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PHILADELPHIA-Employers may have less protection from fiduciary liability for employee investment decisions than many think, a federal appeals court decision suggests.
The decision-involving a Unisys Corp. defined contribution plan that purchased guaranteed investment contracts from Executive Life Insurance Co.-also suggests that employers have to review the work of consultants who work for plans and supplement their work where necessary.
In particular, employers will need to scrutinize investment options for defined contribution plans and the information given to employees about the investments.
The 3rd U.S. Circuit Court of Appeals ruling is one of the first to consider Section 404(c) of the Employee Retirement Income Security Act and related rules from the Labor Department.
Section 404(c) limits employer fiduciary liability for investment decisions made by those in defined contribution plans. But that protection depends on meeting the conditions in the 1992 regulations, such as describing the investment alternatives, including objectives and risk and return characteristics (BI, Oct. 12, 1992).
The appeals court reversed a U.S. District Court's January 1995 summary judgment on the case and sent it back to the district court for trial.
In Meinhardt vs. Unisys Corp., the 3rd Circuit questioned whether fiduciaries to Unisys' plan breached their duties of prudence, disclosure and diversification in buying more than $200 million in GICs from ELIC before California regulators seized the company in 1991.
In defense, Unisys lawyers said even if the company failed to comply with pension law by purchasing Executive Life GICs, Section 404(c) protected the Blue Bell, Pa.-based company from liability because the participants had control over their investment choices and therefore were responsible for their own losses.
But the appeals court said there was enough evidence to show the district court erred in dismissing the suit. The appeals court also said there were genuine issues concerning whether Unisys breached its fiduciary duties and whether Unisys could use 404(c)'s protections. Because of the summary judgment, those issues hadn't been addressed in the lower court.
Meanwhile, experts say the decision will send employers scurrying to look at their own defined contribution plan descriptions.
This case is "indicative of how slippery 404(c) really is. You may think you are under 404(c)'s protections, but with 20/20 hindsight, you really aren't," said Dennis Coleman, a principal at Kwasha Lipton L.L.C. in Fort Lee, N.J. "Companies need to look at this case closely and see how they can protect themselves so they don't get into the same position that Unisys is in," he said.
To meet the 404(c) standards, many employers would have to add investment options and information to participants.
What's more, following the 3rd Circuit ruling, companies will try to protect themselves by making "a paper trail that describes all the things that they should be doing" to comply with the 404(c) regulations, said Mr. Coleman.
What's key is the process plan sponsors use to select and monitor investments, and the procedures used in communicating to participants, said David Wray, president of the Profit Sharing/401(k) Council of America in Chicago.
"It's critical that the sponsor goes through a thorough process of choosing managers and crafting investment options," Mr. Wray said. "Then if they go into a court of law, the prudence protection will be there for them."
Labor Department Associate Solicitor Marc Machiz said plan sponsors should be fine if they comply with the 404(c) regulations.
"I don't think there is anything in the (appeals court) opinion that changes or calls into question the legal framework set out in the DOL's regulation," Mr. Machiz said.
The appeals court said Unisys could use 404(c) as its defense but must show where it applies in the case. The court said it didn't have enough evidence to decide whether participants had control of their investments.
In questioning Unisys' degree of prudence, the appeals court said Unisys did not act prudently when it invested in five-year contracts with Executive Life.
According to the decision, Unisys relied on its consultant, Johnson & Higgins, to analyze ELIC's creditworthiness. But Murray Becker, a GIC consultant at that time with J&H, said in his deposition that J&H was not a credit-rating agency and recommended companies that Standard & Poor's Corp. had rated AAA.
And J&H had recommended three-year contracts; Unisys bought its first of three five-year contracts in 1987 and soon afterward terminated J&H.
Writing for the appeals court, Judge Carol Los Mansmann said "a reasonable fact finder could conclude that Unisys passively accepted its consultant's positive appraisal of Executive Life without conducting the independent investigation that ERISA requires."
In addressing diversification, the appeals court said because the risk of loss was only among the GIC contracts, it was appropriate to decide whether the fixed-income and insurance contract funds-which held the Executive Life GICs-were adequately diversified. But, that decision was left for the district court to make.
In the disclosure issue, the court said that in previous cases it has held fiduciaries cannot mislead participants, and while 404(c) protects fiduciaries from investment decisions participants make, it doesn't relieve them from disclosing information to participants.
While the appeals court said it could not decide whether Unisys was obligated under 404(c) to tell participants about the risks involved and Executive Life's financial condition, it did say there were a number of disclosure issues that needed sorting out.
The court said: "While Unisys was not obligated to share with participants everything it knew about GICs and Executive Life, it was obligated to impart to participants material information of which it had knowledge that was sufficient to apprise the average plan participant of the risks associated with investing in the fixed income and insurance contract funds" that held Executive Life investments.
No trial date has been set.
John P. Meinhardt et al. vs. Unisys Corp., 3rd U.S. Circuit Court of Appeals; Nos. 95-1156, 95-1157, 95-1186, Jan. 4, 1996.