Appellate Court Affirms City National’s Liability in Self-Dealing Suit

The 9th U.S. Circuit Court of Appeals has affirmed a lower court’s ruling that City National Corporation engaged in self-dealing in administering its own retirement plan and has also affirmed most of the damages City National is required to pay.

A federal judge in the U.S. District Court for the Central District of California found that City National Corporation violated employee retirement laws when it chose its own staff to administer its employee retirement plan in exchange for millions of dollars of unchecked, unreasonably high compensation.

The district court granted the Department of Labor’s (DOL)’s motion for summary judgment on damages. Specifically, in an order dated February 8, 2017, the district court awarded $7,367,382.13 in damages.

City National appealed the grant of summary judgment that found it liable under Employee Retirement Income Security Act (ERISA) Section 406(b) for self-dealing and the amount of damages and prejudgment interest. City National does not contest that it engaged in what is typically prohibited self-dealing by setting and approving its own fees from plan assets for serving as its own recordkeeper, but contends that this conduct is exempted under ERISA Section 408(c)(2) as “reasonable compensation” for services provided by a fiduciary such as recordkeeping services, according to the appellate court opinion.

The 9th Circuit rejected this argument, citing prior cases in which it found that the “exemption for reasonable compensation under § 408(c) does not apply . . . to a fiduciary who engages in a prohibited transaction under § 406(b) by paying itself from the assets of a welfare benefit plan. “In other words, while a plan may pay a fiduciary ‘reasonable compensation for services rendered’ under [section 408], the fiduciary may not engage in self-dealing under [section 406(b)] by paying itself from plan funds,” the opinion says.

The 9th Circuit then turned to the issue of damages. It said that under its own circuit precedent, the loss associated with a prohibited transaction is at least “the entire cost of the prohibited transaction.” The appellate court said that in cases where the fiduciary has engaged in self-dealing, it has previously held that the “entire cost” of the transaction is the total amount of the illegal compensation that the fiduciary paid itself. City National argues that if the District Court had considered offsets to the damages award based on estimates of certain direct expenses such as employee compensation and third-party expenses, it would have been clear that the plan never suffered a loss, that is, that the bank never received more compensation than necessary for performing its recordkeeping services.

However, the 9th Circuit found that City National failed to meet its burden to show that it is entitled to these offsets because these offsets are effectively based on unreliable and insufficient evidence. “We conclude that no reasonable jury could find in favor of City National given the paucity of the evidence demonstrating that the additional offsets represent expenses actually incurred by CNB in servicing the plan,” the opinion states.

However, the appellate court did find that the District Court abused its discretion by awarding interest on City National’s liability for the gross amount of its recordkeeping compensation instead of on its net compensation after unopposed offsets were deducted. “In doing so, the district court effectively required City National to pay interest on more than the entire cost of the transaction. Therefore, we reverse the district court on this issue and remand for a recalculation of the prejudgment interest portion of damages,” the 9th Circuit concluded.