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Earlier this year, Judge G. Patrick Murphy of the U.S. District Court for the Southern District of Illinois sent a collective shiver down the spines of Fortune 500 CFOs when he ruled that a revised pension plan adopted by IBM Corp. five years ago violated federal employment law. The class action against Big Blue was brought on behalf of roughly 130,000 current and past employees who allege that the company violated the age discrimination prohibitions of ERISA by converting its old defined-benefit pension plan to a cash-balance plan in July 1999. IBM’s conversion was just part of a much wider movement by American corporations in recent years to get out from under the high costs and layers of federal regulations associated with the administration of traditional defined-benefit plans. In finding for the plaintiffs, Murphy described IBM’s cash-balance plan as a “clever, but ineffectual, response to law that it finds too restrictive for its business model.” That’s a standard, it goes without saying, that might be seen to have broad applicability. Which is why the IBM case is being closely monitored in boardroom circles throughout the country. Beginning with Bank of America Corp. in the mid-1980s and accelerating through the 1990s, hundreds of major corporations converted from traditional defined-benefit plans to cash-balance plans. By 1999, the year IBM adopted its new plan, the Pension Benefit Guarantee Corp. estimated that 20 percent of the Fortune 500 had already switched to cash-balance plans, and an additional 30 percent to 40 percent were planning to make the move. In all, the PBGC said, the switch had affected more than 10 million workers, a number that only grew in the following years. The motive, of course, was money. In the traditional defined-benefit pension universe, employers made the contributions, managed the assets and assured positive rates of return. The employer was generally required to give the employee the option of receiving a lifetime annuity at retirement, and the plan was insured by the PBGC, a federal institution funded through premiums paid by — you guessed it — participating corporations. All that was pretty pricey. By switching to cash-balance pension plans, a formula that computes benefits at a steady rate throughout an employee’s tenure, companies cut back the big pension increases earned by long-term employees in their final years of employment. The cash-balance plans, sometimes called hybrid plans, are something of a cross between a traditional defined-benefit pension and the newer defined-contribution plan, such as 401(k)s. As with 401(k)s (and your Social Security statements), employees can monitor their accruing pension balance in an individual “account,” but, as with defined-benefit plans, employees make no contributions to the account and do not decide how it is invested. Defined contribution plans, such as 401(k)s, are even cheaper to maintain than cash-balance plans, as employers put the onus on their employees to fund their retirements, usually making small matching contributions (though even those small contributions have greatly diminished in recent years). Moreover, surveys show that about one quarter of all employees don’t participate in their employers’ 401(k) plans. That percentage jumps to two-thirds among employees making less than $40,000 annually. For the most part, Congress has nibbled around the edges of the pension problem, offering only stopgap legislation. To date a larger overhaul of the pension system has been stymied as labor and big business spar over the contours of a new pension regime. This summer Congress debated several prospective bills but let them languish as representatives turned toward re-election races. The lobbying on the issue has been intense and not without controversy. In June, the Treasury Department’s inspector general announced that IBM lobbyists, with assistance from department officials, had altered an internal department memo on cash benefit pensions. The memo included a list of “talking points” arguing against proposed congressional legislation that would prohibit Treasury from adopting regulations stating that cash-balance plans do not violate federal age discrimination laws, in contravention of Murphy’s ruling. Treasury did at one point issue regulations stating that cash-balance plans do not violate federal discrimination law but pulled them down in the face of strong public criticism. With Congress gridlocked on pension reform, the federal courts have stepped into the fray. Dozens of corporations are being sued for altering their pension plans, with the potential liabilities running into the hundreds-of-billions of dollars. The lead case against IBM was filed in November of 1999 by employees who claimed the new plan amounted to a “pension pay cut.” IBM contends that its switch to a cash-balance plan complied with ERISA, but Murphy disagreed. By making the switch, he ruled in February, IBM unfairly penalized senior employees whose benefits (often taken in lieu of increased wages) would have greatly accelerated under the old plan in their final years before retirement. The parties have been awaiting Murphy’s ruling on how much IBM will have to pay to satisfy its pension requirements. In late September, the company announced that it had settled with about 15,000 members of the class, those employed with the company on July 1, 1999, (the date of the plan conversion) who were terminated before they worked for five years, the minimum vesting time under the new plan. At press time terms of the settlement were undisclosed, but in a Securities and Exchange Commission filing, IBM estimated that the total cost of Murphy’s ruling would be about $6.5 billion. The company has already announced its intention to appeal. Though that would be the largest pension judgment in history, IBM has said that its plan is sufficiently funded to meet the payouts as they become due and the judgment would not affect the company’s present cash flow. So what’s the rumpus? IBM claims that it shouldn’t have to make the payments because it had no way of knowing that its cash-balance plan would be declared illegal. The judge rejected that argument, noting in his February ruling that ERISA’s prohibition against age discrimination predated the adoption of the plan. But IBM received some new support for its appeal in June, when a federal judge in Maryland ruled that Murphy’s decision would lead to “illogical” results. The Maryland case also involved a 1999 conversion from a defined-benefit plan to a cash-balance plan. But the judge found that just because an employee might receive a lesser annuity at 65 under the cash-balance plan, ERISA did not mandate that standard as the sole measure of plan benefits. Rather, the court found, other factors, such as whether the plan increased employer contributions with age, should be considered in judging whether the plan has discriminatory impact. The confusion in the courts has only led to a freeze in pension plan conversions and increased clamoring for a clarification by Congress of the pension rules. But that appears a ways off and, in any case, will probably come too late for IBM and other companies already caught in the pension litigation vortex. At press time, Murphy had issued a short stay delaying his final ruling, as the parties were involved in late settlement negotiations. Copyright �2004 TDD, LLC. All rights reserved.

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