Arbitration ruling piques sponsors' interest

A federal appeals court decision allowing The Charles Schwab Corp.'s 401(k) plan executives to compel arbitration in a fiduciary breach dispute will prompt more plan sponsors to examine this strategy to reduce their ERISA liability risks, attorneys and defined benefits consultants say.

"The implication that including arbitration clauses in plan documents may be a way to avoid ERISA claims is important," said George Sepsakos, a Washington-based principal at Groom Law Group. "It definitely got our clients' attention."

Although arbitration clauses in plan documents are rare, "I foresee more of this happening," because of the Schwab ruling, Mr. Sepsakos said.

"This is definitely an area that sponsors will explore," said Jana Steele, a Chicago-based senior vice president, defined contribution, for Callan LLC. "I don't expect them to go run out and add it tomorrow, but I expect they will talk to counsel."

The 9th U.S. Circuit Court of Appeals ruled Aug. 20 that an arbitration provision in the 401(k) plan docu-ment trumped efforts by a former plan participant to pursue his ERISA-based complaints in court.

In the case of Michael F. Dorman et al. vs. The Charles Schwab Corp. et al., Mr. Dorman sued in 2017, alleging plan executives had violated their fiduciary duties. He said the plan favored Schwab investment products that charged higher fees and performed worse than comparable funds from other providers.

A District Court judge ruled for Mr. Dorman in January 2018, rejecting Schwab's argument that its arbitration provision covered this dispute. However, a three-judge appellate panel reversed the decision, sending the case back to the lower court.

"This case will encourage more plan sponsors with the hope that other courts will apply this ruling," said Jordan Mamorsky, a New York-based associate for the Wagner Law Group. He noted that the appellate ruling applies only to the 9th Circuit, which covers Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon and Washington.

The Schwab ruling is "potentially a game-changer" for DC plans within the 9th Circuit, said Eric S. Mattson, a Chicago-based partner at Sidley Austin LLP. "It opens a door that had been closed in ERISA cases."

In the Schwab case, the appeals court judges wrote that prohibitions against arbitration in ERISA cases had been in effect in the 9th Circuit since a 1984 ruling. However, the Schwab decision means that case "is no longer binding precedent," the judges wrote.

A key issue for the judges was noted in a "not for publication" opinion — a legal term saying the court's comments cannot be used as precedent — that accompanied their formal ruling. "A plan participant agrees to be bound by a provision in the plan document when he participates in the plan while the provision is in effect," they wrote.

"The plan expressly agreed in the plan document that all ERISA claims should be arbitrated," they added. "Dorman also did not waive any rights that belong to the plan."

This not for publication opinion also highlighted one reason why the appeals court reversed the District Court judge's ruling. The District Court judge had incorrectly ruled that Mr. Dorman left the plan before the arbitration clause was added, according to the appeals court judges.

"The record reflects that Dorman participated in the plan for nearly a year while the (arbitration) provision was in effect," they explained. Mr. Dorman left the plan in December 2015.

"We regularly communicate changes in the plan to participants," said Mayura Hooper, a Schwab spokeswoman. The plan had assets of $3.59 billion as of Dec. 31, 2018, according to the latest 11-K statement.

Todd M. Schneider, an attorney for Mr. Dorman, declined to discuss the case. "We are looking at our options as to how to proceed," he wrote in an email. He is founder and partner of Schneider Wallace Cottrell Konecky Wotkyns LLP, Emeryville, Calif.

ERISA lawyers and DC consultants were quick to add the Schwab case doesn't automatically represent a panacea for sponsors seeking to reduce ERISA liability.

"Be careful what you wish for," said Nancy Ross, a Chicago-based partner at Mayer Brown LLP, explaining that arbitration agreements can have drawbacks.

"Arbitrators are more likely to split the baby," said Ms. Ross, using the biblical reference to King Solomon in describing an arbitrator's choosing a middle ground between competing claims.

Unlike judges, arbitrators are not bound by precedent, Ms. Ross said. There's no guarantee an arbitrator is knowledgeable about ERISA; and, except in rare cases, binding arbitration cannot be appealed.

Ms. Ross said she is telling clients that the implication of the Schwab case "is not clear cut at all" because it is restricted to the 9th Circuit. More appeals courts would have to address similar ERISA arbitration issues, she said. If there's a conflict with the 9th Circuit, then the Supreme Court might be asked to resolve the dispute.

Sponsors contemplating adding an arbitration clause to plan documents must "evaluate the pros and cons" of this approach depending on the specific circumstances of their plans, Mr. Mattson said. Do they include a "class-action waiver," which means employees agree to resolve disputes on an individual basis? Or do they choose an arbitration clause that excludes a class-action waiver? The latter choice could produce an award for a large class of employees if an arbitrator supports them, while the former could backfire if many individuals seek arbitration of disputes, he said.

In the Schwab case, for example, the appeals court's not for publication opinion said Mr. Dorman and the 401(k) plan "both agreed to arbitration on an individualized basis."

DC consultants said they couldn't quantify the percentage of DC plans containing arbitration clauses, adding such clauses would more likely be in larger plans.

Willis Towers Watson LLC has been discussing arbitration clauses with DC clients since 2014, said Michael Weddell, director of retirement, based in Southfield, Mich. Financial services firms are interested in this provision because "they are familiar and comfortable" with this approach outside of ERISA plans, he said.

Mr. Weddell said he doubted there would be a massive rush by sponsors to insert arbitration clauses into plan documents unless the U.S. Supreme Court eventually would be called to address conflicting interpretations by different appellate courts.

DC consultant Martin Schmidt said a few of his clients have added arbitration clauses to their plans, and he cautions executives to be precise. "You have to clearly define in contracts what the liability standards are and what would be subject to arbitration," said Mr. Schmidt, principal at MAS Advisors, Chicago.