they told the participants, and that they sold IPALCO stock, and cashed out their options, only because AES had announced that it would replace the management team at Indianapolis Power & Light." Id. In other words, "[t]he defendants were on their way out the door and had no more reason to hold IPALCO (or AES) stock than to hold any other utility stock, and substantial reasons to diversify." Id. Plaintiffs did not challenge these findings on appeal, id., at *3…

Caltagirone v. NY Community Bancorp, Inc., 2007 U.S. App. Lexis 29516 (2d Cir. Dec. 20, 2007)

Appellate Court Affirms District Court Finding That Plaintiffs Lacked Standing To Sue summarizes Caltagirone v. NY Community Bancorp, Inc., 2007 U.S. App. Lexis 29516 (2d Cir. Dec. 20, 2007):

"The plaintiffs in this case alleged that they were participants in an ERISA plan that suffered losses due to fiduciary breaches…The district court held that neither plaintiff was a "participant" in the plans with statutory standing to sue and granted the defendants' motion to dismiss. The plaintiffs appealed…In its decision on appeal, the U.S. Court of Appeals for the Second Circuit explained that the rights of action that the plaintiffs sought to assert were available only to "participants, beneficiaries, or fiduciaries of an employee benefit plan." A "participant" is "any employee or former employee of an employer . . . who is or may become eligible to receive a benefit of any type from an employee benefit plan."

One of the plaintiffs terminated the day prior to the merger and was therefore never an employee of the acquiring company. The Court found that, even though the employee was still a 401(k) participant, they had never been a participant in a plan administered by the defendants and therefore lacked standing to sue.

The other participant received a distribution of their 401(k) balance prior to the acquisition, but rolled the funds into an IRA administered by the bank. Since the employee was no longer a plan participant, she had no claim. This participant was also an ESOP participant, but had no claim because ESOP participants automatically receive allocations of shares and ESOP fiduciaries do not have the authority to choose investments under the plan:

"This plaintiff also participated in an Employee Stock Ownership Plan (ESOP). Unlike with her Savings Plan account, this plaintiff continued to hold her NYCB ESOP account after she left NYCB and through the end of the class period. The Second Circuit pointed out, however, that the plaintiffs' theory of fiduciary breaches had "no application to the actions of the ESOP administrators" because participants in the ESOP, unlike those in the Savings Plan, could not chose among a variety of investment options but were instead granted shares of NYCB by virtue of their employment. Thus, the "failure-to-disclose" and the "imprudent-investment" allegations had no possible application to the ESOP plan, because neither the administrators nor the participants had the power to choose their investments under this plan. Accordingly, the circuit court found that this plaintiff did not have a claim for benefits relating to her ESOP account, and it affirmed the district court's decision."

DelRosario and Taylor v. King & Prince Seafood Corporation

U.S. District Court Opinion Rendered in King & Prince Seafood Corporation ESOP Litigation discusses the opinion rendered by the U.S. District Court for the Southern District of Georgia in DelRosario and Taylor v. King & Prince Seafood Corporation. The article summarized the findings as follows:

"In summary, the court declined to find that plaintiffs had a valid claim to benefits based upon the plan's distribution policies, and found that the trustees had not violated the terms of the plan in fashioning distribution policies. The court left open the possibility of some form of remedy for violation of the consent rule, underscoring the importance of plan administrators' responsibility to provide timely and proper notice to participants. The court also recognized the validity of considering repurchase obligations in connection with distribution policies and declined to second guess the business judgment of trustees in crafting distribution policies."

While the facts and circumstances of this case are unique, here are some takeaways from the case:

1. Repurchase liability funding decisions such as using ESOP cash instead of redeeming the stock is a matter of business judgment.
   
   
2. Changing the distribution policy to manage the repurchase liability is reasonable.
   
   
3. Changing the distribution policy, rather than amending the plan, is not a violation of the anti-cutback rule. This is consistent with IRC Section 411(d)(6)(C) - Minimum vesting standards - Special rules - Accrued benefit not to be decreased by amendment - Special rule for ESOPs, which provides that the distribution provisions of ESOPs may be modified in a nondiscriminatory manner.
   
   
4. Participants must be provided with the appropriate forms and a notice that meets the 402(f) Safe Harbor Notice requirements no less than 30 days (subject to waiver) and no more than 180 days before the date of which a distribution is made. The article discusses the failures in this case that the resulted from not satisfying the 402(f) requirements:
   
   "The court explained that while the trustees may have implemented the distribution rules in accordance with the ESOP and ERISA, it could not find that rank and file terminated participants were apprised of the material rules of the distribution policy. The court found that participants were not provided consent forms more than 30 days prior to distribution, in violation of the rule. The court further found that the failure of the notices to apprise participants of their right to defer distribution until age 65, of their option to roll stock into an IRA, of the availability of the put option periods, and of the tax consequences of their decision violated the consent rule, as did the failure of the notices to inform participants that they would receive a year old valuation."
   
   
5. In addition to ensuring that you are using the most current fair market value, you also need to make sure the value has not become stale. Here is an excerpt from ESOP Planning: Distributions:
   
   Is the fair market value that you are using an accurate reflection of the market value or has the value become "stale"? If you pay someone a distribution on December 15, 2007, based on the December 31, 2006 stock value, the value is almost 350 days old. Some experts would argue that you are not paying the participant at fair market value. Does a stock value become "stale"? If so, when? There is no clear guidance in this area, and the determination of if and when a value becomes "stale" is subjective and is based on the facts and circumstances of your situation.

UPDATE 5/12/08:

Is ESOP Sponsor Liable for Paying Out Sooner Than Required? is an Employee Ownership Update from 2006 that reviews the then pending lawsuit:

In an unusual lawsuit, former employees of King & Prince Seafood are charging that a change in ESOP distribution rules to pay out former participants three years after departure instead of five violated ERISA's anti-cutback requirements. The plan was also changed so that the payout was based on the valuation as of the end of the prior year, rather than when the payout occurred. Paying out sooner than the law requires and basing payments on the last valuation are common plan provisions in ESOPs. A district court certified the case for class action. Employees were upset because under the old rules, they would have received substantially more than under the new ones because the company's stock price rose sharply in the year of the payout. The case Del Rosario v. King & Prince Seafood Corp., No. CVF 204-036 (S.D. Ga. 3/7/06) now must be decided on its merits, but it is a novel theory that what would normally be perceived to be a change in the plan to benefit employees could be interpreted as damaging them by not allowing them the maximum possible time to hold onto their shares.

Order (3/7/06)

LaRue’s Impact on Fiduciary Risk: Number of Lawsuits, Stock Drop Litigation, and Plan Design Litigation

The LaRue Decision Shakes Up Qualified Plan Fiduciaries discusses the impact that LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008) may have on fiduciary risk:

• Number of lawsuits – While it is possible that individual lawsuits could increase, in many cases the amount of damages at the participant level may be too small to justify taking action. Some experts think that this ruling may make it more difficult to proceed with a class action suit.
  
• Stock drop litigation – The most significant impact may be in the number of Stock Drop Litigation suits. While most claims would apply to the plan as a whole, there are ESOP-specific scenarios that could create litigation by individual participants.
  
• Plan design litigation – The article suggests that plan design decisions could create exposure for individual litigation:
  

  For example, while we don't think that administrative errors automatically create fiduciary issues, we do think that independent design decisions might.
  

  Take, for example, the practice of converting terminated participants' ESOP accounts from stock to cash after termination but before distribution. If the stock later goes up considerably in value, could the individual terminees sue the fiduciaries? We think they might be able to do so.
  

  How can one defend against this sort of assault? Well, this is a great example of the real advantage of writing into your document exactly what you intend to do. If the plan provides that terminees' accounts will be treated in this way, and the fact is disclosed in the summary plan description as well, we believe that the exposure is reduced to very little, if any.

Criminal Sentences and Bad Boy Clauses – When ERISA Account Balances Can Be Recovered by the Plan

We recently discussed how a court case provided for Using an Account Balance to Offset Damages Resulting from a Fiduciary Breach. The following items provide some more background on the case, and bad boy clauses, and criminal sentences and ERISA plans:

• "Bad boy" clauses aren't passe after all - but sometimes it takes a judge to do the right thing provides more details about the criminal acts of the case.
  


• It also discusses the pre-ERISA history of Bad Boy Clauses and how they are a violation of the IRC Section 411 vesting requirements.
  


• Qualified Retirement Plan Protection from Creditors discusses how criminal sentences or bad boy clauses are not permitted:
  
  Generally, the terms of a criminal sentence may not order the plan to pay out a participant's benefits to a third party as restitution, even for a crime committed against the employer. For example, suppose an employee embezzled $20,000 from the employer. The employer is not permitted to recover the $20,000 by taking the participant's 401(k) plan assets because of ERISA protection of retirement benefits. There is a limited exception in cases where the crime was committed against the plan. Had the employee stolen $20,000 from plan's assets instead of from the employer, then a Federal court or the U. S. Department of Labor could order the plan administrator to offset the plan's loss against the participant's account. In this case, the participant is presumed to have already received a distribution from the plan for the amount embezzled from the plan.

Fiduciary Convicted of Filing False IRS Form 5500

Company President Pleads Guilty to Lying on Form 5500 and Employer Fined for Lying on Form 5500 discuss how a company president and fiduciary misused plan assets and was convicted of filing a false IRS Form 5500:

The court imposed $153,000 in penalties and fines and a one-year term of federal probation upon Thomas. In 2002,