One by-product of the recent economic downturn in the financial services sector has been an increase in so-called “stock drop” cases filed by the plaintiffs’ bar against financial services companies. These class action lawsuits challenge investments in employer stock held in 401(k) plans, employee stock ownership plans (“ESOPs”) and other defined contribution retirement plans sponsored by financial services companies for their employees. Often the commencement of such an ERISA lawsuit will follow the filing of a complaint on behalf of investors generally, based on alleged securities laws violations by the financial services company. Although ERISA stock drop cases present special challenges for defendants that can make them more difficult to defend than a corresponding securities law case, some plan sponsors have taken certain steps in hope of reducing the risk of potential liability in this area.
While this increased focus of the ERISA plaintiffs’ bar on financial services companies is relatively recent, stock drop cases against plan sponsors facing economic difficulties have been common since the 1990s. Although they may include many counts, ERISA stock drop complaints generally rely on two broad types of allegations. First, plaintiffs typically argue that plan fiduciaries breached their duties of prudence and loyalty under ERISA by investing plan assets in employer stock or offering it as an option for participants to invest in under the plan at a time when the employer was encountering significant financial problems. Second, plaintiffs often allege that plan fiduciaries breached their duties by failing to disclose to plan participants information regarding the company’s financial condition that would be material to the participants’ decision whether to invest in employer stock under the plan. The named defendants in these cases may include not only the plan sponsor but also employees who are members of the plan’s investment committee, and officers and directors of the plan sponsor.
Plaintiffs’ attorneys may view an ERISA stock drop action as easier to litigate than a case brought under the securities laws. For example, they argue that the heightened pleading standards of the Private Securities Litigation Reform Act and Federal Rule of Civil Procedure 9(b) (relating to fraud claims) should not apply in ERISA stock drop cases. Further, they contend that the fiduciary standards of care under ERISA, including the duties of prudence and loyalty, are more stringent than those imposed on an issuer under the securities laws. In light of these advantages from the perspective of plaintiffs’ attorneys, a financial services company that sponsors a plan with significant investments in employer stock is at risk of being the target of an ERISA lawsuit whenever its stock price declines substantially.
Some plan sponsors have taken steps that they believe may reduce this litigation risk. For example, some plan sponsors – hoping to counter arguments that plan investments in employer stock may involve a conflict of interest – have appointed an independent, professional investment manager to determine, on an ongoing basis, whether their plan should continue to invest in employer stock. Other plan sponsors have made an effort to review carefully the provisions of their plan documents concerning investment in employer stock to ensure they are providing appropriate protection. In this regard, a number of courts have held that there is a rebuttable presumption that a fiduciary’s continued investment in employer stock is prudent when it is required by the terms of the applicable plan documents.
While some plan sponsors have succeeded in obtaining dismissal of ERISA stock drop cases at an early stage, others have been unsuccessful. Often, the outcome of a motion to dismiss will turn on the details alleged in the complaint and the particular court’s view of ERISA’s role in the employer stock context. For example, last month a federal district court in Ohio dismissed a complaint challenging the decision to continue making employer stock available as an investment alternative under a 401(k) plan, where the plan sponsor (a bank) had allegedly become subject to substantial exposure for subprime loans, the employer stock price had declined 65%, and the plan’s employer stock fund had lost over $100 million. See In re Huntington Bancshares Inc. ERISA Litigation, Case No. 2:08-cv-0165 (S.D. Oh. Feb. 9, 2009). The court in Huntington Bancshares concluded that these allegations – and the plaintiff’s references to general difficulties in the U.S. mortgage market – did not raise the type of “red flag” that would have required investigation into the prudence of retaining employer stock as an investment option, as “ERISA was simply not intended to be a shield from the sometimes volatile financial markets.”
In contrast, in December 2008 a federal district court in Michigan refused to dismiss a stock drop complaint against Ford Motor Company, emphasizing that the complaint included specific allegations asserting that the company had been mismanaged in a manner that made its stock too risky to be a plan investment. See In re Ford Motor Company ERISA Litigation, Case No. 06-11718 (E.D. Mi. Dec 22, 2008). In the Ford Motor court’s view, the plaintiffs could overcome the presumption that an employer stock investment is prudent by demonstrating that holding the stock had become so risky that no prudent fiduciary would invest any plan assets in it, taking into account not only the stock’s price in the market but also the risk tolerance of plan participants. In the court’s view, a standard that focused solely on the market, and not on participants’ risk tolerance, would “demote the ERISA duty of prudence from being ‘the highest known to the law’ . . . to being largely illusory.” The contrast in the outcomes in Huntington Bancshares and Ford Motor reflects not only a difference in the specificity of allegations in the complaints, but also difference in the courts’ perspectives on the role of ERISA fiduciary duties in the employer stock context.As more decisions in these cases are expected in the coming months, it may become possible to determine whether courts will develop a more consistent view of a fiduciary’s obligations when a plan’s investment in employer stock drops in value.