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The tardy disclosure by Xerox Corp. that it was reducing the benefits of over 100 employees who left the company but were subsequently rehired, has been called a violation of the the Employment Retirement Income Security Act by a federal appeals court. The 2nd U.S. Circuit Court of Appeals said the way the company implemented a “phantom account” offset, through which the hypothetical growth of an employee’s previous lump sum retirement benefits payment was factored into his current benefits calculation, “reduced the amount of benefits on which the employees justifiably relied.” The appeal in Frommert v. Conkright, 04-4609-cv, was decided by 2nd Circuit Judges Rosemary Pooler and Robert Sack, with Eastern District Judge Nicholas Garaufis, sitting by designation. Judge Garaufis wrote the opinion for the court. The plaintiffs were more than 100 Xerox employees who had received lump sum retirement benefits upon leaving the company and, upon their return, began to once again earn retirement benefits. So that previously-retired employees do not receive a windfall in the form of duplicative benefits, the company subjects employees who have previously received a lump sum distribution to an offset based on so-called “phantom accounts.” The term “phantom” is used because that calculation is dependent upon the hypothetical growth, through investments, of the lump sum amounts that were paid to the employee when he or she left the company. For instance, according to the decision, when plaintiff Paul Frommert left the company in 1986, after 26 years service, he received a lump sum of $147,780. After Frommert was rehired in 1989, and phantom investment gains were deducted from his projected pension benefits, he learned that his monthly pension benefit when he retired at age 65 would be only $5.31. This information “came as a shock since I believed the number in the value added statements year over year.” Frommert and his fellow employees filed suit in the Western District, where Chief Judge David Larimer dismissed some claims in 2002 and ultimately dismissed the remainder of the complaint in 2004. The circuit disagreed, holding that ERISA had been violated. Garaufis said one of ERISA’s main objectives is protecting employees’ justified expectations on the benefits they will receive. “Here, that objective was thwarted up until 1998 because the defendants attempted to implement the phantom account offset without properly amending the terms of the Plan or providing adequate notice to rehired employees that their benefits would be reduced because of the hypothetical growth attributed to their prior lump sum distributions,” he said. “Without the benefit of such information, former employees contemplating returning to Xerox were denied the opportunity to make a meaningful decision regarding whether they would accept the terms of Xerox’s pension plan.” The year 1998 was an important dividing line for the court because it was only then that the company fully explained the phantom account and the text of the plan was amended to give the employees the information they needed on the significance of the prior distributions. “Such belated disclosure of so significant a change cannot be squared with ERISA’s mandate,” Judge Garaufis said. The court focused on two provisions in the statute that were adopted by Congress to safeguard employee benefits. The first is the “anti-cutback rule,” in 29 U.S.C. �204(g)(1), which states that the “accrued benefit of a participant under a plan may not be decreased by an amendment of the plan.” The second, under �204(h) as it existed at the time, banned sponsors from amending a plan in a way that reduces future benefit accrual unless employees have proper notice. Disagreeing with Larimer, the circuit held that both provisions were violated here for all employees rehired prior to the full explanation finally offered by the company in a 1998 summary plan description. As an initial matter, the court had to define what it means to “amend” a plan under ERISA. While both the defendants and the lower court considered an amendment to occur when plan administrators change the operation of the plan, the circuit disagreed, finding that, under the plain meaning of the statute, an amendment takes place “the moment when employees are properly informed of a change.” Here, therefore, the plan could not be considered “amended” until the full explanation was issued in the 1998 plan description. The company had argued that the plan had always included the phantom account, but the court said this conclusion was “unreasonable.” “Because we find that the Plan did not always include the phantom account, it follows that the various changes, updates, and explanations from the Plan regarding the existence and nature of the phantom account are not mere clarifications of an existing policy,” Judge Garaufis said. “Rather, they had the effect, whether deliberate or unintentional, of engrafting the phantom account onto the Plan without actually amending its text.” The court also rejected the company’s claim that the employees were not prejudiced because they remained at Xerox through, and beyond, the adoption of the changes. “Imposing a requirement that plan participants must show actual prejudice from a challenged plan amendment by terminating their employment imposes an unduly harsh burden on dissatisfied plan participants,” he said. The real standard that plaintiffs must meet, and have met in this case, is not a showing of “actual prejudice,” Judge Garaufis said, but whether they were “likely to have been harmed.” ISSUES REMANDED The court then remanded the case for the lower court to fashion a remedy “for those employees rehired prior to 1998,” that should “utilize an appropriate pre-amendment calculation to determine their benefits.” But the court rejected the plaintiffs’ plea for the equitable relief of declaring the phantom account as prohibited by ERISA. And while the court could not say “as a matter of law,” that the defendants had fiduciary obligations under the law and “if so whether they breached them,” it concluded those issues were triable issues of fact to be handled on the remand. Robert H. Jaffe of Springfield, N.J., represented the plaintiffs. Margaret A. Clemens and Ryan T. Jenny of Nixon Peabody in Rochester, N.Y., represented the defendants. Jaffe said that the circuit was merely enforcing the admonition of the Supreme Court in Central Laborers’ Pension Fund v. Heinz, 541 U.S. 739 (2004) that ERISA was meant to protect employees’ “justified expectations of receiving the benefits their employers promise them.” “They made it quite clear that any provision in a defined benefit plan which would have the effect of reducing benefits is void, period, gone,” Jaffe said. ERISA defense litigator Nancy G. Ross of McDermott Will & Emery, who was not involved in the Frommert litigation, said that the case represents a long-term trend under which plaintiffs’ lawyers have challenged cut-backs and other changes in benefit plans on procedural grounds, such as lack of notice or improperly-passed amendments. “Twenty years ago, when ERISA was very new, when plan participants claimed they were entitled to something that went beyond the terms of the plan because they had no notice or someone had told them something different, courts were by and large rejecting them out of hand,” Ross said. “Now, more and more courts are accepting these arguments.”

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