Compliance May 6, 2010

Court Gives Baxter 404(c) Protection in Stock-Drop Suit

A court cleared Baxter International of wrongdoing in connection with a 401(k) stock-drop lawsuit.
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U.S. District Judge Joan B. Gottschall of the U.S. District Court for the Northern District of Illinois ruled that Baxter did not violate its Employee Retirement Income Security Act (ERISA) fiduciary duties by keeping company stock in the plan as its share price dropped over word the company was unable to meet its expected earnings goals.

Gottschall found that Baxter qualified for 404(c) safe harbor protection because the plan met the requirements set out in that ERISA section, including:

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  • provide for individual accounts
  • allow participants the opportunity to exercise control over their accounts
  • provide participants with the opportunity to choose from a broad range of investment alternatives
  • give participants sufficient information to make informed investment decisions
  • provide additional safeguards if the plan offers qualifying employer securities.

In her ruling, Gottschall rejected the plaintiff’s contention that the plan was not a 404(c) plan because the plan’s fiduciaries had never explicitly determined that the plan would qualify as such. Also, the court contended, Baxter satisfied 404(c) by providing plan participants with enough information to allow them to make informed decisions about their investment in Baxter stock.

In addition, the court disposed of the plaintiff’s contention that 404(c) would not save the defendants from liability with respect to his claim that the plan violated ERISA by acquiring and holding more than 10% of the plan assets in Baxter stock. The court found it was the participants, and not the Baxter defendants, who caused the plan to hold more than 10% of its assets in company stock because the investments were made by the participants.

The class action brought by Baxter employee David E. Rogers stems from Baxter’s announcement in July 2002 that it had inflated its expected earnings. The announcement caused Baxter’s stock price to drop (see “Appellate Court Allows Stock Drop Suit to Move Forward”).

The case is Rogers v. Baxter International Inc., N.D. Ill., No. 04 C 6476.

Compliance May 6, 2010

DoL: No 404(c) Safe Harbor in Fiduciary Breach Case

Secretary of Labor Hilda L. Solis has warned a federal appellate court that protections for plan participants could be harmed if it does not overturn a lower court ruling giving a directed trustee safe harbor protection against wrongdoing allegations.
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Solis issued the warning in a friend of the court brief filed with the 6th U.S. Circuit Court of Appeals in Tullis v. UMB Bank, in which Solis argued that the lower court misread the safe harbor clause in the Employee Retirement Income Security Act (ERISA). The 404(c) provision was never intended to remove all legal liability from a fiduciary against the impact of their own failures in carrying out their plan duties, Solis contended.

“The Secretary has a significant interest in ensuring that section 404(c), and her regulations giving effect to that provision, are not read to immunize fiduciaries from liability for losses caused by the fiduciaries’ own failure to disclose its knowledge of the investment advisor’s history of misconduct with plan assets, its negligent processing of imprudent and even fraudulent transactions at the direction of the advisory, and its uncritical transmittal of inflated account values provided by the advisor,” the brief said.

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Solis asserted that the 404(c) safe harbor defense applies only where a participant exercises control over his or her investments and the loss caused by imprudent conduct “results from” such exercise of control, which was not true in the current case.

Physicians David H. Tullis and Michael S. Mack participated in the Toledo Clinic Employees’ 401(k) Profit Sharing Plan. In the early 1990s, Tullis and Mack chose William Davis of Continental Capital Corp. as their investment adviser (see “Case Sensitive: Shield Law”).

In 1999, the Securities and Exchange Commission (SEC) entered a temporary restraining order against Continental Capital because two of its brokers were engaged in fraudulent activities. Tullis and Mack alleged that the plan’s trustee, UMB Bank, knew of this fraud, yet failed to inform them of it.

In 2001, UMB Bank filed a lawsuit against Davis and Continental Capital on behalf of the plan alleging that several investments made by David and Continental Capital were improper or simply never took place. Tullis and Mack asserted that UMB, even after filing the lawsuit, never informed them of the fraudulent activities.

Tullis alleged that as of February 2003, UMB had represented that his plan account was $724,561, when in fact it was only $142,269. Mack asserted that UMB represented that his account was valued at $1.6 million when it was worth only $420,794.

Also included in the DoL brief was an argument that the losses stemming from UMB’s actions resulted from UMB’s breaches of its ERISA fiduciary duties. “Allowing a fiduciary to engage in such conduct that directly contributed to the participants’ losses effectively renders hollow ERISA’s fiduciary provisions in section 404(a) and reads the causation limitation implicit in the ‘results from’ language in section 404(c) out of the act,” the brief said.

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