Employer Stock Litigation

Seyfarth synopsis: The Second Circuit reversed dismissal of an ERISA stock drop class action finding plaintiff alleged enough to plausibly show that disclosure of alleged corporate problems would not have done more harm than good and sketching a treasure map for ERISA plaintiffs seeking to recover for 401(k) plan losses.

By Ian H. Morrison and Michael W. Stevens

Many thought ERISA stock drop claims were doomed by the Supreme Court’s 2014 decision in Fifth Third Bancorp v. Dudenhoeffer, and given court rulings since that decision they largely were. The Second Circuit may have reversed that trend in a recent decision.

In Jander v. Retirement Plans Committee of IBM et al., No. 17-3518 (2d Cir. Dec. 10, 2018), investors in the IBM Company Stock Fund, an ESOP contained within the company’s 401(k) plan, claimed that the plan fiduciaries violated the duty of prudence by continuing to invest ESOP funds in IBM common stock, despite knowing that IBM’s microelectronics business was losing money, and was allegedly overvalued in company disclosures. The troubled division was losing $700 million annually, and eventually had to be sold on a write-down, causing IBM’s stock to fall by $12 per share, the complaint alleges.

The district court dismissed the complaint, finding plaintiffs had not pleaded facts showing the fiduciaries could not have reasonably concluded that available alternatives, such as disclosing the alleged difficulties, halting investment in IBM stock, or investing in hedging investments, would not have caused more harm than good.

The Second Circuit reversed. The Second Circuit analyzed Dudenhoeffer, and standards of pleading for a breach of the duty of prudence. The Second Circuit focused on the difference between whether a plaintiff must plead merely that an “average” fiduciary “would not” have viewed available alternatives as more likely to do harm than good to a plan, or a more stringent requirement to plead that “any” fiduciary “could not” have viewed the available alternatives as more likely to harm than help.

The Court declined to weigh in on the difference, however, because it found that the plaintiffs had adequately pleaded a breach of the duty of prudence under either standard. The Court recited several specific factual allegations, such as the fiduciaries’ alleged knowledge of the supposedly artificial price inflation, their power to disclose the truth, and the negative impact of the failure to disclose on the reputation of the company’s management, that cumulatively satisfied the plaintiffs’ burden. Notably, the Court also focused on the allegation that the defendants knew that the eventual disclosure regarding the troubled division was inevitable, and therefore earlier disclosure would have been less harmful to stock price than later disclosure.

By not weighing in on which of the “harm versus help” standards apply, but extensively examining the adequacy of plaintiffs’ specific allegations, and repeatedly noting the district courts’ duty to construe inferences in plaintiffs’ favor on a motion to dismiss, the Second Circuit has given putative ERISA stock drop plaintiffs a roadmap to survive a motion to dismiss, something that has largely eluded them since 2014. ESOP fiduciaries take heed.

By: Ian Morrison and Abigail Cahak

The first (or second) question to ask in any ERISA breach of fiduciary duty case is whether the acts in question are even fiduciary acts.

On appeal in an ERISA “stock drop” case, the Second Circuit focused on that basic question, resulting in a clean win for the defendants.

Participants in the Morgan Stanley 401(k) and Employee Stock Ownership Plans (“Plans”) sued after the great recession caused the value of 2007 and 2008 contributions to the Plans in Morgan Stanley stock to crater, allegedly dropping in value from $2.2 billion to $675 million.  The participants sued alleging that the drop was the result of an imprudent investment because Morgan Stanley’s exposure to subprime and mortgage-backed securities had caused the value of the stock to drop.

On March 28, 2013, the U.S. District Court for the Southern District of New York dismissed the cases because, although the named defendants were de facto fiduciaries under ERISA, the plaintiffs had not alleged enough to overcome the so-called Moench presumption that employer stock investments in plans that require such investments are presumed prudent unless plaintiffs can show the plan sponsor’s impending collapse or other “dire” circumstances.

On appeal, the Second Circuit took a back to basics approach to the case.  In a May 29, 2014 opinion, the court ruled that the defendants were not fiduciaries at all, at least not for purposes of anything at issue in the case.  (Coulter v. Morgan Stanley & Co. Inc., No. 13-2504 (2d Cir. May 29, 2014).)  The Court held that establishing and funding the Plans were “settlor functions” not subject to challenge under ERISA’s fiduciary duty rules.  The Court said that the fact that the Plans were already in existence was irrelevant because at the time the decisions were made, the company stock was not an asset of the Plans. The Court cautioned that fiduciary status does not exist “simply because an employer’s business decision proves detrimental to a covered plan or its beneficiaries.”

With aspects of the Moench presumption subject to review by the Supreme Court, with a decision expected in Fifth Third Bancorp v. Dudenhoeffer later this month, the Court’s move may have been calculated to avoid any need for reconsideration in light of the high court’s ruling.  But the Third Circuit’s decision did rely on a view employee benefits practitioners have long held:  the act of plan funding (the amount as well as the nature of payment) is not a fiduciary act.  That’s not to say that funding a plan with employer stock is free of risk after the Second Circuit ruling, but Coulter certainly gives the defense another tool to fight back against stock drop claims.

 By: Ward Kallstrom and Michelle Scannell

The Ninth Circuit recently grappled with whether the presumption of prudence, which normally protects fiduciaries in stock drop class actions, applies where the plan permits, but doesn’t require or encourage, the fiduciaries to offer employer stock as an investment option.  In Harris v. Amgen, 55 EBC 2093,  the court held that the fiduciaries’ actions in continuing to offer the stock fund option were not cloaked with the presumption of prudence.  This case, and a similar recent Second Circuit decision on the issue, may signal an increased uphill battle for fiduciaries in stock drop cases in some circuits. 

The Presumption of Prudence

There’s an inherent tension between Congress’ mandate in ERISA that fiduciaries act prudently in making investment decisions, and its desire to permit employers to provide loyalty incentives such as employee stock ownership.  In an attempt to reconcile this tension, federal circuits have applied a “presumption of prudence” first articulated by the Third Circuit in Moench v. Robertson, to fiduciary investments in employer stock.  62 F.3d 553 (3d Cir. 1995).  Where the presumption applies, it means that a fiduciary’s decision to invest a plan in employer stock, or offer to plan participants the option to so invest, is a presumptively prudent decision that is reviewed only for an abuse of discretion.  In Quan v. Computer Sciences Corp., the Ninth Circuit, adopting Moench, held that the presumption of prudence is triggered “when plan terms require or encourage the fiduciary to invest primarily in employer stock.”  623 F.3d 870 (9th Cir. 2010). 

Harris v. Amgen

In Harris, current and former employees of pharmaceutical company Amgen and one of its subsidiaries participated in two defined contribution plans (“Plans”) whose investment choices included a company stock fund (the “Amgen Fund”).  (Oddly, the court called them “employee stock ownership plans” — but they were not ESOPs, because ESOPs are required by law to be invested primarily in employer stock, and the Plans did not mandate stock fund investments.)  After the value of the Amgen stock fell, allegedly because of safety concerns about some of Amgen’s products, the employees sued.  They alleged, among other things, that the Plan fiduciaries breached their duty of care by continuing to provide Amgen stock as an investment option when they knew or should have known that the stock price was artificially inflated. 

Defendants moved to dismiss the complaint, asserting that the presumption of prudence applied to the continued offering of Amgen stock throughout the class period.  The district court held that the presumption of prudence shielded the Plan fiduciaries from liability. 

On appeal, defendants asserted four arguments to support their claim that they were entitled to a presumption of prudence.  First, they claimed that the Plans encouraged investment in Amgen stock in that they referred expressly to it as a permissible investment.  The court disagreed, finding that plan language stating that fiduciaries “may offer a stock” did not equate to “encourag[ing]” investment in the stock. 

Importantly, the court also pointed to the Second Circuit’s recent decision in Taveras v. UBS, which refused to apply the presumption of prudence to a plan that merely permitted investment in employer stock, but applied the presumption for a plan that required investment in employer stock.  708 F.3d 436 (2d Cir. 2013).  The Taveras court noted that if the presumption of prudence was triggered for every plan that simply permitted rather than required investment in employer stock, it would be “hard pressed” to imagine that any such plan would not be entitled to a presumption of prudence.  The court thought that such an outcome would be contrary to Moench.  It cited Moench’s reasoning that the presumption exists “primarily in instances where a fiduciary ‘has an explicit obligation to act in accordance with plan provisions by offering employer stock. . .’” (emphasis added).  It also noted that the tension between Congress’ competing concerns underlying the presumption was “weak at best, if not absent entirely,” where a plan does not mandate investment in employer stock.

Second, defendants argued that the Plans encouraged investment in Amgen stock by their provisions regulating the purchase, transfer and distribution of Amgen stock, and ensuring voting rights to participants who invested in the Amgen Fund.  The court rejected this notion, commenting that it thought that a Plan provision stating that participants may not allocate more than 50% of their holdings in the Amgen Fund actually discouraged investment in Amgen stock.  The court failed to observe that this type of clause, common in all stock fund plans except ESOPs, is intended not to discourage investment but to ensure that participants diversify their investments and that fiduciaries fulfill their duties of loyalty and care.   

Third, defendants claimed that the Plan documents evidenced a “longstanding practice and intent” to include Amgen stock as part of the Plan design.  The court disagreed, noting that the cited Plan language took effect after the lawsuit was filed. 

Fourth, defendants argued the Plans encouraged investment in Amgen stock because defendants would have to amend the Plans to make Amgen stock unavailable to Plan participants.  The court found no evidence to support this contention. 

The court thus held that the district court erred in applying the presumption of prudence.  The court held that the fiduciaries’ actions should be evaluated under the normal prudent man standard, which requires that a fiduciary act “with the care, skill, prudence, and diligence under the circumstances then prevailing such that a prudent man acting in a like capacity and similar with such matters would use” in similar circumstances.  29 U.S.C. § 1104(a)(1)(B). 

Although broad application of the presumption of prudence may still sound a death knell for stock-drop claims in some circuits, the Ninth Circuit’s (like the Second Circuit’s) restrictive application of the presumption has laid fertile ground for continued stock-drop litigation.  Given ERISA’s venue rules, the reasoning of the Harris and Taveras courts demonstrates that fiduciaries may need to be prepared to clear a high hurdle in establishing that a plan that merely permits investment in employer stock “encouraged” its fiduciaries to so invest.  These cases highlight the importance of “hard-wiring” stock funds in defined contribution plans by mandating in the plan documents that the participant investment options include an employer stock fund.

By: Ian Morrison, Sam Schwartz-Fenwick and Chris Busey

Any trial lawyer knows the value of a good analogy.

In a recent damages ruling in a complex ESOP case, the Western District of Wisconsin composed a musical metaphor to explain its philosophy on ERISA damages. 

InChesemore v. Alliance Holdings, Inc., No. 3:09-cv-00413 (W.D. Wis. June 4, 2013), Judge William M. Conley awarded $14.2 million to participants in two employee stock ownership plans (ESOPs): the Alliance ESOP and the Trachte ESOP.  The Court awarded to the Alliance Plan roughly $7.8 million, to be paid by Alliance Holdings and its President and trustee of the Alliance ESOP, David Fenkell.  $6.4 million was to be paid to the Trachte ESOP by that ESOP’s trustees.  The Court, however, required “the more culpable” Alliance ESOP trustee, Fenkell, to indemnify the Trachte ESOP Trustees.  Fenkell was the “unquestioned conductor” while the others were “mere musicians”   

The controversy arose from a complex leveraged buyout orchestrated by Alliance Holdings and Fenkell.  Alliance specialized in purchasing companies with ESOPs, merging these ESOPs into an Alliance ESOP, and then selling the companies for a profit.  Alliance attempted to employ this strategy when it acquired Trachte Building Systems, Inc. in 2002, but it could not find a suitable buyer.  So, at the direction of Alliance and Fenkell, a newly formed Trachte ESOP purchased Trachte’s stock.  The defendants then spun off the Alliance ESOP to merge with the newly formed Trachte ESOP.  Soon after the transaction, the value of Trachte stock dropped and so did the account balances of plan participants.

Plaintiffs filed suit in 2009, alleging that Alliance, two of its subsidiaries, the Alliance ESOP, Fenkell, and the Trachte ESOP Trustees had engaged in a prohibited transaction under Section 208 of ERISA, 29 U.S.C. 1058, and breached their fiduciary duties.  After finding the defendants liable for breaches of fiduciary duty and prohibited transactions, the Court, on June 4, 2013, ordered defendants to restore the plaintiffs’ accounts in the Alliance ESOP to their pre-transaction value — at a cost of roughly $7.8 million. 

The Court also awarded damages to a class of Trachte ESOP plaintiffs.  The court previously determined that the leveraging of Alliance ESOP accounts inflated the purchase price for Trachte and caused the Trachte ESOP to overpay for the company’s stock.  The Court measured damages according to what it found to be the amount of the purchase overpayment.  The Court rejected the plaintiffs’ proposed measure of damages (namely the $38 million purchase price minus the value of the now worthless stock).  The Court found that in light of the 2008 financial crisis, plaintiffs failed to show that the fiduciary breaches caused the company’s collapse.  Plaintiffs did show that the breaches caused the Trachte ESOP to overpay for the company by about $8.3 million.  The Court rejected defendants’ argument that the value would have been wiped out by the financial crisis anyway, noting that whether plaintiffs would have later lost the overpayment was beside the point.  Since there was some overlap between damages to the class of all plaintiffs and the Trachte subclass, the Court reduced the overpayment to account for the reinstatement of the Alliance ESOP subclass of plaintiffs into the Alliance ESOP.  The Trachte ESOP Trustees were thus ordered to pay over $6.4 million. 

Although the damages relating to overpayment stemmed from the breaches of the Trachte Trustees, the Court ordered Fenkell and Alliance to indemnify them.  It noted that “Fenkell was the unquestioned conductor and the Trachte Trustees mere musicians.”  The Court singled Fenkell out as “far and away the most culpable party.”  To that end, beyond indemnification, the Court ordered him to disgorge the profits realized from his sale of phantom stock if Trachte would agree to return it to him.  This sum amounted to nearly $2.9 million.  He was also removed as trustee of the Alliance ESOP. 

The Court’s nearly $17 million award shows the potential risk of engaging in transactions a court may find to be manipulative.  In assessing most of the liability to Fenkell, the Court noted it “was increasingly impressed by Fenkell’s complete recall of minor details and sophisticated understanding of ERISA transactions, as well as the law governing those transactions.”  But as this award shows, a keen knowledge of ERISA cannot always get a fiduciary off the hook for breaching duties owed to plan participants.   

While the case largely serves as a cautionary tale for those engaged in novel ESOP transactions, it also shows that courts do take a rational view of ERISA damages.  The Court rejected the plaintiffs’ attempt to recover the full Trachte purchase price because that damage model did not account for broader market factors that affected returns on the ESOP’s investment.  And the Court assigned liability primarily to the individual it felt bore the most culpability, rather than the less responsible ESOP trustees.

By: Ron Kramer and Jim Goodfellow

Recently, in White, et. al. v. Marshall & Ilsley Corp., the Seventh Circuit concluded that a claim against an Employee Stock Ownership Plan can be dismissed if a plaintiff does not overcome the Moench presumption.  In what is becoming an all-to-common result for plaintiffs who bring “stock drop” lawsuits in this circuit, the Seventh Circuit concluded that there were no breaches of any fiduciary duties.

The facts of this case are straight forward.  The named plaintiff was a participant in Marshall & Ilsley’s (“M & I”) ERISA governed retirement savings plan (the “Plan”).  The Plan allowed the named plaintiff to choose how to distribute her savings among more than twenty investment funds with varying risk and reward profiles.  These funds were selected by the Plan’s fiduciaries per the terms of the Plan. 

One of the investment options available, as required explicitly by the Plan, was the M & I stock fund, which consisted of M & I common stock.  This fund was an Employee Stock Ownership Plan (“ESOP”) under ERISA.  The Plan required that the M & I  stock fund be offered at all times, regardless of stock performance, “no matter how dire.”  Indeed, the Plan recognized the likelihood of significant declines, but took a long-term view with respect to the stock’s value, and the benefit of aligning an employee’s interests with that of the company. 

During the recession that followed the housing market collapse, M & I’s stock price dropped 54%, a drop that affected the value of the employees’ investment in the M & I stock fund.

The named plaintiff filed a putative class action and alleged that the Plan’s fiduciaries violated ERISA by continuing to offer the M & I stock fund as an investment option in spite of this precipitous drop in price.  She alleged that the Plan’s fiduciaries violated their duty of prudence under ERISA by continuing to offer M & I stock as one of the investment options.  The named plaintiff alleged that M & I expanded its business to include risky loans outside its normal scope of expertise.  The stock price was pummeled as analysts repeatedly downgraded M & I bonds and stock.  The named plaintiff alleged that these circumstances were dire, and thus gave rise to an investment that was untenably risky for retirement savings. 

The district court disagreed and granted a motion to dismiss the named plaintiff’s claim under F.R.C.P. 12(b)(6).  Plaintiff appealed, and the Secretary of Labor filed an amicus brief supporting plaintiff’s position and questioning the presumption of prudence most courts apply in such cases.  Nevertheless, the Seventh Circuit affirmed.  In its decision, the Seventh Circuit began by analyzing the tension between the fiduciary’s duty to select only prudent investments and the duty to act in accordance with the Plan’s documents.  To analyze the named plaintiff’s claim, the Seventh Circuit applied the Moench presumption, which states that where a plan requires investment in company stock, such investment is presumed to be prudent unless the investment creates an excessive and unreasonable risk for employees.  Generally speaking, investment risk is excessive and unreasonable when the company faces impending collapse.  Thus, according to the Seventh Circuit, a plaintiff can overcome the Moench presumption only when no reasonable fiduciary would have thought that they were obligated to continue offering company stock. 

In applying this standard, the Seventh Circuit rejected the Sixth Circuit’s standard, preferred by the named plaintiff and the Secretary of Labor, which states that the Moench presumption is overcome when a plaintiff can show that a reasonable fiduciary would have come to a different investment decision.  For the Seventh Circuit, this sets the bar too low, in light of the conflicting position in which ESOP fiduciaries find themselves.  Said the court, the purpose of the Moench presumption is to enable fiduciaries to carry out their dual roles and insulate them from short-term market volatility.  The Sixth Circuit’s standard impedes the fiduciary’s ability to perform their duties. 

Turning to the merits of the named plaintiff’s claims, the Court summarily disposed of her theories of liability.  First, the named plaintiff argued that the investment was imprudent because the stock price was objectively overvalued, thus the investors were bound to lose money when the market corrected the price downward.  Second, she argued that investment in the stock was risky because the stock was exposed to price swings that investors cannot tolerate.  Thus, the stock price drop put the fiduciaries on notice that the investment choice was imprudent.

The Court swept aside these concerns because M & I stock is traded publically in an efficient market (which means that the participants were equally capable of observing market conditions and making independent judgments as to the stock’s value), and because the named plaintiff — and those she sought to represent — had other investment options from which they were free to choose based on their own level of risk tolerance.  According to the Court, to find that the fiduciaries had breached their duties would create three unworkable consequences: (1) fiduciaries would be required to anticipate how their company stock would perform in the future, which would require omniscience and foresight; (2) fiduciaries may be required to use non-public inside information in violation of securities laws; or  (3) fiduciaries would be required to beat a presumptively efficient market with their investment choices.  The Court also noted the irony of plaintiff’s position, namely that in divesting the Plan of company stock to avoid liability with respect to the price drop, the Plan fiduciaries may expose themselves to liability with respect to the inevitable up-swing. 

In sum, the Court found that an ERISA fiduciary is not a participant’s individual investment advisor.  Rather, they must look out for the Plan as a whole.  And in this particular case, the downswing in price was not indicative of impending collapse.  Indeed, the Court noted that the M & I stock price trended along with that of its competitors’. 

Interestingly, the Court recognized that its holding could be read to be the death knell for stock drop cases involving plans with employer stock accounts.  The Court indicated that its decision was not to be read that broadly, but also stated that ERISA cannot be read such that fiduciaries are transformed into guarantors of employee retirement savings.

By: Amanda Sonneborn and Chris Busey,           

In Metyk v. KeyCorp, No. 10-CV-2112 (N.D. Ohio Jan. 29, 2013),Judge Donald C. Nugent of the Northern District of Ohio granted Keycorp’s motion to dismiss in a sister case to  Taylor v. KeyCorp, Nos. 10-4163, -4198, -4199, (6th Cir. May 25, 2012), which was previously covered on this blog

Plaintiffs, on behalf of a putative class, brought claims against KeyCorp that mirrored those alleged in Taylor.  Specifically, they alleged that defendants breached various fiduciary duties by imprudently investing plan assets in KeyCorp stock despite knowing of the company’s financial problems. 

In Taylor, the Sixth Circuit held that the named plaintiff lacked standing because she did not suffer any actual loss. She had sold most of her stock in KeyCorp during the period in which it was alleged to be artificially inflated, thereby realizing a net profit from the sale.  The Sixth Circuit explicitly rejected plaintiff’s alternative investment theory.  Under that theory, her injury could be measured by comparing her actual position from the KeyCorp sale to what she would have realized had her money been invested in an entirely different investment option such as the S&P 500.

By contrast, Metyk involved plaintiffs who had purchased KeyCorp stock at the allegedly inflated price and who later sold it after the price declined.  Now, with plaintiffs capable of showing an apparent injury, the  jurisdictional issue was remedied and the court was able to proceed and rule on whether they could satisfy the requisite pleading standard in ERISA stock drop cases.  In analyzing that question, the court adopted the Supreme Court’s standard enunciated in Dura v. Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005).  Although Dura was a securities fraud case, the Metyk court noted that “its common-sense analysis is equally applicable” in the ERISA context.  Under that standard, plaintiffs must plead sufficient facts to show not only economic loss, but that the loss was caused by the alleged breach of fiduciary duty.  That is, plaintiffs must present facts showing that they bought the stock at the inflated price and that the market later learned the truth about the alleged misrepresentation, causing the share price to fall significantly.  Plaintiffs here did not identify any instance where the truth regarding an alleged misrepresentation was revealed to the market or in which KeyCorp’s stock price dropped as a result.  Accordingly, the court dismissed plaintiffs’ claims. 

This decision further signals a general skepticism among the courts with respect to ERISA stock drop claims.  The adoption of the Dura pleading standard in the ERISA context raises the bar for plaintiffs seeking to challenge plan investments in company stock.  It also provides defendants with another chance to defeat these claims before costly discovery can ensue.

By: Mark Casciari and Ada Dolph,

The Court of Appeals for the Sixth Circuit ruled in Pfeil v. State Street Bank & Trust Co., 671 F.3d 585, 591 (6th Cir. 2012) that the presumption that a fiduciary acted reasonably in retaining company stock cannot be applied at the pleading stage of litigation.  Pfiel continues to have an effect on the ability of defendants to sustain dismissals of “stock drop” complaints in that circuit.  On September 5, 2012, in Dudenhoefer v. Fifth Third Bancorp et al., No. 11-3012 (6th Cir. Sept. 5, 2012), the Sixth Circuit followed the rule set forth in Pfeil and reversed yet another dismissal by a district court.  See our prior posting here regarding Pfeil’s role in the Sixth Circuit’s reversal in Griffin v. Flagstar Bancorp Inc., No. 11-1497 (6th Cir. July 23, 2012). 

In Dudenhoefer, the plaintiffs alleged that the defined contribution plan’s fiduciaries were aware that Fifth Third had “switched from being a conservative lender to a subprime lender” and that “its loan portfolio became increasingly at risk due to defaults.”  The plaintiffs alleged further that the fiduciaries failed to disclose and otherwise misrepresented the subprime damage to the company, which caused the company’s stock to be artificially inflated before it plummeted in value.  Over the approximately two-year class period selected by the plaintiffs, the company stock price declined 74 percent.  The court found that the plan document did not “require[]” the company stock fund to be invested solely in company stock.  The plaintiffs alleged that “[a] prudent fiduciary facing similar circumstances would not have stood idly by as the plan’s assets were decimated.”  The defendants argued that the plaintiffs had failed to allege facts to overcome the presumption that they had acted reasonably.  

Noting Pfeil’s holding that the reasonableness presumption “is not an additional pleading requirement and thus does not apply at the motion to dismiss stage,” the Sixth Circuit reiterated that “the proper question” was whether the complaint “pleads facts to plausibly allege that a fiduciary has breached its duty to the plan and a causal connection between that breach and the harm suffered by the plan–that an adequate investigation would have revealed to a reasonable fiduciary that the investment in [Fifth Third Stock] was improvident.”  (internal quotation marks omitted). 

The Sixth Circuit found that the Dudenhoefer plaintiffs stated a claim for fiduciary breach.  The plaintiffs had adequately pled that the defendants had sufficient warning of problems with their investments based on “public information,” including “warnings by industry watchdogs of subprime lending practices, the rise of foreclosures and delinquency rates in real estate loans,” published articles on the same topics, and the closure of other mortgage companies due to their investments in the subprime mortgage industry.  The plaintiffs also pointed to Fifth Third’s participation in the U.S. Government’s Troubled Asset Relief Program (“TARP”) as evidence that the company was in a weakened financial condition and an imprudent investment. 

The plaintiffs also were successful in convincing the Sixth Circuit that a fiduciary decision to incorporate SEC filings into the summary plan description using selected language was sufficient to turn statements made in those SEC filings into a fiduciary act for which liability under ERISA may attach.   

By contrast, on September 4, 2012, the Second Circuit issued a summary order (non-precedential) affirming the dismissal of a “stock drop” complaint in In re Glaxosmithkline ERISA Litigation, No. 11-2289 (2d Cir 2012) reiterating its standard set forth In re Citigroup ERISA Litigation, 662 F.3d 128 (2d Cir. 2011), which we discussed hereCitigroup allowed courts to apply the reasonableness presumption at the pleadings stage.  The Glaxosmithkline panel found that, where the plan terms “require[e] or strongly favor[]” some investment in employer stock, “plaintiffs must plausibly plead that [the employer] faced a ‘dire situation,’” in order to preclude dismissal.  The Second Circuit found that the Glaxosmithkline plaintiffs had failed in that regard, reciting the oft-cited quote that “mere stock fluctuations, even those that trend downhill significantly, are insufficient to establish the requisite imprudence.”  The Second Circuit also found that the mere incorporation of SEC filings into plan disclosures did not give rise to ERISA liability “absent allegations supporting the inference that individual Plan administrators made intentional or knowing misstatements . . . by incorporating SEC filings into the SPDs.”  The Second Circuit affirmed its Citigroup holding that “[w]e decline to hold that Plan fiduciaries were required to perform an independent investigation of SEC filings before incorporating them into the SPDs.”

By: Ron Kramer and Michelle Scannell

The Sixth Circuit has once again reversed the dismissal of a stock drop class action, this time rejecting claims that the presumption of prudence should apply at the pleading stage, that the ERISA Section 404(c) safe harbor should apply, and that the complaint generally failed to state a claim under Twombly and IqbalGriffin v. Flagstar Bancorp Inc., No. 11-1497 (6th Cir. July 23, 2012) (unpublished).


In Flagstar, participants of the Flagstar Bancorp Inc. (“Flagstar”) 401(k) Plan asserted breach of fiduciary duty claims against Flagstar and certain officials and fiduciaries, alleging that it was imprudent for the Plan to have offered Flagstar stock–which dropped 95% in value between January 2007 and April 2010–as an investment option for participant Plan accounts.

Defendants invoked the “presumption of prudence” and moved to dismiss the complaint on various grounds, including failure to state claims for relief and the ERISA Section 404(c) safe harbor protection based on the participant-directed nature of the accounts.

The district court relied on Kuper v. Iovenko, 66 F. 3d 1447 (6th Cir. 1995) and sister circuit jurisprudence in holding that the presumption of prudence is not exclusive to ESOPs and applies to all eligible individual account plans.  Griffin v. Flagstar Bancorp Inc., 51 EBC 1013, 1022 (E.D. Mich. March 31, 2011).  While noting that the Sixth Circuit had not offered guidance on the issue, the district court further determined that the presumption of prudence applied at the pleading stage, and dismissed the action after plaintiffs were unable to demonstrate that Flagstar was on the verge of collapse or other dire circumstances.  Id. at 1023.  The court also concluded that even if the presumption did not apply, plaintiffs failed to state a claim with sufficient clarity under Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), for breach of fiduciary duty because the participants had total control over their investments and Flagstar remained a viable institution despite the drop in its share price.

The Pfeil Decision

Nearly one year after Flagstar was dismissed, the Sixth Circuit held that the  presumption of prudence did not apply at the pleading stage.  Pfeil v. State Street Bank & Trust Co., 671 F.3d 585, 590 (6th Cir. 2012) (reversing dismissal of ESOP action and applying presumption of prudence as an evidentiary standard).  The Pfeil court also ruled that even if defendants met the requirements to invoke Section 404(c) as an affirmative defense, the safe harbor provision does not exempt fiduciaries from their duty to screen investments for participant-controlled accounts.  Id. at 597.  The Pfeil decision signals a divergence from other circuits that have viewed stock drop actions with increasing skepticism and applied the presumption of prudence at the pleading stage.  We blogged about some of those decisions here .

 Review of Flagstar Dismissal

On appeal, the Sixth Circuit relied heavily on the intervening decision in Pfeil and ruled that the presumption of prudence was evidentiary in nature and did not apply at the pleading stage.  The court also cited Pfeil in reiterating that ERISA Section 404(c) does not exempt fiduciaries from their duty to exercise prudence regarding investment options, such as in this case deciding to offer Flagstar stock to plan participants.  Lastly, the court found that the complaint stated a plausible claim for fiduciary breach under Twombly and Iqbal.  The complaint contained forty-seven paragraphs of factual allegations that went far beyond documenting a simple drop in stock price to recite announcements from Flagstar itself, statements by analysts and financial media publications, and actions taken by Flagstar suggesting a precarious financial situation.

Despite increasing judicial skepticism toward stock drop cases in other circuits, the Sixth Circuit appears more favorably inclined to permit these claims to be litigated.  At a minimum, stock drop cases in the Sixth Circuit will not be dismissed on safe harbor claims or the presumption of prudence.

By: Ronald Kramer , Megan Troy and Sam Schwartz-Fenwick

On Friday, in Taylor v. KeyCorp, Nos. 10-4163, -4198, -4199, (6th Cir. May 25, 2012), the Sixth Circuit affirmed a district court’s dismissal in an ERISA stock-drop case, holding the remaining proposed named class plaintiff lacked standing because she could not establish an “injury in fact” when she sold the majority of her holdings in the company stock for a profit at a time she claims the stock was artificially inflated. 

Plaintiffs alleged that defendants breached their fiduciary duty by concealing KeyCorp’s true financial and operating condition, rendering the KeyCorp stock an imprudent investment.  Plaintiffs specifically argued that harm should be measured using an alternative-investment theory, namely, the difference between the investment as taken and the investment as it would have been had the KeyCorp holdings been placed in the S&P 500 Index.  Under this theory, the name plaintiff alleged she was injured as she would have made more money had her KeyCorp holdings instead been invested in the S&P 500 Index.

The Court explicitly rejected this theory of damages under the circumstances.  Explaining that when a plaintiff alleges that the withholding of information results in artificial inflation of company stock, the appropriate measure of damages is the amount of out-of-pocket loss by comparing the stock at its artificially-inflated price to a price it would have been if not tainted by the withheld information.  The Court distinguished cases such as Donovan v. Bierwirth, 754 F.2d 1049 (2d Cir. 1985), which adopted an alternative-investment theory for some ERISA claims.  Because damages based upon an entirely different investment vehicle, such as the S&P 500, are not fairly “traceable” to the defendants’ breach in this instance, the alternative-investment theory is inappropriate.

The Court also held that netting of the named class plaintiff’s gains and losses in her KeyCorp holdings during the class period was required to determine whether the plaintiff suffered actual injury because it was attributable to a single breach of fiduciary duty, the alleged withholding of information. 

This decision is consistent with the evolving trend of court skepticism toward efforts by plaintiffs to prove loss and causation by comparing the performance of a plan investment to an alternative investment that was never part of a plan’s investment menu. In addition, the decision offers a pragmatic approach to assessing loss for standing purposes, and gives defendants additional ammunition in responding to stock drop and other investment-related ERISA claims.

By: Ian Morrison, Meg Troy and Sam Schwartz-Fenwick

On May 8, 2012, the Eleventh and Second Circuits affirmed two district court dismissals of “stock drop” cases at the pleadings stage, joining the long line of recent decisions that demonstrate skepticism towards stock drop claims.  We have reported on some of those decisions here and here.

In Lanfear v. Home Depot, Inc., No. 10-12002 (11th Cir. May 8, 2012), the Eleventh Circuit joined the Second, Ninth, Fifth and Sixth Circuits in adopting the Moench presumption, holding that a 16.5% drop in stock price over a period of more than two months did not indicate that the company was on the “brink of financial collapse” which would have required defendants to deviate from the Plan. 

Plaintiffs alleged that company stock became an imprudent investment when, unknown to the public, company officials engaged in misconduct that artificially inflated the company’s stock price.  The Plan required one of the available investment options to be a Company Stock Fund, which was to be invested primarily in company stock.  The Court held that because the Plan used the term “primarily” instead of “exclusively,” defendants retained limited discretion over investment decisions and were subject to judicial review consistent with the Moench presumption. 

Explaining that the term “presumption” is not an evidentiary presumption, but a standard of review applied to a decision made by an ERISA fiduciary to continue to invest in or hold company stock in compliance with the directions of the Plan, and that “[m]ere stock fluctuations, even those that trend downward significantly, are insufficient to establish that a fiduciary abused its discretion . . . .”  Op. at 30-31 (internal quotations omitted), the Court affirmed the district court’s holding that plaintiffs did not plead facts establishing that the defendants abused their discretion by following the Plan’s directions.

In Fisher v. JP Morgan Chase & Co., No. 10-1303-cv (2d Cir. May 8, 2012) (unpublished), the Second Circuit affirmed a district court’s decision granting defendants’ judgment on the pleadings where, between April 1, 1999 and January 2, 2003, JP Morgan stock fell 55%.

Relying on recent opinions that adopted and applied the Moench presumption of prudence, In re Citigroup ERISA Litig., 622 F.3d 128 (2d Cir. 2011) and Gearren v. McGraw-Hill Cos., 660 F.3d 605 (2d Cir 2011), the Court explained that Plan fiduciaries are only required to divest an EIAP or ESOP of employer stock where the fiduciaries know or should know that the employer is in a “dire situation.”  The Court found plaintiffs did not meet this burden and emphasized that JP Morgan remained a viable company at all times and that, even when the stock was at its lowest price of $15 per share, it still retained significant value.

The court in Fisher further explained that the Moench presumption applies to “all EAIPs and ESOPs,” even when the Plan does not expressly require fiduciaries to offer company stock as an investment option, but rather when the Plan provisions “strongly favor” employee investment in the company.  Op. at 5 (emphasis in original).

Lanfear and Fisher reinforce the increasing degree to which courts are skeptical of ERISA stock drop claims and demonstrate the heightened factual threshold that plaintiffs must overcome at the pleadings stage if the plan at issue is “hard-wired” to provide for an employer stock investment option. 

 Despite increasing judicial skepticism it is important to recognize that some stock drop claims continue to survive motions to dismiss.  For example, in Guididas v. Community Nat’l Bank Corp., No. 11-cv-2545 (M.D. Fla. May 10, 2012), the court denied a motion to dismiss a stock drop claim where plaintiffs alleged that Plan fiduciaries continued to offer company stock as an investment option even after they knew that company stock was worthless in light of the company’s improper business and banking practices.  Relying on Lanfear, the court found these allegations sufficient to state a claim because, taken as true, they demonstrate that the Plan fiduciaries abused their discretion by following the Plan’s directions.