ERISA Service Provider Litigation Health Benefits and the War

ERISA Service Provider Litigation: Health Benefits and the War Against PBMs ABA Joint Committee on Employee Benefits 19th Annual Institute on ERISA Litigation November 7, 2008 Chicago, IL Deborah S. Davidson John R. Richards Morgan, Lewis & Bockius LLP 77 West Wacker Chicago, IL 60601-5094 Telephone: 312.324.1000 Facsimile: 312.324.1001 ddavidson@morganlewis.com jrrichards@morganlewis.com www.morganlewis.com I. II. Service Providers For Health Plans ..............................................................................2 Fiduciary Status And Duties Under ERISA.................................................................4 A. B. C. Fiduciary Provisions ...........................................................................................4 Prohibited Transaction Provisions....................................................................5 DOL Guidance Concerning The Selection And Monitoring Of Service Providers..............................................................................................................7 III. DOL’s Proposed Expansion Of Disclosure Requirements As To Service Providers Receiving Any Compensation From Third Parties For Their Services To Benefit Plans ..............................................................................................................8 Recent Lawsuits Involving PBMs................................................................................12 Key Issues In The PBM Cases .....................................................................................13 A. B. Fiduciary Status Of The PBM .........................................................................13 Standing And Class Certification Issues .........................................................15 1. Standing As A Distinct And Threshold Issue To Class Certification 18 IV. V. 2. Commonality And Typicality Issues Under Rule 23(a)(2) And (3) When The Fiduciary Status Of The Service Provider Varies With Each Contract And Cannot Be Established With Common Proof ........................17 VI. The Next Frontier: Increased Claims Against Plan Fiduciaries Relating To The Fees Of PBMs And Other Health Plan Service Providers? ......................................18 i ERISA Service Provider Litigation: Health Benefits and the War Against PBMs by Deborah S. Davidson and John R. Richards Morgan Lewis & Bockius LLP The fiduciary status of service providers who participate in the management and/or administration of ERISA plans is becoming a key issue in lawsuits challenging the compensation of service providers from third parties as they pertain to health benefit plans.1 Recent lawsuits in the health benefit context have targeted pharmacy benefits managers (“PBMs”), alleging breach of fiduciary duties in negotiating drug prices with retail pharmacies and manufacturers. In this context, plan participants and/or fiduciaries argue that PBMs failed to disclose the true nature and amount of compensation they received from retail pharmacies or drug manufacturers and then failed to pass on such discounts to the plan sponsor, thereby unnecessarily charging the plan, and its participants, higher costs. These lawsuits also charge that PBMs breached their fiduciary duties by choosing formulary drugs that were more expensive so they could pocket extra rebates that they received from drug manufacturers. While most of these lawsuits have asserted claims only against the PBMs, plan fiduciaries may also find themselves at increasing risk for claims by participants alleging – as in recent 401(k) lawsuits2 – that fiduciaries breached their duties by allowing plans to pay excessive compensation to PBMs as plan service providers. Proposed service provider disclosure regulations by the Department of Labor (“DOL”) make it more important than ever for plan fiduciaries and service providers to understand their areas of potential exposure. 1 Participants or beneficiaries commonly assert benefit claims under ERISA Section 502(a)(1)(B), 29 U.S.C. § 1132(a)(1)(B), against third-party service providers and insurers that act as plan administrators. While 502(a)(1)(B) case law sometimes addresses the fiduciary status of third-party administrators – compare Michigan Affiliated Healthcare v. CC Sys., 139 F.3d 546, 549 (6th Cir. 1998) (claims administrator not a fiduciary where it had no discretion or decision-making authority), with Aetna Life Ins. Co. v. Bayona, 223 F.3d 1030, 1033 (9th Cir. 2000) (insurer with responsibility to decide who would receive life insurance policy proceeds was fiduciary) – case law under Section 502(a)(1)(B) is covered elsewhere in this program. 401(k) fee litigation is addressed elsewhere in this program. 2 2 I. Service Providers For Health Plans. In the health plan context, common service providers include claims administrators and a variety of managed care providers. Managed care providers are able to negotiate cheaper benefits than participants in health plans would otherwise receive by contracting with specific providers of health care, dealing with large quantities of patients, and reducing costs by eliminating “unnecessary” treatments. In so doing, providers may offer different forms of health coverage on a self-insured or insured basis, e.g., a traditional open-access arrangement (allowing participants to obtain health coverage from any medical provider), a preferred provider organization (“PPO”) arrangement (encouraging participants to visit hospitals or doctors usually within a preferred network of providers), or a health maintenance organization (“HMO”) arrangement (requiring participants to see only doctors or hospitals within a network of providers). For an insured product, the service provider bears the risk of loss in return for a premium payment. With a self-insured product, the plan sponsor or plan trust bears the risk of loss and the provider merely performs administrative services. PBMs operate as the middlemen that are hired to design, manage, and administer prescription drug programs so as to lower overall costs. Plan sponsors contract with PBMs because PBMs have significant market power: their ability to pool large numbers of health benefit providers enables them to negotiate concessions from drug manufacturers. PBMs enter into service contracts and arrangements with plan sponsors under which they provide various services, e.g., prescription drug benefit services, access to a restricted retail pharmacy network providing favorable prescription drug pricing, mail and specialty drug pharmacy programs, additional benefits offered to plan participants by some or all of the pharmacies in the retail network (such as discounts on non-prescription medical products), and clinical and disease management services. See In re EXPRESS SCRIPTS, INC., PBM Litig., Master Case No., 4:05-MD-01672 SNL, 2008 WL 2952787, at *3 (E.D. Mo. July 30, 2008). In some contracts, PBMs will also agree to limited appeals procedure services where a participant is seeking review of a denied drug claim. See February 11, 2008 Comment Letter on Proposed Regulations: Reasonable Contract or Arrangement Under Section 408(b)(2) – Fee Disclosure from the Pharmaceutical Care Management Association (“PCMA”) to the DOL, available at http://www.dol.gov/ebsa/regs/cmt-408(b)(2)-combined.html. With respect to compensation, retail pharmacies offer PBMs reduced prices and dispensing fees in order to gain access to the PBMs’ vast clientele. PBMs profit on the difference between the amounts billed to the plans pursuant to the contract and the amounts the PBMs paid to the pharmacies. When PBMs operate as a retail pharmacy through mail orders, they make gains on the mark-up between the amount that they pay the drug manufacturer and the amount the plan contractually agrees to pay for that particular drug. See In re EXPRESS SCRIPTS, 2008 WL 2952787, at **1-7 (generally discussing compensation schemes for PBMs). PBMs also receive payments from drug manufacturers. Drug manufacturers pay PBMs administrative fees for the performance of certain services. Additionally, 3 manufacturers contract with PBMs to pay rebates according to various plans’ use of their drugs and to be listed as a “preferred” formulary drug in the plan. Then, plan sponsors often contract for a portion of the rebates that are owed and directly paid to the PBMs. See In re EXPRESS SCRIPTS, 2008 WL 2952787, at **1-7. II. Fiduciary Status And Duties Under ERISA. A. Fiduciary Provisions. Section 3(21)(A) of ERISA employs a functional definition of fiduciary status, providing that a person is a fiduciary with respect to a plan “to the extent” the person (i) exercises any discretionary authority or discretionary control respecting management of the plan or exercises any authority or control respecting management or disposition of its assets; (ii) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of the plan, or has any authority or responsibility to do so; or (iii) has discretionary authority or discretionary responsibility in the administration of the plan. 29 U.S.C. § 1002(21)(A). Section 404(a)(1) of ERISA provides in pertinent part: [A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and A. for the exclusive purpose of: (1) (2) B. providing benefits to participants and their beneficiaries; and defraying reasonable expenses of administering the plan; with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims; by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this title or Title IV. C. D. 29 U.S.C. § 1104(a)(1); see also 29 U.S.C. § 1103(c)(1) (plan assets may never inure to the benefit of the employer; fiduciary must discharge its duties with an eye towards defraying expenses of administering the plan). ERISA permits a named fiduciary to delegate fiduciary responsibilities to other persons. See 29 U.S.C. § 1105(c)(1); 29 C.F.R. § 2509.75-8, FR-12. If the named 4 fiduciary makes such a delegation, the named fiduciary will not be liable for any breaches of the delegatee unless the named fiduciary violates its fiduciary duties under Section 404(a)(1) of ERISA with respect to: (i) allocation or designation; (ii) establishment or implementation of the procedure for allocation or designation; or (iii) continuation of the allocation or designation. 29 U.S.C. § 1105(c)(2). Additionally, the named fiduciary remains subject to co-fiduciary liability. Id.; see also 29 U.S.C. § 1105(a). ERISA’s regulations provide that delegating fiduciary authority is itself a fiduciary function. 29 C.F.R. § 2509.75-8 at D-4. Further, an “appointing” fiduciary who delegates fiduciary functions to others has a duty to monitor the appointed fiduciaries. See 29 C.F.R. § 2509.75-8 at FR-17. The regulations also state that an appointing fiduciary properly exercises the duty to monitor when, at reasonable intervals, it reviews the performance of the appointee “in such a manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan.” Id. However, not all service providers perform fiduciary functions. ERISA permits a fiduciary to retain service providers to perform ministerial functions for the plan. 29 C.F.R. § 2509.75-8, FR-11; see also 29 C.F.R. § 2509.75-8, D-2 (listing examples of ministerial, non-fiduciary functions); Moeckel v. Caremark, Inc., No. 3:04-0633, 2007 WL 3377831, at *27 (M.D. Tenn. Nov. 13, 2007) (ministerial functions may include processing claims, applying plan eligibility rules, communicating with employees, and calculating benefits) (quotations omitted). B. Prohibited Transaction Provisions. ERISA defines a “party in interest” to include (among others) plan fiduciaries and service providers. 29 U.S.C. § 1003(14). ERISA Section 406(a)(1) sets forth the specific actions prohibited between a plan and a party in interest. The rules provide that a fiduciary shall not cause the plan to engage in the following party-in-interest transactions “if he knows or should know that such transaction constitutes a direct or indirect”: • • • • • sale, exchange or leasing of any property between a plan and a party in interest, 29 U.S.C. § 1106(a)(1)(A); lending of money or other extension of credit between the plan and a party in interest, 29 U.S.C. § 1106(a)(1)(B); furnishing of goods, services or facilities between the plan and a party in interest, 29 U.S.C. § 1106(a)(1)(C); transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan, 29 U.S.C. § 1106(a)(1)(D); or acquisition or retention, on behalf of a plan, of any employer security or employer real property in violation of the rules pertaining thereto, 29 U.S.C. § 1106(a)(1)(E). 5 ERISA Section 406(b) supplements the party-in-interest rules by prohibiting a fiduciary from acting in his or her own self interest. These fiduciary “self-dealing” prohibitions provide that a fiduciary may not: • • deal with the assets of the plan in his or her own interest or for his or her own account, 29 U.S.C. § 1106(b)(1); in his or her individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interest of the plan or the interest of its participants or beneficiaries, 29 U.S.C. § 1106(b)(2); or receive any consideration for his or her own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan, 29 U.S.C. § 1106(b)(3). • ERISA Section 408 sets forth a number of specific exemptions from the prohibited transaction rules. For example, ERISA Section 408(b)(2) permits compensation for services or office space rendered by a party in interest on behalf of a plan if: (i) such service or space is “necessary” for the establishment or operation of the plan; (ii) the service or space is furnished under a contract or arrangement which is “reasonable”; and (iii) no more than reasonable compensation is paid for such service or office space. 29 U.S.C. § 1108(b)(2). See 29 C.F.R. § 2550.408b-2.3 For purposes of Section 408(b)(2), a contract or arrangement will not be considered “reasonable” if it does not allow the plan to terminate it without penalty to the plan on reasonably short notice. See 29 C.F.R. § 2550.408b-2(c). Further, a service or office space is “necessary” for the establishment or operation of a plan if it is appropriate and helpful to the plan in carrying out the purposes for which the plan is established or maintained. 29 C.F.R. § 2550.408b-2(b). Whether compensation is “reasonable” for purposes of ERISA Section 408(b)(2) depends on the particular facts and circumstances of each case. See 29 C.F.R. § 2550.408c-2(b)(1). ERISA Section 408(c) also provides in part that nothing in ERISA’s prohibited transaction provisions precludes a fiduciary from receiving any “reasonable compensation” for services rendered or for the reimbursement of expenses properly and actually incurred in the performance of his or her duties. 29 U.S.C. § 1108(c).4 3 The DOL takes the position that Section 408(b)(2) is limited to acts that would otherwise violate the party-in-interest rules in Section 406(a), and does not provide an exemption against the self-dealing provisions of ERISA Section 406(b). See 29 C.F.R. § 2550.408b-2. However, “[c]ourts have diverged over whether this regulation accurately interprets the statue.” Dupree v. Prudential Ins. Co. of Am., No. 99 8337-Civ., 2007 WL 2263892, at *42 (Aug. 10, 2007) (collecting cases). A fiduciary, however, who already receives full-time pay from the sponsoring employer may only be reimbursed actual expenses (i.e., no overhead costs). 29 U.S.C. § 1108(c). 4 6 To the extent that service providers receive compensation from plans or other third parties, such as retail pharmacies or drug manufacturers, they are subject to ERISA’s prohibited transaction rules and should ensure that their contractual arrangements with ERISA plans qualify under Section 408. C. DOL Guidance Concerning The Selection And Monitoring Of Service Providers. Outside the investment context, the DOL has offered more limited guidance to plan fiduciaries with respect to selecting and monitoring service providers. What constitutes an appropriate method of selecting a service provider depends on the particular facts and circumstances. Nevertheless, the DOL has offered general advice to all plan fiduciaries that select service providers. The DOL has suggested: • Fiduciaries selecting service providers should engage in an objective bidding process designed to solicit information on cost, services, and quality sufficient for the fiduciary to make an informed decision. The bidding process should avoid self-dealing, conflicts of interest, or other improper influence. Fiduciaries should ask each prospective provider “to be specific about which services are covered for the estimated fees and which are not.” Fiduciaries should “compare the information received from each prospective provider, including fees and expenses to be charged by the various providers for similar services.” Plan fiduciaries are not always required to pick the least costly provider; and cost is not the only factor to consider. The “quality of services” is also a relevant factor to the selection of a service provider; a fiduciary’s failure to take into account the quality of services is a breach of fiduciary duty under ERISA when the provider is paid by the plan. Fiduciaries should understand the terms of any agreements or contracts they sign with service providers and the fees and expenses associated with the contracts, including “whether the fees and expenses to be charged to plan participants are reasonable in light of the services to be provided.” Plan fiduciaries should obtain a commitment from the service provider to regularly provide fiduciaries with information regarding the services it provides. Plan fiduciaries should “periodically review the performance of service providers to ensure that they are providing the services in a manner and at a cost consistent with the agreement.” • • • • • • 7 • Whether a fiduciary’s monitoring process would be appropriate may depend upon the fiduciary's knowledge of the service provider's work, the cost and quality of the services previously provided by the service provider, the fiduciary's knowledge of prevailing rates for similar services, and the cost to the plan of conducting a particular selection process. Plan fiduciaries should “review plan participant comments or any complaints about the services” and periodically ask the service provider “whether there have been any changes in the information . . . received from the service provider prior to hiring.” • DOL EBSA Fact Sheet: Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan (May 2004), available at http://www.dol.gov/ebsa/newsroom/fs052505.html; DOL Info. Ltr. From Bette J. Briggs to Diana O. Ceresi, Wash. Serv. Bureau No. DLO585, 1998 ERISA LEXIS 6 (Feb. 19, 1998). III. The DOL’s Proposed Expansion Of Disclosure Requirements As To Service Providers Receiving Any Compensation From Third Parties For Their Services To Benefit Plans. Undisclosed compensation that certain service providers receive from third parties has been of increasing concern to the DOL. The DOL’s attention has focused more heavily on fees in the 401(k) context, but recent proposals would impact health plan service providers as well. In December 2007, the DOL proposed an amendment to the Regulations accompanying ERISA Section 408(b)(2) to require disclosure by a plan service provider of all of its compensation – including fees, rebates, and any other source of additional income – as a condition of the exemption from the prohibited transactions provision. See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), Reasonable Contract or Arrangement Under Section 408(b)(2) – Fee Disclosure (Dec. 13, 2007) (to be codified at 29 C.F.R. part 2550). The DOL’s proposal stems from its position plan fiduciaries cannot fully satisfy their ERISA obligations without knowing all of the compensation to be received by the service provider and any conflicts of interest that may adversely affect the service provider's performance under the contract or arrangement. The proposal specifically implicates PBMs, stating: “a pharmacy benefit manager that contracts with an employee benefit plan to manage the plan's prescription drug program would be covered as a service provider to the plan providing third party administration or recordkeeping, and possibly consulting, services.” See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (a) Scope of the Proposal. The proposed regulation, however, “would not apply to contracts or arrangements with entities that are merely providing plan benefits to participants and beneficiaries, rather than providing services to the plan itself.” See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (a) Scope of the Proposal. For example, if a health plan contracts with a medical provider network, such as an HMO, a doctor who is part of the network but has no separate 8 agreement or arrangement with the plan would not be a service provider covered by the proposed regulation. Id.5 Under the proposed amended regulations, for contracts and arrangements between employee benefit plans and certain service providers to be “reasonable” within the meaning of Section 408(b)(2), “the service provider [must] disclose the compensation it will receive, directly or indirectly, and any conflicts of interest that may arise in connection with its services to the plan.” Further, reasonableness is contingent upon (1) the contract or arrangement requiring disclosure from the service provider; and (2) the service provider actually providing all of the required disclosures. See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (f), Compliance by Service Providers. The proposal also requires a service provider to state whether it is an ERISA fiduciary. Id. at § (c) (1) (iii). The proposed regulations would also require a service provider to disclose to plan fiduciaries any material changes to the information it previously had to provide – e.g., a significant change in the amount of the rebate a PBM receives from a drug manufacturer. See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (f), Compliance by Service Providers. Under the proposed regulation, a service provider’s failure to contractually agree and disclose any compensation that it receives from a third party, even if the contract does not require such compensation to be passed on to the plan sponsor, would result in the arrangement being deemed “unreasonable.” As a result, the service contract would not qualify for ERISA Section 408(b)(2)’s prohibited transaction exemption, and the resulting prohibited transaction would have additional consequences to both the service provider and the plan fiduciary. First, the plan fiduciary would be deemed to have violated ERISA Section 406(a)(1)(c). Second, the service provider would be considered a “‘disqualified person’ under the Internal Revenue Code's (Code) prohibited transaction rules and subject to the excise taxes that result from the service provider's participation in a prohibited transaction under Code Section 4975.16.” Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (i)(2), Consequences of Failure to Satisfy the Proposed Regulation. The proposed regulations, however, contain a safe harbor provision for plan fiduciaries that can demonstrate they attempted to comply with the regulations despite the service providers’ failure to make the proper disclosures. See Proposed Rule Amending 29 C.F.R. § 2550.408(b)(2), § (i)(2), Consequences of Failure to Satisfy the Proposed Regulation. Indeed, the DOL states: “in certain circumstances, a responsible plan 5 The proposal affects contracts or arrangements in employee benefit plans between plan sponsor/fiduciaries and service providers that fall within one or more of the following three categories: (1) service providers who provide services as a fiduciary under ERISA or under the Investment Advisers Act of 1940; (2) service providers who provide banking, consulting, custodial, insurance, investment advisory (plan or participants), investment management, recordkeeping, securities or other investment brokerage, or third party administration services, regardless of the type of compensation or fees that they receive; and/or (3) service providers who receive any indirect compensation in connection with accounting, actuarial, appraisal, auditing, legal, or valuation services. 29 C.F.R. § 2550.408(b)(2), § § (a); (c) (1) (i). 9 fiduciary should not be held liable for a prohibited transaction that results when a service provider, unbeknownst to the plan fiduciary, fails to satisfy its disclosure obligations as required by the proposed regulation.” Id. The PBM industry has opposed the proposed regulations, asserting that they would not only affect plan sponsors and fiduciaries, but also would fundamentally alter how service providers of group welfare benefit plans do business by redefining what is a “reasonable contract or arrangement.” In a February 11, 2008 letter to the DOL from the Pharmaceutical Care Management Association (“PCMA”), the PCMA asked the DOL to exclude PBMs from the proposed disclosure requirements. See DOL Proposed Regulations: Reasonable Contract Or Arrangement Under Section 408(b)(2) Fee Disclosure, available at http://www.dol.gov/ebsa/regs/cmt-408(b)(2)-combined.html; ltr. from PCMA to DOL (Feb. 11, 2008). In sum, the PCMA asserts that the proposed requirements would “creat[e] a critical negative effect on the efficient delivery of prescription drug benefits to plan beneficiaries” for the following reasons: • The Federal Trade Commission (“FTC”) has extensively examined the industry and repeatedly concluded that market forces will provide the plans and plan sponsors with sufficient information to assess both the reasonableness of PBMs’ compensation and any conflicts of interest. Monetary disclosure may have the unintended effect of raising costs of prescription drugs. PBMs are only fiduciaries to the extent they have contractually agreed to provide a limited appeals procedure service after a participant has been denied a claim; provided that compensation for such fiduciary services is disclosed, the entire contract should not be subject to the proposed requirement given that such fiduciary services represent only a small portion of overall services and total compensation that PBMs receive for the services that they provide. Id. • • Health insurers have also spoken out against the proposed regulations. America’s Health Insurance Plans (“AHIP),6 on behalf of its members that provide insurance coverage to or administer benefits of employee welfare benefit plans, submitted comments to the proposal suggesting that the DOL withdraw the proposed regulations from further review based on the following concerns: 6 AHIP is a national association representing nearly 1,300 health insurance plans providing health, long-term care, dental, vision, disability, and supplemental coverage to more than 200 million Americans. See DOL Proposed Regulations: Reasonable Contract Or Arrangement Under Section 408(b)(2) Fee Disclosure, available at http://www.dol.gov/ebsa/regs/cmt-408(b)(2)-combined.html; ltr. from AHIP to DOL (Feb. 11, 2008). 10 • • The proposed regulations may impose significant administrative burdens on plan fiduciaries and service providers. The proposed regulations will result in “information overload” that does not lead to meaningful transparency. The proposed regulations will undermine the very flexibility of contracting that is key to assuring that the needs of plan fiduciaries and beneficiaries are met by the contract and its compensation terms. See DOL Proposed Regulations: Reasonable Contract Or Arrangement Under Section 408(b)(2) Fee Disclosure, available at http://www.dol.gov/ebsa/regs/cmt-408(b)(2)-combined.html; ltr. from AHIP to DOL (Feb. 11, 2008). • If the DOL chooses to proceed with the rulemaking, however, the AHIP proposes several revisions and clarifications to the proposed regulations, including the following: • The disclosure requirements should be more closely tailored based on the size and type of plan and the resources available to the plan fiduciary to use the disclosures in a meaningful manner. The regulations should make clear that service providers are not required to disclose the receipt of fees or other compensation unless the service provider is aware that such fees or compensation is paid or reimbursed from assets of the plan. The EBSA should work with plan sponsors, insurance carriers, and plan fiduciaries to identify “gaps” in disclosures that negatively impact the ability of plan fiduciaries to make informed decisions. The DOL should consider potential regulatory responses to address these gaps including fiduciary education, additional changes to the Form 5500 reporting requirements, and possible additional service provider contract requirements. terms. DOL Proposed Regulations: Reasonable Contract Or Arrangement Under Section 408(b)(2) Fee Disclosure, available at http://www.dol.gov/ebsa/regs/cmt-408(b)(2)-combined.html; ltr from AHIP to DOL (Feb. 11, 2008). • • • Written comments on the proposed regulations were due to the DOL on or before February 11, 2008. The regulations have yet to be finalized. 11 IV. Recent Lawsuits Involving PBMs. Lawsuits against PBMs are usually brought by plan participants and/or fiduciaries as purported class actions on behalf of their own benefit plan and other benefit plans with which the PBM contracts. Plaintiffs in these lawsuits frequently assert that PBMs are fiduciaries to the extent that they engaged in the following activities: 1. managing the formulary that defined the scope of the prescription drug benefit plan – i.e., determining whether a particular drug would be deemed a generic or brand-name prescription under the plan, and setting the price that a plan paid for generic and brand-name prescriptions; 2. using its market power and position to favor drugs for the formulary that were more expensive (drug-switching programs) in exchange for monies from drug manufacturers; 3. negotiating with drug manufacturers the prices that the plan pays for drugs; and 4. failing to disclose the true nature and amount of compensation they receive from retail pharmacies or drug manufacturers and then failing to pass on such discounts to the plan sponsor. See, e.g., Chicago Dist. Council of Carpenters Welfare Fund v. Caremark, Inc., 474 F.3d 463, 467 (7th Cir. 2007) (claiming that PBM was an ERISA fiduciary when it negotiated both drug prices and/or rebates with retail pharmacies as well as discounts with drug manufacturers, and when it managed the formulary and drug switching program); Seaway Food Town, Inc. v. Medical Mutual of Ohio, 347 F.3d 610, 612 (6th Cir. 2003) (asserting that claims administrator breached its fiduciary duties by failing to accurately estimate and disclose the true nature and amount of the healthcare provider discounts it actually received, and pass such discounts along to plan sponsor); Moeckel, 2007 WL 3377831, at *3 (alleging that PBM was an ERISA plan fiduciary when, in its sole discretion, it set the price for generic and brand-name prescriptions, determined whether a particular prescription would be adjudicated and priced as a brandname or generic prescription, and managed the formulary and drug-switching program); Bickley v. Caremark Rx, Inc., 361 F. Supp. 2d 1317, 1321 (D. Ala. 2004) (claiming that PBM breached its fiduciary duties under ERISA through undisclosed discounts, rebates, coupons, and other forms of compensation from drug companies and pharmacies), aff’d on other grounds, 461 F.3d 1325 (11th Cir. 2006).7 7 If a claim against a service provider, regardless of its fiduciary status, is based on a legal duty independent of ERISA, it may be governed by state law. ERISA preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan” governed by the statute. 29 U.S.C. § 1144(a). However, ERISA does not preempt “traditional state-based laws of general applicability that do not implicate relations among the traditional ERISA plan entities, including the principals, the employer, the plan, the plan fiduciaries, and the beneficiaries.” Penny/Ohlmann/Nieman, Inc. v. Miami Valley Pension Corp., 399 F.3d 692, 698 (6th Cir. 2005). See, e.g., Gerosa v. Savasta & Co., 329 F.3d 317 (2d Cir. 2003) (claim of actuarial negligence not 12 V. Key Issues In The PBM Cases. A. Fiduciary Status Of The PBM. The key question in PBM cases to date is whether the PBM was acting as a fiduciary with respect to the acts challenged in the complaint. Courts have routinely found that PBMs and other service providers are not fiduciaries when: 1. They perform only ministerial functions. See Pharmaceutical Care Mgmt. Ass'n v. Rowe, 429 F.3d 294, 301 (1st Cir. 2005) (duty to disclose conflicts of interests and payments from drug manufacturers “are purely ministerial and simply not sufficient for us to find that the PBMs are acting as fiduciaries under ERISA”), cert. denied, 547 U.S. 1179 (2006); Martin v. Feilen, 965 F.2d 660, 669 (8th Cir. 1992) (professionals performing only ministerial accounting functions for plan were not fiduciaries); Bickley, 361 F. Supp. 2d at 1332 (noting PBM agreement with plan did not give PBM discretion over benefits decisions; rather, “[a] fair characterization of PBM’s obligations there under is ‘ministerial.’”); Santana v. Deluxe Corp., 920 F. Supp. 249, 253-57 (D. Mass 1996) (holding that an insurance company acting as third-party administrator that only performed ministerial functions was not a fiduciary under ERISA). 2. They make recommendations to the plan sponsor/fiduciary, e.g., ongoing changes to drug formularies or other specific decisions when managing a drug-switching program, but the plan sponsor/fiduciary retains the final discretionary authority as to whether to implement the recommendations. See, e.g., Caremark, 474 F.3d at 477; Moeckel, 2007 WL 3377831, at *22 (same). 3. They have no discretion over plan assets; rather, they are compensated for their adherence to contractual terms from which they have no authority to deviate. See, e.g., Seaway Food Town, 347 F.3d at 617-19 (distinguishing between plan administration/management and mere business decisions that affect an ERISA plan; concluding that service provider was not an ERISA fiduciary where “parties enter into a contract term at arm’s length and where the term confers on one party the . . . right to retain funds as compensation for services rendered with respect to an ERISA plan”); Deluca v. Blue Cross Blue Shield of Mich., No. 06-12552, 2007 WL preempted by ERISA); Bauman v. U.S. Healthcare, Inc., 193 F.3d 151 (3d Cir. 1999) (ERISA did not preempt those claims against HMO alleging negligence in selection, supervision, and training of employees because they “do not involve an attempt to recover benefits due, enforce rights, or clarify future benefits under a plan, but rather seek recovery under the quality standard found in the otherwise applicable [state] law”). A detailed discussion of viable state law claims that are not preempted by ERISA is beyond the scope of this paper. 13 3203131 (E.D. Mich. Oct. 31, 2007) (service provider was not a fiduciary when it negotiated rate contracts with hospitals on behalf of plan, as it was undisputed that “nothing in the agreement between [the service provider] and the plan charges [the service provider] with a duty to negotiate hospital rates for the plan or to act in the plan's interests when negotiating hospital rates”), mot. for reconsid. denied, 2007 WL 4591914 (Dec. 28, 2007). 4. They engage in arm-length negotiations with the plan sponsor/fiduciary prior to establishing a contractual arrangement. Caremark, 474 F.3d at 477 (finding that PBM was not a fiduciary at the time it was engaged in arm’s-length negotiations prior to entering into agreements”); see also Mulder v. PCS Health Sys., Inc., 432 F. Supp. 2d 450, 458 (D.N.J. 2006) (“[t]he fact that [PBM] operated independently in negotiating contracts with drug manufacturers does not make [it] an ERISA fiduciary”). 5. They make business decisions regarding the design, development, and management of their own drug formularies for their own account. See Pipefitters Local 636 v. Blue Cross & Blue Shield of Mich., 213 Fed. Appx. 473, 479 (6th Cir. 2007) (stating “[d]iscretionary authority does not exist where a party . . . makes business decisions on its own behalf, outside its role as a plan administrator”); Seaway Food Town Inc., 347 F.3d at 617 (reiterating “that ERISA is not involved in regulating conduct affecting the establishment of a plan [and] its terms”); Moeckel, 2007 WL 3377831, at *22 (finding PBM’s design and management activities as to its formularies were not “fiduciary in nature;” PBM “developed its propriety formularies for its own account, without reference to any client or plan”). On the other hand, courts have held that service providers may be fiduciaries when: 1. They have actual control over plan assets. See, e.g., Srein v. Soft Drink Workers Union, Local 812, 93 F.3d 1088 (2d Cir. 1996) (insurance company providing benefits to the union became a fiduciary when it collected premiums and retained control of funds that belonged to the union); Briscoe v. Preferred Health Plan, Inc., Case No. 3:02-CV-264-S, 2008 WL 4146381, at *3 (W.D. Ky. Sept. 2, 2008) (holding that health plan service provider breached its fiduciary duties under ERISA by making payments from the plan account belonging to participants to the bankrupt employer despite its knowledge of such bankruptcy and employer’s inability to repay). 2. They have authority to implement their own recommendations without final approval of the plan sponsor/fiduciary. Cf. Caremark, Inc., 474 F.3d at 477; Moeckel, 2007 WL 3377831, at *22. 14 3. They have control over factors that determine the actual amount of their compensation after entering into a contract with the plan. See F.H. Krear & Co. v. Nineteen Named Trs., 810 F.2d 1250, 1259 (2d Cir. 1987) (“after a person has entered into an agreement with an ERISA-covered plan, the agreement may give it such control over factors that determine the actual amount of its compensation that the person thereby becomes an ERISA fiduciary with respect to that compensation”). The PBM’s fiduciary status is typically a dispositive issue. See, e.g., Caremark, Inc., 474 F.3d at 477 (because of finding that PBM is not an ERISA fiduciary under the parties' PBM agreements, plaintiffs may not sustain claims against PBM for breach of fiduciary duty); Moeckel, 2007 WL 3377831, at *28 (same). However, courts have acknowledged that, if a service provider is found to be an ERISA fiduciary, “its compensation derived from undisclosed rebates, coupons, pricing spreads and other activities could be difficult to defend from a claim of self dealing prohibited by 29 U.S.C. § 1106(b)(1) & (b)(3).” Bickley, 361 F. Supp. 2d at 1332. Further, the proposed amended 408(b)(2) regulations could increase PBMs and other service providers’ exposure to prohibited transaction claims if they fail to satisfy all of the proposed disclosure requirements. B. Standing And Class Certification Issues. 1. Standing As A Distinct And Threshold Issue To Class Certification. In many of the PBM cases, a single plan’s participants or fiduciaries assert claims on behalf of all plans with which the service provider contracts, challenging practices of the service provider common to all such plans. Defendants have challenged the standing of these plaintiffs on both constitutional and statutory grounds. From an Article III perspective, defendants have argued that plan participants or fiduciaries cannot assert claims challenging PBM practices if they have not actually been injured from the challenged practices. Article III standing is conferred only upon those who have suffered injury in fact. See Blum v. Yaretsky, 457 U.S. 991, 999 (1982) (“It is not enough that the conduct of which the plaintiff complains will injure someone. The complaining party must also show that he is within the class of persons who will be concretely affected”). Defendants have also challenged the plaintiffs’ statutory standing to sue under ERISA. Standing to assert claims under Section 502(a) of ERISA is limited to “participants” or “beneficiaries” of ERISA-covered benefit plans. See 29 U.S.C. 1132(a). Defendants in PBM and similar cases have argued that participants and fiduciaries of one plan lack statutory standing to assert ERISA claims on behalf of other plans because they are not participants or beneficiaries of those plans. However, a number of courts have held in the class certification context that “an individual in one ERISA benefit plan can represent a class of participants in numerous plans other than his own, if the gravamen of the plaintiff’s challenge is to the general practices which affect all of the plans.” Fallick v. Nationwide Mut. Ins. Co., 162 F.3d 15 410, 422 (6th Cir. 1998) (collecting cases). The Fallick court also ruled that, once an ERISA class representative “establishe[s] his individual standing to sue his own ERISAgoverned plan, there is no additional constitutional standing requirement related to his suitability to represent the putative class of members of other plans to which he does not belong.” Id. at 424. Defendants in these cases may argue that ERISA statutory standing is separate from class certification under Rule 23, and the fact that a complaint is styled as a putative class action cannot give rise to a finding that the plaintiffs are participants or fiduciaries of other plans with standing to sue. See Ortiz v. Fibreboard Corp., 119 S. Ct. 2295, 2314 (1999) (“no reading of the Rule [23] can ignore the [Rules Enabling Act’s] mandate that rules of procedure ‘shall not abridge, enlarge or modify any substantive right’”) (quoting 29 U.S.C. § 2072(b)). For example, in Hastings v. Wilson, 516 F.3d 1055 (8th Cir. 2008), the court held that an individual who cannot establish individual standing with respect to his or her own plan cannot obtain standing over the same plan through a class action law suit. Id. at 1061 (because named plaintiffs were not participants, beneficiaries, or fiduciaries of the plan, the district court correctly held that they lacked standing to bring an action on behalf of other plan participants and beneficiaries). The Second Circuit addressed the issue in a pair of decisions involving a proposed class settlement of claims asserted by both plan participants and fiduciaries against PBMs. Initially, the court vacated and remanded the class settlement for the district court to consider (i) whether certain plan participant plaintiffs could demonstrate injury from the PBM’s alleged failure to pass along formulary rebates to plans it serviced, and (ii) whether another plan trustee plaintiff could demonstrate its plan actually had a contractual relationship with the PBM being sued. See Central States SE & SW Areas Health & Welfare Fund, L.L.C. v. Merck-Medco Managed Care L.L.C., 433 F.3d 181 (2d Cir. 2005) (“Central States I”), subsequent ruling at 504 F.3d 229 (2d Cir. 2007) (“Central States II”). In its first ruling, the Second Circuit stated: “[I]f none of the named plaintiffs purporting to represent a class establishes the requisite of a case or controversy with the defendant[], none may seek relief on behalf of himself or any other member of the class.” 433 F.3d at 199 (citation and internal quotations omitted). However, on a subsequent appeal following remand, the Second Circuit agreed with the district court’s conclusion that, because one plan fiduciary had Article III standing, the court did not need to consider the issue of constitutional standing as it pertained to any other named plaintiffs. Central States II, 504 F.3d at 243. The court stated that “only one of the named Plaintiffs is required to establish standing in order to seek relief on behalf of the entire class.” Id. at 241. 2. Commonality And Typicality Issues Under Rule 23(a)(2) And (3) When The Fiduciary Status Of The Service Provider Varies With Each Contract And Cannot Be Established With Common Proof. Courts are more likely to certify claims against service providers as Rule 23 class actions where “the gravamen of [plaintiffs’] challenge is to the general practices which affect all of the plans.” Fallick at 422 (citations omitted). See also Forbush v. J.C. 16 Penney Co., Inc., 994 F.2d 1101 (5th Cir. 1993) (reversing lower court’s denial of class certification where plaintiff sought to represent members of four different ERISAgoverned pension plans, all administered by one employer, because plaintiff “framed her challenge in terms of [the employer’s] general practice of overestimating social security benefits” in violation of ERISA’s non[-]forfeiture provisions); Caranci v. Blue Cross & Blue Shield of R.I., 194 F.R.D. 27, 39 (D.R.I. 2000) (certifying class of individuals participating in different ERISA plans all administered by same health insurer); Sutton v. Medical Serv. Ass’n of Pa., No. CIV. A. 92-4787, 1993 WL 273429, at *5 (E.D. Pa. July 20, 1993) (certifying class on claim that defendants violated fiduciary duties under ERISA through the formulation and implementation of a claims procedure that defendants admitted they applied uniformly to the claims of the entire class). However, service provider defendants may argue that evidence surrounding their fiduciary status is a distinct and threshold issue that varies between contracts with different plan administrators and, in turn, will overwhelm any common questions between class members. For example, in Mulder v. PCS Health Systems, 216 F.R.D. 307 (D.N.J. 2003), a health plan beneficiary asserted fiduciary duty claims against the plan’s PBM on behalf of a proposed class of approximately 1,250 plans, each with its own plan administrator and separate contracts with the PBM. While acknowledging that Rule 23 commonality and typicality “can be satisfied despite class members’ participation in numerous plans,” the court ruled that the PBM’s fiduciary status varied from contract to contract and could not provide a hook for commonality and typicality. Id. at 316.8 VI. The Next Frontier: Increased Claims Against Plan Fiduciaries Relating To The Fees Of PBMs and Other Health Plan Service Providers? As detailed above, the recent PBM litigation wave has focused on the PBMs themselves. However, the DOL’s proposed amended 408(b)(2) regulations, if adopted, combined with a plaintiffs’ bar already focused on service provider fees in the 401(k) context, may increase plan fiduciaries’ exposure to claims by participants that the fiduciaries breached their duties by allowing plans to pay excessive compensation to PBMs (or other service providers covered by the proposed regulations) and failing to adequately monitor the quality of services provided.9 Cf. Trull v. Dayco Prods., Inc., Case No. 1:02CV243, 2004 WL 5624128, at *3 (W.D.N.C. June, 21 2004) (plan administrator who selected HMO service provider had duty to continue to monitor HMO; denying summary judgment as reasonable fact-finder could conclude that plan administrator “failed to structure, let alone conduct, a thorough, impartial investigation of which provider or providers best served the interests of the participants and beneficiaries”). 8 The court went on to find that the named plaintiff satisfied Rule 23’s commonality and typicality requirements with respect to a significantly smaller proposed class: participants who received PBM services through benefits plan managed by one plan administrator pursuant to a specific contract with the PBM under which its fiduciary status could be established with common proof. 216 F.R.D. at 316, 318. A detailed description of 401(k) fee litigation is addressed elsewhere in this program. 9 17 There is no “one size fits all” method of selecting and monitoring service providers. In performing these functions, it is up to plan fiduciaries to determine the best fit for the plan. That said, set forth below are some tips that plan fiduciaries should consider to reduce their exposure in this regard: • • • • • • •    Use competitive bidding to select providers, bearing in mind the DOL’s guidance on a prudent selection process. Stay on top of current and proposed disclosure requirements for the 408(b)(2) exemption. Monitor and document service provider performance to ensure that fees are “reasonable” and services “necessary.” Evaluate the adequacy of disclosures to participants. Check corporate indemnifications and indemnification provisions in service provider contracts. Document everything. Buy lots of insurance. 18