The HR Legal News Blog

Lee v. Verizon Communications: Settlors, Fiduciaries and the Two-Hat Rule

Plan sponsors, take note!  Make sure that you understand (i) when you are acting as a fiduciary of your plan and (ii) how to protect yourself when your actions are measured against ERISA’s strict fiduciary standards.

The “two-hat rule” is shorthand for the long-recognized principle that an ERISA plan sponsor sometimes makes decisions in the capacity of the settlor of an employee benefit plan and, at other times, acts as a fiduciary with respect to the plan.  Settlor functions typically arise from the employer’s decision to implement a particular compensation strategy and are not subject to ERISA’s fiduciary standards.  “Settlor” functions generally include activities such as designing, establishing, amending and terminating a plan.  In contrast, an ERISA plan sponsor functions as a fiduciary when undertaking activities related to the administration of the plan.   Typical “fiduciary” functions include, for example, allocating fiduciary responsibilities, appointing and monitoring the performance of fiduciaries, determining investment options and investment policies, interpreting plan language and evaluating claims for eligibility or benefits.  A fiduciary is obliged to act in the sole interest of participants and beneficiaries and with the care, skill, prudence and diligence of a prudent person.

An April 2014 decision by the United States District Court for the Northern District of Texas navigates the murkier waters of the “two-hat” principle.  In Lee v. Verizon Communications, Inc., participants in a defined benefit pension plan objected to their employer’s decision to  fund the benefits of certain retirees through the purchase of a group annuity contract and thereby terminate their participation in the plan.  In October 2012, Verizon amended the Verizon Management Pension Plan to direct the Plan to purchase one or more annuity contracts to fully guarantee and pay the pensions of participants who began receiving benefits before January 1, 2010.  On the same date, Verizon and the Plan fiduciaries selected Prudential as the sole annuity provider.  The premium for the group annuity contract was approximately $8.4 billion–roughly $1 billion more than the amount of the estimate pension liabilities.

The Court pointed out that the decision to amend the Plan is a settlor function and is therefore not subject to review under ERISA’s fiduciary standards.  While Plaintiffs clearly wished that Verizon had consulted the affected participants or elected to keep the annuity contract as a plan asset, these issues pertained to Verizon’s decisions as a settlor and could not sustain a claim for breach of fiduciary duty.

On the other hand, the Court agreed that the selection of an annuity provider is a decision that is subject to ERISA’s fiduciary obligations.  Plaintiffs argued that the fact that the Plan amendment and the selection of Prudential as the annuity provider occurred on the same day “self-evidently” demonstrated  that Verizon and the Plan fiduciaries “did not prudently allow any period of time, much less a reasonable time period for consideration” of their decision.  In fact, according to Plaintiff’s own pleadings, almost two months prior to the selection of an annuity provider, Verizon appointed an independent fiduciary to represent the interests of the Plan and participants and beneficiaries in connection with the selection of an annuity provider and the negotiation of the terms of the annuity contract.  The Court concluded that plaintiffs failed to state a claim for breach of fiduciary duty.

An ounce of prevention–here, Verizon’s decision to appoint an independent fiduciary–was certainly worth a pound of cure.