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By Mark S. Thomas and Robert W. Shaw
The U. S. Court of Appeals for the Second Circuit has affirmed the dismissal of a case brought against Morgan Stanley Investment Management Inc. ("Morgan Stanley") concerning certain investments in mortgage-backed securities that allegedly violated fiduciary duties imposed under ERISA. The case, Pension Benefit Guaranty Corp. v. Morgan Stanley Investment Management Inc., No. 10-4497-cv (2d Cir. 2011) [enhanced version available to lexis.com subscribers], was a two-to-one decision in favor of the defendant, holding that the plaintiffs failed to state sufficient facts to allege a claim upon which relief could be granted. In reaching that conclusion, the Second Circuit has implied the types of facts that may state a viable claim against a plan asset fiduciary in cases alleging imprudent plan investments.
The Morgan Stanley case was brought by Saint Vincent Catholic Medical Centers, Pension Benefit Guaranty Corp., and Queensbrook Insurance Ltd. against Morgan Stanley, the plan administrator for the fixed-income portfolio of the Saint Vincent Catholic Medical Centers Retirement Plan ("the Plan"). The Plan's fixed-income portfolio comprised about 35% of all Plan assets, and the Plan's investment guidelines stated that the primary investment objective for this portfolio was the preservation of principal with emphasis on long-term growth. The benchmark for the portfolio's performance was the fund known now as the Citigroup Broad Investment Grade Bond Index ("Citigroup BIG"), which the portfolio was to track and at least modestly exceed.
The primary basis for the plaintiffs' claims was an allegedly disproportionate and imprudent investment of the portfolio's plan assets in non-agency mortgage-backed securities. The Amended Complaint alleged that "the selection of the Citigroup BIG index as a benchmark signaled to [Morgan Stanley] that, as an ERISA fiduciary, it was required to execute a low-risk, conservative investment strategy." The Amended Complaint also alleged that "[t]hroughout 2007 and 2008, there were warning signs that these securities were not appropriate for the fixed-income portfolio." For instance, the Amended Complaint referred to investments in subprime mortgage securities issued by companies that "suffered large, publicly disclosed losses in 2007 and 2008 due to the subprime mortgage crisis." The district court held that such facts were not sufficient to support a claim of fiduciary breach by Morgan Stanley and accordingly dismissed the complaint.
On appeal, the majority of the Second Circuit panel determined that plaintiffs' allegations did not "give rise to a plausible inference that Morgan Stanley knew, or should have known, that the securities in the Portfolio were imprudent investments." The decline in market price of the mortgage-backed securities, viewed in hindsight, did not, in itself, give rise to a reasonable inference that those investments were imprudent to buy or maintain and therefore should have been sold at a much-reduced price. The court also observed that, while a rapid decrease in the value of a plan asset might prompt a prudent fiduciary to investigate whether it was still prudent to hold such an investment, the Amended Complaint did not allege that Morgan Stanley had failed to make such an investigation.
The Second Circuit also rejected the plaintiffs' claim of improper diversification, holding that the Amended Complaint did not "plausibly show with factual allegations" that there was a basis for relief based on the plan assets being insufficiently diversified. The non-agency mortgage-backed securities in question comprised 12.6% of the total fixed-income portfolio, which itself constituted about 35% of the Plan's assets. By itself, and even with the other facts alleged, this did not show improper diversification.
Finally, the court rejected the claim that Morgan Stanley did not act in accordance with Plan documents, holding that the Amended Complaint failed to identify any specific violation of such documents. In particular, the Plan's guidelines included thirteen specific investment manager restrictions that Morgan Stanley had to follow unless it obtained written approval from Saint Vincent Catholic Medical Centers's investment committee, yet the plaintiffs did not allege that Morgan Stanley violated any of those restrictions.
Pension Benefit Guaranty Corporation v. Morgan Stanley Investment Management, Inc. serves as a caution that complaints alleging breaches of fiduciary duties under ERISA cannot rely on generalized allegations of imprudence. In particular, with respect to the loss of value of retirement plan assets, plaintiffs will be expected to show more than the mere fact that an asset declines dramatically in value. That fact alone may not support a reasonable inference that the choice to retain the asset in the plan portfolio is a breach of the duty of prudence. Plan sponsors, fiduciaries and participants may indeed wonder when a claim of investment imprudence would be possible if the notorious case of the mortgage-backed securities does not provide it. However, the Second Circuit's decision is a reminder that each such claim must still stand on its own facts, and the court's opinion is a useful demonstration of how those facts may be evaluated.
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