Estate and Elder Law

Ballard Spahr LLP: Supreme Court Denies Review of Second Circuit Cases Adopting Moench Presumption for Fiduciaries of ERISA-Governed Plans

By Patricia A. Smith, Brian M. Pinheiro, and Erin K. Clarke

The U.S. Supreme Court recently refused to grant certiorari for two 2011 Second Circuit stock drop decisions that had adopted the "Moench presumption" for determining whether fiduciaries imprudently invested assets in employer stock. In embracing the Moench presumption, the Second Circuit joined the Fifth, Sixth, Ninth, and 11th Circuits, all of which have adopted the Third Circuit's Moench analysis, first articulated in 1995 in Moench v. Robertson [enhanced version available to subscribers]. 

The Moench presumption presumes compliance with the Employee Retirement Income Security Act of 1974 (ERISA) when employee stock ownership plan (ESOP) fiduciaries invest plan assets in employer stock. The presumption may be overcome only by proof the fiduciary abused his discretion in doing so. As extended to 401(k) plans, this presumption makes it more difficult for a plaintiff to prevail in a lawsuit against a plan fiduciary based on claims that the fiduciary acted imprudently in offering employer stock as an investment option in a 401(k) plan.

ERISA imposes a duty on plan fiduciaries to invest plan assets as a "prudent person" would do. Although ERISA ordinarily requires a fiduciary to act prudently by "diversifying the investments of the plan so as to minimize the risk of large losses," the statute also exempts in eligible individual plan accounts the "acquisition or holding of qualifying employer real property or qualifying employer securities" from the obligation to diversify. 

In both Second Circuit cases, the plans mandated that company stock be offered as an investment option. In Gearren v. McGraw-Hill Cos. [enhanced version available to subscribers], McGraw-Hill employees brought a class action and alleged that the company and its leadership knew or should have known that the company's stock was likely to decline sharply in value once it was revealed that the company's financial services division knowingly gave improperly high credit ratings to financial products linked to the subprime-mortgage market. The plaintiffs claimed that the public's discovery of these ratings practices led to a sharp drop in McGraw-Hill stock.

In Gray v. Citigroup Inc. [enhanced version available to subscribers], the plaintiffs, participants in 401(k) plans for Citigroup employees, alleged that the company invested extensively in subprime mortgages and securities related to such mortgages. The plaintiffs alleged that the company downplayed its exposure to that market, even though it recognized the need to limit that exposure. Thus, the plaintiffs argued that Citigroup knew or should have known that the company would incur substantial losses from the subprime investments, but failed to notify employees about the company's exposure.

The District Court for the Southern District of New York dismissed both complaints. The Second Circuit affirmed the dismissals by applying the Moench presumption of prudence with respect to both eligible individual account plans as well as to ESOPs. The court further held that the presumption could apply at the pleading stage because it is a standard of review applied to an ERISA fiduciary's decision.

The attorneys in Ballard Spahr's Labor and Employment Group and Employee Benefits and Executive Compensation Group provide counseling and representation on matters arising under ERISA, including fiduciary duty questions and related litigation issues. If you have questions on fiduciary investments or related matters, please contact Patricia A. Smith at 856.873.5521 or, Brian M. Pinheiro at 215.864.8511 or, Erin K. Clarke at 215.864.8318 or, or the Ballard Spahr attorney with whom you work.

Copyright © 2012 by Ballard Spahr LLP.
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.


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