PANC 2020: Taking an Economic View of ERISA Litigation

Even as the markets have rebounded since COVID-19 hit in March, plan fiduciaries must be aware of any accusations alleging imprudent investment options, especially when it comes to the possibility of a second wave of the coronavirus.

David Tabak, managing director at NERA Economic Consulting, offered an economic approach to this challenging ERISA [Employee Retirement Income Security Act] litigation environment on the last day of the 2020 PLANADVISER National Conference. If the U.S. experiences a second wave of the coronavirus this winter, even if its impact is not as massive as earlier this year, plan fiduciaries will need to keep a careful eye on investments, he said during the virtual session. “At some point now, it’s easy to say that some of these risks were foreseeable as a possibility, especially if there is a second wave in December,” he stated in the virtual panel.

Tabak cited several monumental ERISA cases retirement industry professionals should consider, including Fifth Third Bank v. Dudenhoeffer and Summers v. State Street Bank Trust Co. Speaking on the famous Fifth-Third Bank v. Dudenhoeffer ruling—which found that non-employee stock ownership plan (ESOP) fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, with the exception of diversifying the fund’s assets—Tabak emphasized the economics behind the case.

“If you have a large stock, you can start with the presumption that it traded in an efficient market. If you simplify down to the most basic and least controversial, you can’t expect people to outjudge the market when you have a security stock market bond that’s widely followed. [The ruling] said that if you have a security of stock from a large corporation, you should expect that you shouldn’t have to outguess the market,” he said.

In the case of Summers v. State Street Bank Trust Co., the court said market prices following the issue of a letter by the then-United Airlines CEO projecting financial doom did not drop to a level signifying impending bankruptcy and, therefore, State Street was not imprudent in using market prices to determine the value of the investment. According to the court, State Street was not obligated to second-guess that the market was overvalued. In the end, the court found that State Street had not breached its fiduciary duties.

Still, companies heavily impacted by market volatility due to COVID-19 should consider their equity value along with any debt. Tabak cited Judge Richard Posner of the 7th U.S. Circuit Court of Appeals in Chicago, who analyzed risk in market theory. “Judge Posner said, ‘Consider what happens if you have a company that loses value, has debt and its equity cushion is shrinking.’ Even if the market is efficient, the riskiness of any investment may change because of the change of the value in company. Equity will become leverage and thus riskier. This doesn’t say you shouldn’t be reacting with the volatility and change in company stock,” Tabak noted.

He also called on investment advisers to initiate a cost-analysis for clients that may be concerned about opaque investments. Additionally, advisers are responsible for pinpointing what areas of focus are important to their clients. For example, ask about their position on transparency and fees, Tabak suggested.

On the registered investment adviser (RIA) and Securities and Exchange Commission (SEC) side, Tabak touched on potential future litigation to look out for. If a company performs well in yearly returns, it’s unlikely it will be examined by the SEC. However, if an organization announces poor earnings, it will most likely be examined by the SEC to see if it should be brought to suit, Tabak said.

Lawsuits involving mergers and acquisitions (M&As) may increase as well, he said, notably concerning deals where one company retracts an offer because of economic decline. “Generally, you are not allowed to back out because of a general market downturn,” Tabak said. “But, if the downturn affected the company disproportionately, then in many cases you are allowed to drop that company.” However, a company that backs out of the deal can also be sued for monetary damages by the opposing organization, Tabak added.

Additionally, a company may risk securities litigation if it misrepresents the likelihood of a successful deal. Future allegations may blame a fiduciary for going along with a risky deal during a volatile market, and question whether participants should have been advised because of the risk in an uncertain economy.

Companies should also look out for business interruption claims, Tabak said, and whether a government-imposed lockdown or limiting indoor or outdoor capacity counts as a business interruption. “Those are some of the very few things people thought of when writing business insurance, that the government would mandate a 25% capacity one day,” he concluded. “From an ERISA standpoint, it’s worth taking a look at and seeing if there’s pending litigation, because a win can be a big gain.”