By Pamela L. Signorello, Kim S. Orbeck, Terrence R. McInnis and Cathy A. Simon,
On October 19, 2011, the U.S. Court of
Appeals for the Second Circuit affirmed the dismissal of two putative
class actions alleging that ERISA fiduciaries breached their duties to
plan participants by imprudently continuing to offer company stock as an
investment option. The cases, which were on appeal from the U.S.
District Court for the Southern District of New York, were argued in
tandem because they involved substantially similar facts and raised
similar issues. This advisory explains the decisions in In re: Citigroup ERISA Litigation and Gearren, et al. v. The McGraw-Hill Companies, et al.
Citigroup had two retirement plans, each of which mandated that the
Citigroup Common Stock Fund (composed of shares of Citigroup common
stock) be included as an investment option in the plan. Plaintiffs in
the Citigroup ERISA litigation were participants in, or beneficiaries
of, the plans who invested in Citigroup stock from January 1, 2007,
through January 15, 2008 (the Class Period), during which time
Citigroup's share price fell from $55.70 to $26.94. Plaintiffs alleged
that Citigroup's participation in the ill-fated subprime mortgage market
caused the stock price drop during the Class Period.
Likewise, plaintiffs in the McGraw-Hill matter were participants in
two retirement plans, which also were eligible individual account plans
(contribution plans invested primarily in qualifying employer
securities). During the Class Period alleged in that case (December 3,
2006, through December 5, 2008), McGraw-Hill's share price fell from
$68.02 to $24.23. Plaintiffs alleged that the provision of inflated
ratings to financial products linked to the subprime mortgage market by
Standard & Poor's, the financial division of McGraw-Hill, caused the
stock price drop during the Class Period.
In both matters, plaintiffs asserted two primary claims. First, they
alleged that defendants breached their fiduciary duties of prudence and
loyalty by refusing to divest the plans of company stock, which,
according to plaintiffs, was an imprudent investment option during the
respective Class Periods. Second, they alleged that defendants breached
their fiduciary duties by failing to provide complete and accurate
information to plan participants.
On the first claim, the Second Circuit determined that defendants'
decisions not to divest the plans of company stock or impose
restrictions on participants' investment in that stock are entitled to a
presumption of prudence and should be reviewed for an abuse of
discretion. In so holding, the Second Circuit joined the Third, Fifth,
Sixth and Ninth Circuits, all of which have adopted the presumption of
prudence (also referred to as the "Moench" presumption after the Third Circuit decision in Moench v. Robertson, 62 F.3d 553 (3rd. Cir. 1995) [enhanced version available to lexis.com subscribers]). According to the Second Circuit, the Moench
presumption "provides the best accommodation between the competing
ERISA values of protecting retirement assets and encouraging investment
in employer stock." To date, no court of appeals has rejected the Moench presumption.
In applying the Moench presumption of prudence, the Second
Circuit held that fiduciaries should override plan terms requiring or
strongly favoring investment in employer stock only when "owing to
circumstances not known to the [plan] settlor and not anticipated by
him," maintaining the investment in company stock "would defeat or
substantially impair the accomplishment of the purposes of the [plan]."
According to the Court, a settlor, mindful of the long-term horizon of
retirement savings, would not intend that fiduciaries divest from
employer stock at the sign of any impending price decline. Instead,
"only circumstances placing the employer in a 'dire situation' that was
objectively unforeseeable by the settlor could require fiduciaries to
override plan terms." Although proof of the employer's impending
collapse may not be required to establish liability, "mere stock
fluctuations, even those that trend downhill significantly, are
insufficient to establish the requisite imprudence to rebut the Moench presumption."
The Second Circuit also emphasized that a fiduciary's actions should
not be judged in hindsight but rather with reference to the time of each
investment decision. "We cannot rely, after the fact, on the magnitude
of the decrease in the employer's stock price; rather, we must consider
the extent to which plan fiduciaries at a given point in time reasonably
could have predicted the outcome that followed." The Second Circuit
concluded that, in these cases, plaintiffs failed to allege facts
sufficient to show that defendants either knew or should have known that
Citigroup or McGraw-Hill was in the sort of "dire situation" that
required them to override plan terms.
Although the Second Circuit affirmed the District Court's holdings,
it rejected the District Court's determination that defendants were
insulated from liability simply because they had no discretion to divest
the plans of employer stock. According to the Second Circuit, "such a
rule would leave employees' retirement savings that are invested in
[company stock] without any protection at all - a result that Congress
sought to avoid in enacting ERISA."
On plaintiffs' second primary claim, the Second Circuit held that (1)
defendants had no duty to provide participants with nonpublic
information pertaining to expected performance of company stock; and (2)
plaintiffs did not sufficiently allege that defendants, in their
fiduciary capacities, made any knowing misstatements regarding company
stock. The Court also held that, under the circumstances presented in
these cases, defendants were not under a duty to independently
investigate the accuracy of the companies' SEC filings before
incorporating them into the Summary Plan Documents.
According to the Court, "[w]hile we cannot rule out that such an
investigation may be warranted in some cases, plaintiffs have not
alleged facts that, without the benefit of hindsight, show that it was
warranted here." The Court further observed that "requiring Plan
fiduciaries to perform an independent investigation of SEC filings would
increase the already-substantial burden borne by ERISA fiduciaries."
The Court affirmed the dismissal of plaintiffs' remaining claims inasmuch as they were derivative of the two primary claims.
In both cases, Judge Straub dissented in part and concurred in part.
In particular, Judge Straub objected to the Second Circuit's adoption of
the Moench presumption, finding "no justification for cloaking
fiduciaries' investment decisions in a mantle of presumptive prudence."
The fact that there was a dissent may increase the likelihood of
rehearing en banc.
©Troutman Sanders LLP
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