Appellate Court Weighs Foot Locker Cash Balance Disclosure Failures

The 2nd U.S. Circuit Court of Appeals has ruled against Foot Locker in an Employee Retirement Income Security Act (ERISA) lawsuit involving communications and benefit accrual formulas in the company’s evolving pension offerings.

The bench trial took place in the United States District Court for the Southern District of New York, before Judge Katherine B. Forrest, and resulted in Foot Locker being ordered to reform its cash balance plan to calculate accrued benefits in a way participants argued they were entitled to. Participants’ arguments revolved around that fact that Foot Locker did not fully describe or disclose a period of “wear-away” that could result for some participants during the transition from a traditional defined benefit to a cash balance approach, “a phenomenon which effectively amounted to an undisclosed freeze in pension benefits.”

Judge Forrest ruled the plan’s summary plan description (SPD) as well as other communications to participants failed to inform them that their benefits would be subject to a period of “wear-away” during which new accruals would not increase the benefit to which a participant was already entitled.

Background information provided in case documents shows that under the original defined benefit plan, participants had been entitled to an annual benefit beginning at age 65 that was calculated on the basis of their compensation level and years of service. The benefit took the form of an annuity, and, “with exceptions not relevant to the appeal,” employees were not given the option to receive its aggregate value as a lump sum. In contrast, under the newly introduced cash balance plan, participants held a hypothetical account balance that, upon retirement, could be paid out as a lump sum or used to purchase an annuity.

As such, Foot Locker established a beginning balance based on any given participant’s earned DB plan benefit and a 9% discount rate, as well as a mortality discount. Following the conversion, participants’ account balances were credited with pay credits and an interest credit at a fixed annual rate of 6%.

According to Foot Locker’s stance, the problem of potential cutbacks was rectified by a stopgap measure that defined a participant’s actual benefits as the greater of the participant’s benefits under the defined benefit plan as of December 31, 1995, or the participant’s benefits under the new cash balance plan. The “greater of” provision, Foot Locker argued, “had the benefit of ensuring that participants would not lose money due to Foot Locker’s switch to a cash balance plan, consistent with ERISA’s ban on plan amendments that reduce a participant’s accrued benefit, which is known as the anti-cutback rule.”

NEXT: Appellate court proves skeptical 

But, the judge determined this also meant that participants’ actual benefits would remain effectively frozen for some period of time following conversion. That is, until participants earned enough pay and interest credits to close the gap between the value of their cash balance account and their old benefits, their actual benefits would remain frozen at the value of their old benefits as of the first day of 1996, due to the operation of the “greater of” provision. During that period, any pay and interest credits earned by a participant would not increase his or her actual benefits, but merely reduce the gap between the value of the participant’s cash balance account and the participant’s old benefits. That phenomenon, the fact that a participant’s actual pension benefits did not increase despite continued employment, is known in the benefits industry as “wear-away.”

The district court judge determined that Foot Locker viewed announcing a benefits freeze as a “morale killer,” and that “conversion to a cash balance plan had the advantage of being able to obscure what was an effective freeze, without the accompanying negative publicity, loss of morale, and decreased ability to hire and retain workers.” Foot Locker introduced the new cash balance plan to its employees in a series of written communications, all of which the district court found to have “failed to describe wear-away,” to have “failed to clearly discuss the reasons for the difference” between the value of a participant’s old and new benefits, and to have been “intentionally false and misleading.”

On appeal, Foot Locker did not challenge the district court’s determination that it violated ERISA. Instead, the company quarrels with the district court’s award of equitable relief under ERISA 502(a)(3), arguing that the district court erred by: “(1) awarding relief to plan participants whose claims were barred by the applicable statute of limitations; (2) ordering class-wide relief on participants’ § 404(a) claims without requiring individualized proof of detrimental reliance; (3) concluding that mistake, a prerequisite to the equitable remedy of reformation, had been shown by clear and convincing evidence as to all class members; and (4) using a formula for calculating relief that resulted in a windfall to certain plan participants.”

In short, the 2nd Circuit has rejected all of these lines of argument and affirmed the judgement of the district court to award equitable relief.

NEXT: Decision clearly based in Amara precedent 

On the time-barring issue, Foot Locker argued that participants “were put on constructive notice of wear-away (and thus on notice of their claims under ERISA 102 for the summary plan description’s failure to disclose wear-away) when they received lump sum payments upon retirement that exceeded their account balances under the new pension plan.” The company argued, accordingly, the that the clock on participants’ “102 claims” began running upon retirement, rendering untimely the claims of participants who left Foot Locker more than three years before this suit was brought. 

Citing a legal principle called the “Novella framework,” the appellate court ruled against this argument, as follows: “As a threshold matter, participants would have had not only to notice the disparity between the lump sum payment and account balance, but also to recognize that the disparity had some significance worth further investigation. For participants who had been assured by Foot Locker that they were receiving a more competitive retirement benefits package in which their account balance would grow each year, the fact that they were receiving the larger of two numbers on a page would not necessarily make apparent to them that their benefits had in fact been frozen for months or years … Even assuming that participants picked up on the disparity, in order to discover wear-away, participants would still have had to make a sophisticated chain of deductions about the meaning of the information on their statements and the mechanics underlying their benefits, with the opaque guidance contained in the SPD as their guide.”

Moving on to the matter of “requiring individualized proof of detrimental reliance,” the appellate court is equally unmoved, noting that Foot Locker’s arguments are “foreclosed by the Supreme Court’s reasoning in CIGNA Corp. v. Amara.” The argument runs as follows: “On writ of certiorari, the Supreme Court vacated the district court’s judgment [in the CIGNA/Amara case], concluding that the remedy of plan reformation was not available under § 502(a)(1)(B) because the relevant statutory text speaks of enforcing the terms of the plan, not of changing them. The Supreme Court stated, however, that the district court could have instead granted such relief under § 502(a)(3) of ERISA, which allows a participant to obtain other appropriate equitable relief to redress ERISA violations. In so stating, the Supreme Court rejected the argument that a showing of detrimental reliance was always required for relief under § 502(a)(3).”

The third and fourth matters of appeal are also flatly rejected based on the facts of the case, leaving in place the district court’s ruling and award of equitable relief.

Read the full text of the decision here.