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Rule 23 Skidoo James P. Baker
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hree recent circuit court of appeals decisions have placed a damper on the growth of ERISA class action lawsuits. History, of course, has a way of repeating itself. For example, “23 Skidoo” is an American slang expression that became popular during the Roaring Twenties. The possible source of the expression derives from the peculiar geography of the Flatiron Building at Madison Square in New York City. It is a triangular-shaped building located on 23rd Street at the intersection of Fifth Avenue and Broadway. Its unusual shape and location causes winds to swirl along the sidewalks that flank the building. For those who think our American ancestors were of a nobler ilk, think again. During the 1920s, groups of men would gather at the foot of the Flatiron Building to watch women passing by have their skirts blown up their legs revealing ankles (and perhaps even knees), which were seldom seen in public. The local police would James P. Baker is an ERISA litigation partner in the San Francisco office of Winston & Strawn. His practice focuses on ERISA litigation and the counseling of employers on the entire spectrum of employee benefit and executive compensation matters. The National Law Journal recognized Mr. Baker as one of the nation’s 40 best ERISA attorneys and Chambers USA (2007–2011) describes him as “an ERISA legend on the West Coast.” In addition, he’s been listed in other legal directories as a leading attorney nationally for ERISA litigation, including the Legal 500 US (2008–2010), The Best Lawyers in America (2009–2011), and Northern California Super Lawyers (2005–2011). He is “AV” rated by Martindale-Hubbell. The views set forth herein are the personal views of the author and do not necessarily reflect those of the law firm with which he is associated.
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routinely break up these packs of male gawkers, purportedly telling the lingering men to “23 Skidoo.” While Federal Rule of Civil Procedure 23 is not the Flatiron Building in New York City, it has attracted a large number of ERISA gawkers. Beginning with the collapse of Enron, the plaintiffs’ bar seized upon the idea of pleading their claims as class action cases. No doubt, plaintiffs realized that by raising the stakes for defendants (and by providing defendants with a pathway to settle all class member claims), they could engineer bigger recoveries and bigger attorney fees awards for themselves. Class action status permits attorneys to earn fees based on a percentage of the total recovery. Regular ERISA litigation does not, as it employs the “lodestar” method (reasonable hours and reasonable rates).
Class Action 401(k) Plan Claims The complexities surrounding Federal Rule of Civil Procedure 23 are not for the faint of heart. Following the US Supreme Court’s decision in LaRue v. DeWolff Boberg & Associates, Inc.,1 the ability to certify a class involving alleged losses to defined contribution plan accounts has become more difficult. In LaRue, the US Supreme Court concluded: We therefore hold that although § 502(a)(2) does not provide a remedy for individual injuries distinct from plan injuries, that provision does authorize recovery for fiduciary breaches that impair the value of plan assets in a participant’s individual account.
Can individual plan account damages form the basis of a class action? Two recent circuit court of appeals decisions confirm that “23 Skidoo” may apply to the question of certifying ERISA class action 401(k) plan claims as these courts denied class certification.2 A Third Circuit Court affirmed the dismissal of an ERISA class action where the plaintiff failed to show Article III standing.3 The demise of each class was based on the inherent “intra-class conflicts” resident among 401(k) plan participants. Given the individual nature of 401(k) plan investments and the individual nature of each 401(k) plan participant’s potential damages, the Seventh Circuit in Spano explained that “the propriety of class treatment … will turn on the circumstances of each case.”
A Brief History Class actions are an exception to the usual rule that legal disputes are to be conducted by individual parties. It is a principle of general application in Anglo-American jurisprudence that one is not bound by a judgment in personam in a litigation in which he or she is not designated as a party or to which he or she has not been made a party by service of process.4
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The class suit was an invention of equity to enable it to proceed to a decree in suits where the number of those interested in the subject of a litigation is so great that their joinder as parties in conformity to the usual rules of procedure is impracticable.5 The facts of Hansberry v. Lee 6 dealt with a racially restrictive covenant that barred African Americans from purchasing or leasing land in a Chicago neighborhood. The Supreme Court ruled that res judicata did not bind a subsequent plaintiff who had not been adequately represented in the earlier civil action. In a prior class action lawsuit, the racially restrictive covenant had been upheld. In the second lawsuit, the plaintiff, Lee, along with all other neighborhood landowners, had been members of the class. In reversing the Illinois Supreme Court, the US Supreme Court explained: “Because of the dual and potentially conflicting interests of those who are putative parties to the agreement in compelling or resisting its performance, it is impossible to say, solely because they are parties to it, that any two of them are of the same class.”7 The class action device is a relatively new creature of the Federal Rules of Civil Procedure. It was brought to life as a separate device in 1938 in the original version of Rule 23. It was not until 1966, however, that the class action mechanism that we have learned to love in Rule 23 gained its current form.
The Allure of ERISA Class Actions Since the collapse of Enron in 2001, the ERISA plaintiffs’ bar has circled dead or dying corporations that sponsor 401(k) plans containing employer stock. Plaintiffs lawyers have had a field day filing class action ERISA lawsuits against economically challenged companies. The early cases followed a familiar pattern: defendants filed motions to dismiss, the court denied defendants’ motions to dismiss, followed by a settlement. The class action settlement amounts in the early cases were large: •
In re Global Crossing ERISA Litigation (2004)—settlement amount $79 million;
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In re Enron Corp. ERISA Litigation (2005)—settlement amount $257 million;
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In re AOL Time Warner, Inc. ERISA Litigation (2009)— settlement amount $100 million;
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In re General Electric ERISA Litigation (2009)—settlement amount $49.5 million; and
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In re Merrill Lynch Securities, Derivative & ERISA Litigation (2009)—settlement amount $75 million.
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The Seventh Circuit Denies Class Certification in a 401(k) Plan Dispute After the US Supreme Court’s decision in LaRue, the defense bar has argued that ERISA fiduciary breach claims on behalf of defined contribution/401(k) plan participants are individual in nature and cannot be certified as class actions. Some courts have agreed. For example, the Central District of California held that certifying an ERISA class action stock drop case under Federal Rule of Civil Procedure 23(b) (1)(B) was improper following the US Supreme Court’s decision in LaRue.8 In denying class certification in Spano (which sought to certify a class of 180,000 members), the Seventh Circuit took a different tack. The Spano court found that the individual nature of each participant’s injury precluded certification because plaintiffs could not meet the typicality or adequacy requirements of the Rule: To determine whether class treatment is appropriate, we must distinguish between an injury to one person’s retirement account that affects only that person, and an injury to one account that qualifies as a plan injury.9
The Seventh Circuit emphasized the extreme importance of getting class certification right: An order certifying a class usually is the district judge’s last word on the subject: there is no later test of the decision’s factual premises (and, if the case is settled, there could not be such an examination even if the district judge viewed the certification as provisional). Before deciding whether to allow a case to proceed as a class action, therefore, a judge should make whatever factual and legal inquiries are necessary under Rule 23.10
One of the Spano defendant’s primary claims was that the plaintiffs’ class definition failed to meet the standards of Rule 23(c)(1)(B) which requires an order certifying a class to “define the class and the class claims, issues or defenses ….” Plaintiffs’ class definition, the defendants asserted, was so diffuse as to be no definition at all. The Seventh Circuit agreed. The most important part of a class certification order is the place where the district court defines the class: This is a vital step. Both the scope of the litigation and the ultimate res judicata effect of the final judgment depend on the class definition. If the unnamed members of the class have received constitutionally adequate representation, then the judgment in the class action will resolve their claims, win or lose.11
The definition of the class used by the Spano plaintiffs is all too familiar. It included anyone who had ever been a participant in the
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Boeing 401(k) plan, as well as anyone in the future who would become a plan participant. The Seventh Circuit bid this class definition “au revoir”: The class definition adopted by the district court is breathtaking in its scope. Anyone, in the history of Time, who was ever a participant in the Boeing Plan, or who in the future may become a participant in the Boeing Plan, is swept into this class, if he or she “may have been affected by the conduct set forth in this Complaint.”12
The Seventh Circuit began its class definition analysis by observing that the Third Circuit faced the same type of vague class definition in In re Schering Plough Corp. ERISA Litig.13 Schering involved a “stock drop” class action claim. Plaintiffs alleged Schering Plough stock was imprudent because its price had declined from $60 per share to less than $20 per share. Michele Wendel, the named plaintiff in Schering Plough, was a former Schering employee who had signed a release of all claims at the termination of her employment. The Third Circuit ruled that Wendel’s class failed because she could not meet the typicality and adequacy of representation requirements.14 Although Wendel’s legal claims appeared to be the same as those as the class she sought to represent, her release of all claims gave rise to a possible defense that was unique to Wendel. Due to her release of all claims, it was possible that Wendel might not even have a monetary stake in the outcome of the case. The Third Circuit also observed that the record did not disclose how many others in the putative class might have also signed releases of all claims. As to adequacy, the Third Circuit ruled that Wendel might have different incentives from her fellow class members and thus a different willingness to pursue litigation due to the fact of her executed release.15 The Spano plaintiffs’ primary fiduciary breach claim stemmed from Boeing’s Technology Fund and the Boeing Stock Fund as plan investment options. The Court observed that many participants in the Boeing plan never held a single share in either or both of those funds. Given the huge factual differences among the members of the illdefined class, the Seventh Circuit ruled that Spano had failed to meet the typicality requirement of Rule 23(a): “It seems that a class representative in a defined contribution case would at a minimum need to have invested in the same funds as other class members. ….” “There must be congruence between the investments held by the named plaintiff and those held by members of the class he or she wishes to represent.” This lack of congruence creates an impermissible conflict between class members, where “the alleged conduct harms some participants and helped others.”16 The same concerns also precluded the Seventh Circuit from finding that Spano met the adequacy of representation requirement.
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The requirement that there be “congruence between the investments held by the named plaintiff and those held by members of the class he seeks to represent means that the scope of a class definition in 401(k) Plan disputes will become smaller. The days when plaintiffs could summarily assert the class encompassed all 401(k) plan participants from the past and the future simply does not meet this investment congruence requirement.”17 A further factor that may also narrow the scope of future 401(k) plan class actions is the question of Article III standing and redressability. The Eighth Circuit affirmed the dismissal of an ERISA class action “stock drop” claim where the plaintiff alleged out-of-pocket losses but failed to show a direct connection between his losses that may have been caused by product recalls and the defendant fiduciaries’ actions.18 We do not, however, agree that in the present context a purported “abstract violation” of a fiduciary duty is sufficient to create standing for all persons to whom the duty is owed. Such a position fails to account for the third requirement of standing: redressability.19
The Spano Court Rejects a “No Notice/No Opt Out” Class In addition to meeting the requirements of Rule 23(a) for numerosity, commonality, typicality, and adequacy, all class actions must also fit within one of the three types of classes described at Rule 23(b). It has become common for ERISA plaintiffs to ask courts to certify classes as “no notice, no opt-out” classes under Federal Rules of Civil Procedure 23(b)(1) or (b)(2). The Seventh Circuit observed that applying the mandatory class action device too liberally risked depriving people of one of their most important due process rights—the right to their own day in court. One telling observation by the Spano court concerned whether claims of imprudence could properly be certified under Federal Rules of Civil Procedure 23(d)(1)(B) or 23(b)(1)(a): A claim of imprudent management, for example, is not common if the alleged conduct harms some participants and helped others, which appears to be the case. Without the common interests, there is no reason to assume that an adjudication of one person’s claim “as a practical matter, would be dispositive of the interests of the other members not parties to the individual adjudications or would substantially impair or impede their ability to protect their interests.”20 The plaintiffs fare no better under Rule 23(b)(1)(A). … That part of the rule is concerned with the risk of inconsistent or varying adjudications that might establish incompatible standards of conduct for the defendant. The plaintiffs assume that Boeing could
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not simultaneously offer the Technology Fund to some people and not to others, but we do not see why that would be a problem.21
Two reasons motivate ERISA plaintiffs’ attorneys in seeking certification under Rule 23(b)(1) or 23(b)(2) convenience and cost. It is obviously much easier not to send out a notice when there are 180,000 potential class members (such as in Boeing ). Aside from the required class member notice under Rule 23(b)(3), the plaintiffs also face the daunting task of fighting with defendants over whether or not the questions of law or fact common to class members predominate over any actions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.
The Presumption of Prudence The Spano court observed that the plaintiffs’ best opportunity to state a class-wide defined contribution plan claim is found in plans offering company stock. A claim of imprudent investment in company stock could potentially harm all 401(k) plan participants. But the strictures of the “presumption of prudence” doctrine concerning company stock investments present plaintiffs with a very high hurdle. The Third, Fifth, Sixth, Seventh, and Ninth Circuits have adopted the “presumption of prudence” concerning a plan fiduciary’s decision to permit 401(k) plan money to be invested in employer stock. In Quan v. Computer Scis. Corp.,22 the court determined that the “presumption of prudence” was consistent with ERISA’s statutory text and trust law principles. By presuming that a plan fiduciary acted prudently in selecting company stock as a plan investment, the court struck the “appropriate balance between the employee ownership purpose of employee stock ownership plans and eligible individual account plans and ERISA’s goal of ensuring proper management of such plans.” The Ninth Circuit observed that the presumption alleviates the pressure on plan fiduciaries to “predict the future of the company stock fund’s performance” because it makes it less likely that a plan fiduciary would be tempted to use insider information to divest the plan from company stock, since continued investment in the plan will be presumed prudent. To overcome the presumption of prudence, the plaintiffs must allege facts that call into question the company’s viability as an ongoing concern or prove a “precipitous decline” in the company’s stock price in conjunction with evidence that the company is “on the brink of collapse” or is “undergoing serious mismanagement.” Plaintiffs must also show that there were “publicly known facts that would trigger the kind of careful and impartial investigation by a reasonable fiduciary,” and that the plan’s fiduciary failed to perform that investigation.
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In these five circuits, 401(k) plan class certification becomes problematic: •
What does the language of the 401(k) plan say?
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Is the employer stock given as a matching contribution?
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Can the plan participant terminate participation in the employer stock fund at any time? At retirement?
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What are the economic circumstances of the sponsoring employer?
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Is the company on the verge of financial ruin?
Individual facts and context often drive the ERISA fiduciary breach analysis.
Conclusion While “Rule 23 Skidoo” may sound harsh, it is not far off the mark. The new mantra for 401(k) class actions appears to be “Less is more.” According to these three recent circuit court of appeals decisions, a properly defined 401(k) plan class must now allege the ERISA class shares congruent investments and that the plaintiffs’ claimed losses share a redressable connection to Defendants’ actions.
Notes 1. 552 U.S. 248 (2008). 2. See Spano v. The Boeing Co., 633 F.3d 574 (7th Cir. 2011); In re Schering Plough Corp. ERISA Litig., 589 F.3d 585 (3d Cir. 2009). See also Langbecker v. EDS, 476 F.3d 299 (5th Cir. 2007). 3. Brown v. Medtronic, Inc., 628 F.2d 451 (8th Cir. 2010). 4. Pennoyer v. Neff, 95 U.S. 714. 5. Hansberry v. Lee, 311 U.S. 32, 40–41 (1940). 6. 311 U.S. 32. 7. 311 U.S. at 44. 8. In re First American ERISA Litig., 258 F.R.D. 610 (C.D. Cal. 2009). 9. 633 F.3d 574, 581 (7th Cir. 2011) 10. Id. at 583, quoting Szabo v. Bridgeport Machs., Inc., 249 F.3d 672, 676 (7th Cir. 2001). 11. Id. at 584, see Cooper v. Federal Reserve Bank of Richmond, 467 U.S. 867 (1984). 12. Id. at 586.
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13. 589 F.3d 585 (3d Cir. 2009). 14. Id. at 599–600. 15. Id. at 602. 16. Spano, 633 F.3d at 588. 17. Id. 18. Brown v. Medtronic, Inc., 628 F.3d 451 (8th Cir. 2010). 19. See Lujan v. Defenders of Wildlife, 504 U.S. 555, 560, 112 S. Ct. 2130, 119 L. Ed. 2d 351 (1992). 20. FRCP 23(b)(1)(B). 21. Spano, 633 F.3d at 588. 22. 623 F.3d 870 (9th Cir. 2010).
Copyright © CCH incorporated. All Rights Reserved. Reprinted from Benefits Law Journal Summer 2011, Volume 24, Number 2, pages 87-94, with permission from Aspen Publishers, Wolters Kluwer Law & Business, New York, NY, 1-800-638-8437, www.aspenpublishers.com
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