What is the Correct Standard of Prudence in Employer Stock Cases?

What is the Correct Standard of Prudence in Employer Stock Cases?

45 J. Marshall L. Rev. 541, Spring 2012

Author: José M. Jara

I. Introduction

A decade after the collapse of Enron and WorldCom, the headlines were flooded with the collapse of companies like Bear Stearns and Lehman Brothers due to the subprime mortgage crisis. After this latest economic crisis, the continued investment in common stock via a retirement plan may be considered risky for purposes of achieving a suitable retirement; however, this is not necessarily true. Common stock can arguably be a prudent investment within the overall investment portfolio of a retirement plan. In reality, common stock often fluctuates in value, so a drop in the stock price over a period of time should not be the basis of a lawsuit claiming the stock was an imprudent investment. Many prudent investors purchase stock that fluctuates, but becomes profitable in the long run. As the great investor Warren Buffet once said, "In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." Accordingly, investment in common stock can be judged on a uniform basis in accordance with a well-crafted retirement portfolio and can ultimately be deemed a prudent investment.

Yet, with the stock market crisis of 2008, many companies that provide pension plans with an option to invest in employer stock have been the subject of lawsuits claiming violations of the fiduciary provisions under the Employee Retirement Income Security Act of 1974 ("ERISA"). Many cases have involved companies on the verge of bankruptcy, causing employer stock to become worthless. Nonetheless, even after a decade of the billion dollar losses in retirement savings by participants in the more publicized cases of the Enron, WorldCom and Global Crossing, participants are still investing a considerable percentage of their retirement account balances in employer stock today.

Over the years, given the subprime mortgage crisis, scandals such as those involving Enron and Bernie Madoff, the unprecedented government bailout, and the international economic crises, many participants in 401(k) plans have seen the value of their account balances drop dramatically in their investments in employer stock. In this regard, the individuals and entities responsible for the administration of 401(k) plans, and frequently the members of the companies' board of directors, have been sued by 401(k) participants under ERISA for breach of fiduciary duty. Usually the class action complaints allege that the plan's investment in employer stock was imprudent and/or that certain misrepresentations or omissions were made about the company's financials that precluded participants from making informed decisions about their investment in employer stock.

In cases involving employer-directed contributions, as well as cases involving participant-directed contributions, the allegations of many of these cases sound very much like matters that would be alleged as violations of federal securities laws but for the fact that the plaintiffs are participants in a plan governed by ERISA. In fact, many of the same plaintiffs have brought suits alleging securities law violations in addition to bringing ERISA lawsuits.

A bright line rule has not yet developed as to liability in these stock drop cases. In fact, to date, very few of these cases have been fully litigated. Motions to dismiss have been granted or denied, motions for summary judgment have been granted or denied, and a large number of settlements have been reached. Over the past decade, these settlements have totaled over $1 billion. Yet, despite these risks and uncertainties, many employers still offer employees the opportunity to invest in the employer's common stock. [footnotes and chart omitted]

This excerpt was reprinted with permission from The John Marshall Law Review

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