Playing hide-the-doughnut was fun when we were kids. However, it is totally unacceptable when explaining pension benefits to plan participants, as one large corporation recently learned the hard way. Osberg v. Foot Locker, Inc., No. 15-3602, 2017 U.S. App. LEXIS 12041 (2nd Cir. July 6, 2017).
On January 1, 1996, Foot Locker converted its "traditional" defined benefit pension plan to a "cash balance plan." Under the traditional plan, participants were entitled to a monthly annuity beginning at age 65, calculated based on their compensation level and years of service. Participants could not take their pension in a lump sum form.
In contrast, under the cash balance plan, participants were assigned a "hypothetical" account balance that, upon retirement, could be paid out as a lump sum or converted to an annuity. The cash balance accounts were hypothetical because they were only a bookkeeping entry; participants did not have an actual account as they would in, say, a 401(k) plan.
The switch to the cash balance plan required Foot Locker to convert participants' then accrued pension benefits under the traditional plan into a number that would become their initial hypothetical account balance under the cash balance plan. The hypothetical account would then receive pay credits based on a percentage of the participant's pay, and interest credits at a specified rate. However, for the conversion, Foot Locker used a formula which guaranteed that the vast majority of participants' initial account balances would be worth LESS than the value of the accrued pension benefits they had earned under the former traditional pension plan.
The cash balance plan also defined participants' benefits as the "greater of" (A) the benefit earned under the traditional plan as of January 1, 1996, and (B) the benefit earned under the cash balance plan. Because the initial account balance under the cash balance plan was worth LESS than the accrued pension benefit earned under the traditional plan, this greater of formula meant that participants would accrue no new benefits for a period of time after the conversion-sometimes for YEARS-a phenomenon pension practitioners refer to as "wearaway." Foot Locker never informed participants that, under the new cash balance plan, they would receive no new benefits for a period of time.
In 2007, Geoffrey Osberg brought a class action lawsuit against Foot Locker for failing to disclose the wear away to participants, and requested that the court reform the cash balance plan such that they would immediately begin accruing new benefits after the conversion. However, the district court ruled for defendants, reasoning that plaintiffs had failed to show "actual harm." The Second Circuit Court of Appeals reversed and remanded back to the district court for further proceedings, holding that proof of "actual harm" was not a prerequisite for the equitable remedy of reformation of the plan.
Following the remand, the district court held a two-week bench trial at which 24 witnesses testified. Based on the evidence, the district court ruled that Foot Locker had misled plaintiffs about their pension benefits, thereby violating their fiduciary duties, and ordered Foot Locker to reform the cash balance plan such that plaintiffs would receive (A) the accrued pension benefit they had earned under the traditional plan as of the time of the conversion, PLUS (B) the hypothetical account balance under the cash balance plan, as increased by all pay and interest credits allocated to the hypothetical account-not the "greater of" A or B.
Foot Locker appealed on the ground that some class members' claims were time barred. The Second Circuit Court of Appeals disagreed, reasoning that (i) Foot Locker did not inform class members about the wearaway, (ii) the wearaway was not apparent on the face of their pension checks, and (iii) Foot Locker made misstatements to the class members which suggested that the value of their accrued pension benefits under the traditional plan was fully reflected in their initial hypothetical cash balance plan account, when, in fact, it was not; it was greatly understated. Therefore, class members could not reasonably have been expected to know about the wearaway until their attorney informed them about it in 2005. Accordingly, their claims were timely. Having rejected Foot Locker's arguments, the Second Circuit affirmed the district court's remedy of reforming the plan under the A+B methodology.
Wearaway-the phenomenon of accruing no new pension benefits for a period of time after a change in the plan's benefit formula--typically occurs after an employer has converted its traditional defined benefit pension plan to a cash balance plan. However, the wearaway is usually not evident to participants. Therefore, if you are or will be receiving pension benefits under a cash balance plan, it is best to have an experienced pension lawyer check things out for you to determine whether everything is on the up and up, or whether, instead, you are another cash balance victim.
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