Second Circuit: Plan Is Liable for Unreasonable Interpretation and Not Properly Informing Participants of Rights

Practical Law Legal Update 0-553-2545 (Approx. 7 pages)

Second Circuit: Plan Is Liable for Unreasonable Interpretation and Not Properly Informing Participants of Rights

by Practical Law Employee Benefits & Executive Compensation

Background

The plaintiffs in Frommert are Xerox employees who were previously employed by the company and subsequently rehired, having received a lump-sum distribution of their accrued pension benefits when they left. They brought suit under ERISA against the Xerox Retirement Income Guarantee Plan (Plan) and individually named Plan administrators (Plan Administrators), arguing that the plan administrator's interpretation:

Violates ERISA's notice provisions.
Is an unreasonable interpretation of the Plan.

Retirement Plan

The Plan is a floor-offset retirement plan, which includes elements of defined benefit and defined contribution plans. The Plan has three parts:

The Retirement Income Guarantee Plan formula (RIGP), which is used to calculate the defined benefit annuity. The formula takes 1.4% of the participant's highest average yearly pay, based on the participant's five-highest-paying calendar years, and multiplies it by the participant's years of service, up to 30.
The Cash Balance Retirement Account (CBRA), a defined contribution system consisting of an account with yearly contributions from Xerox. The account accrues interest at a rate of 1% above the one-year Treasury Bill rate. The account also includes the beneficiary's transferred balance from Xerox's pre-1990 profit-sharing plan (1990 is the baseline because the Xerox Plan was restated in 1989).
The Transitional Retirement Account (TRA), a defined contribution system that provides an account with the beneficiary's transferred balance from the pre-1990 profit sharing plan, increased based on investment results.

The totals of each beneficiary's CBRA and TRA are converted into annuities and the monthly values of the three accounts are compared. The beneficiary then receives benefits from the account with the greatest monthly value. The RIGP amount is independent of market performance and therefore provides a floor of benefits, because the greatest monthly amount will always be at least the RIGP.

The underlying issue in Frommert is how the plaintiffs' prior lump-sum distribution affects the determination of benefits under the Plan on reentry into the Plan. The Plan had used a phantom account offset method to reduce rehired employees' retirement plan benefits by the amount of the prior distribution. Under this method, a participant's account was treated as if the lump sum had remained in the plan and then subtracted from the current value of the participant's prior distribution in that same account.

Case History

The plaintiffs brought suit under:

ERISA Section 502(a)(1)(B), arguing that the phantom account offset method failed to take into account the prior lump-sum distribution was an improper interpretation of the Plan and that they were entitled to greater benefits.
ERISA Sections 1022 and 1054(h), arguing that they were not appropriately notified of the offset.

In Frommert I, the US District Court for the Western District of New York granted summary judgment in favor of the defendants. On appeal, the Second Circuit vacated the grant of summary judgment. The Second Circuit held that:

The Plan Administrator's use of the phantom account offset method was an improper interpretation of the Plan, because the Plan did not contain the phantom account offset and it was never validly amended to include it.
The phantom account offset violated the anti-cutback rule under ERISA Section 204(h) which requires plan administrators to provide 15 days notice of any amendment creating a significant reduction in the rate of future benefit accrual.
The plan administrator's use of phantom account offset was unreasonable under the Firestone deference, which gives the plan administrator discretionary authority to interpret plan terms and de novo review.

On remand, the district court used as an offset the nominal value of the prior lump sum distribution. The district court did not apply a deferential standard of review and rejected the alternate methods of calculating the offset proposed by the Plan Administrator.

The Second Circuit affirmed the District Court's interpretation of the Xerox Plan (Frommert II). However, the US Supreme Court reversed and remanded, stating that the Second Circuit erred in holding that the district court could refuse to defer to the Plan Administrator's interpretation of the Plan on remand simply because the Second Circuit found the Plan Administrator's previous related interpretation to be invalid, and that the court must defer to the Plan Administrator's interpretation.

The Second Circuit then remanded the case to the district court to determine the appropriate offset, applying Firestone deference. In Frommert III (referred to as Frommert), the district court applied Firestone deference and held that the Plan Administrator's interpretation was reasonable.

The plaintiffs appealed the district court's decision, arguing that:

The Plan Administrator's offset method:
- is not a reasonable interpretation of the Plan under Firestone deference; and
- violates ERISA's notice requirements.
The district court erred in failing to permit the plaintiffs to conduct discovery on the issue of whether the Plan Administrator was operating under a conflict of interest.

Outcome

In a published decision that vacated the judgment of the district court and remanded the case for further proceedings, the Second Circuit:

Held that the proposed offset is:
- an unreasonable interpretation of the Plan; and
- a violation of ERISA's notice provisions.
Affirmed the district court's decision to deny the plaintiffs' request for additional discovery.

The Second Circuit first identified the two deferential standards of review at work in Frommert:

The Plan Administrator's interpretation of the Plan is entitled to the Firestone deference because it is a new interpretation of plan terms, based on a question raised on remand. The district court applied this level of deference to the Plan Administrator's proposed offset. Under the Firestone deference, a court may overturn a plan administrator's decision only if the decision to deny benefits was:
- without reason;
- unsupported by substantial evidence; and
- erroneous as a matter of law.
The Second Circuit reviewed the district court's interpretation of the Plan for an abuse of discretion.

The Second Circuit remanded the case to the district court to determine an appropriate remedy, noting that the court should first consider equitable remedies in tandem with the question of whether the plaintiffs satisfy the standard of "likely prejudice." If no equitable remedy is available, the district court should consider the unreasonable interpretation claim (the appropriate remedy for that claim would be enforcement of the Plan).

Finally, the Second Circuit held that the district court did not abuse its discretion in declining to reopen discovery on the issue of whether the Plan Administrator is operating under a conflict of interest because the Administrator is an employee of Xerox, which is ultimately responsible for funding the plan.

Reasonable Interpretation

The Second Circuit held that the offset is inconsistent with the Plan's plain terms and is therefore an unreasonable interpretation of the Plan.

The Plan provides that if a participant's accrued benefit is distributed before the "Normal Retirement Date" and the participant then recommences active participation in the plan, the participant's accrued benefit must be offset by the benefit attributable to the earlier distribution.

To justify the Plan Administrator's proposed offset, the defendants argued that, since the Plan provides that a beneficiary's benefits must be reduced by the prior lump-sum distribution, the RIGP benefit must be reduced by the amount of the prior lump sum distribution. The RIGP is expressed in the form of an annuity, and therefore the lump-sum distribution must be converted into an "actuarially equivalent" annuity before making the offset.

The Second Circuit held that the defendants' approach is unreasonable because it makes rehired employees worse off under the plan in terms of actual benefits received as compared to newly-hired employees. It does not place rehired employees and newly hired employees in an equivalent position.

The Second Circuit compared how two hypothetical employees, one a rehired employee with 35 years of total experience, and the other an employee with 25 years of continuous experience and never rehired, would fare under the Administrator's proposed offset. The Second Circuit found that even if the two employees had an equivalent highest average salaries, the rehired employee's RIGP would be less than the employee who was never rehired. The rehired employee's benefit would be exposed to more market risk.

ERISA permits retirement plans to treat rehired employees worse than newly-hired employees, if such terms exist in the plan, but they do not exist in the Xerox Plan. Because the Plan does not define the offset in accordance with the Plan Administrator's proposal and provides a contradictory result, it is unreasonable.

Notice

The Second Circuit also held that even if the Plan Administrator's proposed offset was reasonable, it still cannot be enforced because proper notice was not provided to the Plan's participants, as required by ERISA. The Plan violated ERISA's notice provisions because the Plan's summary plan descriptions (SPDs):

Do not clearly identify the circumstances that will result in an offset. Instead, they only state that a lump-sum distribution may reduce the RIGP benefit. A beneficiary would therefore not know that a prior distribution from a plan account would reduce his benefit after being rehired.
Fail to provide the interest rate used to make the actuarial equivalence, making the SPDs insufficiently accurate and comprehensive. The Second Circuit rejected the defendants' arguments that this holding could result in SPDs that are clogged with technical minutiae, defeating the underlying purpose of SPDs (to be clear, concise guides to the plan). The Xerox Plan's SPDs could have sufficiently explained the offset by "including a brief statement that the RIGP benefit would be offset by the appreciated value of any prior distribution." In the alternative, the SPD could have provided an example calculation of benefits under the offset.

Practical Implications

Frommert reminds practitioners once again about the scope of deferential review permitted by the plan administrator. After three district court decisions and a decision by the Supreme Court, the Plan is found to be liable for an unreasonable interpretation of the plan and for not properly informing participants of their benefits under the SPD. Practitioners are reminded to properly inform participants of the plan terms, notify them of any amendments and provide appropriate notice under Section 204(h) of the Internal Revenue Code (IRC).

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Second Circuit: Plan Is Liable for Unreasonable Interpretation and Not Properly Informing Participants of Rights | Practical Law