August, 2009

Possible Defenses in 412(i) Pension Plan Cases

By Connie M. Anderson, Esq.

Several cases pertaining to the funding of 412(i) pension cases have recently been filed in state and federal court. Typically these cases allege fraud and negligence with respect to the commissions paid on the insurance that is used to fund the plans, the representations made concerning the tax deductibility of the contributions to the plans, and representations with respect to the IRS’s approval of the qualification of the plan under 412(i).

These cases stem from plans that were established prior to an IRS Revenue Ruling in 2004, which held that: “(1) a qualified pension plan cannot be a section 412(i) plan if the plan holds life insurance contracts and annuity contracts for the benefit of a participant that provide for benefits at normal retirement age in excess of the participant’s benefits at normal retirement age under the terms of the plan; and (2) employer contributions under a qualified defined benefit plan that are used to purchase life insurance coverage for a participant in excess of the participant’s death benefit provided under the plan are not fully deductible when contributed, but are carried over to be treated as contributions in future years and are instead potentially deductible in future years.” Rev. Rul. 2004-20.

The lawsuits over these issues involve 412(i) plans and representations that occurred prior to the Revenue Ruling in 2004. Several complaints have been challenged on the grounds that the claims are preempted by ERISA, or that the requirements for pleading fraud or Bus. & Prof. Code §17200 actions have not been met.

Generally speaking, the courts have held that claims concerning post-plan representations are not preempted by ERISA, in part because they do not “relate to” the plan, its administration, or its benefits. However, at least one court has left open the issue of whether a failure to disclose commissions may be preempted by ERISA. In Hausman v. Union Bank, 2009 U.S. Dist. LEXIS 39074 (May 8, 2009), the court hinted that an argument may be able to be made that the failure to disclose commissions falls under the purview of an ERISA statute concerning prohibited transactions. The defendant in that case did not make such an argument, however, and the issue was not decided.

At least one court has also dismissed claims relying upon representations concerning the deductibility of contributions to a 412(i) plan. In Berry v. Indianapolis Life Ins., 2009 U.S. Dist. LEXIS 61572 (July 16, 2009), the court held that:

As a matter of law, any representation or prediction by an Indianapolis Life agent as to how the IRS would treat the 412(i) pension plans, and the funding thereof, in the future is either an unactionable opinion or was unjustifiably relied upon. . . It is inherently unreasonable for any person to rely on a prediction of future IRS enactment, enforcement, or non-enforcement of the law by someone unaffiliated with the federal government. As such, the reasonable reliance element of any fraud claim based on these predictions fails as a matter of law.

Id. at *14-15 (citing ruling on prior motion to dismiss).

The foregoing cases may be of assistance in crafting defenses to a 412(i) case alleging misrepresentations or omissions concerning commissions or tax deductibility of contributions.

In addition, some California cases involving 412(i) plans may also plead causes of action for violation of Bus. & Prof. Code § 17200. There may be a potential challenge to such claims based on the requested remedy. Restitution, for example, may be had only of money or property that was unfairly or unlawfully obtained. Essentially, the courts have held that a defendant must have obtained something to which it was not entitled and the victim must have given up something that he was entitled to keep. In cases alleging misrepresentations of the tax deductibility of contributions, defendants may argue that this requirement cannot be met. And while this argument may conceptually appear to be more difficult to make with undisclosed commissions, it still could be said that such allegations fall under the type of restitution prohibited by Day v. AT&T, 63 Cal. App. 4th 325 (1998) (where phone cards did not provide the number of minutes advertised on the card, the remedy was damages).

The first wave of variable annuity litigation consisted of securities fraud class actions involving the placement of variable annuities into 401K plans. Plaintiffs claimed that they were paying for a redundant tax deferral, as their 401K plan already had tax deferred status. Ultimately, many of these cases were settled for significant sums.

The next wave of variable annuity litigation will likely also involve high exposure class actions, but this time the lawsuits will likely focus on advertising related to the products, as well as certain attributes of the products themselves. Essentially plaintiffs may allege fraud, false advertising, suitability, and negligence claims concerning, among other things: (1) the impact of fees on hypothetical returns shown in advertising materials; (2) suitability given the customer’s age; and (3) the fees related to death benefits.

Plaintiffs may claim that advertising materials that show the value of a variable annuity over time as compared to a mutual fund do not include the fees associated with the annuity. When fees are included, the comparison favors the mutual fund for over 20 years. Plaintiffs may also make claims that given high fees and early withdrawal penalties, variable annuities are not suitable for older investors.

Another strategy Plaintiffs could adopt is to assert that advertising fails to disclose the relative cost of death benefits. While this example is simplified for brevity, in a hypothetical account with an initial investment of $200,000, an accumulation value of $225,000 in the second policy year, and an accumulation value at the time of death of $175,000, one argument that might be made is that the amount “insured” is not the $225,000, but only the $50,000 difference between the value at the time of death and the earlier accumulation value. Plaintiffs may claim that the cost of the benefit is multiple times what is actually insured and is therefore unwarranted.

Defending against variable annuity claims will require in-depth knowledge of the products and previous related litigation. One strategy to consider in defending against variable annuity claims is based on the many attributes and available add-ons to the annuities. In particular, the higher fees are justified by a guaranteed principal investment, particularly given the current economic crisis. The current economy also aids defendants in making the argument that the true death benefit provided by an annuity includes the principal investment.

There are other aspects of the annuities that may be attacked, and the specific allegations will vary by product. There are likewise numerous possible strategies and defenses for dealing with such claims. This article, however, provides an example of what we may soon be facing.

Connie M. Anderson, Esq.
Chair, Financial Products & Services Litigation Group
Klinedinst PC

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