Retirement Plan Communications Failed to Adequately Disclose Implications of Wear-Away Period to Retirement Plan Participants | Practical Law

Retirement Plan Communications Failed to Adequately Disclose Implications of Wear-Away Period to Retirement Plan Participants | Practical Law

In Osberg v. Foot Locker, Inc., a plan sponsor that converted a defined benefit plan to a cash balance plan and instituted a wear-away was ordered to reform the plan to provide the benefit that the participants reasonable expected because the plan's communications to participants did not clearly and adequately explain the implications of the wear-away and how benefits were calculated.

Retirement Plan Communications Failed to Adequately Disclose Implications of Wear-Away Period to Retirement Plan Participants

by Practical Law Employee Benefits & Executive Compensation
Published on 06 Oct 2015 • USA (National/Federal)
In Osberg v. Foot Locker, Inc., a plan sponsor that converted a defined benefit plan to a cash balance plan and instituted a wear-away was ordered to reform the plan to provide the benefit that the participants reasonable expected because the plan's communications to participants did not clearly and adequately explain the implications of the wear-away and how benefits were calculated.
On September 29, 2015, the US District Court for the Southern District of New York issued a decision in Osberg v. Foot Locker, Inc., holding that an employer which acted as sponsor and administrator of a defined benefit plan violated ERISA Sections 404(a) and 102 (29 U.S.C. §§ 1104(a) and 1022) because it did not adequately disclose and explain the implications of the plan's conversion to a cash balance plan (No. 07 Civ. 1358 (KBF), (S.D.N.Y. Sept. 29, 2015)). Specifically, the plan's communications did not properly inform plan participants that new accruals of service would not increase their pension benefits during a "wear-away", which was instituted as a cost-saving measure. The court ordered the employer to reform the plan to provide the class of participants with the benefits that they reasonably expected to receive based on the employer's misrepresentations.

Background

On January 1, 1996, Foot Locker converted its defined benefit pension plan to a cash balance plan. To convert each participant's account balance from the old plan to the new plan, Foot Locker used a formula that created a wear-away in which participants' pension benefits did not grow despite continued service to the company. Foot Locker relied on this wear-away, which essentially froze plan benefits, as a source of cost-savings. The freeze of additional accruals in the cash balance plan was accompanied by a new 401(k) plan for employees.
Foot Locker was the sponsor and administrator of its cash balance plan. It informed plan participants of the plan conversion and wear-away period in several documents, including:
  • The letter to plan participants announcing the changes.
  • A "Highlights Memo" sent to employees with additional information on the changes.
  • The plan's summary plan description (SPD) that was distributed in December 1996.
  • Booklets distributed to plan participants that provided individualized "total compensation" statements and listed each employee's current account balance.
  • Individualized annual pension plan statements provided to participants.
However, all of these communications failed to:
  • Adequately describe wear-away and the resulting freeze in benefits. The SPD did not disclose wear-away and also did not explain the technical terms used in its discussion of the plan conversion.
  • Clearly and accurately discuss the reasons for the difference between a Participant's accrued benefit under the old plan and his cash balance under the new plan.
A class constituting all plan participants at the time of the 1996 conversion and their beneficiaries sued Foot Locker under ERISA in the Southern District of New York, seeking reformation of the cash balance plan to conform to the benefits they understood that Foot Locker had promised them, which were benefits that continued to grow with additional service to the company.

Outcome

On September 29, 2015, the court issued its decision in Osberg, holding that the class of participants is entitled to reformation of the Foot Locker plan because it showed:
  • Violations of ERISA Sections 404(a) and 102(a) (29 U.S.C. §§ 1104(a) and 1022), based on the 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.
These are the elements are required for plan reformation under Amara v. Cigna. In Amara, retirement plan participants sued their employer and the plan under ERISA Section 102(a) and 204(h) (29 U.S.C. §§ 1022(a) and 1054(h)), claiming that the defendants' communications to participants failed to give them proper notice of their benefits and misled them as to the nature of their benefits. The district court held in favor of the plaintiffs and ordered an award under ERISA Section 502(a)(1)(B) (29 U.S.C. § 1132(a)(1)(B)). Although the Second Circuit affirmed, the US Supreme Court held that plan documents summarizing the plan (such as an SPD) could not constitute the terms of the plan for purposes of ERISA Section 502(a)(1)(B) (see Article, Expert Q&A on the Impact of CIGNA Corp. v. Amara). (Following a district court decision on remand, the defendants appealed and the Second Circuit articulated these three elements in its 2014 Amara decision (775 F.3d 510, 525-31 (2d Cir. 2014)).)

ERISA's Fiduciary Duty and Disclosure Standards

As plan administrator with discretionary authority over the cash balance plan, Foot Locker is a plan fiduciary. Under ERISA Section 404(a), Foot Locker has a fiduciary duty of care toward the plan participants and beneficiaries. The duty of care entails providing accurate written communications regarding the plan. For example, under the Department of Labor's regulations, plan fiduciaries have an affirmative duty to make participants clearly "see" the circumstances under which they will not receive the benefits described in the SPD that they might otherwise reasonably expect to receive (see 29 C.F.R. § 2520.102-3(l)). SPDs must clearly and accurately disclose how the plan works.
The court found that Foot Locker's SPD and other communications were not written clearly or accurately. Foot Locker had a duty to disclose and explain wear-away and failed to do so. The statements provided in the plan communications regarding the wear-away period were intentionally false and misleading and designed to conceal its effect as a freeze on the growth of participants' benefits. The human resources employees who helped draft these communications deliberately concealed the negative impact that wear-away would have on participants' benefits.
Although Foot Locker asserted that it relied on the advice of counsel when drafting the communications, the court found that inside and outside counsel did not have all of the facts necessary to provide a clear understanding of the number of participants affected by wear-away.
Furthermore, the rollout of the 401(k) at the time of the plan conversion could not make up for Foot Locker's deceptive communications.

Class-Wide Mistake

The court also held that the class of plaintiffs proved by clear and convincing evidence that, as a result of Foot Locker's false, misleading, and incomplete Plan descriptions, employees were ignorant of "the truth about their retirement benefits." Numerous plan participants testified at trial that they did not understand or realize what was actually occurring when the plan converted from a defined benefit plan to a cash balance plan – specifically, that their retirement benefits would not grow despite providing additional service to the company. Foot Locker employees who helped administer the plan also testified that they were aware that participants would not be familiar with wear-away and would have to be educated on the topic.

Fraud or Inequitable Conduct

In its 2014 Amara decision, the Second Circuit described equitable fraud as generally consisting of "obtaining an undue advantage by means of some act or omission which is unconscientious or a violation of good faith." Equitable fraud does not require a showing of intent to deceive or defraud. The court in Osberg held that there is no doubt that Foot Locker engaged in equitable fraud because it sought and obtained cost savings by altering the participants' plan without disclosing the full extent or impact of those changes.
Inequitable conduct involves deception or even mere awareness of the other party's mistake combined with superior knowledge of the subject of that mistake or inequitable conduct. Where inequitable conduct is established by a plaintiff, reformation follows as a matter of course. The court held that the class proved by clear and convincing evidence that Foot Locker engaged in inequitable conduct regarding the amendment and conversion of its cash balance plan.

Remedy

The court ordered that the Foot Locker cash balance plan be reformed to actually provide the benefit that the misrepresentations in the plan communications inequitably caused class members to reasonably expect.

Practical Implications

Osberg builds on Amara and provides a useful lesson for retirement plan administrators. Administrators must ensure that plan communications accurately and accessibly explain the terms of the plan, especially changes to the plan that are detrimental to plan participants and beneficiaries, such as instituting a wear-away in a cash balance plan. The requirement to provide accurate plan communications overrides all countervailing business considerations, such as avoiding harm to employee morale or employee recruitment initiatives.