Plan Sponsor Loses Suit Based on Misleading Plan Communications

A recent court decision reminds fiduciaries that It’s not enough to communicate the potential impact of plan changes to participants – those communications are expected to be accurate.

The U.S. District Court for the Southern District of New York issued a decision that emphasizes the importance of accurate communications to employees regarding changes in qualified retirement plan benefits.

In Osberg v. Foot Locker, Inc., the plaintiffs in the class action consisted of nearly 16,000 participants in a defined benefit pension plan sponsored by Foot Locker. According to an analysis by Kilpatrick Townsend & Stockton LLP, Foot Locker amended its pension plan effective Jan. 1, 1996 to become a cash balance plan by converting the accrued benefit as of Dec. 31, 1995 into an initial account balance. It did so by employing a series of calculations and assumptions. Participants were allowed to elect a lump sum under the new structure, but if this was paid prior to normal retirement it would not include a specific early retirement subsidy that applied if an early retirement annuity was elected.

‘Wear’ Withal

However, Foot Locker used some interest rate assumptions to determine the initial account balance that were so high (9%, rather than a more common 6%), they resulted in an accrued benefit that was less than the Dec. 31, 1995 benefit in almost every case. Consequently, in order to comply with ERISA’s anti-cutback rule (which dictates that accrued benefits may not be reduced, though future accruals may be reduced or eliminated completely), the new plan calculated benefits based on a “greater of” approach, in which the benefit payable was actually the greater of the Dec. 31, 1995 accrued benefit (the “A” Benefit) and the accrued benefit determined by the cash balance formula (the “B” Benefit) applying the pay and interest credits to the initial cash balance account. Until the point at which a participant’s cash balance account grew enough to produce an accrued benefit greater than the Dec. 31, 1995 benefit, he or she would not earn any additional benefits despite continued service. This “wear-away” essentially resulted in an accrued benefit freeze for a number of years for virtually all of the active participants.

Here the court found that not only did Foot Locker management understand that a wear-away would occur, but they also chose the initial conversion rates which resulted in lower opening balances as a means of cost savings.

‘Missed’ Communications

The numerous communications to participants — an announcement letter to participants, a highlights summary of the changes, personalized booklets that provided “total compensation” statements and initial cash balance account, and a summary plan description (SPD) — all failed to describe this wear-away and the resulting freeze in benefits for a period of time. According to Foot Locker, participants had the information necessary to inform them they were in a period of wear-away, although it conceded that the wear-away effect was not dealt with explicitly because it believed the concept was too complicated and the variations and effects too unpredictable. But, the court disagreed, finding from testimony of plan participants that the communications to them led them to believe their pension benefits were growing with their years of service – though they did not realize that even the growing accounts did not yet equal their accrued benefit as of Dec. 31, 1995.

U.S. District Judge Katherine B. Forrest noted that all of the plan communications not only failed to describe wear-away, they all neglected to clearly discuss the reasons for the difference between a participant’s accrued benefit under the old plan and his or her balance under the new plan. Not only did the court hold that all the statements were intentionally false and misleading, Judge Forrest noted that the SPD contained a number of intentionally false misstatements.

The court noted that ERISA imposes strict standards of conduct for fiduciaries of qualified retirement plans if they have any discretionary authority or responsibility in the administration of the plan, including the duty to disclose and explain an amendment’s impact on benefits. Moreover, in its ruling, the court noted that the U.S. Supreme Court has held that when “reasonable employees … could have thought that [their employer] was communicating with them [about the contents of the plan] both in its capacity as employer and in its capacity as plan administrator,” the employer is acting as a fiduciary under ERISA.

Foot Locker was ordered to retroactively reform the benefit structure to calculate the initial cash balance account based on a different (6%, rather than 9%) discount rate and actually provide the “A plus B” benefit to which the participants reasonably believed they were entitled. In addition, it ruled that any participant who had already retired will not only receive the difference between the “A plus B” benefit and the benefit actually received, but will also receive interest at an annual rate of 6% from the date of their underpayment.

It’s worth noting that the problem here wasn’t the conversion, nor the wear-away effect itself – the issue was a determination that the Foot Locker fiduciaries intentionally hid the wear-away effect from participants, allowing them to believe they were accruing additional benefits during a time when they were not. The remedy of the court then was to force Foot Locker to give participants the benefits which the communications led them to believe they were earning.

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