Under Deferential Review, Second Circuit Again Nixes Xerox's Use of Phantom Account

Xerox Corp.'s use of a phantom account in calculating and offsetting its employees' pension benefits was unreasonable under the terms of the plan and violated the notice requirements of the Employee Retirement Income Security Act, the U.S. Court of Appeals for the Second Circuit ruled (Frommert v. Conkright,2d Cir., No. 12-67-cv, 12/23/13).         

Judge Rosemary S. Pooler, writing for the court in its Dec. 23 ruling, remanded the case to the district court with instructions for it to consider which equitable remedies—if any—were appropriate to redress the participants' claims.         

Pooler's ruling marks the third time the Second Circuit has weighed in on the case since it was originally filed in 2000. In 2010, the U.S. Supreme Court ruled that the plan administrator's interpretation of the plan and execution of the offset was entitled to deference.         

In the instant ruling, the Second Circuit once again found that the plan administrator's interpretation was unreasonable, “even with the deferential standard of review afforded to both the district court and the Plan Administrator.”       

Litigation History         

The Xerox case arose from a dispute over the company's use of a “phantom account” offset to calculate the benefits of employees who were rehired after they had previously received lump-sum distributions of their pension benefits. A group of employees argued that the use of this offset violated ERISA.         

In July 2004, the U.S. District Court for the Western District of New York ruled that Xerox didn't illegally reduce benefits by applying the offset.         

On appeal, the Second Circuit ruled that Xerox had violated ERISA's anti-cutback provision and remanded the case to the district court, instructing it to craft a remedy.         

The administrator proposed taking prior distributions into account by expressing those distributions as an annuity starting at normal retirement age. The district court didn't give any deference to this proposed interpretation and instead ruled that Xerox had to pay anyone rehired prior to 1998 who had received a distribution of benefits the difference between the lump-sum pension benefits they received when they first left Xerox and the benefits they earned after they were rehired.        

The Second Circuit affirmed in 2008.         

The Supreme Court ruled in April 2010 that the lower court had to give deference to the administrator's interpretation of the plan with respect to the treatment of prior distributions to employees who were rehired prior to 1998.         

In 2011, the district court determined that Xerox's interpretation of the plan was reasonable and entitled to deference, and that the employees were on notice that there would be some offset to account for prior distributions.         

The participants appealed the ruling to the Second Circuit. Several entities filed amicus briefs with the court, including the Department of Labor.         

Offset Unreasonable          

On appeal, the participants and the DOL argued that the district court erred in finding that the offset was a reasonable interpretation of the plan. The Second Circuit agreed, saying that, “even with the deferential standard of review afforded to both the district court and the Plan Administrator, the offset is inconsistent with the Plan's plain terms and is therefore an unreasonable interpretation of the Plan.”         

According to the Second Circuit, the plan administrator's offset approach converted prior lump-sum distributions into annuities using interest rates set by the Pension Benefit Guaranty Corporation and then decreased participants' annuities by that converted value. However, Section 9.6 of the plan provided that any participant who recommenced participation in the plan after receiving a distribution shall have his benefit offset by “the accrued benefit attributable to such distribution,” the Second Circuit said.           

“[T]his is unreasonable because it makes the rehired workers worse off under the Plan in terms of actual benefits received,” the Second Circuit said. Under this formula, the Second Circuit said, a participant who worked from 1980 to 2005 would receive a higher benefit than a similarly-situated worker who worked from 1960 to 1970 and then again from 1980 to 2005.         

On this point, the Second Circuit clarified that “ERISA plans may be constructed to change the risk borne by rehired employees or reduce such employees' benefits in a manner that treats them worse than newly hired employees, provided that such terms exist in the plan.” However, because such terms “do not exist here,” the Second Circuit found that the proposed offset “produces an absurd and contradictory result and is therefore unreasonable.”         

Notice Requirement Violated          

The participants and the DOL also argued that the proposed offset violated ERISA's notice requirements. The Second Circuit agreed again.         

According to the Second Circuit, the plan's summary plan description provided that, “[t]he amount [a beneficiary] receive[s] may also be reduced if [the beneficiary] had previously left the Company and received a distribution at that time.” Comparing this provision with the terms of the plan, the Second Circuit found that “the SPDs fail to clearly identify the circumstances that will result in an offset, are insufficiently accurate and comprehensive, and fail to explain the ‘full import' of Section 9.6 of the Plan.”         

The Second Circuit took issue with the fact that the SPDs indicated that benefits “may”—rather than “will”—be reduced, calling this a “critical omission.” The SPDs also failed to describe the mechanics of any such offset, the Second Circuit said.          

In so finding, the Second Circuit rejected the Xerox defendants' argument that this holding would “run[] the risk of making future SPDs unreadable.”         

The Second Circuit said that the SPD “could have sufficiently explained the Plan Administrator's proposed offset by including a brief statement that the [annuity] benefit would be offset by the appreciated value of any prior distribution or by providing an example calculation of benefits that employed the offset.”
 Excerpted from a story that ran in Pension & Benefits Daily (12/26/2013).