Commentary: Court clarifies how committees should monitor third-party providers

The U.S. District Court for the Western District of Pennsylvania, Pittsburgh, recently provided much-needed guidance on the largely unexplored duty of ERISA fiduciaries — such as corporate committees handling pensions, investments and retirement assets — to monitor service providers. Pursuant to ERISA, not only must these committees initially select service providers in a prudent manner, but the committees must further observe an ongoing duty to monitor and, if necessary, remove underperforming providers.

In the case, Scalia vs. WPN Corp., et al., the Department of Labor sued a number of parties, including the retirement committee of Severstal Wheeling Inc. and two of the retirement committee's individual members. Severstal Wheeling was a steel manufacturer headquartered in Wheeling, W. Va. According to the Department of Labor, the pension funds under the retirement committee's care, which at one time totaled nearly $50 million, suffered significant losses during the global economic downturn of 2008, when the vast majority of the pension funds' assets remained undiversified for a period of months in a small portfolio of energy stocks.

The retirement committee had hired a professional and nationally renowned investment manager, Ronald Labow and his investment firm WPN Corp., to act as its outside investment manager to invest the pension assets. After years of exceptional performance and returns, however, Mr. Labow made the decision to hold the undiversified energy stocks. Mr. Labow's decision, which cost the pension plans more than $15 million in market losses, was in direct contravention to the retirement committee's request for an appropriately diversified portfolio.

After almost five years of litigation, the District Court entered summary judgment in favor of the retirement committee on the Labor Department's remaining claim, which alleged that the committee failed to prudently monitor Mr. Labow while he served as investment manager. The Labor Department's other claims against the retirement committee, including a failure to invest claim, were previously discarded by the District Court on a motion to dismiss. According to the Labor Department, if the retirement committee monitored Mr. Labow more closely, or fired the investment manager sooner, it could have avoided the many millions of dollars of losses to the pension funds.

The District Court's opinion ultimately set forth at least four key takeaways for committees handling the pension assets, retirement funds or other investment activities for their respective organizations.

The hallmark to appropriate ERISA monitoring, according to the federal court in the WPN Corp. case, is the selection and adherence to a prudent monitoring framework to oversee third-party service providers. Although there is no one-size-fits-all procedure, the retirement committee's procedure, which primarily centered on the review of quarterly reports from an outside investment consultant, was deemed sufficient by the court. Importantly, an appropriate monitoring scheme must be robust enough to alert a committee to an underlying problem.

The retirement committee in the WPN Corp. case was able to point to a specific paper trail to support the prudence of its monitoring scheme. The committee, for example, had a comprehensive written agreement governing Mr. Labow's role as investment manager, documented all major decisions in writing, kept detailed minutes of committee meetings, and otherwise memorialized its activities in writing and in real time. When Mr. Labow's misadventure occurred, and the retirement committee was forced to jump into corrective action, the committee's monitoring activities and written record of these activities increased to near daily occurrences. In the end, the committee was able to prove its prudence through specific documents, which went a long way in convincing the federal District Court that appropriate monitoring occurred all along.

The retirement committee, which was composed of only two members at times overseeing more than $30 million in assets, relied on the help of qualified experts to bolster its monitoring team. For example, the committee worked with Mercer to review investment performance on a periodic basis, and engaged an expert ERISA lawyer from an international law firm to guide it through various activities. The federal court specifically noted the importance of these expert partners as a key part of the committee's monitoring prudence.

One of the driving forces behind the Labor Department's lawsuit was the lack of deep pockets to satisfy the pension plans' losses. Although a judgment against Mr. Labow totaling more than $15 million was obtained in a separate proceeding, execution on that judgment ended well short of the full amount. Mr. Labow lacked insurance coverage for his actions, which led the Labor Department to sue the retirement committee in an attempt to reach its insurance coverage and potentially increase the collectible damages for the case. If Mr. Labow had appropriate insurance coverage in place commensurate to the many millions of dollars of assets he was managing, the Labor Department likely never would have pursued the retirement committee.

Charles Kelly and Michael J. Joyce are partners at Saul Ewing Arnstein & Lehr LLP, Pittsburgh. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.