Opinion
No. 11-440.
October 6, 2011.
H. CHRISTOPHER BARTOLOMUCCI, Counsel of Record, NICHOLAS J. NELSON, BANCROFT PLLC Washington, D.C., Counsel for Petitioner.
QUESTION PRESENTED
Whether petitioner's ERISA plan investment advisor — Bernard Madoff — is a covered person under the ERISA Compliance Bond that respondent sold to petitioner.
RULE 29.6 STATEMENT
Schupak Group, Inc., has no parent corporation, and no publicly held company owns 10% or more of its stock.
TABLE OF CONTENTS
QUESTIONS PRESENTED ............................... i RULE 29.6 STATEMENT .............................. ii TABLE OF AUTHORITIES .............................. v OPINIONS BELOW .................................... 1 JURISDICTION ...................................... 1 STATUTES AND REGULATIONS PROVISIONS INVOLVED ............................... 1 INTRODUCTION ...................................... 2 STATEMENT OF THE CASE.............................. 3 REASONS FOR THE GRANTING THE WRIT................. 11 I. Appellate Courts Have Taken Divergent — and Flawed — Approaches in Analyzing Whether an ERISA Compliance Bond Covers Investment Advisors Such as Bernard Madoff................................ 11 II. This Case Presents an Important and Recurring Question Affecting Thousands of ERISA Plans, Including Those Plans Victimized by Bernard Madoff.................. 23 CONCLUSION........................................ 25 APPENDICES Appendix A Summary Order of the United States Court of Appeals for the Second Circuit (June 8, 2011)................................. 1a Appendix B Opinion and Order of the United States District Court for the Southern District of New York (April 13, 2010)................................ 6a Appendix C Order Granting Extension of Time to File Petition for Certiorari (August 31, 2011)............................. 21a
TABLE OF AUTHORITIES
CASES Billings v. UNUM Life Ins. Co. of Am. 459 F.3d 1088 Binder v. Commercial Travelers Mut. Accident Ass'n of Am. 165 F.2d 896 Cent. States, S.E. S. W. Areas Pension Fund v. Cent. Transp., Inc. 472 U.S. 559 Cumberland Packing Corp. v. Chubb Ins. Corp. 29 Misc.3d 1208 District of Columbia v. Greater Wash. Bd. of Trade 506 U.S. 125 Employers-Shopmens Local 516 Pension Trust v. Travelers Cas. Surety Co. of Am. 235 P.3d 689 rev. denied, passim Greenough v. Tax Assessors of City of Newport 331 U.S. 486 Hemi Grp., LLC v. City of New York, New York 130 S. Ct. 983 (2010) In re Beacon Assocs. Litig. 745 F. Supp. 2d 386 Joseph Rosenbaum, M.D., Inc. Defined Benefit Pension Plan v. Hartford Fire Insurance Co. 104 F.3d 258 passim Taylor v. Mayo 110 U.S. 330 REGULATORY MATERIALS 29 C.F.R. § 2550.403a-1 29 C.F.R. § 2550.412-1 29 C.F.R. § 2580.412-1 29 C.F.R. § 2580.412-3 29 C.F.R. § 2580.412-3 29 C.F.R. § 2580.412-3 29 C.F.R. § 2580.412-3 29 C.F.R. § 2580.412-6 29 C.F.R. § 2580.412-10 29 U.S.C. § 1002 29 U.S.C. § 1102 29 U.S.C. § 1103 29 U.S.C. § 1112 Guidance Regarding ERISA Fidelity Bonding Requirements available at 2008 WL 5459779 and passim 29 U.S.C. § 301 et seq OTHER AUTHORITIES Bandler Varchaver How Bernie Did It et al., ERISA Bond Claims Over Employer Stock Losses: The Landscape in a Post-Enron World Madoff's Victims
, (11th Cir. 2006)............................. 23 , (2d Cir. 1948)................................ 10 , (1985)......................................... 17 , (A), 2010 N.Y. Slip Op. 51754(U) (N.Y. Sup. Ct. Oct. 8, 2010)...................... 22 , (1992)......................................... 3 , (Or. App. 2010), 249 P.3d 542 (Or. Feb 17, 2011) (Table)........................... , (1947)........................................ 21 , ........................... 7 , (S.D.N.Y. 2010)........................ 8 , (9th Cir. 1996)....................... , (1884).................................... 21 (c)........................... 14, 22 .................................... 4 ............................. 2, 4, 23 (a)................................. 6 (b)................................. 6 (c)................................. 6 (d)...................... 4, 6, 23, 24 ................................... 22 (d)................................ 6 (21)(A).............................. 12, 21 (a)(1)................................... 14 (a).................................. 14, 22 ................................... 1, 2, 23 U.S. Dep't of Labor, , Field Assistance Bulletin No. 2008-4 (Nov. 25, 2008) ( http ://www.dol.gov/ ebsa/regs/fab2008-4.html)........................... Welfare and Pension Plans Disclosure Act, ................................... 4 Black's Law Dictionary (9th ed. 2009)................. 13, 21 James Nicholas , , CNNMoney (Apr. 30, 2009), http://money.cnn.com/2009/04/24/ news/newsmakers/madoff.fortune/index.htm ................... 7 Merriam-Webster Online Dictionary, http:www.merriam-webster.com .............................. 21 Patrick J. O'Connor , 10 Fidelity L.J. 19 (2004)................................. 24 Restatement (Second) of Trusts (1959)........................ 21 Wall Street Journal, (Mar. 6, 2009), http://s. wsj.net/public/resources/documents/ st_madoff_victims_20081215.html ............................ 7PETITION FOR CERTIORARI
Schupak Group, Inc., respectfully petitions this Court for a writ of certiorari to review the judgment of the United States Court of Appeals for the Second Circuit in this case.
OPINIONS BELOW
The opinion of the Second Circuit is reported at 425 F. App'x 23 and is reproduced in the appendix hereto ("App.") at la. The opinion of the United States District Court for the Southern District of New York is reported at 716 F. Supp. 2d 262 and reproduced at App. 6a.
JURISDICTION
The judgment of the Second Circuit was entered on June 8, 2011. App. la. On August 31, 2011, Justice Ginsburg extended the time to petition for certiorari to and including October 6, 2011. App. 21a. The jurisdiction of the Second Circuit was based on 28 U.S.C. § 1291. The jurisdiction of this Court is invoked under 28 U.S.C. § 1254(1).
STATUTORY AND REGULATORY PROVISIONS INVOLVED
Section 412 of the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1112(a), provides in pertinent part:
Every fiduciary of an employee benefit plan and every person who handles funds * * * of such a plan * * * shall be bonded as provided in this section * * *. * * * Such bond shall provide protection to the plan against loss by reason of acts of fraud or dishonesty on the part of the plan official, directly or through connivance with others. 29 C.F.R. § 2580.412-1 provides in pertinent part: Every administrator, officer and employee of * * * any employee pension benefit plan subject to this Act who handles funds of other property of such plan shall be bonded as herein provided; * * *.
INTRODUCTION
Bernard Madoff perpetrated the most devastating financial fraud in American history. Among his many victims were employee benefit plans governed by ERISA. The ERISA plan sponsored by petitioner Schupak Group, Inc. (Schupak), which entrusted Madoff to handle its investments, lost more than $1.2 million. Fortunately, or so at first it seemed, the plan had insurance — an "ERISA Compliance Bond" that protected against losses caused by the dishonest or fraudulent acts of covered persons. ERISA and its implementing regulations require employee benefit plans to carry such bonds. See 29 U.S.C. § 1112; 29 C.F.R. § 2580.412-1.
The ERISA Compliance Bond (the Bond) that respondent Travelers Casualty and Surety Company of America (Travelers) sold to Schupak covered any "employee," a term that the Bond defined broadly to include any person who is "[a] trustee, an officer, employee, administrator or a manager, except an administrator or a manager who is an independent contractor." Bond § C. But when Schupak filed a claim under the Bond, Travelers denied coverage on the ground that Madoff was not a covered person.
This case raises an important and recurring question concerning ERISA's bonding requirements and the scope of coverage of ERISA compliance bonds: whether an ERISA plan's investment advisor who handles funds invested by the plan is covered by a standard form ERISA compliance bond. That question is important, not only to those ERISA plans and plan beneficiaries defrauded by Bernard Madoff, but to all ERISA plans. And, as shown below, appellate courts have taken divergent approaches in considering whether standard form ERISA compliance bonds cover investment advisors such as Madoff.
STATEMENT OF THE CASE
ERISA's Bonding Requirements
"ERISA sets out a comprehensive system for the federal regulation of private employee benefit plans." District of Columbia v. Greater Wash. Bd. of Trade, 506 U.S. 125, 127 (1992). Section 412 of ERISA, 29 U.S.C. § 1112, and its implementing regulations "generally require that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan shall be bonded." U.S. Dep't of Labor, Guidance Regarding ERISA Fidelity Bonding Requirements, Field Assistance Bulletin No. 2008-4, at 1 (Nov. 25, 2008) ( available at 2008 WL 5459779 and http://www.dol. gov/ebsa/regs/fab2008-4.html) (hereinafter, DOL Guidance Bulletin). "ERISA's bonding requirements are intended to protect employee benefit plans from risk of loss due to fraud or dishonesty on the part of persons who `handle' plan funds or other property." Id. The bond required by Section 412 of ERISA is "sometimes referred to as an ERISA fidelity bond." Id. at 2. The Travelers bond at issue here was sold to Schupak as an "ERISA Compliance Bond."
ERISA's bonding regulations incorporate the bonding requirements of ERISA's predecessor statute, the Welfare and Pension Plans Disclosure Act, 29 U.S.C. § 301 et seq., (the WPPDA). See 29 C.F.R. § 2550.412-1. The regulations provide that "[e]very administrator, officer and employee of * * * any employee pension benefit plan subject to [the WPPDA] who handles funds or other property of such plan shall be bonded as herein provided." Id. § 2580.412-1. The regulations further provide: "Such bond shall provide protection to the plan against loss by reason of acts of fraud or dishonesty on the part of such administrator, officer, or employee, directly or through connivance with others." Id.
As noted, "[e]very administrator, officer and employee" of an ERISA plan who handles plan funds must be bonded. Id. The terms "administrator," "officer" and "employee" are broadly defined in ERISA's bonding regulations. The regulations state:
For purposes of the bonding provisions, the terms "administrator, officer, or employee" shall include any persons performing functions of the plan normally performed by administrators, officers, or employees of a plan. As such, the terms shall include persons indirectly employed, or otherwise delegated, to perform such work for the plan, such as pension consultants and planners, and attorneys who perform "handling" functions * * *.
Id. § 2580.412-3(d).
Investment advisors who handle plan funds are included in this class of persons who must be bonded. As the Department of Labor has explained, "[e]very person who ` handles funds or other property' of an employee benefit plan * * * is required to be bonded unless covered under one of the exemptions in section 412 * * *." DOL Guidance Bulletin at 3 (italics omitted). "Therefore, a service provider, such as a third-party administrator or investment advisor, will be subject to bonding under section 412 * * * if that service provider handles funds or other property of an employee benefit plan." Id. at 4. See also id. ("Fiduciaries must be bonded * * * if they `handle' funds or other property of an employee benefit plan and do not fall within one of the exemptions in section 412 or the regulations.").
Schupak's ERISA Compliance Bond
In 2003, Schupak, as the sponsor for an ERISA plan, purchased an ERISA Compliance Bond from Travelers. Incorporating ERISA regulations and terminology, the Bond requires Travelers to cover the loss of "`funds and other property' as this phrase is used in Title 29 Code of Federal Regulations Section 2580.412-4" resulting from "dishonest or fraudulent acts committed by an `employee.'" Bond §§ A, C.
Section 2580.412-4 is one of the ERISA regulations governing compliance bonds.
The Bond defines an "employee" as "any natural person" who is
A trustee, an officer, employee, administrator or a manager, except an administrator or a manager who is an independent contractor, of any Employee Welfare or Pension Benefit Plan (hereinafter called Insured Plan) covered under this Policy.
Id. § C.
The Bond does not define the terms in the phrase "[a] trustee, an officer, employee, administrator or a manager," but ERISA's bonding regulations define some of those terms — "administrator," "officer" and "employee." See 29 C.F.R. § 2580.412-3(a)-(d). The Bond is a "blanket bond" within the meaning of ERISA's regulations. Blanket bonds "[c]over all the insured's officers and employees with no schedule or list of those covered being necessary and with all new officers and employees bonded automatically * * *." Id. § 2580.412-10(d).
Bernard Madoff's Fraud
Bernard L. Madoff operated one of the largest Ponzi schemes in history; some $170 billion flowed through his fraudulent scheme. By the time of his arrest in 2008, Madoff was representing to nearly 5,000 clients that he held a total of nearly $65 billion in investments on their behalf that he did not in reality have. The total actual loss to clients was more than $13 billion.
United States v. Madoff, S.D.N.Y. No. 09-cr-213, Sentencing Hrg. Tr. 43 (June 29, 2009), available at http://www.justice.gov/ usao/nys/madoff/20090629sentencingtranscriptcorrected.pdf.
See Madoff, Government's Sentencing Memorandum at 2, (June 26, 2009) (Doc. 92) (citing Presentence Investigation Report (PSI)).
See Madoff, Sentencing Hrg. Tr. 43 (citing PSI).
Among the entities doing business with Madoff were more than 100 retirement or pension plans. One aspect of Madoffs scheme was that clients who did not have large sums of money to invest often pooled their resources in "feeder funds" managed by third parties, who then, in accordance with the clients' expectations, put the funds in Madoff's control for investment.
See List of Customers, Ex. A to Affidavit, Secs. Investor Prot. Corp. v. Bernard L. Madoff Inv. Secs. LLC, No. 08-01789-BRL (S.D.N.Y. Bankr. Feb. 3, 2009) (Doc. 76); see also Madoff, Plea Hrg. Tr. 30-32 (Mar. 12, 2009), available at http://www. justice.gov/usao/nys/madoff/madoffhearing031209.pdf; Wall Street Journal, Madoff's Victims (Mar. 6, 2009), http://s.wsj.net/ public/resources/documents/st_madoff_victims_20081215.html.
See James Bandler Nicholas Varchaver, How Bernie Did It, CNNMoney (Apr. 30, 2009), http://money.cnn.com/2009/04/24/ news/newsmakers/madoff.fortune/index.htm.
Schupak entrusted funds in its Group Defined Benefit Plan (the Plan) to Madoff and suffered a loss of more than $1.2 million due to Madoff's fraud. Compl. ¶ 1. Beginning in 2003, Schupak through the Plan invested funds as a limited partner in FGLS, LLC, at Madoff's recommendation, and Madoff managed the funds as trustee and investment manager for Schupak. Id. ¶ 9. FGLS unconditionally entrusted the funds to Madoff, who had full trading discretion over the accounts. Id. ¶ 10. After December 11, 2008, Schupak suffered a loss of $1,260,725 in funds invested in FGLS as a result of Madoffs fraud. Id. ¶ 15.
This case comes to this Court on a motion to dismiss. The factual allegations in Schupak's complaint therefore must be accepted as true. See Hemi Grp., LLC v. City of New York, New York, 130 S. Ct. 983, 986-987 (2010).
"On December 11, 2008, news broke that Madoff had been operating a multi-billion dollar Ponzi scheme for nearly twenty years. Madoff pleaded guilty to securities fraud and related offenses on March 12, 2009, and was subsequently sentenced to 150 years in prison." In re Beacon Assocs. Litig., 745 F. Supp. 2d 386, 394 (S.D.N.Y. 2010).
Travelers' Denial of Coverage Under the Bond
In January 2009, Schupak filed a claim under the Bond by submitting a Proof of Loss form to Travelers along with documents supporting the amount of the loss. Schupak informed Travelers that "[f]rom April 2003, the Schupak Group Defined Benefit Plan invested funds as a limited partner in FGLS, LLC, which in turn entrusted the funds to Bernard Madoff as custodian and investment [t]rustee." Proof of Loss at 1.
Travelers initially responded that "there is a question as to if Mr. Bernard Madoff is considered an `Employee' under the bond." Letter from Thomas Bowes of Travelers to Donald Schupak (Feb. 26, 2009). Travelers suggested that Madoff was an excluded independent contractor under the Bond's definition of "employee." Donald Schupak, the CEO of Schupak Group and the Plan Administrator, replied to Travelers' letter. See Letter from Donald Schupak to Thomas Bowes (Apr. 2, 2009). He pointed out that, in the Bond's definition of "employee," the independent contractor exception applies to "an administrator or a manager who is an independent contractor" but does not apply to a "trustee." Bond ¶ C (emphasis added). Nor does the independent contractor exception apply to an "officer [or] employee." Id.
After a further exchange of correspondence, Travelers denied Schupak's claim. Travelers based its denial of coverage on the ground that Schupak had failed to provide
documentation to support your position that Bernard L. Madoff was an Employee as defined in the Bond, including, but not limited to, any documentation appointing Bernard L. Madoff as a trustee of the Insured Plan or appointing him an investment manager to manage some or all of the assets of the Insured Plan other than a manager who is an independent contractor.
Letter from Thomas Bowes to Donald Schupak (Apr. 29, 2009).
The Decisions Below
Schupak filed suit against Travelers and alleged that "Travelers has wrongfully denied Schupak's timely and complete Proof of Loss and refused to pay Schupak's claim in violation of the terms of the bond." Compl. ¶ 3. Schupak's complaint sought "a declaration that Travelers must pay Schupak's loss under the terms of the bond." Id. ¶ 39.
The district court dismissed Schupak's complaint for failure to state a claim. App. 7a. The court gave two reasons — both of which Schupak challenged on appeal, and neither of which the Second Circuit saw fit to rely upon for its decision. First, the district court ruled that Schupak "failed to plead any facts demonstrating that its Proof of Loss included the required notarized signature." App. 18a. Second the court ruled that Schupak's "claim is insufficient to demonstrate a plausible inference of Schupak's adequate cooperation under the terms of the Bond." App. 19a. The district court also ruled that "any attempt by [Schupak] to replead would be futile." App. 18a.
But see Letter from Thomas Bowes of Travelers to Donald Schupak (Feb. 26, 2009) ("We acknowledge receipt of the completed Proof of Loss received via facsimile on January 29, 2009. We will now commence our investigation and loss verification into this claim.") (emphasis added); see also Binder v. Commercial Travelers Mut. Accident Ass'n of Am., 165 F.2d 896, 900-901 (2d Cir. 1948) ("[T]he defendant received, accepted, and retained the proof of loss, thereby admitting its sufficiency in form.").
But see Compl. ¶ 27 (alleging that "Schupak further offered to cooperate all along with the Travelers' investigation including permitting access to the Schupak premises to review records, if need be.").
The Second Circuit affirmed, but for reasons entirely different, but no more persuasive, than the district court's reasons. First, the Second Circuit stated that "Schupak's complaint, read liberally, contains no factual allegations giving rise to a reasonable inference that Madoff was a `trustee' for purposes of the Bond." App. 5a. The court added that "the complaint is utterly conclusory with respect to Madoff's status under the Bond." App. 5a (citing Compl. ¶ 19). Second, the Second Circuit stated that "the complaint asserts, on its face, that funds in question were placed in Madoff's control after passing through a third party intermediary, FGLS, LLC, see [Compl.] ¶¶ 9-10, thereby negating the plausibility of any assertion that Madoff was affiliated with the ERISA plan whose assets the Bond insured." App. 5a. The Second Circuit cited no authority for this proposition.
REASONS FOR GRANTING THE WRIT
I. Appellate Courts Have Taken Divergent — and Flawed — Approaches in Analyzing Whether an ERISA Compliance Bond Covers Investment Advisors Such as Bernard Madoff.
Three appellate courts, including the court below in this case, have addressed and decided the question whether an ERISA plan's investment advisor, such as Bernard Madoff, is covered by a standard form ERISA compliance bond. These appellate rulings are striking in that each court took a different — and flawed — approach in analyzing that question. These appellate cases demonstrate that lower courts require guidance on the proper approach to interpreting ERISA compliance bonds in light of ERISA's bonding requirements and on the question whether investment advisors who handle plan funds are covered persons under standard language used in such bonds.
Rosenbaum
The leading case is the Ninth Circuit's decision in Joseph Rosenbaum, M.D., Inc. Defined Benefit Pension Plan v. Hartford Fire Insurance Co., 104 F.3d 258 (9th Cir. 1996). The ERISA compliance bond in Rosenbaum and the Travelers bond at issue here use the exact same operative language, and the facts of the two cases are very similar. Dr. Rosenbaum, the administrator of a pension plan, "caused some hundreds of thousands of dollars of plan money to be invested in second mortgages in California residential real estate." Id. at 260. The money was managed by one Stanley Glickman and invested through a company called Property Mortgage Company, Inc. Id.
Property Mortgage Company failed, causing the pension plan to suffer a significant financial loss. Dr. Rosenbaum alleged that Glickman — much like Madoff — "looted the cash accounts and ran a Ponzi scheme" by "paying off old investors with new investors' money." Id. The Ninth Circuit assumed on appeal that "Dr. Rosenbaum's ERISA plan lost money because of Mr. Glickman's dishonesty." Id.
The pension plan had an ERISA "employee dishonesty bond" issued by Hartford. Id. Dr. Rosenbaum contended that "Mr. Glickman is a person whose dishonesty was covered by the bond." Id. Just like the Travelers bond obtained by Schupak, the Hartford bond covered an "employee" and defined that term to include "[a] trustee, an officer, employee, administrator or a manager, except an administrator or a manager who is an independent contractor." Id. at 261. Dr. Rosenbaum argued that Glickman was a "trustee" and thus was covered by the bond's definition of "employee." Id.
The Ninth Circuit first asked "whether Mr. Glickman was a fiduciary," and held that "Dr. Rosenbaum established a genuine issue of fact as to whether Mr. Glickman was a fiduciary." Id. The Ninth Circuit explained that "`[f]iduciary' is defined functionally in ERISA, see 29 U.S.C. § 1002(21)(A), and includes those who render investment advice for a fee under certain circumstances." Id.
Although Dr. Rosenbaum had sufficiently established that Glickman was a fiduciary, the Ninth Circuit nevertheless held that Glickman was not a "trustee" for purposes of the bond. The court noted that "Dr. Rosenbaum's plan expressly designates the trustees: his wife and himself" and that "Mr. Glickman was not designated at any time as a trustee for Dr. Rosenbaum's plan." Id. at 262.
The court also stated that "[a]ll trustees are fiduciaries, but not all fiduciaries are trustees." Id. (citation omitted). The Ninth Circuit therefore concluded that "[t]he Hartford bond did not cover Mr. Glickman." Id. at 264. The Rosenbaum court correctly held that an ERISA plan investment advisor such as Glickman is a plan fiduciary. But the Ninth Circuit erred in holding that Glickman was not a "trustee" for purposes of the ERISA compliance bond at issue in that case. The very purpose of such a bond is to provide insurance against fraud by plan fiduciaries who handle plan funds. See DOL Guidance Bulletin at 2 ("The fidelity bond required under section 412 of ERISA specifically insures a plan against losses due to fraud or dishonesty (e.g., theft) on the part of persons (including, but not limited to, plan fiduciaries) who handle plan funds or other property."). Having found that Glickman was a plan fiduciary who directed the investment of plan funds, the Ninth Circuit should have concluded that he was also a trustee for purposes of the bond. See Black's Law Dictionary (9th ed. 2009) (defining "trustee" as "One who stands in a fiduciary or confidential relation to another; esp., one who, having legal title to property, holds it in trust for the benefit of another and owes a fiduciary duty to that beneficiary.") (viewed on Westlaw Next).
Although Travelers relied heavily upon Rosenbaum in the brief it submitted to the Second Circuit, see Travelers C.A. Br. 6, 24-27, and apprised the court that Rosenbaum is "virtually identical" to this case, id. at 26, the Second Circuit declined to follow Rosenbaum and indeed made no mention of that case in its opinion.
Travelers argued below that, under Rosenbaum, Madoff was not a trustee because, like Glickman, he was not designated in plan documents as a trustee. See id. But the Second Circuit declined to adopt Travelers' Rosenbaum argument, and for good reason: It is flat-out wrong.
Under ERISA, a plan fiduciary can be a trustee without being specifically designated as such in plan documents. ERISA requires every employee benefit plan to designate "one or more named fiduciaries" in a written instrument. 29 U.S.C. § 1102(a)(1). ERISA also states that "one or more trustees * * * shall be either named in the trust instrument or plan instrument described in section 1102(a) of this title or appointed by a person who is a named fiduciary." 29 U.S.C. § 1103(a) (emphasis added). See also 29 C.F.R. § 2550.403a-1(c).
Here, Schupak's complaint alleges that Madoff was appointed as a trustee to handle plan funds. See Compl. ¶ 1 ("Schupak entrusted funds in its Group Defined Benefit Plan for Schupak Group, Inc. to Madoff"); id. ¶ 9 (Schupak "had Madoff manage the funds as a trustee and investment manager for Schupak"); id. ¶ 14 ("The reference to `trustee' [in the Bond] does not limit coverage to only trustees specifically named under the Plan"). The Proof of Loss form that Schupak submitted to Travelers (and attached to the complaint) states that "Bernard L. Madoff [was] delegated by the Plan Trustee as Custodian and Investment Trustee." Proof of Loss at
1. See also Schupak C.A. Br. 23 ("Madoff was appointed as a trustee by a named fiduciary of the Schupak Plans, Donald Schupak.").
In sum, the Ninth Circuit in Rosenbaum was correct that an investment advisor who handles plan funds, such as Glickman in that case or Madoff in this one, is a plan fiduciary. But the Rosenbaum court erred in holding that Glickman was not a trustee covered by the ERISA dishonesty bond in that case. Although Glickman was not expressly designated as a trustee in plan documents, he could have been appointed as a trustee.
Local 516
The Court of Appeals of Oregon has also faced the question presented here. See Employers-Shopmens Local 516 Pension Trust v. Travelers Cas. Surety Co. of Am., 235 P.3d 689 (Or. App. 2010), rev. denied, 249 P.3d 542 (Or. Feb 17, 2011) (Table).
In Local 516, the two plaintiff ERISA plans "had agreements with Capital Consultants, LLC (CCL) to receive investment management services," and "both agreements authorized CCL to manage plaintiffs' designated funds." 235 P.3d at 692. Each plan filed a Proof of Loss with its insurers, Travelers and Hartford, claiming that the plans suffered losses caused by CCL's principals. Id. Each plan had an ERISA compliance bond just like the one at issue here, in that the bonds covered an "employee" defined as "[a] trustee, an officer, employee, administrator or a manager, except an administrator or a manager who is an independent contractor." Id. (quoting the bond). And, as here, "[t]he terms used in that definition of `employee' ( i.e., trustee, officer, employee, administrator, manager) [were] not specifically defined in the" bonds. Id. (court's italics).
Unlike the Ninth Circuit in Rosenbaum and the Second Circuit in this case, the Oregon Court of Appeals recognized that those italicized terms should be construed in light of ERISA's bonding regulations and the "purposes of ERISA's bonding requirement." Id. at 696. The court reasoned that "the text of the [bond] strongly suggests an intention that, at the very least, the pertinent provision in the ERISA regulatory scheme provide context for understanding the meaning of those terms." Id. And the court noted that the title of the bond was "Welfare and Pension Plan ERISA Compliance." Id. (court's emphasis). The court thus found it "clear that the definition of `employee' was informed, at least in part, by the ERISA regulatory scheme concerning the bonding of those who handle plan funds and property." Id. Accordingly, the court "turn[ed] to the ERISA regulatory scheme to assist in interpreting the meanings of employee, officer, and administrator in the policy." Id. (court's italics).
The Oregon Court of Appeals held that the plans' investment advisors at CCL were not covered by the bonds. After perusing the various definitions in ERISA regulations, see id. at 696-697, the court held that CCL's principals were "administrators for purposes of ERISA's bonding requirements." Id. at 697. The court stated:
CCL's principals "perform[ed] functions for the plan[s] normally performed by administrators" — that is, management of the plans' funds. 29 C.F.R. § 2580.412-3(d). Accordingly, for purposes of ERISA's bonding requirements, CCL's principals are properly considered administrators under the terms of 29 C.F.R. section 2580.412-3(d).
Id.
Having found that CCL's principals were "administrators," the court held that they were subject to the independent contractor exception applicable to administrators. See id.
The Oregon Court of Appeals' analysis in Local 516 varies significantly from that of the Ninth Circuit in Rosenbaum and the Second Circuit in this case. The Local 516 court recognized that the interpretation of an ERISA compliance bond should be "informed by the ERISA bonding scheme generally and the pertinent [ERISA regulatory] definitions of `administrator,' `officer,' and employee,' specifically." Id. at 698.
Cf. Cent. States, S.E. S.W. Areas Pension Fund v. Cent. Transp., Inc., 472 U.S. 559, 568 (1985) ("We agree * * * that trust documents must generally be construed in light of ERISA's policies").
Yet the court's analysis was incomplete. Although the court considered whether the CCL principals were "employees, officers, [or] administrators" under ERISA regulations, the court failed to consider whether they were "trustees" for purposes of the bond — even though it recognized that the bond "clearly provides coverage" for "the named insured's trustees" "to the extent that they are handling the plan's funds." Id. at 698 n. 11.
The Second Circuit's Decision
The Second Circuit gave short shrift to Schupak's claim that Bernard Madoff was a covered person under the Bond. The court decided this case against Schupak for two reasons, neither of which were the district court's reasons for dismissing the complaint.
First, the Second Circuit said that
Schupak's complaint, read liberally, contains no factual allegations giving rise to a reasonable inference that Madoff was a `trustee' for purposes of the Bond. Indeed, the complaint is utterly conclusory with respect to Madoff's status under the Bond. See Compl. ¶ 19.
App. 5a. But the complaint quite clearly does allege that Madoff had the status of a trustee under the Bond:
• Paragraph 1 of the complaint alleges that "Schupak entrusted funds in its Group Defined Benefit Plan for Schupak Group, Inc. to Madoff."
• Paragraph 2 alleges that "Madoff had complete control" over these funds and that "Madoff acted as a trustee with regard to" Schupak's plan.
• Paragraph 9 alleges that "Madoff manage[d] the funds [invested in FGLS, LLC] as trustee and investment manager for Schupak."
• Paragraph 10 alleges that "Madoff had full trading discretion over the accounts."
• And Paragraph 32 alleges that "Madoff had full control of the Schupak funds and had complete unfettered discretion as trustee for the Schupak Plans."
The lone paragraph cited by the Second Circuit in support of its characterization of the complaint as "conclusory," Paragraph 19, alleges that "Madoff was such a `trustee' covered by the bond." That allegation may or may not be conclusory if read in isolation, but it was hardly the only allegation in the complaint regarding Madoff's status under the Bond.
The Second Circuit's second reason for affirming the judgment below was the following:
Moreover, the complaint asserts, on its face, that funds in question were placed in Madoff's control after passing through a third party intermediary, FGLS, LLC, see [Compl.] ¶¶ 9-10, thereby negating the plausibility of any assertion that Madoff was affiliated with the ERISA plan whose assets the Bond insured.
App. 5a. This is simply ipse dixit. The Second Circuit did not explain why the fact that funds were controlled by Madoff through FGLS "negat[ed] the plausibility that * * * that Madoff was affiliated" with the plan. Nor did it explain why, if so, this meant Madoff could not be a covered person for purposes of the Bond. And the Second Circuit cited no authority whatsoever for this proposition.
The Second Circuit's reasoning in this regard is in clear tension with Rosenbaum. In Rosenbaum, the plan funds at issue passed through a third party entity. See Rosenbaum, 104 F.3d at 260 ("[T]he money was invested through Property Mortgage, Inc., managed by a man named Stanley Glickman"). Yet the Ninth Circuit did not remotely suggest that this was a basis for denying coverage under the bond at issue there.
Furthermore, the Department of Labor has given guidance in tension with the Second Circuit's reasoning. DOL has advised that an investment advisor is a fiduciary, and must be bonded, even if the plan's funds are held by a third party institution.
As DOL explained:
[E]ven though funds and other property of the plan are in the custody of a bank, the investment advisor has discretionary authority with respect to plan investments and is deemed to be "handling" plan funds. Therefore, an investment advisor is required to be bonded.
Letter from Alan D. Lebowitz, Assistant Adm'r for Fiduciary Standards, Pension and Welfare Benefit Programs, U.S. Dep't of Labor to Michael Tagtow (May 13, 1983) ( available at 1983 WL 400632).
The Second Circuit erred in this case: Bernard Madoff is a covered person, a "trustee," under the ERISA Compliance Bond sold by Travelers. As the Oregon Court of Appeals recognized, the Bond's language should be interpreted in light of the "purpose[] of ERISA's bonding requirement." Local 516, 235 P.3d at 696. That purpose is to "insure[] a plan against losses due to fraud or dishonesty (e.g., theft) on the part of persons (including, but not limited to, plan fiduciaries) who handle plan funds or other property." DOL Guidance Bulletin at 2. There can be no doubt that Schupak has alleged that Madoff, who "had full control of the Schupak funds and had complete unfettered [investment] discretion," Compl. ¶ 32, was such a person. See Rosenbaum, 104 F.3d at 261; 29 U.S.C. § 1002(21)(A).
Section 1002(21)(A) provides in part that, with certain exceptions, "a person is a fiduciary with respect to a plan to the extent * * * (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so."
Schupak has alleged that Madoff was entrusted with the authority to handle and invest plan funds, see Compl. ¶ 1, and hence was a "trustee" for purposes of the Bond. See Black's Law Dictionary (9th ed. 2009) (defining "trustee" as "One who stands in a fiduciary or confidential relation to another; esp., one who, having legal title to property, holds it in trust for the benefit of another and owes a fiduciary duty to that beneficiary."); Restatement (Second) of Trusts § 3(3) (1959) ("The person holding property in trust is the trustee."); Merriam-Webster Online Dictionary (defining "trustee" as "one to whom something is entrusted" and "a natural or legal person to whom property is legally committed to be administered for the benefit of a beneficiary") (http://www.merriam-webster.com); see also Taylor v. Mayo, 110 U.S. 330, 335 (1884) ("A trustee may be defined generally as a person in whom some estate interest or power in or affecting property is vested for the benefit of another."); Greenough v. Tax Assessors of City of Newport, 331 U.S. 486, 494 n. 19 (1947) (same). Madoff did not have to be designated by name as a trustee in plan documents; he could be, and was, appointed as a trustee by a named fiduciary of the plan. See 29 U.S.C. § 1103(a); 29 C.F.R. § 2550.403a-1(c).
Cf. Cumberland Packing Corp. v. Chubb Ins. Corp., 29 Misc.3d 1208(A), 2010 N.Y. Slip Op. 51754(U), at *5 (N.Y. Sup. Ct. Oct. 8, 2010) ("Madoff was an Employee under the [insurance] Policy because of the definition of Employee under clause (3) of the Employee definition due to his status as a `natural person fiduciary, trustee, administrator or Employee' of Cumberland Pension").
Not only is Madoff a "trustee" for purposes of the Bond, he is also a covered "officer, employee, [or] administrator." Bond § C. Under the ERISA bonding regulations, "[e]very person who ` handles funds or other property' of an employee benefit plan within the meaning of 29 C.F.R. § 2580.412-6 (i.e., a plan official) is required to be bonded" unless an exemption applies. DOL Guidance Bulletin at 3 (DOL's italics). Section 2580.412-6 provides:
A plan administrator, officer, or employee shall be deemed to be "handling" funds or other property of a plan, so as to require bonding * * *, whenever his duties or activities with respect to given funds or other property are such that there is a risk that such funds or other property could be lost in the event of fraud or dishonesty on the part of such person, acting either alone or in collusion with others.
See also DOL Guidance Bulletin at 4 (bonding requirement reaches "persons, such as service providers, whose duties and functions involve access to plan funds or decision-making authority that can give rise to a risk of loss through fraud or dishonesty"). Madoff clearly engaged in the "handling" of plan funds under section 2580.412-6.
Furthermore, 29 C.F.R. § 2580.412-3(d) provides that
For purposes of the bonding provisions, the terms "administrator, officer, or employee" shall include * * * persons indirectly employed, or otherwise delegated, to perform [ plan functions], such as pension consultants and planners, and attorneys who perform `handling' functions within the meaning of § 2580.412-6.
Accordingly, because Schupak has alleged that Madoff handled plan funds — and caused plan funds to be lost through his fraud — the Complaint adequately pleads that Madoff was an "administrator, officer, or employee" under the ERISA regulations. That fact should inform the construction of the phrase "officer, employee, [or] administrator" in the Bond. Bond § C. See Local 516, 235 P.3d at 696.
To the extent that there is any ambiguity in the Bond, it should be construed against Travelers, the party that drafted the Bond. See, e.g., Billings v. UNUM Life Ins. Co. of Am., 459 F.3d 1088, 1095 (11th Cir. 2006) ("It is well-established in this circuit, and among our sister circuits, that once we conclude an ERISA-governed plan is ambiguous, we apply the doctrine of contra proferentem to resolve the ambiguities in the insurance contract."); Kunin v. Benefit Trust Life Ins. Co., 910 F.2d 534, 538-539 (9th Cir. 1990); Schupak C.A. Reply Br. 14-15.
II. This Case Presents an Important and Recurring Question Affecting Thousands of ERISA Plans, Including Those Plans Victimized by Bernard Madoff.
ERISA and its implementing regulations generally require every fiduciary of an employee benefit plan, and every person who handles plan funds, to be bonded. See 29 U.S.C. § 1112(a); 29 C.F.R. § 2580.412-1; DOL Guidance Bulletin at 1. This bonding requirement applies to thousands of ERISA plans in the United States.
The question presented in this case is whether an investment advisor who handles plan funds — here, Bernard Madoff — is covered by a standard form ERISA compliance bond. This is an important and recurring question. The Bond that Travelers sold to Schupak provides coverage for losses due to the fraud or dishonesty of an "employee," a term broadly defined to include "[a] trustee, an officer, employee, administrator or a manager." Bond § C. The bonds at issue in both Rosenbaum and Local 516 used identical language. A law review article co-authored by insurance lawyers and a St. Paul Travelers representative has described a similar definition of "employee" as "representative" of ERISA bonds. Patrick J. O'Connor et al., ERISA Bond Claims Over Employer Stock Losses: The Landscape in a Post-Enron World, 10 Fidelity L.J. 19, 56 (2004).
Investment advisors generally must be bonded if they handle plan funds. See 29 C.F.R. § 2580.412-3(d); DOL Guidance Bulletin at 4. Yet three appellate courts — the Second Circuit in this case, the Ninth Circuit in Rosenbaum, and the Oregon Court of Appeals in Local 516 — have now held that standard form ERISA compliance bonds do not cover investment advisors such as Madoff. If these courts are wrong, then ERISA plans and their beneficiaries are wrongly being denied coverage for significant losses caused by the fraud and dishonesty of persons such as Madoff. And even if these courts are correct, that means insurance companies are selling "ERISA Compliance Bonds" that do not, in fact, bring a plan into compliance with ERISA's bonding requirements, because the bonds do not cover investment advisors, such as Madoff, who must be bonded. Either way, this Court should grant certiorari in this case to clarify whether a standard form ERISA compliance bond covers a person such as Bernard Madoff that ERISA requires to be bonded.
CONCLUSION
For the foregoing reasons, the petition for a writ of certiorari should be granted.