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Guest Article

Litigation Issues In Cash Balance Plans


by Howard Shapiro /1/ and Robert Rachal /2/

McCalla, Thompson, Pyburn, Hymowitz & Shapiro
Poydras Center
Suite 2800 - 650 Poydras Street
New Orleans, Louisiana 70130
(504) 524-2499
(504) 523-8679

E-MAIL:
Howard@Mtphs.com
Robert@Mtphs.com

Copyright (c) 1999 Howard Shapiro & Robert Rachal
McCalla, Thompson, Pyburn, Hymowitz & Shapiro, L.L.P.


TABLE OF CONTENTS
  1. Introduction
  2. The Basics On Cash Balance Plans
    1. The Pros
    2. The Cons
  3. The Legal Issues
    1. ADEA and Related Issues
      1. "Rates of Accrual" - ADEA and "Frontloading/Backloading"
      2. "Wearaway" Issues Under ADEA
      3. "Intent" and Plan Design
      4. "Disparate Impact" and Plan Design
    2. "Accrued Benefit" Issues - the "Whipsaw" § 205(g) Issue in Early Payouts
    3. Fiduciary and Notice Issues
      1. Fiduciary Communication Issues - the Duty to Disclose "Material Information"
      2. Communicating Differences in Benefits and "Wearaways"
      3. § 204(h) Notice Requirements
      4. Fiduciary Issues in Plan Design and Administration
  4. ERISA Procedural Defenses
  5. Litigation To Date
    1. The Aull v. Cavalcade Pension Plan Case
    2. The Edsen v. Bank of Boston Case
    3. The Corcoran v. Bell Atlantic Corp. Case
    4. The Engers v. AT&T Pension Plan Case
    5. The Eaton v. Onan Corporation Case

I. Introduction

In the past few years a revolution has occurred in the pension area as more and more companies switch from traditional "final average pay" and like pension plans to cash balance plans. The latest estimates are that approximately 22 of the Fortune 100 have adopted cash balance plans and that these types of plans cover eight to nine million workers. /3/ Further, articles come out weekly reporting that other major employers, such as IBM, Citigroup, Aetna and CBS, are switching or are considering switching to cash balance plans. /4/ It is only recently, however, that cash balance plans have entered the general public debate on pension policy through articles in publications such as the Wall Street Journal. Likewise, litigation has lagged behind plan formation, with the six major cases to date having all been filed from the mid-1990's onward. The pace of this litigation, however, is likely to quicken with increased publicity (much of it adverse) and as the ERISA plaintiff's bar and pension public interest groups become more familiar with these types of plans and the arguments and potential grounds for challenging them.

This article examines cash balance plans from a litigation perspective. Section II of this article sets forth the basics on cash balance plans, including why they are being adopted and the source of the controversy regarding cash balance conversions. Section III addresses the types of issues that are being litigated - or that we believe are likely to be litigated - regarding cash balance plans. This section sets forth the basic factual and legal issues by subject matter. Section IV of this article addresses general procedural defenses under ERISA and Section V concludes with a detailed discussion of the litigation to date.

II. The Basics On Cash Balance Plans

A. The Pros

Despite the litigation risks discussed herein, sophisticated employers are switching to cash balance plans in increasing numbers. At its most basic level, a cash balance plan is simply a defined benefit plan that uses a different pension formula than a traditional pension plan. A cash balance plan formula provides a "hypothetical account balance" that looks like a § 401(k) account; this account balance is made up of two components: (i) a work credit (e.g., 3% of pay) and (ii) an interest credit to that account balance (e.g., 6% per year). Other characteristics that are commonly (although they do not have to be) part of a cash balance plan are:

  1. The benefit is somewhat front loaded (and thus is of more value to younger workers) because the account balance earns compounding of interest over a longer period of time;

  2. The benefit of the value of the hypothetical account balance is communicated to the employees at least annually; and

  3. The benefit offered and typically paid is a lump sum upon termination.

In contrast, traditional pension plans are typically heavily back loaded (i.e., benefits accrue mostly in the final years of service) because of a combination of factors: (i) benefits are tied to years of service; (ii) for plans with early retirement subsidies, only those with substantial years of service qualify for those subsidies; and (iii) many plans use "final career average pay" formulas that effectively tie the benefit to the pay earned in the final 5 to 10 years of service. Also, traditional plans use a formula expressing the benefit in the form of an annual benefit commencing at normal retirement age; thus, for those who are far from this age, the benefit that will be due can be calculated only by using significant assumptions as to long-term future employment. The net result of these features is that:

  1. Only those employees who follow the traditional career path of long-term service with one company will qualify for a substantial benefit;

  2. This benefit will be hard to calculate and not have much meaning for employees until they reach ages (typically late 40's to mid 50's) that are near to when they will qualify for this benefit; and

  3. For those employees who are near to qualifying for a substantial benefit, they are effectively in "pension jail" because they cannot change employers without incurring substantial costs in lost benefits.

These differences between a cash balance and a traditional pension plan typically result in the cash balance plan providing a better understood benefit that is of more value to and more equitably distributed among a mobile workforce. Likewise, because cash balance plans are still defined benefit plans, they have certain advantages over defined contribution plans such as § 401(k) plans and the like. A table comparing cash balance plans with traditional defined benefit plans and defined contribution plans discloses that cash balance plans often combine the best features of each:

Characteristic Traditional Defined Benefit Plan Defined Contribution Plan Cash Balance Plan
Employee appreciation Low High High
Investment risk/profit Employer Employee Employer
Portability Low High High
Usual payment form Annuity Lump sum Lump sum or Annuity
Ability to grant past service Yes No Yes
Ability to grant post-retirement increases Yes No Yes if annuity
Ability to provide early retirement subsidies, retiree medical and other ancillary benefits Yes No Yes
PBGC coverage Yes No Yes
Funding flexibility Yes No Yes

Notably, cash balance conversions have occurred at the highest rates in industries that have gone from a regulated to a dynamic business environment (e.g., financial services, telecommunications). In these industries, cash balance plans often fit the business goals of attracting a more mobile work force. For many companies, though, their human relations and business goals are targeted to encouraging employees to remain with the company throughout their career, particularly as they approach the senior status associated with the ages around the late 40's to early 50's. For these companies, it typically makes little business sense to convert from a traditional pension plan (which characteristics further these goals) to a cash balance plan.

B. The Cons

Despite the favorable aspects discussed above, cash balance plans have become highly controversial and have been subjected to political scrutiny and significant national negative press. /5/ To be more precise, this controversy and negative press relates to the conversion of traditional plans to cash balance plans, which is how the vast majority of cash balance plans come into being. This controversy and negative press from conversions occurs because employees in around the 40 to 50 year old age bracket receive the worse of both plans - their first 20 or so years of accrual were low because they were in a back loaded traditional plan while their last 15 or so years of accrual is likewise low because they are now in a more front loaded cash balance plan. In other words, they have lost the large accrual increase associated with the last years of employment in most traditional plans. The chart below illustrates this dynamic by using a 50 year old employee who worked his first 30 years under a traditional plan and will, post conversion, work his last 15 years under a cash balance plan. The chart compares two cash balance plans with a traditional plan, each of which assumes accruals start at age 20 and accrue benefits to the same point of $180,000 at age 65. It is assumed both cash balance plans have typically level accruals of $20,000 every five years whereas the traditional plan has the typical back-loaded jump in the final 15 years of service. Finally, one cash balance plan has no "wear away" (a period of no accruals detailed below) while the other has a five-year "wearaway."

COMPARISON CASH BALANCE PLAN CONVERSION

Cash Balance Plan conversion illustration

As the above chart shows, it is not unusual in some cash balance conversions for the 40 to 50 year old employee to lose one-third to as much as one-half of his expected pension. Although the lost future pension increase was only an expectation - not a legal entitlement - this loss has created disgruntled employees who often (i) complain to the press, government agencies and politicians and (ii) are willing to initiate or join suits to challenge the plans. Employees have also complained and are suing over claims that companies misled or failed to inform them about the prospective effects of the cash balance conversions.

Many companies have dealt with these employee morale and related issues by offering "transition benefits" that lessen or eliminate the loss. Although a detailed discussion of the types and methods of transition benefits is beyond the scope of this article, the two basic types of transition benefits and their major pros and cons are listed below:

Type of Transition Benefits for Long-Term EmployeesMajor ProsMajor Cons
Allow certain groups of employees to elect Cash Balance plan or stay in traditional plan
  • Employees get to choose what is best for them
  • Risks of suit are lessened
  • Can be costly
  • Can muddle human relations goals sought by conversion
  • Need to give employee sufficient information to make informed choice
Provide certain groups of employees some enhancement (e.g., higher accrual rates, lump sum bumps)
  • Can accurately target how much and who want to benefit
  • Can complicate plan administration
  • "Transition cliffs" can create own groups of disgruntled employees

III. The Legal Issues

The primary court claims against cash balance plans arise under ERISA and the Age Discrimination in Employment Act ("ADEA"). /6/ To date, these claims can be categorized into three basic types: (1) technical "rate of accrual" and "whipsaw" claims; (2) traditional age discrimination claims; and (3) disclosure claims. The technical claims are caused by the fact cash balance plans do not fit neatly into ERISA's accrual and vesting rules, which rules were designed for traditional pension formulas. Traditional age discrimination claims are targeted against the employer as plan sponsor/designer and involve claims that the plan was adopted, designed, or is being administered or used to discriminate against older workers. Finally, disclosure claims assert the employer or plan fiduciaries failed to comply with their statutory and fiduciary obligations under ERISA to inform - or at least not mislead - the participants regarding the effect and significance of the cash balance conversion. Details on these various claims are set forth in the next sections.

A. ADEA and Related Issues

Cash balance plans receive much adverse publicity premised on the notion they discriminate against older workers. Much of the litigation has likewise addressed these issues, with one focus being that the cash balance formula itself is inherently discriminatory and violates the Age Discrimination in Employment Act ("ADEA") and ERISA prohibitions against ceasing or reducing "the rate of an employee's benefit accrual . . . because of the attainment of any age." /7/ Likewise, some are claiming that "wearaways" (i.e., setting the opening account balance below the accrued benefit) violate ADEA because they eliminate accruals for older workers for certain periods of time. Finally, some litigants claim the adoption of cash balance plans may itself be discriminatory because of the knowledge such plans may adversely affect older workers.

1. "Rates of Accrual" - ADEA and "Frontloading/Backloading"

The crediting of interest in cash balance plans does not fit neatly within the "backloading" or the "frontloading"/age discrimination accrual rules. Fortunately, as detailed at the end of this section, the IRS has provided some guidance so that cash balance plans may comply with these accrual rules; this guidance approves "frontloaded plans" by distinguishing between frontloading and age discrimination.

The cause of the "frontloading" and the "backloading" claims is the handling of the compounding of the interest credit in the cash balance formula. Cash balance formulas do not fit neatly within the accrual rules under § 204(b) of ERISA because these rules were designed with traditional "career average pay" and "final average pay" formulas in mind. In contrast, in a cash balance formula if interest is credited each year as earned, the interest credit rises yearly as the account balance increases from prior accruals. Over time, some could argue this may violate the "backloading" rules of § 204(b)(1)(A)-(C) of ERISA by, e.g., causing the rate of accrual to be more than 133% of any prior year's rate. On the other hand, if the cash balance plan is "frontloaded" - i.e., it credits the future compounding of the interest credit in the year in which the interest credit is earned - some argue the rate of accrual appears to decrease in violation of the age discrimination provisions of § 204(b)(1)(H)(I) of ERISA that prohibit reduction in the rate of accruals "because of the attainment of any age." /8/ The following tables and graph (which are actuarially simplified for purposes of demonstration) illustrates these principles:

TABLE 1 - BACKLOADED PLAN
INTEREST EARNED EACH YEAR
(Assuming $20,000 pay, 5% pay credit,
6% interest credit, annuity factor of 10,
and normal retirement age of 65)

Age Pay Credit Interest Credit Account Balance Benefit Accrual Rate of Benefit Accrual
40 $1000 0 $1,000 $100 0.50%
41 $1000 $60 $2,060 $106 0.53%
42 $1000 $124 $3,184 $112 0.56%
43 $1000 $191 $4,375 $119 0.59%
44 $1000 $263 $5,638 $126 0.63%
45 $1000 $338 $6,976 $134 0.67%
46 $1000 $419 $8,395 $142 0.71%
47 $1000 $504 $9,899 $150 0.75%
48 $1000 $594 $11,493 $159 0.79%
49 $1000 $690 $13,183 $169 0.85%
50 $1000 $791 $14,974 $179 0.90%

TABLE 2 - FRONTLOADED PLAN
INTEREST CREDITS ACCRUED BY PROJECTING TO NRA
(Assuming $20,000 pay, 5% pay credit,
6% interest credit, annuity factor of 10,
and normal retirement age of 65)

Age Pay Credit Earned and Projected Interest Credit Projected Account Balance Benefit Accrual Rate of Benefit Accrual
40 $1000 $3,292 $4,292 $429 2.15%
41 $1000 $3,049 $8,341 $404 2.02%
42 $1000 $2,820 $12,161 $382 1.91%
43 $1000 $2,604 $15,765 $360 1.80%
44 $1000 $2,400 $19,165 $340 1.70%
45 $1000 $2,207 $22,372 $321 1.61%
46 $1000 $2,026 $25,398 $303 1.52%
47 $1000 $1,854 $28,252 $285 1.43%
48 $1000 $1,692 $30,944 $269 1.35%
49 $1000 $1,540 $33,484 $254 1.27%
50 $1000 $1,396 $35,880 $240 1.20%

Rates of Accrual illustration

As the foregoing graph shows, in a "backloaded" plan the rate of accrual rises as the account balance increases because the interest credits become larger; in a "frontloaded" plan the rate decreases each year because there is one less year of interest compounding. On remedies, the IRS can ultimately disqualify a plan if it violates the "backloading" rules or the rules against age discrimination. The courts are just beginning to deal with "backloading" issues in suits brought under ERISA: To date, one court noted it could reform the plan to comply with the accrual rules, but it would remand to give the plan trustees the first opportunity to correct the plan terms. /9/

Fortunately, the IRS (the agency charged with interpretation of the accrual provisions under the IRC, ERISA and ADEA) /10/ has provided a method for cash balance plans to resolve the "backloading"/"frontloading" dilemma. Specifically, the IRS requires plans to be "frontloaded" - i.e., interest credits must be projected and accrued to normal retirement age ("NRA") in the year in which the interest credit is earned. If the plan is frontloaded, then the IRS deems that the decrease in rate of accrual caused by this frontloading is not on account of age. The IRS has promulgated this guidance in three separate releases.

In IRS Notice 96-8 (released Jan. 18, 1996) /11/ the IRS, among other things, suggested it would approve cash balance plans only if they are frontloaded. This notice defined cash balance plans as either "backloaded interest credit plans" or "frontloaded interest credit plans." The IRS then states that it did not believe "backloaded interest credit plans" could satisfy any of the accrual rules and also opined that "benefits attributable to interest credits are in the nature of accrued benefits . . . and thus, once accrued, must become non-forfeitable." /12/

In the Preamble to the September 19, 1991 final regulations on "Nondiscrimination Requirements for Qualified Plans," /13/ the IRS specifically provides that frontloading of a cash balance plan does not violate the prohibitions against reductions in the rate of accrual based on age:

Among other requirements, the interest adjustments through normal retirement age must be accrued under the plan in the year the hypothetical allocation in which they relate is accrued . . . . The fact that interest adjustments through normal retirement age are accrued in the year of the related hypothetical allocation will not cause a cash balance plan to fail to satisfy the requirements of section 411(b)(1)(H), relating to age-based reductions in the rate at which benefits accrue under a plan. /14/

This Preamble did not explicate the basis for that statement, leading some commentators to suggest it should thus be due little or no weight by the courts. /15/ However, the IRS's previous guidance related to age discrimination and rates of accrual provide a sound basis for this statement. In the temporary regulations issued on April 11, 1988 /16/ addressing these issues, the IRS noted the following:

  • A defined benefit plan does not cease or reduce the rate of accrual on the basis of age "solely because of a positive correlation between increased age and a reduction or discontinuance in benefit accruals or account allocations under a plan." /17/ and

  • Plans can provide for benefit accrual reductions that will closely correlate to age (and that in fact must decrease for each participant as he gets older), e.g., provide for 2% credit for first 15 years of service and 1% thereafter. /18/

To sum up, IRS guidance provides that positive correlation between age and the rate of accrual is not, in itself, discrimination on the basis of age. This is consistent with ADEA and the caselaw under ADEA in which the Supreme Court itself has ruled that acting based on "reasonable factors other than age" - even if those factors strongly correlate with age such as seniority, years of service, or salary - is not age discrimination. /19/ Thus, that the rate of accrual decreases because of the compounding of interest is not the same thing as decreasing because of age. It is mathematics, not age, reflecting the unexceptional fact that a younger employee has more time to build up an account balance. /20/ This result is also supported by common sense and the economic realties of the accruals. If the cash balance plan has been properly designed to avoid "whipsaws," then how projected interest is "accrued" does not affect what the participant receives. Rather, the participant receives the pay credit and interest credit charged to the hypothetical account balance until the date of distribution. Accordingly, for plans using level accruals (some plans provide enhanced pay credits based on age or length of service) the employee is treated the same regardless of age: A 50 year old would receive the same distribution as a 25 year old with the same pay and years of service. /21/ That the IRS requires a plan to treat projected interest as "accrued" for purposes of complying with technical accrual rules does not affect the benefits paid - nor should it somehow make the employer or plan's motivation or action discriminatory. Moreover, although the "equal cost" defense (detailed in subsection 3 below) does not by its terms apply to the "rate of accrual" section of ADEA, /22/ the economic realities of the accruals in which all employees are treated the same regardless of age - they thus have "equal cost" - would counsel against construing the "rate of accrual" section to proscribe the IRS-mandated handling of projected interest. /23/

To date, the most analogous cases address "imputed service" in which an employee is treated as if he worked until normal retirement age to calculate the value of a benefit. The argument in this context (like the "rate of accrual" argument in the cash balance context) is that imputed service makes the benefit calculation a function of age: The imputed service is tied directly to age of hire, with younger employees receiving more "imputed service" because they were hired at a younger age. In Lyons v. Ohio Educational Ass'n /24/ the Sixth Circuit held this imputed service does not violate ADEA. First, the court noted plaintiffs had failed to produce any evidence of a discriminatory intent in adoption of the "imputed service"; rather the record showed imputed service was adopted for the "reasonable factors other than age" of buying out expensive workers by offering them the same benefit they would have received had they stayed at work. Evidence of intent could no be inferred from the "disparate impact" of the imputed service because this would circumvent the limitations on disparate treatment claims. /25/ Finally, the court noted that even if plaintiff's theory was accepted, it does not prove discrimination because it merely reflects that younger workers will accrue more benefits because they have more time to accrue those benefits:

Clearly, an employee who began work when older will have less time to accumulate years of service, and therefore will receive a lower benefit upon reaching [the normal retirement age] 62, other things being equal; this is true under either early or normal retirement. . . . [T]he disparity that plaintiffs find objectionable is a product of their length of service and age when originally hired by [the employer]. Thus any disparity merely reflects the actuarial reality that employees who start work at an early age accumulate more years of service in reaching the normal retirement age of 62. /26/

This holding is supported by the Seventh Circuit's Quinones v. City of Evanston opinion in which the court, per Judge Easterbrook, noted this same reasoning justifies disparities in a defined benefit plan under an "equal cost" defense as long as the employer contributed the same percentage for each employee. /27/ In contrast, the Ninth Circuit in the "imputed service" case of Arnett v. California Public Employees Retirement System /28/ concluded a disparate treatment claim was stated because "imputed service" meant the benefit varied based on age of hire. The court left open the question whether drafting a plan with knowledge of this effect sufficed in itself to establish discrimination. /29/ The court distinguished Lyons because the Sixth Circuit, unlike the Ninth Circuit, does not apply a "but for" test for age discrimination. /30/

These age discrimination in "rates of accrual" issues have been raised in relation to cash balance plans in Aull v. Cavalcade Pension Plan, Eaton v. Onan Corporation and Engers v. AT&T Management Pension Plan. The courts, however, have yet to rule on whether they will follow the IRS guidance. It must also be noted that the IRS has recently given troubling signals that it may be reconsidering its guidance. Initially, Carol Gold, the director of the IRS Employee Plans Division, in March 1999 stated:

Gold, however, said IRS should reexamine the issue of whether cash balance plans result in a reduction of benefits based on age.

Gold said that even though IRS, in previously published guidance, said it is not a problem, "I think we need to take another look at the issue." /31/

Since then, the IRS has sided with the plaintiffs on other issues in two of the cash balance cases currently in litigation, Eaton v. Onan Corporation and Lyons v. Georgia Pacific. As part of the Eaton case the IRS District Director for the Cincinnati office has also questioned whether cash balance formulas "satisfy the clear and straightforward requirement" against reductions in rates of accrual because the formula's "benefit accrual rate decreases as a participant attains each additional year of age." /32/ In other words, at least one major IRS official has apparently bought into the belief the cash balance formula is inherently discriminatory. In September 1999, the IRS required determination letters for cash balance plans to be referred to and handled by the National Office - which the IRS characterizes as a "delay" but not a "freeze" on these approvals. /33/ The IRS (along with the Department of Labor and the EEOC) is also examining the age discrimination issues, including the rate of accrual issue, and has asked for public comments in an attempt to publish guidance by the end of 1999. /34/

2. "Wearaway" Issues Under ADEA

"Wearaways" are one of the most controversial policy issues in cash balance plans. "Wearaways" arise when a defined benefit plan is converted from a traditional pension formula to a cash balance formula and the opening hypothetical account balance is set or falls below the "accrued benefit" under the prior plan. Because ERISA § 204(g) prohibits any "cutback" in that accrued benefit, the plan must offer the accrued benefit form the old plan as long as it is greater than the hypothetical account balance. /35/ The net result is that an employee will fail to accrue an increase in benefits until his hypothetical account balance and subsequent accruals exceeds his former accrued benefits - i.e., the difference "wearaways." The following table and graph (actuarially simplified) illustrate this principle:

TABLE 3 - WEARAWAY
(Assuming $20,000 pay, 5% pay credit, 6% interest credit)

Age Pay & Earned Interest Credit Hypothetical Account Balance Accrued Benefit Increase In Accrued Benefits Real Rate of Benefit Accrual
Opening Balances - $50,000 $55,000 - -
40 $1000 $51,000 $55,000 0 0.00%
41 $1060 $52,060 $55,000 0 0.00%
42 $1124 $53,184 $55,000 0 0.00%
43 $1191 $54,375 $55,000 0 0.00%
44 $1263 $55,638 $55,638 $638 0.32%
45 $1338 $56,976 $56,976 $1,338 0.67%
46 $1419 $58,395 $58,395 $1,419 0.71%
47 $1504 $59,899 $59,899 $1,504 0.75%
48 $1594 $61,493 $61,493 $1,594 0.79%
49 $1690 $63,183 $63,183 $1,690 0.85%
50 $1791 $64,974 $64,974 $1,791 0.90%

Wearaway illustration

As the foregoing graph demonstrates, "wearaways" can result in employees failing to accrue any increase in their pension benefits for years. This raises several issues under ERISA and ADEA. For example, participants can argue that creation of the "wearaway" was age discriminatory - or at least provides evidence of age discrimination - because older workers are more likely to be adversely affected by the wearaway. Under ERISA an argument can be made the plan fiduciary has a duty to inform employees of this "wearaway" - which is discussed in the following fiduciary section of this article. "Wearaways," especially when coupled with the frontloaded nature of cash balance plans, also greatly increase the reduction in rates of accrual for long-term employees. Finally, it could be argued "wearaways" violate the "backloading" accrual rules because any future accrual is going to be more than 133% of the zero accrual during the wearaway period. Fortunately, ERISA requires accruals to be judged based on the amended plan - which should mean judged based on changes to the hypothetical account balance that continues to increase during the "wearaway" period. /36/

Although the Supreme Court in cases such as Lockheed Corp. v. Spink, /37/ grant an employer broad authority as "settlor" to design plan terms, "wearaways" can - and are - being challenged based on the notion they were adopted for improper purposes. Fiduciary issues regarding setting the opening account balance were raised in the Corcoran v. Bell Atlantic /38/ case discussed below. The claim "wearaways" are discriminatory is being presented in the Engers v. AT&T Management Pension Plan case discussed below.

3. "Intent" and Plan Design

It is no surprise that a prudent employer will conduct studies before it converts an existing plan to, or adopts from scratch, a cash balance pension plan. These studies typically analyze how benefits would be paid out under different formulas based on, e.g., compensation, length of service, and the ages of the employees. If the plan is a conversion from a "final average pay" plan, these studies often show substantial decreases in benefit accruals for long term employees as compared to the "final average pay" jump. An argument can be made (and is being made in the Eaton v. Onan Corp. and Engers v. AT&T Management Pension Plan cases discussed below) that it constitutes intentional age discrimination to adopt a cash balance plan formula with knowledge that the plan will adversely affect older employees.

Although no court had yet directly ruled on this issue in the cash balance context, such a claim would have at least three substantial hurdles to cross. /39/ First, is the Supreme Court's principle in Lockheed Corp. v. Spink /40/ that an employer acts as a settlor in designing plans, including pension plans, and has no obligation to provide any benefits under ERISA:

Nothing in ERISA requires employers to establish employee benefit plans. Nor does ERISA mandate what kind of benefits employers must provide if they choose to have such a plan.

. . .

Plan sponsors who alter the terms of a plan do not fall into the category of fiduciaries. . . . .[E]mployers or other plan sponsors are generally free under ERISA, for any reason at any time, to adopt, modify, or terminate welfare plans. When employers undertake those actions, they do not act as fiduciaries, but are analogous to the settlors of a trust. /41/

Thus, the termination of the old plan cannot be, in itself, discriminatory. This means any comparison between the benefits provided under the new cash balance plan with those that could have been earned under the old plan would be based on the false legal premise that there was some entitlement to those (now-ex) future benefits. Stated another way, neither ERISA (or ADEA) was meant to "lock in" older workers to higher benefits or to inject courts into redesign of benefits and compensation plans. /42/

Second, is the principle under ADEA /43/ and the Supreme Court's case Hazen Paper Co. v. Biggins, /44/ that acting based on "reasonable factors other than age" - even if those factors strongly correlate with age such as years of service, seniority or salary - is not age discrimination. Thus, if courts apply these two principles to cash balance plan design, a plaintiff should not be able to show such design was age discrimination simply because the employer knew its design would have an adverse impact on older employees; rather, a plaintiff would need to show the employer adopted the design with the intent to have that effect, i.e., "because of" age. In most cases this should not be possible, as employers are adopting plan designs based on numerous "factors other than age," e.g., costs, mobility of workforce.

Third, is the point detailed in the Lyons case discussed above that younger employees typically accrue more benefits because of the unexceptional proposition that they are in the pension plan for a longer period of time, not because of age. On a related point, at least for plans designed without "wearaways," those plans should be able to establish the "equal cost" defense. Under ADEA, discrimination based on age regarding an employee's "terms, conditions, or privileges of employment" is nonetheless lawful if the employer establishes for its benefit plan that "where for each benefit . . . the actual amount of payment made or cost incurred on behalf of an older worker is no less than that made or incurred on behalf of a younger worker." /45/ If the cash balance plan has been properly designed to avoid "whipsaws," then for plans using level accruals /46/ the employee is treated the same regardless of age: A 50 year old is credited and would receive the same distribution as a 25 year old if they had the same pay and years of service. /47/ The "cost" or actual amount of payment made for both the younger and older worker is equal, e.g., each receives a credit of 5% of pay and a 6% interest credit. Moreover, the Seventh Circuit in Quinones has noted that a younger employee's ability to grow an account balance for a longer period does not affect this defense because the amount contributed is the same for each:

An employee who works under a defined-contribution plan between the ages of 25 and 45 will have more in the account at age 65 and receive a higher annual pension than an employee who works between the ages of 45 and 65. Because this difference does not violate the ADEA (recall that the employer contributes to the account an identical percentage of salary for both workers) it would make no sense to say that an equivalent adjustment to a defined-benefit plan violates the Act. And the EEOC's [equal cost] regulation has reached this conclusion. /48/

Finally, in most instances it would be unreasonable to infer a discriminatory intent from the loss of future accruals typically involved in a cash balance conversion. Plaintiffs often argue because these loss of future accruals adversely affect older workers they must have been designed to get rid of these older workers - thus, this plan change in itself suggests discrimination. But, if this were the business goal, companies could simply and directly freeze their plans (thus incurring no future accrual cost) and/or use plan assets to offer early retirement packages (which are authorized under ADEA) to induce older workers to leave. In other words, it makes no sense to infer discrimination when companies have cheaper - and lawful - ways to accomplish the purported prohibited goal.

4. "Disparate Impact" and Plan Design

As noted, much of the negative publicity surrounding cash balance plans seems to focus on the claim these plans adversely affect older, long service workers - i.e., these workers were harmed by going from "final average pay" plans that were age-favored to age-neutral cash balance plans. An "intent" claim would likely, as discussed above, run into proof that the cash balance plan was likely adopted for numerous "reasonable factors other than age" such as to lower costs, to provide a better understood benefit, or to better match a mobile workforce. Such a claim may also be legally categorized as a "disparate impact" claim. As detailed below, this claim would likewise be subject to substantial hurdles.

A "disparate impact" claim is premised on proof that a facially neutral policy or practice that has a significant adverse impact based on the prohibited characteristic may be unlawful simply because of that adverse impact, even without proof of any discriminatory intent. /49/ The basic proof scheme for such a claim is as follows:

  1. Plaintiff must make out a prima facie case by showing the challenged practice causes a statistically significant adverse impact (i.e., typically at least 2 standard deviations) based on the prohibited characteristic;

  2. The employer may rebut this prima facie case by, e.g., establishing the "business necessity" of the challenged practice; and

  3. The plaintiff can rebut this defense if he or she can show the employer refused to adopt an effective alternative practice with lesser adverse impact. /50/

Many courts, however, do not recognize "disparate impact" claims at all for age discrimination under ADEA: Today only the Second, Eighth and Ninth Circuits explicitly recognize such a claim. /51/ Even if this "disparate impact" claim were recognized in general, it is questionable whether it would be applied in the pension context: One court has noted that virtually any cutback in wages or benefits is likely to have an adverse impact based on age because older workers tend to earn more and have greater benefits. /52/ This court recognized that disparate impact theory was never meant to "lock in" older workers to higher benefits or to inject courts into redesign of benefits and compensation plans. /53/

Finally, any disparate impact claim based on comparing the benefits provided by the old "final average pay" plan with the benefits provided by the converted to new cash balance plan would be based on a false premise: That the employee was entitled to continuation of that age-favored "final average pay" plan. Rather, as the Supreme Court has repeatedly stated (and as ERISA itself provides) an employer has no obligation to provide any benefits under ERISA and may freeze or terminate that plan at anytime. This freeze or termination would have a far larger disparate impact than a plan conversion and yet, unless ERISA and the Supreme Court's statements were to be robbed of meaning, would thus not be subject to challenge on a disparate impact theory. This means that any disparate impact challenge (even if allowed) would have to be limited to analysis of the benefits provided by the new cash balance plan. Because these plans are typically age neutral and adopted for substantial business reasons, there is usually no adverse impact. Stated another way, a plaintiff should not be able to make out a disparate impact claim by comparing an age-favored plan to an age-neutral plan because there is no legal (or policy) entitlement to continuation of that age-favored plan.

B. "Accrued Benefit" Issues - the "Whipsaw" § 205(g) Issue in Early Payouts

"Accrued benefit" issues can arise in numerous contexts in the design and implementation of cash balance plans. For example, as noted above, ERISA § 204(g) prohibits the amendment converting a traditional plan to a cash balance plan from decreasing the "accrued benefit" under the traditional plan. This leads to "wearaways" if the opening hypothetical account balance is set below this amount. The most significant "accrued benefit" issue, however, involves the payment of the hypothetical account balance as a lump sum at termination. Cash balance plans are typically designed to pay this benefit at termination and this balance is also what is communicated to the employees as their "benefit." ERISA, however, was not designed with cash balance plans in mind and, instead, is premised on the notion that in a defined benefit plan the benefit due is an annuity beginning at the normal retirement age, typically age 65. ERISA enforces this obligation through several interrelated provisions:

  • ERISA § 3(23) /54/ defines "accrued benefit" as the benefit "expressed in the form of an annual benefit commencing at normal retirement age";

  • ERISA § 205(a) & (b)(1)(A) /55/ provide that all defined benefit plans must pay that "accrued benefit" in the form of a qualified joint and survivor annuity; /56/

  • ERISA § 205(g) /57/ & 203(e) /58/ provide that a lump sum may be immediately distributed if (i) its present value of the accrued benefit is less than $5,000 and (ii) the present value is determined used the approved interest rates and mortality table in 205(g);

  • ERISA § 205(g) /59/ & 203(e) /60/ provide that for distributions greater than $5,000, they can be made only if (i) the participant and spouse elect to receive the lump sum benefit and (ii) that lump sum is calculated as the present value of the accrued benefit using approved mortality tables and the "GATT rate" - i.e., the annual rate of interest on 30 year Treasury securities;

  • ERISA § 203(a) /61/ requires that all vested benefits are nonforfeitable.

The net result of these provisions (and the parallel IRC provisions of §§ 411(a) & 417(e)) /62/ is that to distribute a lump sum, the plan must calculate what the hypothetical account balance would be at normal retirement age under the plan (typically age 65) and then discount that value to present value at date of distribution using the approved mortality tables and GATT rates. Some cash balance plans have provided for interest rate credits greater than the GATT rate, which can result in the value of the discounted present value of that accrued benefit being greater than the hypothetical account balance at termination. Put simply, the hypothetical account balance grows at a higher rate than the rate at which it is being discounted. The following table and graph illustrate this "whipsaw" principle assuming only a .5% whipsaw caused by using a 6% interest credit and a 5.5% GATT rate:

TABLE 4
"WHIPSAW" FROM PROJECTION
TO AND FROM NRA

-Hypothetical Balance
Projected Forward
At 6% to NRA
Accrued Benefit Discounted at 5.5%
to Date of Distribution
Terminate and Distribute at Age 49 $50,000 $54,187
Age 50 $53,000 $57,167
Age 51 $56,180 $60,311
Age 52 $59,551 $63,628
Age 53 $63,123 $66,809
Age 54 $66,911 $70,484
Age 55 $70,926 $74,360
Age 56 $75,182 $78,450
Age 57 $79,692 $82,765
Age 58 $84,474 $87,317
Age 59 $89,542 $92,119
Age 60 $94,915 $97,186
Age 61 $100,610 $102,531
Age 62 $106,646 $108,170
Age 63 $113,045 $114,120
Age 64 $119,828 $120,396
NRA Age 65 $127,018 $127,018

Whipsaw illustration

As the foregoing example illustrates, the "whipsaw" can result in substantial increases in the hypothetical account balance. Not surprisingly, this "whipsaw" issue has been raised in three of the five cases litigated to date, i.e., the Aull, Edsen, and Georgia Pacific cases. In the Edsen case discussed in detail below, the district court approved use of a two-tier interest credit structure (i.e., a higher interest credit for active service and a lower 4% credit once an employee terminated and takes his distribution) that resulted in the hypothetical account balance at termination/payment always being greater than the present value of the accrued benefit. /63/ At least one recently designed cash balance plan has attempted to avoid this issue by defining NRA to equal vesting - i.e., NRA is defined as five years of service. /64/ For its part, the IRS has provided "safe harbor" guidance on this issue in Notice 96-8, which discusses proposed regulations to address this issue. To achieve this "safe harbor" IRS Notice 96-8 requires:

  1. The plan be "frontloaded" - i.e., that it accrues the interest credit projected to NRA in the year in which the interest credit is earned;

  2. The plan use the GATT rate for interest credits or no greater than the approved rates set forth in the Notice, e.g., the CPI plus 3%, discount rate on 6 month T-Bills plus 150 basis points.

If the foregoing is followed, the IRS assumes that the approved rates do not exceed the GATT rates and deems that a plan has made a "reasonable good faith" interpretation of applicable law. The one case to date to consider Notice 96-8, Edsen v. Bank of Boston, /65/ quoted parts of this notice approvingly in upholding a non-safe harbor "two-tiered" interest crediting structure. Although no court has ruled on this issue yet, it appears highly likely that a court would defer to this IRS guidance in upholding a plan that followed the Notice 96-8 "safe harbor" approach. /66/

C. Fiduciary and Notice Issues

1. Fiduciary Communication Issues - the Duty to Disclose "Material Information"

Courts are using the Restatement (Second) of Trusts /67/ to begin to impose "duties to inform" of "material information" on ERISA fiduciaries. /68/ Section 173 of the Restatement (Second) of Trusts imposes two basic "duties to inform" on fiduciaries. The first requires the fiduciary to provide "complete and accurate information" upon request:

The trustee is under a duty to the beneficiary to give him upon his request at reasonable times complete and accurate information as to the nature and amount of the trust property . . . /69/

The second duty requires the fiduciary, in certain limited circumstances, to disclose information even if there is no request or inquiry:

Ordinarily the trustee is not under a duty to the beneficiary to furnish information to him in the absence of a request for such information. . . . [H]e is under a duty to communicate to the beneficiary material facts affecting the interests of the beneficiary which he knows the beneficiary does not know and which the beneficiary needs to know for his protection . . . " /70/

Under the Restatment this duty to inform arises only when (i) the facts are "material" to the beneficiary, (ii) the fiduciary "knows" the beneficiary is unaware of these facts, and (iii) the beneficiary needs to know these facts to protect his interests. Courts have varied on how stringent, if any, of a "duty to inform" of "material information" they will impose. /71/ Some examples of situations in which courts have imposed this duty include:

  • Disclosing to persons who are losing group health coverage their health plan continuation and conversion rights and the procedures needed to obtain those rights; /72/

  • Disclosing to HMO participants financial incentives that may influence medical treatment; /73/

  • Disclosing to prospective retirees any early retirement packages or severance plans that are available or under "serious consideration"; /74/

  • Disclosing to retirees the irrevocability of a "joint and survivor" election; /75/ and

  • Disclosing to early retirees the tax consequences of electing a lump sum form of payment. /76/

This "duty to inform" issue has not yet been pursued in cash balance litigation. Note, also, that this duty to inform can arise in the union collective bargaining context under § 8(a)(5) of the National Labor Relations Act ("NLRA"), and is being pursued under the NLRA in relation to a cash balance conversion. /77/ The next section addresses how courts might construe breach of fiduciary duty claims as applied to various issues that may arise under cash balance plans.

2. Communicating Differences in Benefits and "Wearaways"

As noted earlier, one of the major criticisms leveled against cash balance plans is that they adversely affect older workers. The other major criticism is that employees are not told how their benefits are affected by a conversion to a cash balance plan, e.g., will they be subject to "wearaway" periods; how do their new benefits compare to the benefits they would have earned under the old plan. /78/ In response to this criticism, the Senate and House have recently introduced bipartisan legislation entitled the "Pension Right to Know Act." /79/ This act would amend ERISA § 204(h) to require "large" employers (defined as plans with more than 1,000 participants) who change their plans to cash balance plans to provide individualized pension statements comparing their pension before and after conversions at: the date of conversion, and three, five and ten years after the conversion, and at NRA. /80/ Unless and until this or similar legislation is passed, disclosure in this area will be controlled principally by § 204(h) of ERISA (discussed in the next section) and the fiduciary duties discussed below.

Under a fiduciary duty claim, "wearaways" and comparisons of benefits raise different issues. The duty to communicate "wearaways" is the stronger argument. Applying the factors from § 173 of the Restatement (Second) of Trusts, the argument would be:

  1. The fact that the employee is not going to accrue any pension benefits for several years is "material" to that employee;

  2. The plan fiduciary "knows" or at least strongly suspects the employee is unaware of these facts, and;

  3. The employee needs to know these facts to protect his interests by, e.g., considering alternative employment and/or alternative retirement savings strategies.

The disclosure claim will be strengthened if, during the "wearaway" period, the employer provides the employee annual or projected benefit statements showing increases in the hypothetical account balance without disclosing the accrued benefit. The employee can argue this was a misrepresentation by asserting a "reasonable employee" would assume that this increase in account balance was an increase in pension benefits. If the court agrees, it will be far more likely to find a fiduciary breach. /81/ Of course, these claims may be avoided by simply providing on the account statement the balance of the "accrued benefit" and explaining that the employee is entitled to the greater of the accrued benefit or the hypothetical account balance.

The same type of arguments can be made for general comparisons of benefits earned under the cash balance plan as opposed to what may have been earned had the old plan been kept in existence. There is one crucial difference, however: In the wearaway context the accrued benefit is a relatively fixed amount to which the employee is already entitled, /82/ whereas projections of benefits under the old plan presupposes there was some entitlement to those continued accruals. This presumption is false under ERISA, as an employer has the right at any time to freeze or terminate accruals. /83/ A notice that in converting to a cash balance plan the employer exercised that right, thereby eliminating further accruals under the old plan - and thus eliminating "projected benefits" - would be accurate. Thus, the projection if shown would be zero. An argument can still be made that an employer would need to show what "would have happened" had the old plan stayed in effect, but it is a weak one given these facts. Logically, it is no different than projecting what "would have happened" had the employer turned into Santa Claus and dedicated all profits to employees' pensions.

3. § 204(h) Notice Requirements

Section 204(h) of ERISA requires notice of any "significant reduction in the rate of future benefit accrual" after the amendment implementing the reduction is adopted and at least 15 days before it becomes effective. /84/ On December 14, 1998 the IRS released its final regulations interpreting § 204(h). /85/ These regulations set forth the following provisions related to the conversion of a traditional plan to a cash balance plan:

  1. Section § 204(h) notice is required only for changes to the annual benefit commencing at normal retirement age ("NRA"); thus, no notice is required for changes to optional forms of benefits or to early retirement subsidies; /86/

  2. Any plan provision that affects the rate of future benefit accrual of that benefit will require notice, and notice is required if the amount of the amended benefit at NRA is "reasonably expected" to be less than the benefit at NRA before the amendment; /87/

  3. Notice can be a summary of the change as long as it is "written in a manner calculated to be understood by the average plan participant" and need not include how the benefit of each individual participant is affected; /88/ and

  4. The notice must be given to each affected individual participant and alternate payees and any applicable union; first class mail or hand delivery of the notice is deemed acceptable. /89/

Under ERISA § 204(h), the employer converting to a cash balance plan will typically need to provide § 204(h) notice because the new cash balance formula is likely to significantly reduce the benefit that would have been due at NRA under the old plan. If there is doubt, the employer should nonetheless consider sending this notice, as the remedy for failure to comply with this notice requirement is draconian: The amendment is not effective and participants continue to accrue benefits at the pre-amended rates unless and until proper notice is sent. /90/ This § 204(h) notice need only be a summary of the changes and need not include how each employee's benefit is affected, but that summary must fairly describe the changes "in a manner calculated to be understood by the average plan participant." /91/

4. Fiduciary Issues in Plan Design and Administration

ERISA's "settlor-fiduciary" distinction should apply to cash balance plans. Thus, an employer is a "settlor," not a fiduciary, when designing and adopting a cash balance plan. /92/ In the unpublished Corcoran case discussed in detail below, the Third Circuit applied this principle to dismiss a claim the employer breached fiduciary duties in determining the interest and mortality assumptions to use to set the cash balance plan's opening account balance./93/

On the other hand, once the plan is adopted the employer/plan committee will be a fiduciary regarding the administration of that plan. Thus, all of § 404 of ERISA's duties of loyalty and duty of care will apply. /94/ Likewise, under ERISA's functional definition of "fiduciary," /95/ the employer will likely be treated as a fiduciary to the extent the employer communicates about plan benefits. /96/

IV. ERISA Procedural Defenses

ERISA's general procedural defenses should apply to claims made on cash balance plans. Because these defenses are detailed in numerous publications, /97/ the ones most likely to apply to cash balance claims are only outlined here:

  1. Standing - To have standing to bring a claim under ERISA § 502(a), most plaintiffs must qualify as "participants." /98/ A "participant" is someone who is either (i) in, or reasonably expected to be in, covered employment or (ii) former employees who have a reasonable expectation of returning to covered employment or who have a colorable claim to vested benefits. /99/ For former employees who have "cashed out" of the cash balance plan by taking a lump sum, the argument would be they are no longer "participants" because they no longer have a claim to vested benefits. Most plaintiffs will, however, be asserting in their complaint or in response to a motion to dismiss a claim for benefits and most courts will allow this asserted claim to suffice to provide standing. 100 Forcing plaintiffs to assert a claim for benefits to acquire standing, however, increases the chance the court will require that plaintiff to exhaust his administrative remedies through the plan review process.

  2. Exhaustion of Remedies/"Arbitrary and Capricious" Review - On any claim for benefits under the plan terms, virtually every court will require the plaintiff to exhaust his administrative remedies by filing and processing that claim through the plan review process. Courts are split on whether exhaustion is required when the claim for benefits is premised on alleged statutory violations instead of the plan terms. 101 From the plan's perspective, exhaustion has two primary benefits: (i) it allows the plan committee to build a favorable, complete record for the basis for its decision, and (ii) assuming the plan grants the plan committee discretion to construe the plan terms, to the extent the claim is based on construction of those terms, the plan committee's decision will be subject only to "arbitrary and capricious" review.

  3. Preemption - Section 514(a) of ERISA preempts any state law claim that "relates to" an employee benefit plan. In addition, if this claim is one that could arise under the civil enforcement § 502 of ERISA, this preemption is "complete": i.e., it may provide the basis for removal and jurisdiction in federal court. 102 Preemption can thus be used to (i) dismiss numerous state law contract, fraud, negligence, emotinal distress and like claims and (ii) relatedly, limit the remaining claims to ERISA's "equitable remedies." For example, in the age discrimination area, ERISA preemption can be used to limit any state law age discrimination claim to that which is prohibited by the federal law of ADEA. 103 This is significant if, for example, state law allows disparate impact claims while the federal circuit construes ADEA as not allowing such claims.

  4. No private right of action - When challenging cash balance plans, plaintiffs often plead highly technical claims that rely on IRS regulations and guidance. While the Internal Revenue Code ("IRC") and ERISA have many parallel provisions, some of the IRC provisions go beyond ERISA. Accordingly, any claims based on these non-parallel provisions and attendant regulations are subject to dismissal because the IRC, in itself, does not provide for a private right of action. 104

  5. Statute of Limitations - ERISA expressly provides for a statute of limitations only for clams of fiduciary breach (i.e., within three years after knowledge of the breach or within six years if no knowledge). 105 Benefit claims and statutory claims will be based on the most analogous state claim, which is often considered to be contractual. "Accrual" of the claim will be determined by federal law and will typically depend on one of two events: (i) when the plaintiff discovers or should have discovered the facts giving rise to the alleged violation, or (ii) when the benefit claim is denied by the plan. 106

  6. Proper Party Defendant - The proper party defendant is determined by the nature of the claim, e.g., plan fiduciaries for fiduciary breach claims, the plan itself for benefits claims. 107 Note most courts conclude the employer is not a proper defendant to a claim for benefits, 108 which can have substantial practical significance in defending or settling such a claim. 109

  7. Limitation to "Equitable Remedies" - ERISA limits itself to "equitable remedies." 110 The remedy for benefit claims is typically straightforward: The plan is obligated to pay the benefits due but the plaintiff cannot recover any extra-contractual damages. When the plaintiff is seeking a benefit not provided by the terms of the plan, the "equitable remedy" available is unclear: Depending on the nature of the claim, some courts construe their equitable powers broadly to order, e.g., specific performance, restitution, plan reformation, while other courts construe the claims as prohibited claims for "money damages." 111

V. Litigation To Date

A. The Aull v. Cavalcade Pension Plan Case

The principal cash balance claims in the Aull case involved age discrimination and the accrued benefit/"whipsaw" issue. In Aull, the pension plan offered the employees the greater of the benefit provided by two pension formulas: a traditional "career average pay" formula and a "cash balance" formula. The cash balance formula credited the hypothetical account balance with 2% of compensation and an interest credit of 6% for each year in which the employee continued employment. The plan was frozen effective June 1989. The parties disagreed over how the plan addressed what to do with the hypothetical account balance when an employee had no more benefit service (i.e., when the employee left employment or the plan was frozen).

The plan practice from 1989 to 1994 was to use the 1989 PBGC rate of 7.75% to project the hypothetical account balance forward to the NRA of age 65 and the PBGC rate at the date of determination to discount this projected balance back to present value - this practice produced a "whipsaw" effect in the early 1990's of 10 to 12% effective annual growth in the frozen hypothetical account balance. In 1994 the plan went to floating matching rates to project forward and to discount - i.e., the PBGC rate at date of determination. This resulted in effective annual growth in the hypothetical account balance of approximately 4 to 5%. In the litigation, a major claim was that the cash balance rate of accrual decreased on account of age in violation of ERISA - i.e., an across-the-board attack on all cash balance plan formulas.

The cash balance issues in Aull were pursued principally before the IRS in a determination letter request and an audit. Plaintiff in the form of "interested party" comments to the IRS asserted, e.g.:

  1. The interest credit is part of the "accrued benefit" - by freezing any accruals and not providing for interest credits post-freeze the plan cut back on the accrued benefit of 6% interest credit;

  2. Use of floating PBGC rates also constituted a forfeiture by imposing a penalty for not taking a distribution in 1989 and a cut back by decreasing the "accrued benefit," which benefit included the 1989 PBGC rates of 7.75%.

A settlement was reached with the IRS that has become part of the global settlement of this case. The IRS and the plan agreed to a "safe harbor" approach that includes the following:

  1. Use of the PBGC rate in effect for each year to project from the 1989 frozen date to the benefit determination date and the same PBGC rate to project forward to NRA, with a floor PBGC rate of 6% for both;

  2. The plan must offer a minimum lump sum equal to the hypothetical account balance as of the benefit determination date (i.e. the 1989 frozen benefit projected forward with 6% floor); and

  3. The IRS agreed these projection and crediting methods do not violate the age discrimination rules.

B. The Edsen v. Bank of Boston Case

The Edsen case dealt with the "whipsaw" issue in projecting a hypothetical account balance to and from normal retirement age. 112 In Edsen, in October 1989 a subsidiary bank's plan was combined into Bank of Boston's cash balance plan. Bank of Boston's plan provided for a pay allocation of an increasing percentage of income (from 4% to 11%) based on years of service until the employee achieved 40 years of service. The plan also provided for a two-tiered interest credits: While employed, the employee would receive the 3 month Treasury bill rate plus .5%, with a floor of 5.5% and a ceiling of 10%; once the employee left, if he took his distribution before normal retirement age the interest credit for projection was a flat 4%. By being set below the § 205(g) of ERISA rates (§ 417(e) of the IRC), the 4% rate for projecting benefits guaranteed that the hypothetical account balance at date of distribution would never be greater than the present value of the accrued benefit at normal retirement age. 113

Plaintiff filed a class action claiming the plan should have used at least the floor rate of 5.5% to project the hypothetical account balance to NRA. The plaintiff argued failure to use this rate was (i) a cutback of accrued benefits in violation of § 203(2)(e) of ERISA and 417(e) of the IRC and Treas Reg. 1.417(e), and (ii) a forfeiture in violation of § 203(a) of ERISA and 411(a) of the IRC and Treas Reg. 1.411(a). Regarding the "accrued benefit" issue, the court used the principles in Notice 96-8 and the purposes of cash balance plans to approve the "two tiered" interest credit structure:

At first impression, this logic appears simple and compelling; by using a 4% rate to arrive at an annuity equivalent of her normal retirement annuity, the Retirement Plan "fixed" the outcome of the computation so that the result would always be less than the value of the Cash Balance Account. . . . However, to require the Plan to use an interest rate of 5.5% (or the interest rate applicable at the time of distribution) would defeat the objectives of a Cash Balance Plan. The Plan was introduced to allow plan participants to know the dollar value of their accrued benefits at any given point in time before retirement and to allow younger employees an opportunity to accrue more benefits earlier in their careers.

As explained by the Internal Revenue Service in Notice 96-8, "most cash balance plans are designed to permit a distribution of an employee's entire accrued benefit, after termination of employment, in the form of a single sum equal to the employee's hypothetical account balance as of the date of distribution." Since the defined benefit plan rules under the Internal Revenue Code were drafted to address traditional annuity plans, a cash balance plan must incorporate a formula that ensures that a pre-retirement lump sum distribution in an amount equal to the cash balance account will always equal or exceed the present value of the participant's normal retirement benefit. These provisions "mimic the benefit and accrual structure" of a more traditional annuity plan. IRS Notice 96-8.

Using a 4% rate to project future interest credits ensures that the Cash Balance Account does what it promises to do: the current balance at any point in time is equivalent to the present value of the Plan participant's retirement benefit. Since 4% is always less than the applicable PBGC discounting rate, participants who receive the cash balance in their accounts will always receive an amount that is equal to or greater than the present value of their normal retirement benefit. 114

On the forfeiture issue, plaintiffs argued that conditioning the right to the higher interest credit on delaying distribution constituted an impermissible forfeiture. The court disagreed, holding that its prior ruling the 4% rate complied with § 205(g)/417(e) meant there could be no forfeiture under ERISA or the IRC because the IRS's forfeiture regulations specifically allow for use of § 417(e) rates in determining the present value of the accrued benefit. 115

As of September 1999, this case is on appeal to the Second Circuit Court of Appeals. Interestingly, Notice 96-8 itself suggests that use of a two-tiered interest rate structure may constitute a forfeiture. In one section the Notice states interest credits are "in the nature" of "accrued benefits" protected from forfeiture:

Under a cash balance plan, the retirement benefits payable at normal retirement age are determined by reference to the hypothetical account balance as of normal retirement age, including benefits attributable to interest credits to that age. Thus, benefits attributable to interest credits must be taken into account in determining whether the accrual of the retirement benefits under a cash balance plan satisfies one of the rules in section 411(b)(1)(A),(B), or (C). Moreover, benefits attributable to interest credits are in the nature of accrued benefits within the meaning of § 1.411(a)-7(a), rather than ancillary benefits, and thus, once accrued, must become nonforfeitable in accordance with a vesting schedule that satisfies section 411(a). 116

And, in the only section that mentions "two-tiered" rates, the Notice goes on to state that using the lower rate to project benefits to NRA would result in a forfeiture:

Under the proposal, if a frontloaded interest credit plan specified a variable index for use in determining the amount of interest credits that is [greater than the approved § 417(e) "safe harbor" rates], distribution of a single sum equal to the employee's hypothetical account balance would not satisfy both section 411(a) and section 417(e). If such a plan provided that the rate used for projecting the amount of future interest credits was no greater than the interest rates used under section 417(e)(3), the projection would result in a forfeiture. 117

C. The Corcoran v. Bell Atlantic Corp. Case

The Corcoran case dealt with fiduciary and § 204(g) "cutback" issues in determining the opening hypothetical account balance. 118 In 1991 Bell Atlantic increased the year at which participants qualified for the early retirement subsidy ("ERS") of an unreduced pension. In 1995 Bell Atlantic amended its pension plan to become a cash balance plan. On the ERS issue, the court applied the applicable Senate Report to conclude that the § 204(g) right to "grow into" an ERS consists only of the right to have additional years of service count in qualifying for the benefit; it does not include the right to have those years of service count in determining the amount of that benefit. 119

On cash balance issues, the plaintiffs claimed (i) the company breached fiduciary duties in determining the interest and mortality assumptions to calculate the opening hypothetical account balance, and (ii) calculation of the opening hypothetical account balance violated § 204(g) of ERISA because the interest and mortality assumptions used to convert the old pension benefits to that balance were less favorable than those used for earlier lump sum calculations. The court dismissed plaintiffs fiduciary duty claim, concluding the plan sponsor owed no fiduciary duties regarding its amendment of a plan. 120 In its first opinion, on the § 204(g) issue the district court denied the motion to dismiss to allow discovery to determine if the favorable interest and mortality assumptions - which had been used in three discrete window plans - became a permanent feature of the plan and thus protected under § 204(g). 121 In a subsequent opinion, the district court dismissed the remainder of the complaint because plaintiffs apparently could not pursue the "window plan" theory. 122

On appeal, the Third Circuit affirmed in an unpublished opinion. 123 Applying Lockheed v. Spinks, the court held:

Plaintiff's attempt to distinguish between an employer's decision to amend the plan from the design of the terms of that amendment is unavailing. Bell Atlantic adopted a new cash balance design which converted the plan's standard benefit from an annuity to a cash balance account. To determine an opening cash balance, the plan amendment necessarily required the selection of certain interest rates and mortality assumptions to convert the annuity form of benefit into a lump sum. The selection of assumptions was therefore a design function and nonfiduciary in light of Lockheed. 124

D. The Lyons v. Georgia Pacific Case 125

The Lyons case also addressed the "whipsaw" issue. The pre-revised Georgia Pacific cash balance plan provided for payment of the hypothetical account balance at the time of distribution without making any calculation to and from NRA. The plan provided for interest credits of the PBGC immediate rate plus .75%; during the relevant period the pre-revised § 205(g) discount rate to present value was that PBGC rate for "cash outs" under $3,500 and 120% of the PBGC rate for calculating the present value of accrued benefits over $25,000. This left a potential "whipsaw" of .75% if the plan were required to do the forward and back calculation using the PBGC rate - e.g., for the named plaintiff this would have increased his lump sum benefit approximately $13K, from $36K to $49K. Plaintiff brought his class action claim under the provision of ERISA relating to "cash outs," § 203(e)(2) of ERISA, and the IRS regulations implementing the parallel §§ 411 & 417(e) provisions of the Internal Revenue Code ("IRC"). 126

The court dismissed the case, concluding plaintiff could not pursue his claim under § 203(e)(2) of ERISA for entitlement to the PBGC §§ 205(g)/417(e) discount rates for amounts over the "cash out" $3,500 limit. Section 203(e) before it was revised in 1994, provided in pertinent part:

  • If the present value of any nonforfeitable benefit with respect to a participant in a plan exceeds $3,500, the plan shall provide that such benefit may not be immediately distributed without the consent of the participant.
  • For purposes of paragraph (1), the present value shall be calculated -
    • by using an interest rate no greater than the applicable [PBGC] interest rate if the vested accrued benefit (using such rate) is not in excess of $25,000, and
    • by using an interest rate no greater than 120 percent of the applicable [PBGC] interest rate if the vested accrued benefit exceeds $25,000. 127

The court reasoned that under the plain language of § 203(e) (2), the provision requiring use of the PBGC interest rate applied only "for purposes of" calculating the lump sum cash out. Thus, to the extent the IRS regulations could be read to provide for use of the PBGC interest rate beyond this statutory language, these regulations were invalid under Chevron. The court also noted that if the regulations were read as plaintiff suggested, they would "not so much preserve value as they create an economic windfall not intended by ERISA." The Lyons case is presently on appeal to the Eleventh Circuit and the IRS has filed an amicus curie brief in support of the plaintiff's claims. In this brief, the IRS also asserts that determination letters are of "no import" to claims brought under ERISA. 128

It must be noted that Lyons would likely have little relevance to cases brought after §§ 203(e) and 205(g) of ERISA were revised in 1994 to a flat GATT rate. 129 The plaintiff in Lyons apparently pursued their claim only under the pre-revised § 203(e)(2) because, under that pre-revised statute, 120% of the GATT rate would not have resulted in any "whipsaw" benefit to himself or others entitled to more than $25,000. Since the revision in 1994, § 203(e) and 205(g) of ERISA (like the parallel IRC §§ 411/417(e)) now provide for a flat GATT rate to calculate the present value of benefits, regardless of the amount of that benefit. Thus, if the plan provided for interest credits greater than the GATT rate, the plaintiff would be able to argue that not just § 203(e)(2) - but also § 205(g) of ERISA - requires the use of GATT to calculate the present value of the accrued benefit. And, unlike § 203(e), section 205(g) of ERISA provides statutory support for using those GATT rates to calculate the present value of all levels of benefits.

E. The Engers v. AT&T Pension Plan Case

AT&T recently converted to a cash balance plan for its management employees, which conversion has been challenged in the AT&T case filed in federal district court in New Jersey. 130 In the initial filing, plaintiffs' alleged numerous claims under various legal theories, including (i) state law contract and tort, (ii) benefit claims, and (iii) age discrimination claims under ADEA and state law. These age discrimination claims were based on both disparate treatment and disparate impact theories. The court dismissed this pleading, holding that the following claims were dismissed "with prejudice":

  1. State common law contract and tort claims because they are preempted under ERISA;

  2. Federal ADEA "disparate impact" claim because that theory of liability is not recognized for ADEA; and

  3. State age discrimination claims are preempted to the extent they go beyond ADEA for liability (e.g., the "disparate impact" claim) or remedies (e.g., punitive damages).

The court dismissed without prejudice the federal "disparate treatment" ADEA claim to allow the plaintiffs to replead, if they can, that they have met the EEOC administrative prerequisites to bring an ADEA claim. Likewise, the court dismissed without prejudice the ERISA benefits claims, for which the plaintiffs will have to exhaust administrative remedies by submitting the claim to the plan review process. In a re-filed amended complaint plaintiffs now assert, among other things, that:

  1. The rate of accrual in the plan decreases on account of age in violation of ADEA and ERISA;

  2. AT&T intentionally discriminated against older workers in violation of ADEA by adopting a plan with substantial "wearaways" and that provides older workers less benefits than they would have received under the old plan;

  3. AT&T violated its fiduciary duties and its "SPD duties" to fully inform the participants of the adverse changes caused by the plan conversion;

  4. AT&T violated § 510 of ERISA by designing a plan with wearaways to interfere with the attainment of benefits by older workers.

As of September 1999, many of these claims are subject to a pending motion to dismiss.

F. The Eaton v. Onan Corporation Case

Unlike the other cases discussed, the Eaton case has not been litigated to any form of resolution. The limited pleadings available suggest this case appears to be principally over age discrimination and rate-of-accrual issues related to cash balance planes. The case was originally filed on May 19, 1997. According to the amended complaint and answer, Onan Corporation manufactures electric generators and is a wholly owned subsidiary of Cummings Engine Company. Onan had a § 401(k) profit sharing plan and a defined benefit pension plan that provided for a "final average pay" pension. The defined benefit plan was offset by the benefits earned in the § 401(k) plan. In 1988 Onan froze the § 401(k) plan and in 1989 Onan converted the pension plan from a traditional "final average pay" plan to a cash balance plan. As part of this conversion, the benefits consultant did detailed analyses of how the new formulas would affect employees based on age and service. The cash balance formula adopted provides for different interest credits based on whether the employee remains employed.

Plaintiffs are bringing a class action under ERISA and ADEA with stipulated classes (with approximately 2500 participants affected) and trial set for December 1999. There has been class notice and no substantive motions to date. Plaintiffs are bringing the following claims: 131

  • The cash balance formula decreases accruals on the basis of age in violation of ERISA and ADEA;

  • The effect of the calculation of the cash balance lump sum benefit is to discriminate on the basis of age in violation of ADEA;

  • Adoption of the formula was a "willful" ADEA violation because Onan knew of the cash balance formulas' effect on older, long service employees; 132

  • Onan failed to provide § 204(h) notice of the change to the cash balance formula;

  • Onan cut back on accrued benefits in the conversion in violation of § 204(g) of ERISA; and

  • The Onan cash balance plan is backloaded in violation of § 204(a)(1) of ERISA.

In Eaton the plaintiffs (like the plaintiffs in Aull) are also pursing certain of their claims before the IRS. Specifically, plaintiffs are seeking disqualification of the Onan Corp. plan in tax court 133 on the basis that, e.g., (i) the Onan Corp. cash balance formula violates the back-loading requirements of the IRC and ERISA and (ii) the plan fails to provide for payment of the actuarial equivalent of the accrued benefit in violation of § 417(e) of the IRC. The IRS has filed an answer in which it agrees with plaintiffs on both of these issues.


Footnotes

1 Howard Shapiro is a partner with the New Orleans law firm of McCalla, Thompson, Pyburn, Hymowitz & Shapiro, L.L.P., where he represents management in all aspects of labor, employment, and employee benefits law. Mr. Shapiro is a Senior Editor of Employee Benefits Law (BNA 1991) and devotes much of his practice to employee benefits litigation.

2 Robert Rachal is an associate with McCalla Thompson, where he represents management in all aspects of labor and employment law, including employers, plans and plan fiduciaries in employee benefits litigation. The authors wish to thank Nicole Eichberger for her research assistance in preparing this article and Melinda St. Germain and Beth Clark for their help in designing the graphs for this article.

3 Albert B. Crenshaw, "Companies Embrace New Pension Plan," Washington Post, Financial (Jan 31, 1999).

4 Ellen B. Schultz & Kyle Pope, "CBS is Replacing Its Pension Program With Cash Balance Plan, Stock Options," Wall Street Journal at B10 (March 24, 1999); Paul Breckett, "Citigroup Makes Move to Change Pension Benefits," Wall Street Journal (April 2, 1999); Vinetta Anand, "Cash Balance: Aetna Lets Older Employees Choose Their Plans," Pension & Investments (March 22, 1999).

5 For example, the Wall Street Journal, USA Today, and NBC and CBS Nightly News have each run stories critical of cash balance plans.

6 The Internal Revenue Code does not provide for a private right of action. Nonetheless, plaintiffs can bring a claim in tax court seeking plan disqualification based on the claim the plan violates the IRC. This approach is being used in the Eaton v. Onan Corporation case discussed infra.

7 § 4(i)(1)(A) of ADEA, codified at 29 U.S.C. § 623(i)(1)(A); § 204(b)(1)(H)(i) of ERISA, codified at 29 U.S.C. 1054(b)(1)(H)(i). The IRC also has a parallel provision codified at IRC § 411(b)(1)(H). These parallel provisions were enacted as part of OBRA of 1986, Pub. L. 9-509, 100 Stat. 1874, with the IRS delegated the authority to issue regulations interpreting these provisions.

8 E.g., § 204(b)(1)(H)(i) of ERISA, codified at 29 U.S.C. 1054(b)(1)(H)(i).

9 Devito v. Pension Plan of Local 819 IBT Pension Fund, 975 F. Supp. 258, 267-270 (S.D.N.Y. 1997); see also Carollo v. Cement and Concrete Workers Dist. Council Pension Plan, 964 F. Supp. 677, 681-83 (E.D.N.Y. 1997) (concluding plan violates accrual rules but deferring to later proceedings appropriate remedy).

10 Pursuant to § 101 of the Reorganization Plan of 1978 (43 FR 47713), § 9201 of OBRA, and § 4(i)(7) of ADEA, the IRS regulations on these issues are controlling under the parallel ADEA and ERISA provisions.

11 1996 WL 17901.

12 1996 WL 17901 at p.4.

13 56 FR 47524 (Sept. 19, 1991).

14 Id. at 47528.

15 See, e.g., Lee A. Sheppard, "The Down-Aging of Pension Plans, 1999 Tax Notes Today 6-6 (Jan. 8, 1999).

16 IRS Temp. Reg. § 1-411(b)-(2), 53 FR 11876 (April 11, 1988).

17 IRS Temp. Reg. at §1.411(b)-(2)(a). The temporary regulation does also provide, however, that any reduction in the rate of benefit accrual "may not be based, directly or indirectly, on the attainment of any age," §1.411(b)-(2)(b)(3)(ii), and that "whether a limitation is indirectly based on age is determined with reference to all the facts and circumstances." §1.411(b)-(2)(b)(2)(ii).

18 Temp. Reg. at §1.411(b)-(2)(b)(3)(i).

19 See Hazen Paper Co. v. Biggins, 113 S.Ct. 1701, 1705-06 (1993); 29 U.S.C. § 623(f)(1).

20 Cf., e.g., Quinones v. City of Evanston, 58 F.3d 275, 279-80 (7th Cir. 1995) (noting under "equal cost" defense that increased value caused by balance being held longer for a younger employee is not discriminatory under the ADEA). .

21 For example, a $20,000 annual salary with a 5% pay credit and a 6% interest credit accrued for five years would result in each employee receiving $5,683 if they took their distribution at termination.

22 The "equal costs" defense by its terms applies only to subsections (a) through (d) of § 4 of the ADEA. 29 U.S.C. § 623(f)(2). The "rate of accrual" section is in subsection (i). See 29 U.S.C. § 623(i)(1)(A).

23 Cf., Quinones, 58 F.3d at 279-80.

24 53 F.3d 135 (6th Cir. 1995).

25 Id. at 139-40.

26 Id. at 140.

27 Quiniones, 58 F.3d at 279-80.

28 179 F.3d 690 (9th Cir. 1999).

29 Id. at 694-96 & n.8.

30 Id. at 695 n.7.

31 Colleen T. Congel, Remedial Amendment Period Extension Under Consideration, Official Says, Cash Balance Plans at G-10, Daily Tax Report (March 4, 1999).

32 Cash Balance Plans Rep. Sanders Repeats Call for Review of Cash Balance Age Discrimination Issues, BNA Pension Reporter (Lead Report, Sept. 2, 1999) (quoting technical advice request).

33 See BNA Pension & Benefits, Issues Discussing Cash Balance Plans Discussed at ALI-ABA Teleconference, (Nov. 5, 1999).

34 See BNA Pension & Benefits, Cash Balance Plans: IRS Seeks Comments for Analysis of Tax Law Issues in Plan Conversions (Oct. 20, 1999); BNA Pension & Benefits, Issues Discussing Cash Balance Plans Discussed at ALI-ABA Teleconference, (Nov. 5, 1999).

35 § 204(g) of ERISA, 29 U.S.C. § 1054(g).

36 For example, ERISA provides that under the 133% rule, the rate of accrual is judged based on the plan as amended - i.e., as if the plan amendment implementing the cash balance formula had been in effect for all prior years. § 204(b)(1)(B)(i), 29 U.S.C. § 1054(b)(1)(B)(i).

37 116 S.Ct. 1783 (1996).

38 21 EBC 2360 & 2369, aff'd, 22 EBC 1489 (3rd Cir. 1998).

39 This issue was raised tangentially in an ADEA "wrongful termination" case, Goldman v. First Nat. Bank of Boston, 985 F.2d 1113 (1st Cir. 1993). In Goldman the plaintiff, who was terminated as part of a reduction in force, claimed, e.g., that Bank of Boston's adoption of a cash balance plan constituted general evidence of age discrimination. The court rejected this claim, noting that based on the record no reasonable inference of discrimination was possible as plaintiff had failed to produce any evidence that older workers were disadvantaged by the new cash balance plan. Id. at 1119-20.

40 116 S.Ct. 1783 (1996); see also, e.g., Hughes Aircraft Corp. v. Jacobson, 119 S.Ct. 755, 763 (1999) (noting same principle applies to pension plans).

41 Id. at 1789 (citations omitted).

42 See Finnegan v. Trans World Airlines, 967 F.2d 1161, 1164-65 (7th Cir. 1992).

43 29 U.S.C. § 626(f)(1).

44 113 S.Ct. 1701, 1705-06 (1993).

45 29 U.S.C. § 623(f)(2)(B)(ii).

46 Those plans that provide enhanced pay credits based on age or length of service should be able to show an even greater cost incurred on behalf of older workers.

47 For example, after five years of service a $20,000 annual salary with a 5% pay credit and a 6% interest credit would result in each employee receiving $5,683 if they took their distribution at termination.

48 Quinones v. City of Evanston, 58 F.3d 275, 279 (7th Cir. 1995).

49 See, e.g., Lindemann & Grossman, Employment Discrimination Law, 81-95 (3rd Ed. 1996).

50 See, e.g., Lindemann & Grossman, Employment Discrimination Law, 81-95 (3rd Ed. 1996).

51 See, e.g., Mullin v. Raytheon Co., 164 F.3d 696, 701 (1st Cir. 1999) (collecting cases); Mangold v. California Public Utilities Comm., 67 F.3d 1470, 1474 (9th Cir. 1995). Prior to the Supreme Court's 1993 Hazen decision, courts simply assumed without much analysis that "disparate impact" analysis under Title VII was transported wholesale to the ADEA. Hazen cast this in doubt and, since then, most courts have rejected disparate impact claims based on (i) the reasoning of Hazen, (ii) ADEA's "reasonable factors other thjan age" language, (iii) ADEA's legislative history, and (iv) Congress's failure to amend ADEA in 1991 to include a disparate impact claim. See Mullin, 164 F.3d at 700-04.

52 Finnegan v. Trans World Arilines, Inc., 967 F.2d 1161, 1164-65 (7th Cir. 1992). See also DiBiase v. Smithkline Beechum Corp., 48 F.3d 719, 731-32 (3rd Cir. 1995) (noting that ADEA does not require older workers be given enhanced benefits to avoid disparate impact claims).

53 Id.

54 Codified at 29 U.S.C. § 1102(23).

55 Codified at 29 U.S.C. § 1055(a) & (b)(1)(A).

56 The applicable Treasury Regulations require a singly life annuity be paid for unmarried participants.

57 Codified at 29 U.S.C. § 1055(g).

58 Codified at 29 U.S.C. § 1053(e).

59 Codified at 29 U.S.C. § 1055(g).

60 Codified at 29 U.S.C. § 1053(e).

61 Codified at 29 U.S.C. § 1053(a).

62 The IRS is the agency charged to issue regulations on the minimum participation, vesting, and funding provisions of ERISA. See § 3002(c) of ERISA, 29 U.S.C. § 1202(c). Sections 203 and 205 of ERISA fall within Part 2 of Subtitle B of Subchapter I of ERISA on "Participation and Vesting."

63 Edsen v. Retirement Plan, Bank of Boston, 182 F.R.D. 432, 437-39; 22 EBC 1834 (D. Ver. 1998).

64 Vinetta Arand, "Bank Plan Blurs Line Between DB,DC," Pensions & Investments (Sept. 21, 1998).

65 182 F.R.D. 432, 22 EBC 1834 (D. Ver. 1998).

66 As noted, under § 101 of the Reorganization Plan of 1978 (43 FR 47713) the IRS regulations on these issues are controlling under the parallel IRC and ERISA provisions.

67 Plaintiffs also may assert that the summary plan description describing the conversion and the new plan require "full disclosure" of any adverse effects based on the applicable Department of Labor regulations, 29 C.F.R. § 2520.102-2 and 102-3.

68 This trend has been accelerated by the Supreme Court's decision in Varity Corp. v. Howe, 116 S.Ct. 1065 (1996), which made clear that a fiduciary breach claim for individual relief can be pursued under § 502(a)(3) of ERISA. Prior to this, it was an open question whether individual relief could be sought for fiduciary breaches. See Massachusetts Mutual Life Ins. Co. v. Russell, 105 S.Ct. 3085 (1985) (no claim for individual relief for fiduciary breaches under § 502(a)(2) of ERISA); compare, e.g., McLeod v. Oregon Lithoprint Inc., 46 F.3d 956 (9th Cir. 1995) (assuming same under remaining § 502(a)(3 of ERISA); Simmons v. Southern Bell Telephone & Telegraph Co., 940 F.2d 614 (11th Cir. 1991) (same). A detailed discussion of this issue is contained in Howard Shapiro & Robert Rachal, Duty to Inform and Fiduciary Breaches: The "New Frontier: In ERISA Litigation, 14 The Labor Lawyer 503 (Winter/Spring 1999).

69 Restatement (Second) of Trusts § 173.

70 Restatement (Second) of Trusts § 173 comment d.

71 See, e.g., Pocchia v. NYNEX Corp., 81 F.3d 275 (2nd Cir. 1996) (holding when plaintiff made no inquiry there was no duty to inform of plan change before it is adopted); Switzer v. Wal-Mart Stores, Inc., 52 F.3d 1294 (5th Cir. 1995) (concluding no duty to correct confusion absent a specific participant-initiated inquiry indicating such confusion exists).

72 E.g., Eddy v. Colonial Life, 919 F.2d 747 (D.C. Cir. 1990).

73 Shea v. Esenten, 107 F.3d 625 (8th Cir.), cert. denied, 118 S.Ct. 297 (1997).

74 E.g., Fischer v. Philadelphia Electric Co., 994 F.2d 130 (3rd Cir. 1993).

75 Jordan v. Federal Express Corp., 116 F.3d 1005 (3rd Cir. 1997).

76 Farr v. U.S. West Communications, Inc., 151 F.3d 908 (9th Cir. 1998).

77 § 8(a)(5) of NLRA, 29 U.S.C. § 158(a)(5). Section 8(a)(5) imposes on the employer a duty to furnish relevant information to union representatives during contract negotiations. See generally, PATRICK HARDIN, THE DEVELOPING LABOR LAW, Vol. I at pp. 650-85 (BNA 3rd ed., 1992). One group of union employees has apparently already filed an unfair labor practice with the National Labor Relations Board, complaining that the employer failed to provide the union sufficient information to make an informed decision when the union agreed to convert to a cash balance plan. See Ellen Schultz, "Cash Pensions Trigger Protest of New Allies," Wall Street Journal at C1 (Jan. 21, 1999).

78 E.g., Ellen Schultz, "Cash Balance Plans Save Firms Millions but Hide Pitfalls for Their Workers," Wall Street Journal at A1 (Dec. 4, 1998); Ellen Schultz, "Ins and Outs of Cash Balance Plan," Wall Street Journal at C1 (Dec. 4, 1998); Ellen Schultz, "Some Workers Face Pension Hit," Wall Street Journal at C! (Dec. 18, 1998).

79 Ellen Schultz, "Bill Would Require Greater Disclosure When Employers Change Pension Plans," Wall Street Journal at B8 (March 19, 1999); 106th Cong., 1st Sess., H.R. 1176 and S. 659.

80 Id.

81 See, e.g., Varity Corp. v. Howe, 116 S.Ct. 1065, 1074-75 (1996) (holding intentional misrepresentation is a clear breach of the fiduciary duty of loyalty); Ballone v. Eastman Kodak Co., 109 F.3d 117, 125-26 (2nd Cir. 1997); Estate of Becker v. Eastman Kodak Co., 120 F.3d 4 (2nd Cir. 1997).

82 The lump sum present value of this benefit will vary, however, as the GATT interest rate moves.

83 E.g., Lockheed Corp. v. Spink, 116 S.Ct. 1783 (1996).

84 § 204(h) of ERISA, 29 U.S.C. § 1054(h). Of particular importance to employers, if proper § 204(h) notice is not sent, the amendment is not effective and participants continue to accrue benefits at the pre-amended rates unless and until proper notice is sent. E.g, Treas. Reg. § 1.411(d)-6, A-14, 63 FR 68678, 68683-84 (Dec. 14, 1998). Other sections of ERISA also impose notification requirements that may be relevant, e.g., § 102 of ERISA, 29 U.S.C. § 1022 (summary plan descriptions), § 104(b)(1) of ERISA (notice of "material modifications").

85 Treas. Reg. § 1.411(d)-6, 63 FR 68678 (Dec. 14, 1998).

86 Id. at A-5, 63 FR at 68681.

87 Id. at A-6 & A-7, 63 FR at 68681.

88 Id. at A-10, 63 FR at 68682.

89 Id. at A-11

90 E.g, Treas. Reg. § 1.411(d)-6, A-14, 63 FR 68678, 68683-84 (Dec. 14, 1998).

91 Id. at A-10, 63 FR at 68682.

92 Lockheed Corp. v. Spink, 116 S.Ct. 1783, 1789 (1996); Hughes Aircraft Co. v. Jacobson, 119 S.Ct. 755, 763-64 (1999).

93 Corcoran v. Bell Atlantic Corp., 22 EBC 1489, 1492-93; 159 F.3d 1350 (3rd Cir. 1998) (Table).

94 § 404 of ERISA, 29 U.S.C. § 1104.

95 § 3(21) of ERISA, 29 U.S.C. § 1002(21).

96 See, e.g., Varity Corp. v. Howe, 116 S.Ct. 1065, 1071-74 (1996).

97 See, e.g., BNA Employee Benefits Law, Chpt. 10 (2nd ed. 1991).

98 Section 502(a) also provides certain causes of action for plan fiduciaries.

99 E.g., Bruch v. Firestone, 489 U.S. 101 (1989).

100 E.g., Panaras v. Liquid Carbonic Ind. Corp., 74 F.3d 786 (7th Cir. 1996) (standing based on non-frivolous claim to benefits); Shahid v. Ford Motor Co., 76 F.3d 1404 (6th Cir. 1996) (standing if "but for" alleged breaches would be eligible for benefits); cf. Raymond v. Mobil Oil Corp., 983 F.2d 1528 (10th Cir. 1993) (former employee who was lumped sum out had no standing).

101 Cf., e.g., Horan v. Kaiser Steel Retirement Plan, 947 F.2d 1412 (9th Cir. 1991) (no exhaustion for claim for breach of fiduciary duty) with Counts v. American General Life & Accident Ins. Co., 111 F.3d 105 (11th Cir. 1997) (exhaustion also required for statutory claims)

102 E.g., Toumajian v. Frailey, 135 F.3d 648 (9th Cir. 1998).

103 E.g., Devlin v. Transportation Communications Int'l Union, 1999 WL 203254 (2nd Cir. 1999).

104 E.g., Reklau v. Merchants National Corp., 808 F.2d 628, 631 (7th Cir. 1986). Note that dismissal does not necessarily end the matter, as some plaintiffs are pursuing these claims directly before the IRS. The only formal remedy the IRS can offer, however, is plan disqualification, which would not be in the interest of the participants and which would thus raise interesting issues of conflicts between class counsel and the class.

105 § 413 of ERISA, 29 U.S.C. § 1113.

106 See generally, BNA Employee Benefits Law, 641-43 (2nd Ed. 1991) & 289-94 (1995 Supp.).

107 See generally, BNA Employee Benefits Law, 627-28 (2nd Ed. 1991).

108 E.g., Madden v. ITT Long Term Disability Plan, 914 F.2d 1279 (9th Cir. 1990)

109 ERISA and the IRC grant an employer substantial flexibility in funding a pension plan. See §§ 301 - 08 of ERISA, 29 U.S.C. §§ 1081-86. Thus, even if the plan is held or agrees to be liable to pay more benefits, the employer itself may fund these increased liabilities over 5 to 30 years depending on the characterization of the cause of the increased liabilities.

110 E.g., Mertens v. Hewitt Associates, 113 S.Ct. 2063 (1993); Massachusetts Mutual Life Ins. Co. v. Russell, 473 U.S. 134 (1985).

111 Compare, e.g., McLeod v. Oregon Lithoprint, Inc., 102 F.3d 376, 378-79 (9th Cir. 1996) (Employee lost benefits because of lack of notice - court construed claim for benefits lost as claim for money damages) with Jordan v. Federal Express Corp., 116 F.3d 1005, 1015-16 (3rd Cir. 1997) (plaintiff claiming breach of duty to disclose irrevocability of "joint and survivor" election allowed to seek back benefits and/or recision of election and ability to designate a new beneficiary); Howe v. Varity Corp, 36 F.3d 746, 756-57 (8th Cir. 1994), aff'd, 116 S.Ct. 1065 (1996) (class transferred into plan of spun-off company that went bankrupt -- reinstatement of plaintiff class in plan and award of money for benefits deprived as restitution).

112 Edsen v. Retirement Plan, Bank of Boston, 182 F.R.D. 432, 22 EBC 1834 (D. Ver. 1998).

113 Id. at 434, 437-38.

114 Id. at 438.

115 Id. at 439-40 (citing and applying Treas. Reg. § 1.411(a)-11(d)).

116 IRS Notice 96-8 at § III(A), 1996 WL 17901 (Jan. 18, 1996).

117 Id. at § IV(B).

118 Corcoran v. Bell Atlantic Corp., 1997 WL 602859, 21 EBC 2360 (E.D. Penn. Sept. 23, 1997) & 21 EBC 2369 (E.D. Penn. Oct. 29, 1997), affirmed, 22 EBC Cas. 1489, 159 F.3d 1350 (3rd Cir. 1998) (Table).

119 Corcoran, 1997 WL 602859 at *2 to *6, affirmed, 22 EBC at 1491-92.

120 Corcoran, 1997 WL 602859 at *8 to *9.

121 Id. at *6 to *8.

122 21 EBC 2369 (E.D. Penn. Oct. 29, 1997).

123 22 EBC Cas. 1489, 159 F.3d 1350 (3rd Cir. 1998) (Table).

124 Id. at 1492-93.

125 Slip Op. No. 1:97-cv-0980-JOF (N.D. Ga. March 18, 1999).

126 IRC section 411 parallels in relevant part § 203 of ERISA while IRC § 417(e) parallels in relevant part § 205(e) of ERISA. The IRS is the agency charged to issue regulations on these parallel provisions. See § 3002(c) of ERISA, 29 U.S.C. § 1202(c).

127 29 U.S.C. § 1055(e) (West 1993) (emphasis added).

128 See BNA Pension Reporter, Cash Balance Plans IRS Supports Participants' Suit Over Calculation of Pension Benefits, (Lead Report, August 26, 1999).

129 Lyons would have potential relevance to plans that exercised their rights not to adopt the GATT rates until the latest of January 1, 2000. See § 205(g)(3)(B), 29 U.S.C. § 1055(g)(3)(B).

130 See Management Employees of AT&T v. AT&T and AT&T Management Pension Plan, Civil Action No. 98-3660 (NHP), re-filed as Engers et al. v. AT&T and AT&T Management Pension Plan.

131 In a related case, a former employee who apparently led a group at Onan protesting the adoption of the cash balance plan brought an age discrimination and retaliatory discharge case. At trial, the Judge granted Onan a directed verdict on the ERISA retaliation claims and the jury found for Onan on the age claims. This case is currently on appeal, with the Department of Labor joining plaintiff as amicus. See Ellen Schultz, "Pension Protestor: Fired For Complaining," Wall Street Journal (Feb. 11, 1999).

132 Compare Goldman v. First Nat. Bank of Boston, 985 F.2d 1113 (1st Cir. 1993). In Goldman the plaintiff, who was terminated as part of a reduction in force, claimed, e.g., that Bank of Boston's adoption of a cash balance plan constituted general evidence of age discrimination. The court rejected this claim, noting that based on the record no reasonable inference of discrimination was possible as plaintiff had failed to produce any evidence that older workers were disadvantaged by the new cash balance plan. Id. at 1119-20.

133 Robert Arndt v. Commissioner of Internal Revenue and Onan Corporation, Docket No. 334-99 "R."

Copyright 1999 Howard Shapiro & Robert Rachal
McCalla, Thompson, Pyburn, Hymowitz & Shapiro, L.L.P.

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