Numerous ERISA stock drop suits filed in the wake of the recent financial crisis continue to work their way through the system. To date, no case has gone to trial, but several have resulted in notable decisions at the motion to dismiss and/or summary judgment stages – with victories for both plaintiffs and defendants. The following are two examples of recent decisions in subprime-related class action lawsuits.
Johnson v. Radian Group, Inc.
In Johnson v. Radian Group, Inc., No. 08-2007, 2010 WL 2136562 (E.D. Pa. May 26, 2010), the district court granted the defendants’ motion to dismiss an amended putative class action complaint for breach of fiduciary duties. The Johnson complaint asserted claims against the plan’s employer-sponsor, a credit enhancement company that offered mortgage insurance and other financial services (the “Sponsor”), and the plan’s named fiduciaries, and was filed on behalf of all participants whose plan accounts held Sponsor stock. The plaintiff alleged that the defendants breached their fiduciary duties to prudently and loyally manage the plan and to not mislead plan participants about the risks associated with Sponsor stock in relation to the Sponsor’s investment in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”), an issuer, servicer and investor in credit-sensitive residential mortgage assets, in which the Sponsor held a 46% interest. The plaintiff further alleged that the Sponsor failed adequately to disclose that it faced a “monumental liquidity crisis” caused by the subprime mortgage crisis coupled with C-BASS’s business model, and that as the subprime mortgage market deteriorated giving rise to a material increase in mortgage loan defaults to which C-BASS was vulnerable, the Sponsor failed to disclose this investment risk to participants. On these allegations, the plaintiff asserted that the Sponsor breached fiduciary duties owed to participants by imprudently continuing to offer Sponsor stock as an investment option and matching contributions.
In granting the motion to dismiss, the court applied the presumption of prudence first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 533 (3d Cir. 1995), which affords deference to fiduciary decisions regarding investment in employer stock. Under the Moench presumption, fiduciaries investing in company stock where the plan at issue encourages such investment are presumed to have acted consistently with ERISA fiduciary duties, and their conduct is judged under an abuse of discretion standard.
The court held that the Moench presumption properly applied in Johnson, where the plan called for all matching contributions to be made in Sponsor stock and therefore required investment in the stock. The court also rejected the plaintiff’s argument that, because plan fiduciaries had the ability to add, remove or change plan options, the Moench presumption should not apply, noting that courts apply the presumption to plans that offer various investment options. The court further held that inclusion of the Sponsor stock fund was not discretionary just because the Sponsor had the right to amend the plan to discontinue investments in Sponsor stock. The right to amend a plan is a settlor function not subject to review under ERISA’s fiduciary provisions.
In addition, the court found that the plaintiff failed to rebut the Moench presumption where the plaintiff failed to demonstrate that the defendants could not have believed reasonably that continued adherence to the plan’s terms was in keeping with the settlor’s expectations of how a prudent trustee would operate. Specifically, the plaintiff had failed to plead facts to support the kind of “dire situation” that would require plan fiduciaries to depart from the plan’s terms requiring investment in company stock, in part because the plaintiff did not demonstrate that the defendants were aware of any “monumental liquidity crisis” at the time that the Sponsor announced that its investment in C-BASS was materially impaired. The court also noted that the drop in the Sponsor’s stock price after this announcement was insufficient in itself to rebut the Moench presumption.
The court also dismissed the plaintiff’s claims for breach of the duties of disclosure and loyalty for failure to put forth allegations sufficient to sustain those claims. Having dismissed the plaintiff’s original complaint for failure to state a claim, the court granted the defendants’ motion to dismiss the amended complaint with prejudice.
Dann v. Lincoln National Corp.
In another recent decision addressing claims challenging the inclusion of company stock in a retirement plan, the court allowed the plaintiff’s claims to go forward. In Dann v. Lincoln National Corp., No. 08-5740, 2010 WL 1644276 (E.D. Pa. Apr. 20, 2010), the district court denied the defendants’ motion to dismiss a putative class action complaint for alleged breaches of ERISA fiduciary duty in connection with inclusion of employer stock in a 401(k) plan offered by a corporation that sold, among other things, retirement income products (the “Sponsor”).
The Dann complaint asserted claims against the Sponsor and its CEO on behalf of all plan participants and beneficiaries whose accounts held Sponsor stock, alleging that the defendants knew or should have known that, as financial markets struggled in 2008, the Sponsor was exposed to investment losses due to its investments in mortgage-backed securities, structured investment products and other derivative securities. On these allegations, the plaintiff claimed that the defendants breached their duties of prudence and loyalty by continuing to invest the plan’s assets in Sponsor stock. The plaintiff further alleged that the defendants breached duties by failing to disclose complete and accurate information about the company’s exposure to investment losses, which prevented plan participants form making informed investment decisions, and failed to adequately monitor other plan fiduciaries or to provide them with complete and accurate information about the risk of loss.
In their motion to dismiss, the defendants argued, among other things, that they were entitled to a presumption of prudence for their decision to invest in Sponsor stock, and that they had met their disclosure obligations. While the court agreed that the Moench presumption applied because a component of the plan was an employee stock ownership plan that was designed to invest primarily in Sponsor stock, it denied the defendants’ motion to dismiss on the ground that the plaintiff had pleaded “dire circumstances” sufficient to overcome the presumption. The plaintiff’s allegations of dire circumstances included: (i) that the Sponsor stock price incurred a “precipitous decline,” at one point a 90% drop; (ii) that the defendants knew or should have known of the company’s exposure to losses in its investment portfolio, particularly when, among other things, two ratings agencies had downgraded the Sponsor’s credit and debt ratings; and (iii) that certain defendants suffered conflicts of interest because their compensation was tied to the price of Sponsor stock, creating an incentive for those defendants to continue investment in the stock. Accordingly, the court held that the plaintiff had sufficiently alleged circumstances that might cause a prudent plan fiduciary to discontinue investment in Sponsor stock, and that the plaintiff was entitled to discovery on his prudence and loyalty claims.