The latest retirement industry litigation decision comes out of the U.S. District Court for the Northern District of Illinois, Eastern Division, pertaining to an Employee Retirement Income Security Act (ERISA) challenge filed against the company CNA Financial, its subsidiaries and the fiduciaries of its 401(k) plan. 

Plaintiffs alleged various violations of ERISA related to the cancellation of a group annuity contract. Also named as a defendant in the lawsuit is the plan trustee, Northern Trust Company.

The defendant and Northern Trust moved under Federal Rule of Civil Procedure 12(b)(6) to dismiss all claims against them, while the Continental defendants moved to dismiss one claim. With this new decision the motions are all denied, “except as to the plaintiff’s request for damages relief against Continental.”

Important to note, this represents only an interim decision in the case, and in resolving a Rule 12(b)(6) motion the court “assumes the truth of the operative complaint’s well-pleaded factual allegations, though not its legal conclusions … In setting forth those facts at the pleading stage, the court does not vouch for their accuracy.”

Relevant background shared in the decision states the plaintiff is a former employee of CNA Financial, an insurance holding company. The plaintiff was a participant in the CNA 401k Plus Plan, and Northern Trust was the plan’s trustee. One of the plan’s investment options was a fund called the CNA Fixed Income Fund. According to case documents, until the end of 2011, a core investment of the fund was a group annuity contract offered by a company which at that time was a subsidiary of CNA Financial.

According to case documents, the parent company was permitted to discontinue the contract only in limited circumstances, such as the plan’s failure to qualify as a qualified pension, profit-sharing, or stock bonus plan under Section 401(a) of the Internal Revenue Code; the failure of the plan’s trustee to make required contributions; or a decision by the plan’s trustee or sponsor to make other funding arrangements for the plan. The plan itself, by contrast, could terminate the contract at any time, within the confines of the fiduciary duty.

At some juncture, the plan and the parent company added a “Minimum Interest Guarantee Rider” to the contract in question, which guaranteed that the annual interest rate credited to the plan’s investment under the contract would never fall below 4%. According to the text of the decision, the rider remained in place until December 31, 2011, when the contract was discontinued “pursuant to an agreement executed two days earlier between Northern Trust and [the parent company], which provided that at the request of’ the plan’s trustee, the contract would be cancelled.”

The plaintiff alleges that the contract’s cancellation was not made with his and the other beneficiaries’ interests in mind, but rather to improve the parent/subsidiary companies’ financial positions and/or to make them a more attractive target for potential buyers. Details in the case documents suggest that prior to the contract’s cancellation, the contract had earned returns at or above the 4% floor; it earned a 6.5% gross rate of return in 2007 and 2008, 6.25% in 2009, 4.55% in 2010, and 4% in 2011.

“Because interest rates had fallen to much lower than those in place when the rider was executed in 1990, the 4% guarantee represented a favorable rate for the plan,” the decision states. “Had the plan not cancelled the contract, the plan’s overall earnings during … almost certainly would have been higher, because most of the plan’s funds had been invested in the contract with its guaranteed a minimum 4% return … So the contract’s cancellation likely had significant negative financial consequences for the plan.”

NEXT: Plan assets versus guaranteed contracts 

In weighing the arguments presented by the various parties as to whether the charges should be heard in a full trial, the court notes that the “contract certainly was an asset of the plan,” but just as important is whether the contract was a guaranteed minimum interest rate rider as well.

“The circuits have followed two approaches in determining whether something is a plan asset under ERISA. Citing Leigh v. Engle, the Ninth Circuit adopted a functional approach asking whether the item in question may be used to the benefit (financial or otherwise) of the fiduciary at the expense of plan participants or beneficiaries,” the decision states. “This approach is also applied in Acosta v. Pac. Enters. Other circuits, following Department of Labor guidance, have adopted a property rights approach, under which the assets of a plan generally are to be identified on the basis of ordinary notions of property rights under non-ERISA law … The Seventh Circuit has not adopted either approach, and it is unnecessary to choose between them here because the contract’s guaranteed interest rate rider was a plan asset under both.”

So the guaranteed minimum interest rate was an “asset” of the plan, but was its termination along with the contract a “use” or “transfer” of the asset? The decision goes on: “As noted, the contract effectively gave the plan the right to a dollar amount from [the parent company] equal to the difference between a 4% return and whatever the plan otherwise have earned from the contract. The contract’s termination effectively transferred that right back to [the parent company], for it no longer had to make good on its 4% guarantee.” The conclusion is that the plaintiff “has properly pleaded the occurrence of a prohibited transaction under Section 406(a)(1)(D).”

For its part, Northern Trust seeks dismissal of certain counts, the claims alleging violations of Sections 404(a)(1) and 405(a), on the ground that it was a directed trustee and therefore did not violate any fiduciary duties. Particularly, Northern Trust contends that the plaintiff has not alleged that it breached any fiduciary duties of prudence or loyalty, reasoning that it “is self-evident that, at the time of the cancellation, Northern Trust could not perform the hindsight comparison of return rates after cancellation.”

“But the complaint alleges not only declining returns after the contract’s cancellation, but also declining returns for several years prior to the cancellation,” the decision points out. “Northern Trust saw multiple consecutive years of declining returns approaching closer and closer to the contract’s guaranteed 4% floor, and rather than maintaining that floor for the plan in what clearly appeared to be a declining market, it allowed the plan to give it up for nothing in return. Although the evidence may show that Northern Trust had valid reasons for doing what it did, the court at this stage is limited to the complaint’s well-pleaded factual allegations and the reasonable inferences drawn therefrom. Those facts give rise to a reasonable inference that Northern Trust’s following the direction to relinquish the contract in a declining market was plainly imprudent, thereby breaching its duty of prudence. “

Other counts against the various defendants are considered and allowed to proceed past this initial procedural hurdle—but again it remains unclear how the actual case will pan out. One count has been tossed by the court, targeting one of the subsidiaries of the parent company involved.

Read the full complaint here.