Pomerantz LLP

May/June 2016

POMTalk: Defined Benefit Plans Truly Benefit Public Employees


As I visit institutional investor clients across America, a frequent topic of discussion is a cost/benefit analysis of defined benefit vs. defined contribution plans. As I will more fully explain below, research and experience have demonstrated that public pension funds and the employees they serve likely do best contributing to a defined benefit plan coupled with a portfolio monitoring service.

Most state, municipal, and county workers are covered by a traditional defined benefit plan.

The financial crisis of 2008 and its aftermath led some public pension funds to consider shifting some or all of their pension systems from a defined benefit to a defined contribution plan. In fact, six states have replaced their traditional defined benefit plan with a mandatory hybrid plan (which requires participation in both a defined benefit and a defined contribution plan): Georgia, Michigan, Rhode Island, Utah, Tennessee, and Virginia.

Prior to the financial crisis, while feeling the glow of the stock market’s stellar performance of the 1990’s, Michigan and Alaska introduced plans requiring all new hires to participate solely in a defined contribution plan. Meanwhile, California, Indiana, and Oregon adopted hybrid plans. Colorado and Ohio have introduced optional defined contribution plans. Enrollment in these plans has been modest, with most workers choosing to continue to maintain the protection against investment risk and the promise of an annuity that defined benefit plans offer. In Alaska, however, despite the fact that nearly three quarters of its public employees are not covered by Social Security, all new hires are required to join a defined contribution plan. The result is that Alaskan state workers and teachers hired since July 2006 do not have any form of defined benefit protection.

According to a 2014 study by Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli of the Center for Retirement Research of Boston College, what motivated states to introduce a defined contribution plan differed before and after the financial crisis. Before 2008, some saw it as a way to offer employees an opportunity to manage their own money and participate directly in a rapidly rising stock market. In contrast, after the financial crisis, cost and risk factors motivated some states to make the shift.

A 2016 study by Nari Rhee and William B. Fornia of the University of California, Berkeley, modeled how retirement income would fare for teachers on three types of pension: (1) the current defined benefit offering from the $186 billion California State Teachers Retirement System (“CalSTRS”) for hires since 2013; (2) an idealized 409(k) plan (similar to defined contribution); and (3) a cash balance plan with guaranteed 7% interest on contribution. The result, in a nutshell: for the vast majority of California teachers (six out of seven), the CalSTRS defined benefit pension provided greater, more secure retirement income compared to a 401(k)-style plan.

Apart from the rewards of defined benefit plans touted by numerous studies, a significant benefit available to these plans—that is not available to defined contribution plans -- is that their investment portfolios may be monitored by professionals who are expert in identifying and evaluating losses attributable to financial misconduct, and providing advice to institutional investors on how best to maximize their potential recoveries worldwide. The United States sees hundreds of new securities fraud class actions filed each year, as well as approximately 100 class action settlements. Institutional investors that do not engage a portfolio monitoring service run the risk of leaving money on the table by not participating in settlement recoveries or taking affirmative action to recover their losses when appropriate.

Public pension funds that offer a defined benefit plan coupled with a portfolio monitoring service get top marks for ensuring that their employees will enjoy a secure and amply funded retirement. 



CFPB Proposes Rule to Override Arbitration Clauses in Contracts for Financial Transactions.

As the Monitor has reported, the Supreme Court opened the door recently to allowing companies to enforce arbitration clauses in contracts with their customers, which would bar class actions. Because most consumer claims are too small to warrant prosecution on an individual basis, this tactic has the potential to insulate these companies from any avenue of redress.

On May 5, the Consumer Financial Protection Bureau issued a proposed rule that would restore customers’ rights to bring class actions against financial firms. The rule would apply to bank accounts, credit cards and other types of consumer loans. As reported in the Times, the new rules would mean that lenders could not force people to agree to mandatory arbitration clauses that bar class actions when those customers sign up for financial products. The changes would not apply to existing accounts, though consumers would be free to pay off their old loans and open new accounts that are covered. The rule would apply only to the consumer financial companies that the agency regulates. It would not apply to arbitration clauses tucked into contracts for cellphone service, car rentals, nursing homes or employment.

The rules are not subject to Congressional approval.

Labor Department Issues Rule Imposing Fiduciary Duty on Brokers Who Advise Clients Investing in Retirement Products or Accounts.

Acting under authority conferred by ERISA, the Labor Department has finally issued a rule requiring brokers who give retirement advice to clients to enter into contracts with them affirming that they have a duty to recommend transactions only when they are in the client’s best interest. The current rule requires only that the investments they recommend be “suitable” for the clients, leaving room for brokers to recommend investments that generate the biggest fees for themselves, rather than those that are best for their customers.

For years the financial services industry has warned that this rule change would impose an enormous burden on them and on investors as well, whose costs (they say) would increase. But, as Senator Elizabeth Warren pointed out recently in a letter to the SEC, some of the biggest objectors to the new rule have been telling their own shareholders that they have nothing to worry about if the fiduciary rule is adopted. That is like trying to have your cake and eating it too.

Warren sent her letter to the SEC because that agency has so far failed in its obligation to revise these rules for regular, non-retirement brokerage accounts and other advisory relationships, even though the Dodd Frank Act requires the agency to do so.

 Agencies Try To Rein In Executive Compensation.

In April the National Credit Union Administration unveiled its proposal to implement a provision of the Dodd-Frank Act by requiring that incentive compensation that top financial executives receive gets deferred for several years and that  firms put in clawback provisions so they can take back bonuses paid to executives responsible for significant losses or illegal actions.

The Dodd-Frank Act charged the NCUA, the Federal Reserve, the Federal Deposit Insurance Corp., the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the U.S. Securities and Exchange Commission with writing rules or guidance that would restrict bonus and other incentive compensation for financial executives, in a bid to limit the temptation to take on excessive risk. Some of these other agencies, at least, are expected to echo the NCUA’s proposal.

U.S. financial regulators set up three different tiers for implementing rules, with executives at firms with $250 billion in assets facing the toughest restrictions, followed by those at firms with assets between $50 billion and $250 billion. Firms that have between $1 billion and $50 billion will be required to put in place risk-management, record-keeping and other monitoring tools.

 Nastiest Case in Delaware.

The Delaware courts, which handle serious matters of corporate governance, are well known for their decorum and high mindedness. But the Delaware Supreme Court is currently mulling the appeal in one of the nastiest, tackiest cases to hit that state in a long time. Alan Morelli, the former chairman of OptimisCorp., a California based healthcare company, is suing the directors who abruptly terminated him in 2012, after receiving accusations that Morelli had sexual relations with an employee and also sexually harassed her. Three of those directors filed their own action against the executive, claiming that in retaliation for their dismissal of him he launched a legal vendetta against them, using $12 million of company funds. After a six day trial last year, the Chancery Court dismissed Morelli’s claims against the directors, concluding that they were unproven. The vice chancellor added that his decision also reflected a sanction against Morelli for paying or threatening witnesses with criminal prosecution or civil action “based on questionable or baseless claims.” One female therapist who accused Morelli of sexual harassment later withdrew the claim, after receiving a promise of a $550,000 series of payments in exchange for her testimony.

During the argument of the appeal, Supreme Court Justice Strine asked whether Optimis is “one of the weirder companies that exists in the world,” observing that “one of the officers of the company was having a relationship with

Mr. Morelli’s ex-wife,” while Morelli, whose office was in his bedroom, was having relations with the employee who subsequently accused Morelli of harassment.

Eighth Circuit Makes it Too Easy to Rebut Presumption of Reliance


In a case called Halliburton II, the Supreme Court reaffirmed the validity of the presumption of reliance under the  fraud on the market theory,” which is critical to securities plaintiffs’ ability to show class-wide reliance on a company’s misstatements. But it also held that a defendant may rebut the presumption of reliance by showing that the alleged misstatements had no “price impact,” i.e. did not affect the price of the stock in question. Under Fed. R. Evid. 301, “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” but the rule does not specify how much evidence must be produced, and Halliburton II did not shed any light on this issue, either. This raises the question: how much evidence is enough to rebut the presumption? Is any showing enough?

In Best Buy, the Eighth Circuit recently handed down the first federal appellate decision to attempt to answer those questions. It is widely accepted that price impact may be proven by evidence showing that either the price increased after an alleged misstatement or that the price decreased after the truth was revealed. In Best Buy, plaintiffs met one but not both of these elements. Specifically, plaintiffs challenged three statements the company made on September 14, 2010. First, it issued an early morning earnings release saying that it was increasing its EPS guidance by ten cents. In response, the stock price opened for trading at a price higher than the previous day’s close. The next two statements were made later that morning in a conference call with analysts, when the CEO and CFO stated that the company’s earnings were “essentially in line with our original expectations for the year” and that it was “on track to deliver and exceed our annual EPS guidance.” The stock price did not increase after the conference call statements. The allegedly corrective disclosure occurred on December 14, 2010, when Best Buy announced a decline in its fiscal third quarter sales and a reduction in its 2011 fiscal year EPS guidance, causing a 15% stock price drop.

In an earlier decision, the district court held that the first misstatement, the early morning earnings release, was not actionable because it was a “forward-looking statement” with appropriate “cautionary language,” and was therefore covered by an Exchange Act “safe harbor” provision. The other two misstatements survived that motion and were the focus of the class certification motion, where defendants claimed that the misstatements did not move the market and that the presumption of class-wide reliance had therefore been rebutted.

In support of its class certification motion, plaintiffs submitted an expert report saying that Best Buy’s stock price had increased in reaction to all three September 14th statements, but did not parse how much of the increase was attributable to each individual statement. Defendants’ expert report said that there was no price impact from the conference call statements because the stock price increased only after the earlier morning press release, and not after the conference call occurred several hours later. In reply, plaintiff’s expert conceded that the conference call statements did not cause an immediate stock price increase, because it essentially just confirmed the representations in the previous early morning release. However, he said that the false statements that came afterwards maintained the artificially inflated price caused by that release.

The district court certified the class, recognizing that price impact (and therefore reliance) can be shown by a price decline in response to a corrective disclosure, and that defendants had failed to make any showing that Best Buy’s stock price did not in fact decrease after the negative news released on December 14th. The district court also found that the alleged misrepresentations could have prolonged the inflation of the price, or slowed the rate of fall, satisfying the “price maintenance” theory of “price impact.”

The Eighth Circuit reversed, pouncing on plaintiffs’ expert’s concession that the conference call statements did not move the stock price, and found that this was “strong evidence” sufficient to negate price impact and therefore class- wide reliance. The majority flatly rejected plaintiffs’ additional contention that the conference call statements caused a gradual increase in the stock price between September and December as “contrary to the efficient market hypothesis.” And the court largely ignored plaintiffs’ additional evidence of price impact, shown by the stock price decline after the corrective disclosure.

This decision is troublesome for several reasons.  Courts have generally found a presumption of reliance exists when shareholders show stock prices fell in response to a corrective disclosure. The Eighth Circuit did not follow that principle, focusing instead only on the front end of the supposed fraud, when misstatements had no obvious impact on the share price. The Eighth Circuit also explicitly rejected the price maintenance theory, which has been heavily relied upon by plaintiffs seeking to prove price impact where misstatements did not move the price of a company’s stock.

A decidedly pro-defendant decision, Best Buy shows that defendants facing securities fraud class actions can significantly narrow or eliminate liability during the class certification phase based on price impact arguments. If followed by other circuits, the decision could have significant negative consequences for securities actions, because false positive statements by a company often have little or no immediate impact on the company’s stock price.

Court Denies Motion to Dismiss Our Staar Surgical Complaint


Judge Fitzgerald of the Central District of California recently denied defendants’ motion to dismiss our action involving STAAR Surgical Company. The action alleges that the company, its CEO and its vice president of regulatory affairs violated section 10(b) of the Securities Exchange Act as well as section 20(a), the “control person” provision.

STAAR is an FDA regulated company that designs, manufactures and sells implantable lenses to correct vision problems. In March of 2014, the company told investors that it believed that it was in compliance with all applicable FDA regulations despite the fact that an FDA inspection of STAAR’s plant was ongoing at the time and the inspector had repeatedly told management that numerous and significant FDA violations had been found. These violations are particularly important to STAAR and its investors because STAAR had a major new lens that was going before the FDA Advisory Panel in mid-March, and these violations would likely delay its approval. The company did not disclose these reports of violations, and investors did not hear about them until the FDA posted them on its website months later. At that point, STAAR’s stock price plunged 17.5%

 Defendants’ main argument for dismissal was that at the time they made their representations of compliance the violation reports were only preliminary and had not been formalized in written notices. The court rejected that argument, holding that because the FDA inspector had repeatedly identified the violations orally to management, defendants would have known that their statements of compliance would mislead investors. The court also held that the company had a duty to disclose the subsequent Warning Letter from the FDA, which stated that the new lens would not be approved by the FDA until the violations were remedied. The court held that, even though the company did not make any further “compliance” representations when it received the Warning Letter, it nevertheless had a duty to correct its prior statement on that subject.

 This opinion is significant because it shows that a statement of compliance can be misleading as a result of the FDA inspector orally identifying violations. Prior cases had dealt with the company having receipt of a written notice of violation or Warning Letter.

New York Adopts Delaware Standards for Going Private Mergers


In a case called the Kenneth Cole Shareholder Litigation, the New York Court of Appeals adopted, as the rule in New York, the MFW decision of the Delaware Supreme Court. There, the Delaware court held that, for claims seeking damages, the business judgement rule can protect the decision of a board of directors to accept a going private merger if certain conditions are met. Ordinarily, such decisions are reviewed under the “entire fairness” test, a very pro-plaintiff standard. The MFW court held that the business judgment rule can apply instead, provided that a series of shareholder protections exist: the merger was approved by both a special committee of independent directors and a majority of the minority shareholders; the special committee was independent and was free to reject the offer and to hire its own advisers; and the vote of the minority was informed and uncoerced. To survive a motion to dismiss, the complaint must allege facts showing that the transaction lacked one or more of these shareholder protections.

Meanwhile, the Delaware Supreme Court has itself recently extended the MFW decision to apply also to director decisions to approve mergers with unrelated entities. In such cases, where the complaint seeks damages, the entire fairness rule is inapplicable, but the courts have typically applied an intermediate standard of review, called enhanced scrutiny.” In a case called KKR, the court has now held that if the MFW conditions are met, the business judgment rule protects such decisions in post-closing actions as well. It added that under those circumstances, a showing of “gross negligence” by the directors is not sufficient to rebut the protection of the rule; “waste” has to be shown, which is an almost insurmountable burden.

Supremes: Statistical Averages Can Provide a Basis for Class-Wide Liability


In Tyson Foods v. Bouaphakeo, the Supreme Court upheld the use of statistical sampling evidence in class actions, at least where such evidence would have been admissible in an individual action. Defendants had argued that such statistical methods improperly treated each individual as if he or she matched a statistical average, thus manufacturing predominance by assuming away the very individualized differences that made class-wide litigation inappropriate in the first place. The Court rejected this premise and focused instead on the relevance of the statistical evidence to the substantive claim at issue. It held that, if a given class member could have used the statistical evidence to obtain a favorable jury verdict in an individual action, then the class could use it the same way. It was up to the jury to decide, in light of all of the evidence presented, whether the statistical average was probative of the situation of each class member.

Particularly under the specific facts of the case, this ruling was a straightforward application of evidentiary common sense. Nevertheless, it was generally seen as a significant victory for the plaintiffs’ bar.

The case involved workers at a pork processing plant who claimed they were not paid overtime for time spent putting on and taking off protective gear, in violation of federal law requiring compensation for such “donning and doffing”  time if it is “integral and indispensable” to their regular work. After the district court certified two classes of employees, the case went to trial and the jury awarded the classes $29 million in damages. On appeal, the defendant argued that the verdict should be thrown out because the classes never should have been certified.

To be certified as a class, the worker-plaintiffs had to prove that they could establish key elements of their claims through generalized, class-wide proof. This was easy for some elements: they all worked in the same plant, had similar job responsibilities, and were subject to essentially the same compensation policies. But the defendant insisted that individualized inquiries into each employee’s total donning and doffing time were necessary because different employees wore different gear and took varying amounts of time to don and doff the gear. It also argued that no class could be certified without proof that every member was injured, which required individualized inquiries into each employee’s time.

Federal law, to some degree anticipating this evidentiary problem, has long required employers to keep accurate records of employee work hours. But despite a 1998 federal court injunction against the very same slaughterhouse requiring it to record employee time donning and doffing protective gear, Tyson Foods had never done so. Instead, it had been compensating workers based on its own approximations of how long those activities should take.

Because there was no good individualized evidence, the worker-plaintiffs used what they called “representative evidence” to show how long workers in each department generally took to don and doff protective gear. Most significantly, they presented a study by an industrial relations expert who drew on a representative sample of 774 videotaped observations of workers and calculated the average time for workers in each department to don and doff their gear.

There are procedural mechanisms to ensure the reliability of this kind of evidence, but the defendant largely ignored them. It did not challenge the expert’s qualifications or statistical methodology. It rejected the workers’ proposal to bifurcate the trial into separate proceedings for liability and damages. While it argued at trial that the expert’s calculations were too high, it did not present a rebuttal expert with different calculations. Instead, in opposing class certification and also at trial, it insisted that it was fundamentally improper to assume that each employee donned and doffed for the same time as the average in the sample. It decried being subjected to a “trial by formula” and barred from raising unspecified “defenses to individualized claims.” And on appeal, it called for a categorical rule barring the use of representative sampling evidence in class actions.

The Supreme Court rebuffed this effort and categorically rejected the idea that class actions required their own special set of evidentiary rules. It emphasized that statistical sampling evidence is routinely used in all kinds of litigation and is often the only practicable means, for plaintiffs and defendants in individual as well as class actions, to collect and present relevant data. Thus, it held that class certification was proper as long as a reasonable jury could have believed that the employees spent roughly equal time donning and doffing. If so, it was for a trial jury to weigh the expert’s average-time calculations against the other evidence presented and to decide whether the statistical average was probative of the time actually worked by each employee.

While the utility of statistical averages in other class actions will vary, the main takeaway is that the issue must be considered in practical terms of how a reasonable jury resolving the underlying substantive claim would view the evidence. In many cases, statistical averages will be the most compelling evidence available and will say a great deal about each member of the class. This was particularly true in Tyson Foods because the defendant had never bothered to keep individualized records (despite being legally mandated to do so), and instead simply paid workers based on its own approximations of how long donning and doffing should take. But in other cases with stronger evidence of meaningful individualized variations, a jury might find statistical averages less useful.