Court: ESOP Covered Under Insurer's Fiduciary Liability Policy

June 30, 2003 ( - An insurer is still liable for employee stock ownership plan (ESOP) fiduciary breach claims, even though the insurer failed to list the plan as being covered under its fiduciary liability policy.

>That was the ruling by US District Judge Michael Mihm of the US District Court for the Central District of Illinois in St. Paul Mercury Insurance Co. v. Foster, where Mihm found the liability policy was “reformed” when a representative of the insurer acknowledged that the insurer had mistakenly failed to list the ESOP on the policy.   Mihm rejected St. Paul’s claim that the employer should have given it notice that attorneys for the participants had requested plan documents four months before filing the lawsuit, finding instead the employer gave adequate notice of the ESOP participants’ suit charging the employer’s executives with breach of fiduciary duty, according to Washington-based legal publisher BNA.

Case History

>The case stems from Keach v. U.S. Trust Co. , filed by participants in Foster & Gallagher Inc.’s (F&G) ESOP. The court has issued 18 decisions in the Keach case over the past several months, each decision addressing the various liability of executives and other parties that participated in a recapitalization of the ESOP.

F&G, a direct marketing firm, established an ESOP In 1988. In 1995, the company’s board of directors decided to recapitalize the ESOP. After the recapitalization was approved, the ESOP used the proceeds of a $70-million loan to purchase nearly 3.6 million F&G shares.

In the years following the ESOP recapitalization, several states brought investigations against F&G’s subsidiary, Michigan Bulb Corp., surrounding the company’s sweepstakes promotions.  While Michigan Bulb and F&G settled most of the lawsuits brought by the states, Michigan Bulb’s revenue declined from $197 million in 1998 to $65 million in 2000. F&G’s gross revenues dropped from $471 million in 1998 to $337 million in 2000.

As a result of the Michigan Bulb investigations, the value of the ESOP’s F&G shares dropped from $20 per share to just under $9 per share. In addition, the total value of the F&G shares owned by the ESOP decreased more than 90% from a net value of more than $82 million in 1997 to a net value of just over $7 million in 1998.

Two plan participants sued F&G and its board of directors, the ESOP’s trustee, US Trust Co., the ESOP’s administrative committee, and Valuemetrics Advisors Inc. alleging they breached their ERISA fiduciary duties by entering the 1995 ESOP transaction.

Liability Policy

>F&G, though its insurance broker Aon Financial Services Group, sought a new fiduciary liability policy in 2000 after the expiration of its previous policy. However, when Aon submitted a fiduciary liability application to St. Paul, it failed to list the ESOP as a plan to be covered by the policy. Regardless, it was undisputed that F&G’s ESOP was the only ERISA plan that would have been covered under the liability policy.

>St. Paul issued a fiduciary liability policy to F&G that failed to list the ESOP. An Aon representative discovered the omission of the ESOP and requested that St. Paul add the ESOP to the policy.   St. Paul reissued the policy in October 2000, again failing to include the ESOP.

>In February 2001 F&G’s new insurance broker, Hobbs Group, discovered the omission of the ESOP in the St. Paul policy. Hobbs wrote to St. Paul requesting that the ESOP be added to the policy. A St. Paul underwriter determined that F&G and St. Paul had intended to provide coverage for the ESOP and that F&G had paid a premium consistent with ESOP coverage. Although the underwriter agreed to add the ESOP to the policy, the policy was never amended.

Covered ESOP

>Mihm  denied St. Paul’s motion for summary judgment, finding the liability insurance policy at issue was “reformed” when the St. Paul underwriter determined that F&G and St. Paul had intended to provide coverage for the ESOP. The fact that the underwriter failed to amend the plan following her discovery “is really irrelevant, as St. Paul admits that it put a halt to her efforts once notice of the Keach claim filtered through its system,” the court said.

>Additionally, Mihm rejected St. Paul’s argument that the damages sought in the Keach case were uninsurable because the ESOP participants sought restitution, which is uninsurable as a matter of public policy. With the ruling, the court found that although the Keach plaintiffs sought restitution, they also sought other remedies that would be insured under the policy.

>Further, the court dismissed St. Paul’s contention that the losses claimed in the Keach case were exempt from the policy because the F&G executives covered by the policy had realized personal gains through their alleged breach of fiduciary duty. It was premature to argue that the executives personally profited from their alleged fiduciary breaches, the court said in denying summary judgment to St. Paul.

The same judge had previously ruled that consulting firm Valuemetrics was not an ERISA fiduciaryeven though it had provided yearly stock evaluations for the ESOP for a number of years.   Mihm rejected an argument that the consultant’s stock evaluations constituted investment advice, which gave the consultant fiduciary responsibilities (See  ESOP Consultant Not an ERISA Fiduciary ).  

The latest case isSt. Paul Mercury Insurance Co. v. Foster,C.D. Ill., No. 01-1382, 6/26/03.