Terms and Marketing of Annuity Insufficient to Support RICO Fraud Claims

In 2007, Paul Harrington purchased a MarketPower Bonus Index Annuity (the “Annuity”) from Equitrust Life Insurance.  The Annuity uses “index accounts” to generate “index credits” that increase the annuity’s total amount based on periodic changes in the closing value of the S&P 500.  The Annuity also permitted annual withdrawals to an extent with no penalty; larger withdrawals were subject to diminishing surrender charges and market value adjustments.  The Annuity also included a premium bonus whereby Equitrust added 10% of the premiums paid in the first year. In 2009, Harrington brought a putative class action against Equitrust (Harrington v. EquiTrust Life Ins. Co., 2015 U.S. App. LEXIS 2717) for violations of RICO and Arizona law.  After Harrington filed a motion for class certification, Equitrust moved for summary judgment.  The district court granted summary judgment, entered judgment for Equitrust, but declined to award costs without any explanation.  Both parties appealed.

Harrington specifically alleged RICO violations of mail fraud (18 USC §1341) and wire fraud (18 USC §1343).  The violations can either be premised on a non-disclosure or an affirmative representation, but non-disclosure can support fraud only if the person charged breached an independent duty.  Harrington based his complaint entirely on the language of the Annuity contract and marketing materials - specifically, the (1) promise of premium bonuses, (2) the application of the Annuity’s market value adjustment, and (3) the circumvention of state nonforfeiture laws.

The Ninth Circuit agreed with the district court finding no actionable predicate acts.  Harrington claimed that the bonus was fraudulent because Equitrust failed to disclose that no additional money is invested when the bonus is credited and that the bonus is recouped by Equitrust crediting lower index credits than it might have in a contract without bonuses.  However, Equitrust delivered exactly what it promised.  Equitrust accurately described the program and it was unclear whether the Annuity would not outperform a non-bonus annuity.  As to the market value adjustment, Harrington alleged that the marketing materials failed to disclose a constant used for calculating the adjustment.  Again the Court rejected Harrington’s argument, noting the meticulous explanation and examples of the adjustment formula.  Finally, Harrington argued that the Annuity had an optional maturity date, based on Equitrust’s policy of affording annuitants relief from fixed-date terms upon request, which violated Arizona non-forfeiture law.  His argument failed because he offered no authority for his proposition and suffered no recognizable injury from his claim.

Addressing Equitrust’s appeal, the Ninth Circuit explained that a court is within its discretion to deny costs to a prevailing party under F.R.Civ.P. 54(d), but must explain the denial.

The Ninth Circuit affirmed summary judgment, vacated the order denying costs, and remanded to the district court for an explanation.

Supreme Court Clarifies Duty of Prudence for ESOP Fiduciaries

Under ERISA, §1104(a)(1)(B) imposes a duty of prudence on pension plan fiduciaries. This duty is accompanied by the requirement to diversify investments. These obligations are altered, however, for employee stock ownership plans (ESOP); §1104(a)(2) states that to the extent that the duty of prudence requires diversification, the duty is not violated by acquiring or holding company stock. In Fifth Third Bancorp v. Dudenhoeffer (2014 WL 2864481), former employees and ESOP participants alleged that Fifth Third Bancorp (FTB) and its officers breached the duty of prudence under ERISA. The complaint stated that the fiduciaries knew or should have known that FTB stock was excessively risky and overvalued, based on both public and inside information. The duty of prudence, they alleged, was violated by continuing to hold and purchase company stock when they should have sold the stock, refrained from purchasing more, and/or disclosed the negative information to reflect the true value.

The Supreme Court held that ESOP fiduciaries acquiring company stock are not liable for losses that result from a failure to diversify, but they are still subject to a duty of prudence. A breach of the duty of prudence must allege that an alternative lawful action existed for the fiduciary, and a prudent fiduciary would believe that the action was not more harmful than helpful. Imprudence will not be found on allegations of failing to trade stock based on insider information that would violate insider trading.  The Court directed to lower courts to consider whether the fiduciary could have made the not the more harmful than helpful determination.

The case was remanded to determine whether a claim was properly alleged.

Second Circuit Affirms Dismissal of ERISA Claim Arising from Lehman Collapse

In an important decision, the Second Circuit affirmed dismissal of plaintiffs' class action claims asserting ERISA claims against the employee benefit plan committee and others at Lehman Bros.  See In re Lehman Bros. ERISA Litig. (http://www2.bloomberglaw.com/public/desktop/document/In_re_Lehman_Brothers_ERIS_Li_Docket_No_1104232_2d_Cir_Oct_14_201).  Plaintiffs alleged that the plan committee should have done more to protect investors in Lehman's Employee Stock Ownership Plan ("ESOP"), contending that the plan committee should have recognized the risk of Lehman Bros. stock in the months leading to Lehman's collapse and curtailed or limited the exposure of investing employees in the plan.  Unlike the Lehman securities litigation where large pay outs to plaintiffs were made, the ERISA case was dismissed at the pleading stage and that dismissal was affirmed by the Second Circuit, likely spelling the end of the ERISA litigation. The set up of the Lehman plans provided significant benefit to the defendants.  Lehman had several plans.  The plan at issue invested solely in Lehman stock, and employees were only allowed to place a specified percentage of their contributions in that plan.  Moreover, because that plan was designated solely to invest in Lehman stock, the committee had no discretion to make other investments.  Except for a limited exception to comply with ERISA fiduciary duties, the committee also had no discretion to simply not make investments.  Plaintiffs' case ultimately boiled down to two issues:  First, plaintiffs argued that the committee should have seen major risk factors at Lehman and investigated to uncover facts that the general public was not privy to.  Had they done so, plaintiffs contend, they would have recognized Lehman presented an enormous risk and pulled out of Lehman securities.  The problem with this argument, the Second Circuit recognized, that had the committee uncovered such non-public facts, the committee would have been precluded under federal securities laws from trading on such material, non-public information.  Accordingly, the Second Circuit properly concluded that failure to uncover and trade upon material, non-public information could not constitute a cognizable claim.  Second, plaintiffs asserted that the committee should have investigated Lehman's financial statements and public filings for misstatements before incorporating them in the plans disclosures.  The Second Circuit noted that to require the committee to separately scrutinize the company's public filings created an unreasonable administrative burden and in any event plaintiffs pled insufficient facts to show that the committee should have suspected material misstatements.

This case is quite favorable for plan committees.  It is, however, dependent in significant part on the favorable set up of the Lehman plan at issue and the committee's own lack of discretion under that plan.