Compliance August 21, 2008

Court Upholds Cash Balance Plan Designs

In a continuing trend of federal court rulings backing cash balance plans, the 9th U.S. Circuit Court of Appeals has ruled the plans do not discriminate against older workers in favor of their younger counterparts.
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The 9th Circuit issued the latest ruling in a case involving Southern California Gas Company and its SCGC Pension Plan, which employees charged violated the Employee Retirement Income Security Act (ERISA) by being discriminatory. The 9th Circuit decision upheld a ruling by U.S. District Judge Manuel L. Real of the U.S. District Court for the Central District of California in favor of the company.

The latest ruling written by Circuit Judge N. Randy Smith becomes the fifth federal appellate court to find that cash balance plans do not discriminate if younger workers end up with higher balances because that is a product of the time value of money. In addition, Smith said cash balance formulas do not reduce an older worker’s accrued benefit because he or she attains a certain age, and cash balance plans do not violate ERISA’s anti-backloading rules.

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However, the appeals court reinstated the participants’ claim that the plan sponsor violated ERISA’s notice requirements by not giving them notice of the cash balance plan’s “wear-away effect.”

The case is Hurlic v. Southern California Gas Co., 9th Cir., No. 06-55599, 8/20/08.

Previously upholding cash balance plan designs were the 2nd Circuit Court of Appeals (see Federal Appellate Panel Clears Two More Cash Balance Plans), 3rd Circuit (see Cash Balance Proponents Get Two Legal Victories), 6th Circuit (see 6th Circuit Latest to Reject Cash Balance Age Discrimination Claims), and the 7th Circuit (see IBM Cash Balance Discrimination Ruling Reversed).

Compliance August 20, 2008

State Street Sued over Mortgage-Backed Investments

A Massachusetts plumbing and air conditioning supply company sued State Street over allegations it misrepresented a bond fund ultimately invested in mortgage-backed securities as a low-risk 401(k) investment option.
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F.W. Webb Company filed the suit against State Street Bank and Trust Company, State Street Global Advisors (SSgA), and CitiStreet over what Webb charged were the SSgA Yield Plus Fund’s ultimate losses because of it holdings in sub-par mortgage-backed securities. The suit was filed by Boston lawyer David E. Lurie.

Even though the investment option was repeatedly represented to Webb as being like a money market portfolio, only with better returns, starting in 1996, Webb alleged State Street changed the investment strategy for the Yield Plus account to emphasize riskier lower-quality securities.

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“Defendants exposed the Yield Plus Fund to investments in low-quality debt securities, creating an inappropriate level of risk far out of line with the stated investment objectives of the F.W. Webb 401k Plan and those of a traditional money market fund,” the suit alleged.

According to the suit, the Yield Plus Fund, contrary to its purportedly conservative investment strategy, fell dramatically because of its overexposure to risky, low-quality assets and securities in mid-2007. The Board of Directors for the SSga Yield Plus Fund decided to liquidate the fund as of May 31.

CitiStreet Involvement

The suit names CitiStreet as a defendant because since 2000 it provided F.W. Webb with the investment management and recordkeeping/administrative functions previously provided by State Street Bank and SSgA.

“That stability of the Yield Plus Fund might not have a stable value was never discussed at these meetings (with State Street and CitiStreet),” the suit alleged. “Believing that the Yield Plus Fund continued to have the stability of a money market fund and was a relatively risk-free investment for its participants, and based on its satisfactory performance over time, Plaintiffs had no reason to question the advisability of inclusion of the Yield Plus Fund in the F.W. Webb 401(k) Plan.”

The suit alleged the decision to change the Yield Plus fund to move it into mortgage-backed securities was at a particularly bad time in the housing market.

“To make matters worse, during the 2005-2007 timeframe, SSgA—in violation of its fiduciary duties and with wanton disregard for the interests of the F.W. Webb 401(k) Plan participants— chose to invest the Yield Plus Fund heavily in risky financial instruments such as low-quality, mortgage-backed bonds supported by subprime home loans and other illiquid asset-backed securities,” the suit claimed. “These high-risk, low quality investments directly exposed the Yield Plus Fund to the volatility of the subprime mortgage market at the time when it was publicly reported that defaults of subprime mortgages were skyrocketing, and that numerous subprime lenders were facing insolvency.”

The F.W. Webb 401(k) Plan had 1,281 participants as of year-end 2006, with about $100 million in assets.

State Street has been slapped with a number of suits its funds later invested into mortgage-backed securities (see SSgA Hit with Two More Subprime Suits).

The Webb suit is available here.

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