Slaying Goliath?: Reversal of Arbitration Confidentiality Order

James Dever never imagined his efforts would overturn a gag order imposed upon private arbitration proceedings. In the midst of a long, successful career with Oppenhemier he was forced to resign for apparently unwarranted reasons centering around his involvement in the investigation of a subordinate’s dishonest and unethical business practices with an elderly couple. The subordinate, Stephen Toussaint, was sentenced to four years in prison, whereas, Dever was asked to step down from his branch manager role by the Chief Executive of Oppenheimer and told to be gone in six months, allegedly claiming pressure from the State of Massachusetts.

Common place in the financial industry is the confidentiality given to both financial institutions and customers regarding any arbitration proceedings. Arbitration agreements are standard, but some do more harm to individuals than the very benefit they were intended to provide. Dever encountered this very issue as the confidentially order regarding his investigation of Toussaint’s unethical business practices and other various documents did more harm than good. His name was damaged in the financial sector, causing him great financial stress. Dever fought to reverse the confidentiality order in an effort to clear his name and bring this matter to the public's eye.

Despite strong objections from Oppenheimer arguing attorney-client privileges and customer privacy laws, Judge McIntyre ruled that “the public’s interest in transparency trumps a financial institution’s interest in concealing its dealings with employees, regulatory agencies, and their lawyers.” In the wake of this substantial ruling, we can attest to the need for more transparency within the financial industry. We may see others challenge long-stood assumptions regarding blanket privacy provisions for arbitrations. Letting some sun light in may benefit both customers and the "honest majority" within the financial sector.

For a more detailed review of this case, one may wish to review the articles written by Boston Globe reporter Beth Healy.

New Year, New Fiduciary Standard?

It has been about six months since the passing of the Dodd-Frank financial reform law—and that means the results from the many studies commissioned by the Act will begin to be released. Dodd-Frank specifically required the Securities and Exchange Commission to look into regulatory standards and oversight gaps between investment advisors and brokers. Last week, the SEC released the results of its study on Section 913 and 914 dealing with the fiduciary duty issue and stricter investment-adviser examinations, respectively.

The issue of whether to impose a uniform fiduciary standard has been met with both fierce support and opposition. Currently, advisers are held to a fiduciary standard that requires them to act in the best interest of their clients, while brokers are only required to offer suitable products to retail customers. The problem with the dual standard arises where brokers offer advice and sell investment products—blurring the lines for retail investors and making it hard to tell when they are receiving sound investment advice or just a sales pitch.

However, last Friday, the SEC handed over its staff study to Congress recommending a uniform fiduciary standard. The study, if implemented as is, would hold brokers to the same fiduciary level as investment advisers under the Advisers Act when brokers are providing personalized investment advice about securities to retail investors. Therefore, under this study, brokers would only be held to a higher fiduciary duty when acting like an investment advisor.

Justification for a uniform standard stems from the issue of retail investors being unable to distinguish between a broker and an investment advisor. According to the SEC, if consumers are receiving investment advice, regardless of the source—broker or advisor—retail consumers should be protected uniformly. Accordingly, such a standard would achieve that goal. The SEC study also states that it attempted to balance retail investors’ need for protection with their ability to have access to various investment products. Because the standard only applied to brokers when giving investment advice, the SEC takes the position that a wide array of products will continue to still be available.

Further, in an attempt to close oversight gaps and keep implementation costs “to a minimum,” the SEC study also “recommends that when broker-dealers and investment advisers are performing the same or substantially similar functions” the regulatory protections should be “harmonized”, but the study lacks specific details on how to achieve this “harmonization.”

Ultimately, however, the staff study suggests additional research and analysis into this area before any implementation. Additionally, there is no statutory deadline for any follow-up rulemaking pursuant to this study, so it seems unlikely that much will be done without further research and analysis. SEC Commissioners Kathleen Casey and Troy Paredes share this view in their Statement Regarding Study on Investment Advisers and Broker-Dealers and emphasized the need for further research before any uniform fiduciary standard rulemaking begins.

The Wrongful Distribution of Retirement Benefits to a Plan Fiduciary is Prohibited by ERISA Section 406(b)

Although the distribution of benefits to a plan participant is not a “transaction” as that term is used in Section 406(a), the wrongful distribution of benefits to a plan fiduciary is clearly prohibited conduct under Section 406(b). For example, in Lockheed Corp. v. Spink, 517 U.S. 882 (1996), the plaintiff brought suit against his employer (administrator of his 401(k) plan) under Section 406(a)(1)(D) because the employer wrongfully allowed some of its employees to receive early retirement benefits that the plaintiff was unable to receive. Id. at 892-93. The respondent argued that the payment of benefits is not a “transaction” under Section 406(a). Id. at 892. In its holding, the Court agreed with the respondent, but made clear that its holding was strictly limited to the language of Section 406(a). Indeed, the Court clarified that “the payment of benefits is in fact not a ‘transaction’ in the sense that Congress used that term in § 406(a).” Id. at 892 (emphasis added).

The narrow scope of Lockheed becomes clear upon a review of subsequent federal caselaw. See Armstrong, 2004 WL 1745774, at *10 (holding “payments to participants in accordance with plan terms not to be transactions within the meaning of [Section 406(a)]”); Owen v. SoundView Financial Group, Inc., 54 F.Supp.2d 305, 323 (S.D. N.Y. 1999) (holding that “ERISA's “Prohibited Transaction” rules, see 29 U.S.C. §§ 1106(a) [ERISA Section 406(a)]…are not applicable to the payment of Plan benefits to a Plan beneficiary, because the beneficiary is not a “party in interest”). The limited scope of Lockheed is confirmed by the equally limited scope of Section 406(a). For instance, Section 406(a), entitled, “Transactions between plan and party in interest,” is plainly intended to govern only those transactions in which fiduciaries cause a plan to engage. Indeed, Section 406(a)(1) begins with the following language: “A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect. . . .” (emphasis added). Section 406(a)(1) then lists five narrow types of transactions in which a fiduciary should not cause a plan to engage. Courts have determined that the purpose of Section 406(a) is limited to “prevent[ing] plan fiduciaries from engaging in certain transactions that benefit third parties at the expense of plan participants and beneficiaries.” Armstrong v. Amsted Industries, Inc., 2004 WL 1745774, at *10 (N.D. Ill. 2004); Marks v. Independence Blue Cross, 71 F.Supp.2d 432, 437 (E.D. Pa. 1999).

The limited holding of Lockheed (and the subsequent federal court decisions) does not, however, apply in many cases. Indeed, a plaintiff’s prohibited transactions claim against a defendant may be brought under a completely separate ERISA provision: Section 406(b). This Section, entitled “Transactions between plan and fiduciary,” may more clearly apply to a defendant’s conduct. Importantly, unlike Section 406(a), Section 406(b) does not specifically limit which types of transactions apply to the Section. As such, the “transactions” contemplated under Section 406(b) are much broader in scope than those specifically set forth in Section 406(a). Moreover, rather than aiming to prevent plan fiduciaries from engaging in transactions that benefit third parties at the expense of plan participants and beneficiaries, Section 406(b) aims to prevent—among other things—plan fiduciaries from engaging in prohibited transactions for their own account. A plan fiduciary wrongfully using his or her power to obtain a higher distribution than is warranted, for example, obviously falls under the broad conduct contemplated under Section 406(b).

Finally, Section 408(c)(1) reads as follows:

Nothing in [ERISA Section 406] shall be construed to prohibit any fiduciary from—

(1) receiving any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries.

A plain reading of this Section establishes that Section 406 should be construed to prohibit a fiduciary from receiving a benefit that is computed and paid on a basis which is inconsistent with the terms of the plan as applied to all other participants and beneficiaries.

Can a 401(k) plan member recover damages to his individual account caused by a Plan Administrator’s breach of fiduciary duty?

An ERISA Plaintiff cannot seek individual monetary damages for a Plan Administrator’s breach of fiduciary duty to the plan. Importantly, however, seeking damages on behalf of the 401(k) Plan as a result of a Plaintiff’s losses in his individual account is explicitly permitted under LaRue v. DeWolff, Boberg & Associates, Inc., 552 U.S. 248 (2008), which held that ERISA Section 502(a)(2) authorizes recovery by a plan participant for fiduciary breaches “that impair the value of plan assets in a participant's individual account.” 522 U.S. at 256. The Supreme Court in LaRue made clear its reasoning for this holding:

Whether a fiduciary breach diminishes plan assets payable to all participants and beneficiaries, or only to persons tied to particular individual accounts, it creates the kind of harms that concerned the draftsmen of § 409.

Id. at 256.

For instance, a Plaintiff may rely upon ERISA Section 502(a)(1)(B) for a Defendant’s failure to provide the Plaintiff with the full 401(k) benefits owed to him under the 401(k) Plan at issue. And the Plaintiff may also rely upon ERISA Section 502(a)(2) for a Defendant’s breaches of fiduciary duties. A plain reading of Sections 502(a)(1)(B) and 502(a)(2) establishes that the two sections provide for different relief. Indeed, as the 9th Circuit explicitly noted in Harris v. Amgen, Inc.:

Section 502(a)(1)(B) allows a plan participant “to recover benefits due to him under the terms of his plan.” By contrast, Section 502(a)(2) encompasses claims based on breach of fiduciary duty and allows for the more expansive recovery of “appropriate relief,” including disgorgement of profits and equitable remedies.

573 F.3d 728, 734, n. 4 (9th Cir. 2009) (citations omitted).

Regardless, some defendants incorrectly assert that “the Eighth Circuit and other courts alike have repeatedly held that participants cannot state claims for breach of fiduciary duty under ERISA Section 502(a) when they are also seeking to recover the same benefits under ERISA Section 502(a)(1)(B).” The falsity of this assertion is clear upon a review of the federal caselaw. Indeed, the cases usually cited are inapplicable in that each is either irrelevant or is limited in scope to claims brought under ERISA Sections 502(a)(1)(B) and 502(a)(3), not Sections 502(a)(1)(B) and 502(a)(2). See Geissal ex rel. Estate of Geissal v. Moore Medical Corp., 338 F.3d 926, 933 (8th Cir. 2003) (narrowly holding that a beneficiary cannot bring a claim for benefits under Section 502(a)(1)(B) and Section 502(a)(3)(B)); Conley v. Pitney Bowes, 176 F.3d 1044, 1047 (8th Cir. 1999) (citing Wald v. Southwestern Bell Corporation Customcare Medical Plan, 83 F.3d 1002, 1006 (8th Cir. 1996) in holding that “where a plaintiff is ‘provided adequate relief by [the] right to bring a claim for benefits under [Section 502(a)(1)(B)],’ the plaintiff does not have a cause of action to seek the same remedy under [Section 502(a)(3)(B)]”). Some defendants also cite Coyne & Delaney Co. v. BCBS of Va., Inc., 102 F.3d 712 (4th Cir. 1996). However, Coyne is not relevant in that it analyses whether a plan fiduciary can bring a claim for benefits under ERISA Section 502(a)(3). 102 F.3d at 713.

Some plan defendants also rely upon the U.S. Supreme Court’s holding in LaRue v. DeWolff, Boberg & Assoc., Inc., 552 U.S. 248 (2008) for the proposition that duplicative claims under ERISA Section 502(a)(1)(B) and 502(a)(2) are inappropriate. Specifically, defendants may rely upon commentary by Chief Justice Roberts in that case, without revealing that Justice Roberts wrote the concurring opinion rather than the opinion of the Court. Accordingly, his analysis is not binding. Id. at 249. In fact, at the conclusion of his concurring opinion, Justice Roberts acknowledged that his analysis is not binding on the issue: “In any event, other courts in other cases remain free to consider what we have not—what effect the availability of relief under § 502(a)(1)(B) may have on a plan participant's ability to proceed under § 502(a)(2).” Id. at 260.

Indeed, in Crider v. Life Ins. Co. of N. Am., 2008 WL 2782871 (W.D. Ky. 2008), the Western District of Kentucky acknowledged that Justice Roberts’ analysis in LaRue is not binding, and therefore noted that in deciding whether to allow a claim under both ERISA Section 502(a)(1)(B) and Section 502(a)(2), the question for the court is whether the facts the plaintiff alleges “state a claim for breach of fiduciary duty under Section 502(a)(2) which is separate from her claim for benefits under Section 502(a)(1)(B).” Id. at *2. The court further noted that in deciding this question, the Sixth Circuit has on at least three occasions “allowed plaintiffs to pursue both a claim for benefits under Section 502(a)(1) and also to attempt to hold a plan responsible for breaches of fiduciary duty under a separate Section 502(a) action.” Id. Finally, In Hill v. Blue Cross & Blue Shield of Mich., the Sixth Circuit observed that plan-wide claims are distinct from claims seeking to correct the denial of individual benefits. 409 F.3d 710, 718 (6th Cir. 2005).

Finally, it is well-established that “[i]n ruling on a motion to dismiss, a court must view the allegations of the complaint in the light most favorable to the plaintiff.” Guarantee Co. of North America, USA v. Middleton Bros., Inc., 2010 WL 2553693, at *2 (E.D. Mo. June 23, 2010). To survive a motion to dismiss, a claim need only be facially plausible, “meaning that the factual content…allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. (quoting Cole v. Homier Dist. Co., Inc., 599 F.3d 856, 861 (8th Cir. 2010)).

When has an ERISA Plaintiff failed to state a claim for failure to exhaust administrative remedies?

Point #1: Not all ERISA Plaintiffs are required to exhaust administrative remedies prior to filing suit. Indeed, the Eastern District of Missouri has a well-established rule that “ERISA plaintiffs [must] exhaust the plan review procedures before bringing suit, when the plan clearly requires exhaustion.” Wootten v. Monumental Life Ins. Co., 412 F. Supp. 2d 1020, 1024 (E.D. Mo. 2006). So -- does the 401(k) Plan at issue in your case require exhaustion of administrative remedies if a claim for benefits was never denied.

By way of example, some 401(k) Plans provide that:

“[a]ny Participant or Beneficiary who is entitled to a payment of a benefit for which provision is made in this Plan shall file a written claim with the Plan Administrator on such forms as shall be furnished to him by the Plan Administrator…If a claim for benefit is denied by the Plan Administrator, in whole or in part, the Plan Administrator shall provide adequate notice in writing to the Participant or Beneficiary. . . .

As clearly set forth in this 401(k) Plan example, the plan participant need only exhaust administrative remedies—i.e., file a notice of appeal—if the Plan Administrator denied the participant’s claim for benefits. So the next question is: did the Plan Administrator deny, either in whole or in part, a claim for benefits (equivalent to their requests for distribution)? They likely did if, after requesting distribution, the Plaintiff received a distribution notice which clearly stated, “[y]ou are entitled to distribution under the 401(k) Retirement Plan and Trust.”

Some Plan defendants may rely upon a 1997, non-binding Arizona District Court case, McElwaine v. U.S. West, 1997 WL 34609606 (D. Ariz. 1997), to improperly assert that a miscalculation of retirement benefits is somehow a “separate and new claim.” However, the 401(k) Plan at issue in our example does not set forth such a distinction. And again, at least the Eastern District of Missouri has previously held that exhaustion of remedies is only required if a plan “clearly requires exhaustion.” Wootten, 412 F. Supp. 2d at 1024. Since the 401(k) Plan language above does not “clearly require exhaustion” for a miscalculation (as opposed to a denial) of benefits, the Plaintiff in our example should not be required to exhaust his administrative remedies.

Even if the Court deems that a Plaintiff’s claims for benefits were “denied,” a Plaintiff is still not required to exhaust his administrative remedies if he never received any notice of the proper appeals procedure. The Eastern District is clear that plan participants must only exhaust their administrative remedies “when exhaustion is clearly required by the particular plan involved and the beneficiary has notice of the procedure.” Chorosevic v. MetLife Choices, 2009 WL 723357, at *4 (E.D. Mo. 2009).

The Eighth Circuit is also clear that ERISA plaintiffs are not required to exhaust administrative remedies if doing so would be futile. Brown v. J.B. Hunt Transport Services, Inc., 586 F.3d 1079, 1085 (8th Cir. 2009). “When exhaustion is futile, an ERISA beneficiary's claim accrue[s] at the time at which it became futile to apply for benefits, because…at that time there was a de facto denial of [the beneficiary's] claim.” Union Pacific R. Co. v. Beckham, 138 F.3d 325, 332, n. 4 (8th Cir. 1998). A Defendant’s conduct toward a Plaintiff, both before and after the disbursement of their 401(k) funds, may establish that an exhaustion of Plaintiffs’ administrative remedies would be futile.

Should a Court find that a Plaintiff did in fact fail to exhaust his or her administrative remedies, the Plaintiff should move to stay the proceedings in the case to allow him or her sufficient time to exhaust his or her remedies. Both the Eastern District of Missouri and Eighth Circuit (along with other federal courts) have either held or suggested that a stay of court proceedings is a proper procedure to allow an ERISA plaintiff to exhaust administrative remedies. And courts have generally allowed a stay of the proceedings upon request, either directly or in the alternative. For instance, in a recent 2006 case, the defendants moved for a stay or dismissal of the ERISA suit because the plaintiff had not exhausted administrative remedies. Michael v. American Intern. Group, Inc., 2006 WL 5736351, at *1 (E.D. Mo. 2006). Rather than dismissing the plaintiff’s suit, the District Court stayed the case, noting the Eighth Circuit’s previous holding that “where a claimant has prematurely filed suit, a court may stay proceedings to allow the claimant to complete the administrative review process.” Id. at *1; (citing the Eighth Circuit’s holding in Galman v. Prudential Ins. Co. of Am., 254 F.3d 768, 769 (8th Cir. 2001), wherein the Eighth Circuit affirmed the district court’s stay of proceedings to allow for exhaustion of administrative remedies where claimant prematurely filed suit). Moreover, in Painter v. Golden Rule Ins. Co., 121 F.3d 436 (8th Cir. 1997), the Eighth Circuit suggested that a stay of court proceedings to allow time for a plaintiff to exhaust remedies is a proper procedure upon the plaintiff’s request:

We also reject Painter's suggestion that dismissal of Golden Rule's declaratory judgment action was inevitable. The district court never considered Golden Rule's alternative motion to stay the action while contract remedies were exhausted; had Golden Rule pressed that point after the court corrected its subject matter jurisdiction ruling, a stay might have been granted.

Id. at 441. In its opinion, the Eighth Circuit ratified the district court’s determination that a failure to exhaust remedies is not a jurisdictional defect depriving a court of power over a case. See id. at 440.

Other circuits have similarly held that a stay of the case is proper when a court finds that an ERISA plaintiff failed to exhaust administrative remedies. For instance, the Southern District of West Virginia recently held that a stay is proper in an ERISA case to allow a plaintiff to exhaust administrative remedies. In re Workman, 2005 WL 3481509, at *1 (S.D. W.Va. 2005). In that case, the defendants moved to stay the action, and the only issue before the Southern District was whether a stay of the case was proper. Id. After determining that the plaintiff had not exhausted administrative remedies, the court granted the defendants’ motion to stay pending the plaintiff’s exhaustion of administrative remedies. Id. In addition, in Caldwell v. Western Atlas Intern., 871 F. Supp. 1392 (D. Kan. 1994), the Kansas District Court stayed the case pending the ERISA plaintiff’s exhaustion of administrative remedies instead of dismissing the case. 871 F. Supp. at 1397. In its holding, the court opined that “judicial economy will better be served by staying the proceedings related to plaintiff's ERISA claim, rather than dismissing the claim.” Id.

MORE FALLOUT FROM CDO'S AND CMO'S

APS Financial Corporation (“APS”) recently entered in to a Letter of Acceptance, Waiver and Consent (“AWC”) with the Financial Industry Regulatory Authority (“FINRA”). As a procedural matter, the AWC was submitted to FINRA's Department of Market Regulation for acceptance or rejection.

It should be noted from the outset that APS consented to the terms of the AWC without admitting or denying the findings contained within it, to wit: violations of NASD Rules 2110, 2440 and 3010 due to allegedly unfair pricing practices directed at certain customers purchasing corporate bonds, collateralized debt obligation.

A recent review of the Securities Litigation Commentator and a daily review of the Wall Street Journal amply illustrates the ongoing regulatory and private litigation fall-out born of the 2006 – 2008 CDO and CMO boom. Indeed, even Charles Schwab got hit by the SEC for $119 million for allegedly making misleading statements regarding the risks associated with a bond mutual fund containing mortgage-backed securities. For a more in depth and interesting narrative of the practices and characters associated with the securitization of residential mortgage debt, this author highly recommends Michael Lewis' The Big Short.

COGNITIVE DISSONANCE: STATES WITH EXPANDED INVESTMENT ADVISER REGULATORY RESPONSIBILITIES LIKELY TO RECEIVE STAGNANT OR REDUCED FUNDING

This coming summer over 4,000 mid-size investment advisory firms will fall under the auspices of a new regulator: their home state. No longer will they be regulated by the SEC, which managed to conduct regulatory examinations of less than 15% of the approximately 12,000 investment advisers it regulated in 2010. The Dodd-Frank Act's shift of a segment of this nearly unregulated group was intended to improve this situation. But over one-third of the 4,100 investment advisers making the migration will have a new state regulator with either no regular examination program or with an umbilical cord to one of the worst budget crises in the nation: New York, California, Illinois and Massachusetts. And while the regulatory staffs in each of these states are among the best of the best, the situation begs for an answer better than: “we will be able to handle it.” Not only does this answer strain credulity, it seems to ignore the initial premise behind the regulatory shift and expansion of power advocated by state regulators: that they would improve investor protection by doing more and by doing it better than the SEC in the area of regulatory audits for mid-market advisers.

The current lack of a convincing and comprehensive public answer or plan by state regulators in response to the skeptics left the door open for the brokerage industry's self-regulatory organization to insert its foot. Apparently FINRA has recommended that it, or a SRO sister-to-be-created, should fill the feared void. Trade associations haven't missed the opportunity to join the turf war either, with the Financial Services Institute backing FINRA and the Investment Adviser Association siding with the state regulators. This author for one, has no interest in joining the fray and is confident that the data for a more informed evaluation and decision making process will be available in a year or two.

Assuming the states will find a way to digest the new regulatory burdens on the way, investment advisers should begin preparing for the advent of more frequent exams, audits, follow-up inquiries, remedial plans and enforcement actions. Lest I miss the opportunity for a plug – Cosgrove Law, LLC has experience assisting mid-market advisers with compliance issues, regulatory inquiries and enforcement actions.

For more information, or a different take on what I discussed in this entry, see The Wall Street Journal's January 3^rd article on the issues and NCSL.org.