ERISA Litigation Update - December 2011 December 14, 2011
In This Issue

Second Circuit Adopts Presumption of Prudence for Holding of Employer Stock; Determines Fiduciaries Have No Affirmative Duty to Disclose Adverse Information

In a much anticipated decision, the Second Circuit Court of Appeals affirmed dismissal of a stock-drop suit involving two 401(k) plans sponsored by Citigroup, Inc. (“Citigroup”) entities.  The court also affirmed dismissal of a parallel stock-drop case involving two 401(k) plans sponsored by The McGraw–Hill Companies, Inc. (“McGraw–Hill”).  In these decisions, the Second Circuit joins the Third, Fifth, Sixth and Ninth Circuits in adopting a presumption of prudence for the holding of employer stock in plans designed to hold such stock; to date, no circuit court has rejected this presumption.

The facts of the cases are similar to each other and to other stock-drop cases that have emerged in the last decade.  The plans all required offering participants the ability to invest in a company stock fund (“Stock Fund”).  The Stock Funds were offered to participants along with other, diversified investment options.  In the Citigroup case, the price of the employer stock fell from $55.70 to $26.94 between January 1, 2007 and January 15, 2008.  In McGraw-Hill, the stock price declined from $68.02 to $24.23 between December 3, 2006 and December 5, 2008.  These price drops were alleged to have resulted from events in the sub-prime mortgage market.

The Defendants included the plans’ corporate sponsors, the committees responsible for the plans’ operation, and corporate directors and officers.  Each suit alleged that continued holding of the employer stock violated the fiduciary duties of loyalty and prudence under ERISA Section 401(a)(1)(A) and (B), and that the failure to provide greater disclosure about the corporate financial condition was also a breach of the duty of loyalty.  The cases also included subsidiary claims: that directors breached duties in appointing and monitoring plan fiduciaries, that fiduciaries placed their own interests and corporate interests ahead of the interests of participants, and that defendants had co-fiduciary liability for the breaches of others.  The district courts dismissed the complaints on August 31, 2009 (Citigroup) and February 10, 2010 (McGraw-Hill).  The appeals were argued together on September 28, 2010, and were decided by the same panel.

A two-to-one majority of the panel adopted the Moench v. Robertson, 62 F.3d 553 (3d Cir.1995), presumption of prudence for holding employer stock where the plan contemplates holding employer stock.  Under this presumption, “[p]lan fiduciaries are only required to divest [employer stock from a plan] where the fiduciaries know or should know that the employer is in a dire situation.”  The Citigroup court explained that “[m]ere stock fluctuations, even those that trend downward significantly, are insufficient to establish the requisite imprudence to rebut the presumption.”  The majority held that this presumption allows courts to balance the tension inherent in “two of ERISA’s core goals: (1) the protection of employee retirement savings through the imposition of fiduciary duties and (2) the encouragement of employee ownership through the special status provided” under ERISA to plans designed to hold sponsor stock.  The majority applied the presumption at the pleading stage and held that the allegations in each case were insufficient to establish a requisite dire situation.

In dismissing the disclosure claims, the panel further agreed with the Third Circuit that ERISA does not require a fiduciary to provide “investment advice or to opine on the stock’s condition.”  Additionally, the panel held that ERISA does not impose liability for statements made in filings with the Securities and Exchange Commission, even where the public filings were incorporated into a summary plan description, because “defendants who signed or prepared the SEC filings were acting in a corporate, rather than ERISA fiduciary, capacity when they did so.”  The panel affirmed dismissal of the remaining claims as derivative of the dismissed claims and as a matter of pleading deficiency.

In a lengthy dissent, Judge Straub argued that the majority holding represents “an alarming dilution of [ERISA] and a windfall for fiduciaries.” Judge Straub asserted that the presumption of prudence “leaves employees wholly unprotected from fiduciaries’ careless decisions to invest in employer securities so long as the employer’s ‘situation’ is just shy of ‘dire’—a standard that the majority neglects to define in any meaningful way.”  According to the dissent, the Moench presumption “does not appropriately balance ERISA’s competing values” and it dilutes the duty of prudence.  Judge Straub also disagreed with the majority’s approach to disclosure, and would have held instead that ERISA’s fiduciary obligations include “a duty to disclose material, adverse information regarding an employer’s financial condition or its stock, where such information could materially and negatively affect the expected performance of plan investment options.”

The decisions, available through the links above, are In re Citigroup ERISA Litigation, No. 09–3804–cv, __ F.3d __, 2011 WL 4950368, 51 Employee Benefits Cas. 1737 (2d Cir. Oct. 19, 2011), and Gearren v. The McGraw–Hill Companies, 660 F.3d 605 (2d Cir. 2011).  The plaintiffs in each case filed petitions for rehearing and for rehearing en banc on December 6, 2011.

Fourth Circuit Holds Trustees Are Liable Only If Their Fiduciary Breach Caused the Plan’s Loss

In Plasterers’ Local Union No. 96 Pension Plan v. Pepper, No. 10-1364 (4th Cir. December 1, 2011), the Fourth Circuit affirmed the district court’s findings that trustees of a multi-employer pension plan breached ERISA fiduciary duties by not diversifying plan investments and by failing to prudently investigate investment alternatives for the plan.  However, the district court’s holding that the trustees were liable to the plan was reversed because the Fourth Circuit concluded that the lower court never undertook to determine what losses, if any, resulted from the trustees’ breaches of duty.

In 1992, the trustees established an investment strategy designed to avoid losses.  In accordance with this strategy, plan assets were invested solely in certificates of deposit with various banks and one- or two-year Treasury bills.  For 12 years, the trustees never seriously considered any alternatives to this investment strategy.  After the trustees were removed from their positions in 2004, the new trustees sued them, asserting violations of the duties of prudence and diversification under Section 404(a)(1)(B) and (C) of ERISA.  At trial, the plaintiffs’ expert testified that a prudent investment strategy for the plan would have been to invest one-half of the assets in an equity index and the other half in an aggregate bond index. 

The district court found the defendant trustees liable under ERISA Section 409(a) (which imposes liability for fiduciary breaches), holding that, as part of their ERISA duty of prudence, the trustees had an obligation to investigate alternative investment strategies, which they had not done.  The district court also found that defendant trustees had breached their duty to diversify plan investments.  The court determined damages for these breaches by comparing the plan’s actual investment return for the three-year period of 2003 through 2005 to the return the plan would have had if invested in a 50/50 equity/bond mix as advocated by the plaintiffs’ expert.  Using this method, damages exceeded $430,000.

In vacating the district court’s judgment and remanding the case, the Fourth Circuit criticized the district court’s analysis in several respects, even though it did not find fault in the lower court’s holdings that the defendant trustees had violated their fiduciary duties to investigate and diversify.  The appeals court emphasized that, in this context, a causal link between a fiduciary’s breach and the plan’s loss is a prerequisite to liability under ERISA Section 409(a): “simply finding a failure to investigate or diversify does not automatically equate to causation of loss and therefore liability.”  In the Fourth Circuit’s view, the defendant trustees’ failure to investigate could result in a loss to the plan, and liability for the trustees, only if the actual investments they selected were found to be imprudent – a finding the district court had not made.  “Because the court never found that the failure to investigate investment options led to imprudent investments or otherwise found that the investments were objectively imprudent, its analysis lacked the essential element of causation.”  The court of appeals also noted that the district court had failed to address whether the plan’s lack of diversification was “clearly prudent under the circumstances,” as required by ERISA Section 404(a)(1)(C).  The Fourth Circuit instructed that, on remand, in determining whether the investments selected by the defendant trustees were prudent, the district court was to focus on the specific facts and circumstances of the plan, including its size and type (the plan was a defined contribution plan), the demographics of plan participants, and the defendant trustees’ goal and objectives in establishing its investment strategy.

The Fourth Circuit also criticized the district court’s analysis regarding damages.  It faulted the district court’s use of the 2003 to 2005 timeframe for measuring damages, observing that the district court had acknowledged that this period “had been picked out of the air.”  It emphasized the critical role played by selection of the applicable time frame in fixing damages in this context, noting that using the period 1999 to 2005 instead of the period selected by the lower court would have reduced damages by over $300,000.  The appeals court directed that, on remand, the district court (if it does find the defendant trustees liable) “must articulate the reasoned basis for awarding damages based on a particular time frame.”

The Plasterers’ decision illustrates that, while determining whether a breach has occurred is often given central focus in ERISA fiduciary cases, issues related to causation of loss and the determination of damages can frequently be just as important.

Settlement in Major 401(k) Fee Case Is Preliminarily Approved

On December 5, 2011, the U.S. District Court of the Western District of Missouri preliminarily approved an agreement by the parties to settle the putative class action claims asserted by participants in Wal-Mart Stores Inc.’s 401(k) plan. 

In Braden v. Wal-Mart Stores, Inc., et al., Case No. 6:08-cv-3109-GAF (W.D. Mo.), a plan participant asserted putative class claims against the plan’s employer-sponsor and the plan’s named fiduciary, alleging, among other things, excessive and undisclosed fees and imprudent selection of investment options, which included 10 retail class mutual funds, most of which were actively managed.  The plaintiff also alleged that the plan’s directed trustee and recordkeeper was a relevant ERISA fiduciary and breached duties by offering retail mutual funds that paid it revenue sharing, allegedly resulting in millions of dollars in undisclosed fees. 

As reported in Goodwin Procter’s June 22, 2010 Financial Services Alert, in 2009, the U.S. Court of Appeals for the Eighth Circuit had reversed the district court’s dismissal of the action under Fed. R. Civ. P. 12(b)(6), holding that the plaintiff had adequately stated claims for breach of fiduciary duty and prohibited transactions against the sponsor and named fiduciary where the complaint alleged that the named fiduciary entered an arrangement with a service provider for “undisclosed amounts of revenue sharing payments in exchange for services rendered to the Plan,” among other allegations addressed to investment options selected for the plan.  

Under the terms of the settlement, the defendants will pay a total of $13.5 million, the net proceeds of which (after the payment of attorneys’ fees and costs and any administrative expenses) will be used to pay plan expenses.  In addition to this monetary payment, the defendants agreed to certain non-monetary relief concerning fund selection and disclosures to plan participants. 

The defendants agreed that for a two-year period following the settlement, plan fiduciaries will retain an investment advice fiduciary to provide independent advice and recommendations on selection and monitoring of plan investments, will continue to make web-based investment education resources available to plan participants, and will continue the plan’s ongoing process of removing from the plan’s lineup retail mutual funds or funds that pay 12b-1 fees or revenue sharing.  Plan fiduciaries also agreed to consider, where and when appropriate, adding low-cost, passively managed investment vehicles to the plan in addition to the two index funds already offered. 

The defendants further agreed to comply with regulations that govern mandated disclosures to participants, and to provide participants access to investment cost calculation tools. 

A final approval hearing is expected to take place on March 7, 2012.

Upcoming Conference

SIFMA Compliance & Legal Society Annual Seminar
March 18-21, 2012
Miami, FL

Jamie Fleckner  will present on ERISA issues at SIFMA's annual compliance and legal conference. SIFMA's mission is to develop policies and practices that strengthen financial markets and that encourage capital availability, job creation and economic growth while building trust and confidence in the financial industry.