September/October 2004

Because bad facts often result in bad laws, directors of any organization (publicly or privately held, for-profit or not-for-profit, taxable or tax-exempt) need to work with management to re-think their organization’s responsibilities for overseeing employee benefit plans, including deferred compensation plans. The bad facts likely resulting in bad laws come from the Enron ERISA litigation proceeding in the United States District Court for the Southern District of Texas in Houston.

For the reasons discussed herein, governing boards or their compensation committees together with management should, as a priority, review and revise, where appropriate, all existing employee benefit plans so that the board and independent directors serve no more than non-fiduciary “settlor” functions as described below.

The case in a nutshell

The case is a derivative action brought on behalf of Enron’s employees for the loss of their benefits due to the investments made in Enron stock by three of Enron’s employee benefits plans: the ESOP, savings plan and cash balance plan. The bad facts are that Enron employees participating in these plans lost all of their benefits.

The case alleges that the Enron employees’ loss resulted from breach of fiduciary and co-fiduciary duties by the compensation committee of Enron’s board, among other defendants, in failing to oversee and take appropriate action with respect to the investments being made by these plans. Because Enron’s assets are not sufficient, the purpose of the case is to reach insurance coverage and assets of persons other than Enron. The defendants in the case include Enron’s compensation committee, both individually and as a committee, the trustee of the plans, and Enron’s law firms and auditor.

Although the case remains in a pleading and discovery phase, the court held that the case stated a claim against the compensation committee even though that committee exercised no responsibility with respect to the plans. The court based its holding on the definition of fiduciary and the concept of a named fiduciary under ERISA.

Under ERISA, a fiduciary is someone who falls within one of the following prongs:

1. Exercises any discretionary authority or discretionary control with respect to the management of such plan;
2. Exercises any authority or control with respect to the management or disposition of its assets [emphasis added];
3. Renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan or has any discretionary authority or discretionary responsibility to do so; or
4. Has discretionary authority or discretionary responsibility in the administration of such plan.

A named fiduciary under ERISA is someone who is named in the plan instrument, or who, pursuant to a procedure specified in the plan, is identified as a fiduciary. Because the compensation committee had authority to remove the trustees of the plans, the court found that the compensation committee is a named fiduciary having authority regarding the assets of those plans and falling within prong two of the above definition.

What is unsettling about the holding is that the trustees of the plans were directed by the plan documents to invest in Enron stock. Nevertheless the court found that:

• A directed trustee, even of an ESOP that is designed to invest in a designated security of a company, has “some duty . . . to keep apprized of the company's financial condition to the extent that trustee can determine whether its stock is an appropriate, i.e., prudent, investment;” and
• The compensation committee, because it has the power of removal, has some duty to monitor and supervise compliance with the forgoing duty by the trustee.

What is even more unsettling about the holding is that the court dismissed Skilling and Fastow, Enron’s president and CFO, respectively, from the case because neither was named in the plan documents as a fiduciary.

Why the case may result in bad law

The case is a concern because the judge in this case, and perhaps even the judges upon any appeal, want to help the harmed Enron employees reach assets that are not otherwise available to restore some of their losses. Unless there is a different final outcome, the Enron ERISA litigation case will be cited as finding that an organization’s board or compensation committee that has any authority regarding a plan’s assets, including merely the authority to remove a trustee, has some fiduciary duty regarding the investment of those assets.

Far reaching impact

This case is far reaching because it deals with an “employee benefit plan” under ERISA. Therefore, the holding impacts every organization providing employee benefits, including both publicly held companies like Enron and privately held companies, including non-profit and tax-exempt organizations.

In addition, the case finds liability for persons in their capacity as fiduciaries of an employee benefit plan rather than as directors of the employer sponsoring the plan. Therefore, the Ohio and Federal charitable immunity statutes shielding volunteers in their capacities as board members or officers of charitable organizations are not applicable because an employee benefit plan does not fall within the definition of a charitable organization under the Ohio statute or a non-profit organization under the federal statute. Moreover, the Ohio charitable immunity statute is likely not applicable because the Ohio act only gives immunity for breaches of fiduciary duty under state law and perhaps arguably only under Chapter 1702.

Regardless of the ultimate outcome, the Enron ERISA litigation will consume not only the time, but also the energy, of Enron’s compensation committee for possibly the rest of their careers or lives. It will also likely result in legal costs to them personally because Enron does not have the assets to reimburse them the retention or deductible under their D&O policies, and the legal costs may in fact exceed the policy limits, even if there is a favorable outcome.

To avoid this time and energy consuming ordeal of litigation, boards of any organization should work with the organization’s management to re-think whether the board should have any authority that would make the board or any of its committees a fiduciary of any of the organization’s employee benefit plans.

What needs to be re-thought

A body of law has developed under both common law and ERISA that finds that being the “settlor” of a trust does not result in becoming a fiduciary, or having fiduciary duties, under the trust. A settlor is the legal term for the person creating, or serving the role of creator, of the trust.

With respect to ERISA, the settlor is the person who adopts or terminates a plan. The Enron ERISA litigation court recognized that those serving settlor functions on behalf of an employer are not fiduciaries. The Enron court concluded that determining the design of a plan, making decisions regarding the form or structure of a plan, and adopting, amending or terminating a plan does not constitute serving in a fiduciary capacity.

The Department of Labor recognizes that performing settlor functions, to the extent provided by the employer’s board, does not make the board a fiduciary. However, the DOL does state that being responsible for the selection and retention of plan fiduciaries is itself a fiduciary function because that involves the exercise of "discretionary authority or discretionary control respecting management of such plan."

What needs to be re-thought is the appropriateness of limiting the involvement of the board and its committees of directors to:

• Adopting the plan, including designating the original plan fiduciaries as stated in the plan;
• Amending the plan, but delegating to management or an employee committee the authority and responsibility for overseeing and, where appropriate, replacing plan fiduciaries without necessity of an amendment to the plan document; and
• Terminating the plan.

Management is often in a better position, and therefore may be a more appropriate group, to oversee the performance of the plan’s fiduciaries and to remove those fiduciaries where appropriate. The plan document itself can limit management’s discretion in appointing successor fiduciaries, such as limiting any change in trustee to a company having legal trust powers and managing a certain dollar amount of investments or any change in investment manager to a manager registered under the Investor Advisers Act and not having conflicting relationships with the company or related parties. If so, the plan document should make clear that a change in plan fiduciaries may be made without amendment of a plan document or otherwise requiring approval of the employer’s board.

Administrative decisions regarding the operation of the plan should also be delegated to management. This includes rules for determining eligibility; calculations of service and compensation credits for eligibility, vesting and benefits; preparation of employee communications and government reports; collection, allocation and payment of contributions; and processing of claims, including resolution of claims for benefits.

Traditionally under ERISA, the practice was to name the entity of the employer as the named fiduciary. The thought was that stakeholders as the employer, employees and the Department of Labor would look to corporate law and the employer’s governing documents to determine who had fiduciary duties. However, this becomes a dangerous practice after the Enron ERISA litigation case because under all states’ corporation laws, the board of directors ultimately has authority for all matters not expressly reserved to shareholders or members or properly delegated to others. To avoid courts’ finding that boards implicitly assume responsibility because of this ultimate authority, the re-thought plan documents should identify clearly by name or, preferably, title the persons or committee to whom responsibility is actually delegated.

To avoid such risks of liability, we recommend governing boards or their compensation committees together with management review and revise, where appropriate, all existing employee benefit plans so that the board and independent directors serve no more than non-fiduciary “settlor” functions described above. In order to avoid implicit assumption of responsibility because of a board’s ultimate authority for all matters not reserved to members/shareholders or otherwise properly delegated to others, authority other than for settlor functions should be delegated to management or committees of employees clearly identified in plan documents by name or title. This should be done on a priority basis because any change in responsibility under ERISA will likely be held only to apply prospectively.