Guest Article

Cases Highlight Investment Plan Options, Attorney Liability

by Joseph S. Adams

Summary: One recent court case involves a theme that has become increasingly familiar - the charge by plan participants that plan sponsors violated their fiduciary responsibility by improperly investing plan assets in inappropriate funds. Another case concerns a new approach to determining liability for attorney's fees in cases brought against a plan sponsor.

Another Case Alleges Fiduciary Violation in Plan Investment Actions

There have been a number of court cases (First Union, Ikon Office Solutions, and SBC Communications) in which plaintiffs asserted that plan sponsors had violated their fiduciary duties under ERISA by investing plan assets in the plan sponsor's stock or proprietary mutual funds to benefit the plan sponsor at the cost of plan participants. Recently, a similar class action was filed in the Eastern District of Pennsylvania claiming New York Life Insurance Company violated ERISA (as well as the Racketeer Influenced Corrupt Organization (RICO) act and state law) by investing retirement plan assets in the company's own mutual funds.

James Mehling, a former vice president with New York Life, filed a wrongful discharge complaint against the company. He claimed that the company discharged him to prevent him from revealing an allegedly illegal practice of investing retirement plan assets in the company's proprietary mutual funds.

Mehling's lawsuit was later amended in the form of a class action suit on behalf of New York Life employees and agents who participated in the company's pension and 401(k) plans. The class action makes six allegations against New York Life with respect to ERISA violations, as well as several additional allegations with respect to RICO and state law violations. First, the complaint alleges that plan assets inured to the benefit of New York Life because the company wanted to enter the lucrative mutual fund market and used plan assets as "seed money" rather than risking company assets to the high start-up costs and risks associated with creating mutual funds. Second, the complaint alleges that New York Life engaged in a prohibited transaction involving the transfer of plan assets for the benefit of a party-in-interest when it collected exorbitant investment fees. Third, the complaint states that New York Life engaged in self-dealing by investing $1.75 billion of plan assets in its own family of mutual funds so the funds could attract more outside investors, thereby bringing in more fees to the company. Next, the complaint alleges that New York Life breached its fiduciary duties by investing plan assets in mutual funds, a process that typically entails much higher fees than the fees charged by individual investment managers. The complaint then provides that even if it was prudent to invest such a large amount of plan assets in mutual funds, it was imprudent to invest in New York Life's particular mutual funds because they had higher than average fees and mediocre performance. Finally, the complaint alleges that New York Life failed to conduct due diligence in deciding to invest in its own mutual funds, and also neglected to compare its funds to those funds with superior performance and lower fees.

The defendants in the case undoubtedly will rely heavily on the Department of Labor's Prohibited Transaction Exemption 77-3 (PTE 77-3), which specifically permits a mutual fund company to invest the plan assets of its "in-house" retirement plan(s) in the company's own mutual funds if certain conditions are met. Those conditions require that the plan pay no separate investment advisory fee (other than the regular expenses paid by all shareholders in the mutual fund), redemption fees or sales commissions, and also require that all transactions with the mutual fund company occur on a basis no less favorable to the plan than to other shareholders of the mutual fund. The plaintiffs will likely argue that PTE 77-3 does not address many of the specific allegations raised in their complaint, which fall under a fiduciary's more general responsibilities to discharge his or her duties solely in the interest of plan participants.

Because the lawsuit makes allegations similar to those of the unsuccessful First Union plaintiffs, the likelihood of success of the complaint seems doubtful. Further, two of the four plans at issue in the New York Life case are overfunded defined benefit plans, where participants' benefits are not affected by the plan's investment return. However, along with the First Union, SBC Communications and Ikon Office Solutions cases, the New York Life case suggests how plaintiffs' attorneys are continuing to aggressively challenge the use of company-related investments in ERISA plans.

Attorney Held Liable for Costs After Losing Plaintiff's Case

A California district court recently held that an attorney who represents a plaintiff on a contingent fee basis in an ERISA case and who loses the case can be held liable for the plan sponsor's attorney fees. The case is Ghorbani v. Pacific Gas & Electric Company Group Life Insurance, 2000 U.S. Dist. LEXIS 8556 (N.D. Cal. June 16, 2000).

Jane Ghorbani was an employee of Pacific Gas & Electric Company and a participant in the company's group life insurance and long-term disability plan. After being denied disability benefits under the plan, Ghorbani, represented by attorney Clifford B. Malone, Jr., brought a lawsuit under the civil enforcement provisions of ERISA against the plan and the Pacific Gas & Electric Company Employee Benefit Administrative Committee. On Jan. 28, 2000, the court granted summary judgment in favor of the defendants. Under ERISA Section 502(g), the defendants filed a motion for an award of attorney fees.

The U. S. District Court for the Northern District of California determined that attorney Malone could be held liable for the defendants' attorney fees. In deciding this case, the district court noted that the 9th Circuit had sent mixed signals on whether attorney fees should be awarded to defendants in cases brought by individual plan participants. In fact, several courts have stated that individual plan participants should not be liable for such fees because it would compromise the purpose of ERISA by chilling meritorious lawsuits. In this case, however, the court distinguished holding an individual plan participant liable for attorney fees from holding a contingent fee attorney liable, noting that "when a contingent fee attorney brings a case under a statute with a bilateral fee-shifting provision, such as section 502(g), he acquires a stake in a claim which, by statute, has both an upside and a downside." In the court's view, the downside is the possible liability for the defendant's attorney fees, which must be viewed as part of the contingent fee bargain. According to the district court, the plaintiff's attorney becomes a party in interest when a case is brought on contingent fee basis.

In determining whether Ghorbani's attorney should be held liable for the defendant's attorney fees, the court applied the five-factor test set forth in Hummell v. S.E. Rykoff & Co. Under the Hummell test, which was traditionally used to determine if the parties themselves were liable, the court's discretion to award attorney fees is guided by: (1) the degree of the opposing party's bad faith; (2) the ability of the opposing party to pay; (3) whether such an award would deter others from acting in similar circumstances; (4) whether the party requesting fees sought to benefit plan participants or resolve a legal question; and (5) the relative merits of each party's position.

The district court applied these five factors to determine whether attorney Malone should be liable for the defendants' attorney fees. In response to the first factor, the court found that the provision in the contingent fee agreement indemnifying Malone from liability for an award of attorney's fees showed his lack of faith in the merits of the case. Second, the court reasoned that any attorney who wishes to proceed on a contingent fee basis must be presumed to have the financial ability to perform his obligations to his client and any third party. (In contrast, the district court found that Ghorbani did not have the financial ability to pay the defendants' attorney fees.) Third, the court reasoned that awarding fees would ultimately benefit the plan participants because otherwise the costs would be borne by the plan and, indirectly, by the plan participants. The court dismissed the fourth factor, stating that this factor only applies if the participant wins the case and requests an award of fees. Finally, the court determined that Malone was fully capable of evaluating the merits of the case before bringing suit, and therefore should be liable for the defendants' attorney fees.

This decision adopts a new approach with respect to attorney fees in ERISA cases. The decision should not inhibit plan participants from bringing valid claims. As the court indicated, the "deterrent effect of an award is offset by the contingent fee incentive, and serves the statutory purpose of channeling resources to meritorious cases." However, the decision may encourage plaintiffs' attorneys to restructure their fee arrangements to an hours-based system for more questionable claims, which, in turn, should make plaintiffs less willing to pursue such claims.

About the Author. Joseph S. Adams is a partner in the Employee Benefits Department of McDermott, Will & Emery's Chicago office. He is a specialist in the design, drafting, and ongoing qualification of pension plans, profit sharing/401(k) plans and ESOPs. Adams is the contributing editor for the Pension Plan Fix-It Handbook.

Reprinted with permission from the September 2000 supplement to The Pension Plan Fix-It Handbook, ©Thompson Publishing Group, Inc., 2000. All rights reserved.

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