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Mimicking many of their colleagues, Jingdon Zhu and Adrian Fields, two former Schering-Plough Corp. employees, decided to invest their 401(k) savings in company stock in 2001. But they knew nothing about the financial problems that led to a $138 million drop in the value of the New Jersey drug manufacturer's stock only a year later.

When Schering's stock took this dramatic drop, more than 60 percent of the company's employees had invested in the company. Schering stock constituted 61 percent of the 401(k) plan's assets. Many employees lost their entire retirement savings as a result.

In October 2003 Zhu and Fields became the lead plaintiffs in an Employment Retirement Income Security Act (ERISA) class action on behalf of 11,000 current and former plan participants. They alleged that Schering breached its fiduciary duties mandated under ERISA by offering company stock to plan participants when it knew the price was inflated.

But Schering fought back with an argument that has split 40 district courts in a host of ERISA cases. The company maintained that the individual plaintiffs--as opposed to the plan--had no standing to bring a claim based on Section 409(a) of ERISA, which provides for recovery of losses to the plan caused by a fiduciary breach.

The 3rd Circuit Court of Appeals disagreed in August 2004, finding that the plan participants could sue the company and sending the case back for a trial on the merits. The decision, the first federal appeal courts judgment on the standing issue, could affect almost 100 similar lawsuits. And companies now face a new source of liability for missteps that lead to a drop in stock price.

"The persuasive value of this decision will have national repercussions," says Joseph Meltzer a partner at Schiffrin & Barroway, who represented the plaintiffs.

What's Mine Is Ours

Although the standing issue is controversial, Schering had good reason to be hopeful as it commenced the case in the appeals court.

Schering won the first round in 2004, when U.S. District Judge Katharine Hayden ruled that the plaintiffs' contributions were not aggregated assets of the plan, and that their claims covered only their individualized losses. Because Section 409(a) applies only to losses to a retirement plan, Hayden dismissed the claims.

But a unanimous appeals court overturned Hayden's ruling, concluding that it "directly conflicts with the express terms of the saving plan," which made it clear that losses sustained in individual accounts were plan losses.

Senior U.S. District Judge Arthur Alarc?? 1/2 n's decision gives some guidance as to whether an individual employee's losses will qualify as losses to the plan for purposes of an ERISA suit.

"Contrary to the District Court's interpretation of the provisions of the Savings Plan, each participant's deferred payroll compensation was held in trust as the assets of the Savings Plan," he wrote. "Each participant in the Savings Plan was provided with an individualized account and periodically informed of the individual balance in his or her account. The Savings Plan also makes clear the fact that each participant has an individual account does not require any segregation of the funds of the Plan."

Foremost in the court's mind, it appears, were the public policy issues the U.S. Department of Labor (DOL) highlighted in its brief supporting the plaintiffs. DOL attorney Theresa Gee noted that American employees held $2 trillion worth of all private pension plan assets in individual account plans.

"If the District Court and the defendants' broad arguments are correct," Gee wrote, "participants in 401(k) plans and other individual account plans, such as the Enron plans, would be unable to recover losses to the plan caused by fiduciary breaches, even if the majority of the plan's participants lost most of their retirement savings as a direct result of such breaches."

But the case is far from over.

Supreme Intervention

"We are disappointed about the decision and exploring our options," said Rosemary Yancosek, Schering's executive director of global communications. "However, we continue to believe that the case has no merit and we will continue to vigorously defend ourselves."

Schering could seek an en banc review, but the absence of a dissenting judgment makes that unlikely. The company also could apply for certiorari in the Supreme Court. Its chances of success there may depend on the decision of the 5th Circuit in Milovsky v. American Airlines.

In Milovsky, the 5th Circuit held that employees could not sue under ERISA to recover losses when the company's stock crashes. The 5th Circuit has decided to revisit the case en banc. However, the hearing on that case is on hold due to Hurricane Katrina, which has forced the 5th Circuit to move to Houston.

"If the 5th reverses itself so that its ruling corresponds with Schering, I would expect that the Supreme Court will allow the issue to percolate in the circuits," says Matthew Renaud, a partner at Jenner & Block who represent various ERISA defendants. "But if the 5th stands firm, the split in opinion makes a great issue for the Supreme Court."

The prospect of further appellate proceedings, however, has not detracted from Schering's immediate impact. Just three days after the 3rd Circuit released its ruling in Schering, U.S. District Court Judge John Bissell approved a $90 million ERISA settlement for employees of Royal Dutch Shell In Re Royal Dutch/Shell Transport ERISA Litigation. The employees had alleged that Shell breached its fiduciary duty by overstating its oil reserves, causing its stock to fall.

"Shell is the second highest ERISA settlement, second only to the $100 million settlement in the Enron litigation," says Ron Kilgard a partner at Keller Rohrback, who is lead plaintiffs' counsel against Enron and in some 20 other cases, including suits against WorldCom and Global Crossing. "Overall, outstanding ERISA suits have billions of dollars at stake."

Kilgard has no sympathy for the companies that argue that no good deed goes unpunished. "What plan sponsors like to say is that we went to the trouble of offering a plan for the benefit of our employees and what we get in return is a lawsuit," he says. "But offering company stock to employees is not a good deed, and if you're going to have such a plan, lawyers like me will always be around looking for things going wrong--and I'm not feeling guilty about it."

Especially after Schering.

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Julius Melnitzer

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