Fiduciary Afterthought Now A Hot Topic

For Professional Liability Underwriters, Buyers

Securities class-action tag-alongs, as well as cash-balance issues raise red flags

The Wall Street Journal

Gone are the days when the greatest worries for fiduciary liability insurers were claim payouts that fell in the $5-to-$10 million range, mainly for defense costs, and when fiduciary liability placements for brokers were an afterthought to directors and officers liability coverage.

Fiduciary liability insurance, often written by D&O underwriters, basically covers employee benefit plan fiduciaries (people who exercise control over the management or administration of pension, health plans, and the like) for breaches of their fiduciary duties and errors they make. Fiduciary duties are prescribed by the Employee Retirement Income Security Act.

"Let's hope my crystal ball's not clear," Mr. Coonan, vice president and fiduciary product manager for Chubb & Son in Kansas City, Mo., told National Underwriter in a recent interview as he described possible fiduciary liability implications of a Journal article he'd just finished.

The article reported that a public interest group is suing a large public retirement system to get information on management fees paid for alternative investments in venture-capital funds. Suggesting a corollary that could impact fiduciary insurers, he said regulators, public interest groups and unions might start challenging fee arrangements that fiduciaries have with various investment management parties they bring in to manage retirement plan investments.

"We haven't seen activity to any great extent, but I can see it coming," he said, attempting to forecast the next potential nightmare for insurers.

However ominous Mr. Coonan's prediction might be, it wasn't the scariest issue on his mind when he and other experts spoke at the Professional Liability Underwriting Society Employment and Fiduciary Issues Symposium in April. Then, underwriters bemoaned the fact that their crystal balls weren't clear enough a few years ago to foresee an onslaught of "tag-along securities suits," each with alleged damages in the hundreds of millions of dollars they never priced for.

Essentially, the suits arise from the same situations that prompt standard D&O securities cases filed on behalf of shareholders when a company's stock drops in the wake of some adverse financial disclosure. The tag-alongs are repackaged to allege breaches of fiduciary duty, Mr. Coonan said, explaining that the typical allegations have two forksthat company stock is not an acceptable choice for employees to have in a retirement plan, and that management breached its fiduciary duty by failing to adequately disclose matters having to do with the company's fortunes.

"Far and away, that's the big animal that's come out of the jungle in the last two years," he said during the PLUS meeting, noting that such suits were "really kicked off by Enron situation."

"This is a whole new ballgame here and we're talking about mega-bucks," he said. "How do you deal with severity?" he asked. "I wish it was the $64 million question, but that doesn't even come close to covering itand that's just on my book."

And while tag-along suits may be the "claims du jour" focusing the attention of fiduciary liability underwriters, another source of fiduciary claimspension plan conversionsshould not be dismissed lightly, according to Rhonda Prussack, vice president and product manager for fiduciary liability at AIG's National Union in New York, issuing a warning to her co-panelists at PLUS.

Ms. Prussack told NU that her concerns were triggered by the Cooper vs. The IBM Pension Plan decision last July, in which the judge "basically indicted all cash-balance conversions" saying they were inherently discriminatory toward older employees in the way they accrued benefits and that this discrimination violates ERISA.

(Many companies have converted from traditional defined benefit pension plans to cash-balance plans in recent years. Under a traditional defined benefit plan, the employer guarantees a specified benefit at retirement. In a cash-balance plan like IBM's, each employee has a hypothetical account to which contributions and interest payments are credited. See NU, Aug. 11, 2003, for more on the IBM decision.)

At the time of the decision, "I expressed concerns to clients and underwriterseven about plans that converted years ago. I was concerned that this [decision] would reopen those issues" and that lawyers would interpret the statute of limitationwhich starts running when a plan participant has knowledge of a breach of a fiduciary dutyto start running on the date that the IBM decision came down.

"Sure enough, while there hasn't been a flood of them yet, we've started to see claims related to cash-balance conversions that happened seven year ago, nine years ago," she said.

Ms. Prussack also said she's seen claims arising out of the mutual fund investigations by New York Attorney General Eliot Spitzer and securities regulators. "In particular, we're seeing financial institutions being targeted in lawsuits. These are financial institutions that offered their own product to employees within their 401(k) plans [and] had issues related to market timing and late trading," she said. "This is the next big thing that we're very concerned about."

"What's interesting is that we've never really had this many hot topics in fiduciary liability coverage up in the air to worry about," said Carrie Brodzinski, vice president of St. Paul Travelers Bond's executive liability group in Hartford, Conn., noting, for example, that the IBM case is currently on appeal.

In addition, a trend toward settlements in tag-along cases is keeping another key issue from being sorted out. "Really what you've got is a conflict between two bodies of law," she said. "ERISA law says that the first and foremost obligation of a plan fiduciary is to the plan participant. However, that might be in conflict with securities laws [provisions] about when and how you can make certain types of disclosures."

"In some of these cases, the issue is that there are plan fiduciaries, who were also insiders of the company, who knew or should have known that the employer stock in the benefit plan was going to drop. So [to comply with ERISA], they needed to do something about it," she said.

While Ms. Brodzinski said she hadn't seen any claims from pre-IBM cash-balance plan conversions, "there are a lot of different ways companies can get in trouble in making conversions," she said"not the least of which is all the calculations to map accrued and vested benefits of old system into new plan. Some suits allege that companies did it wrong."

Mr. Coonan also said cash-balance conversion cases haven't "been a big activity" for Chubb. "We've had some, but not a big crush of cases."

But "the danger there is that hundreds of companies have done these cash-balance conversions in the last four or five years, including our own company, Chubb," he said. "Should the [next] ruling go the wrong way, it could lead to a new fresh front of litigation."

Mr. Coonan also said the mutual fund wildcard hasn't turned into a big ERISA liability issue yet, "but obviously the plaintiffs' bar has its binoculars out at that neighborhood," he said, noting that a section on the Web site of a plaintiffs' firm specializing in ERISA liability casesthe erisafraud.com site of Seattle-based Keller Rohrbackalludes to the possibility.

Information on the site specifically names eight mutual fund companies the law firm is investigating for breaches of fiduciary duty. The companies served as trustees or investment managers for household name companies like Whirlpool and Coca-Cola, the site says, adding that the funds "may have offered their own proprietary mutual funds as plan investment options even though they allowed institutional investors to engage in trading activities that were improper and potentially illegal, [perhaps benefiting] the institutional investors to the detriment of plan participant[s]."

The site also lists a sampling of 20 tag-along suits the firm is involved in, including Enron, Lucent, Tyco, WorldCom, and Xerox, as well as information on a $69 million Lucent settlement and an $85 million partial Enron settlement.

"When you're looking at that site, you're looking at a lot of my customers. I have some layer on the vast majority of them," Mr. Coonan revealed at the PLUS conference. "A lot of the cases are still open," he added, noting that Chubb has had to put up substantial reserves on those.

In a recent interview, he said that there was some slowdown in tag-along cases late last year and early this year, relative to the two prior years. But the coast isn't yet clear, he said, noting: "I've got four or five brand new cases since this spring."

Reproduced from National Underwriter Edition, September 16, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.