In a long-running class-action lawsuit involving a conversion from a defined benefit (DB) design to a cash balance design, the plan sponsor failed to adequately disclose the potential for wear-away to participants, according to a recent court decision. The court ordered the employer to reform the plan and provide affected participants with the benefits they had reasonably expected to receive. The sponsor plans to appeal the decision. The case highlights the importance of ensuring that disclosures and communications to plan participants provide the appropriate level of detail.
In Osberg v. Foot Locker Inc., a class of participants alleged that the fiduciaries of Foot Locker’s DB plan violated Section 404(a) of the Employee Retirement Income Security Act (ERISA), which requires plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries, as well as Section 102(a), which governs disclosure requirements. The District Court for the Southern District of New York agreed with participants, concluding that “reformation” of the plan document as amended is the appropriate remedy. The order has been stayed pending appeal.
Plan conversion and wear-away
Foot Locker converted its traditional DB design to a cash balance design on January 1, 1996. To avoid violating the anti-cutback rules, benefits were determined based on the greater of the participant’s accrued benefit as of December 31, 1995, and the value of the cash balance benefit. Thus, until the participant’s cash balance benefit caught up to the participant’s accrued benefit as of December 31, 1995, the plan would be subject to a period of wear-away, meaning that participants would not earn additional benefits for some period of time.
The conversion amendment took effect on January 1, 1996, before enactment of the Pension Protection Act of 2006 (PPA) and the 2010 final hybrid regulations, which generally prohibited wear-away after plan conversions. As explained in the 2010 regulations, the PPA mandated an A+B approach1 for conversion amendments after June 29, 2005. If participants receive the most advantageous of the old and new formulas for a number of years, the A+B provisions must take effect when the benefits stop accruing under the traditional formula.
Case and remedy
The plaintiffs’ primary allegation is that Foot Locker did not inform them that the conversion would result in a cessation of benefit accruals during the wear-away period, and its failure to do so violated the plan fiduciaries’ duties under ERISA. In its opinion, the court noted that, while participants received notice of the changes in a series of communications, none addressed the possibility of a wear-away period.
At the trial, the court drew the following conclusions:
- Wear-away was an intended feature of the plan amendment.
- Plan disclosures and other communications failed to disclose wear-away.
- The lack of disclosure was intentional.
- Wear-away impacted thousands of employees, and the plan was still in wear-away status for many of them when they terminated employment and were paid benefits from the plan.
- Participants did not understand that, because of the wear-away, additional service after January 1, 1996, did not increase their retirement benefits.
- Appropriate disclosures would not have been too confusing to participants.
The court’s remedy was to reform the terms of the plan in accordance with the participants’ expectations. In doing so, the court relied heavily on the precedent set in CIGNA Corp. v. Amara, another class-action lawsuit involving a traditional DB-to-cash-balance conversion that resulted in wear-away for many participants. In Amara, the court used a three-pronged test to determine whether participants were entitled to reformation (or judicial correction of the plan’s terms), establishing that the participants must demonstrate:
- Violations of ERISA’s fiduciary and disclosure standards, based on a preponderance of the evidence
- Mistake or ignorance by employees of “the truth about their retirement benefits,” based on clear and convincing evidence
- “Fraud or similar inequitable conduct” by the plan fiduciaries, based on clear and convincing evidence
Violations of ERISA’s fiduciary and disclosure requirements
The court found that as plan administrator, Foot Locker had violated ERISA’s fiduciary obligations and disclosure standards. Under ERISA, fiduciaries have a duty of loyalty and duty of care, and providing participants with accurate and complete written explanations of benefits is central to that role.
Moreover, the court pointed out that these general fiduciary duties are supplemented with specific requirements for the presentation and content of summary plan descriptions (SPDs) and summaries of material modifications (SMMs). The SPD must contain certain information “written in a manner that is easily understood by the average participant and is sufficiently accurate and comprehensive to apprise participants and beneficiaries of their rights and obligations under the plan.” The same fiduciary standards apply to SMMs, which must be provided to participants within 210 days after the end of a plan year in which there is a material change to the plan or when SPD information has changed.
Regulations from the Department of Labor (DOL) require fiduciaries to “exercise considered judgment and discretion by taking into account such factors as the level of comprehension and education of typical participants in the plan and the complexity of the terms of the plan” in the SPD.
Mistake or ignorance by employees
The court found that, as a result of false, misleading and incomplete plan descriptions, employees were ignorant of the “truth about their retirement benefits.” There was sufficient evidence to establish that participants reasonably but mistakenly believed that the pay and interest credits under the post-conversion formula would increase their pension benefit. Participants thought their total benefit would equal the sum of the benefit earned under the traditional DB formula plus the benefit derived from the cash balance formula.
Equitable fraud or inequitable conduct
Equitable fraud may exist without a showing of intent to deceive or defraud. The court held that Foot Locker committed equitable fraud by making changes to its plan to reduce costs without disclosing the full extent or impact of those changes to plan participants. The court also noted that, following the January 1, 1996, amendment, Foot Locker engaged in inequitable conduct by failing to more clearly disclose the wear-away effect of the amendment to the plan’s participants.
The Foot Locker litigation presented unique theories of liability in a cash balance conversion. The outcome should serve as an important reminder to plan sponsors to carefully craft participant communications, including mandatory disclosures such as 204(h) notices, SPDs and SMMs, as well as discretionary communications about plan changes. These communications should always be accurate and written in a manner that clearly explains the terms of the plan, especially when it involves a change that will have a negative impact for participants. Also significant is that this case follows Amara’s precedent for the standards a court should apply to determine whether reformation is the appropriate remedy for violations of ERISA.