Alert September 30, 2010

Federal District Court Grants in Part Motion to Dismiss Securities Lending Case

In Diebold, et al. v. Northern Trust Investments N.A., et al., No. 09-c-1934 (N.D. Ill. Sept. 7, 2010), the U.S. District Court for the Northern District of Illinois granted in part and denied in part a motion to dismiss ERISA breach of fiduciary duty and prohibited transaction claims involving an investment manager’s securities lending program.  This is one of a number of recent cases challenging such programs in light of the recent credit crisis, as previously reported in Goodwin Procter’s June 25, 2009 ERISA Litigation Update.

The case was filed in 2009 by two employees who participated in defined contribution plans that invested in funds managed by the defendant investment manager.  The funds engaged in securities lending under a program that involved the lending of securities held by the funds to borrowers who posted collateral equal to 102% of the value of the borrowed securities.  The collateral was placed into collateral pools, which were then invested in longer-term fixed income instruments in accordance with investment guidelines established for each pool.  The collateral pools generated investment income to the funds participating in the program, a portion of which was paid to the securities lending program manager – also a defendant. 

The plaintiffs alleged that the defendants imprudently managed the collateral pools, causing the funds in which the plaintiffs were invested through their defined contribution plans to lose money.  Specifically, the plaintiffs alleged that the defendants took no steps to amend the securities lending program or change the investment strategy for the collateral pools even after becoming aware that the liquidity crisis in the credit market would make it difficult to sell fixed-income investments like those held by the collateral pools.  The plaintiffs alleged that, as a result, the collateral pools incurred tremendous losses in the wake of the financial crisis.  On these allegations, the plaintiffs asserted claims for ERISA breach of fiduciary duty and prohibited transactions.

The defendants moved to dismiss the breach of fiduciary duty claim on the ground that the plaintiffs “offered nothing but conclusory allegations and 20/20 hindsight” in support of their imprudence allegations.  The court held that while the plaintiffs did not identify a single investment that was indicative of an imprudent investment strategy, they put forth sufficient allegations in their complaint regarding “a set of circumstances . . . that would have caused a prudent investor to amend its securities lending program to protect the assets of the collateral pools” to state a claim under Federal Rule of Civil Procedure 8.  The court also rejected the defendants’ assertion that the plaintiffs’ prudence claim was based on hindsight where the plaintiffs adequately pleaded that the defendants ignored “warning signs.”  While the court sustained plaintiffs’ breach of fiduciary duty claim as posing a fact-intensive question not appropriate for a motion to dismiss, it cautioned that the plaintiffs, to support a judgment, “may well have to demonstrate more than just the fact that [d]efendants knew that the asset-based securities market faced stress.” 

The plaintiffs’ second claim, that the defendants engaged in prohibited transactions, was based on the allegation that the securities lending agreements at issue constituted a “lease of property” between the plans and parties in interest, including the securities lending program manager.  The court dismissed the claim, holding that the plaintiffs’ conclusory allegations that the securities lending program operated as a lease failed to state a plausible claim for relief.  The court noted that the lending agreement attached to the complaint made clear that the lending arrangements did not constitute a lease of plan property.  

Lastly, the court addressed the defendants’ arguments that the plaintiffs lacked standing to assert claims because they failed to plead that they had suffered individual losses, and in any event could not assert class claims on behalf of participants in other plans that they purported to represent.  The court found the complaint’s allegations that the plaintiffs participated in various plans and that the defendants breached duties in managing the securities lending program sufficient to state an actionable loss, and rejected the assertion that the plaintiffs’ class claims failed on the pleadings.  The court stated that any argument regarding the plaintiffs’ ability to represent participants in other plans would be addressed at the class certification stage.  This holding stands in contrast to a decision earlier this year by a different federal court dismissing at the pleading stage claims against the defendants with respect to a securities lending program where the plaintiff lacked standing because no losses resulted from the alleged conduct.  Fishman Haygood Phelps Walmsley Willis & Swanson L.L.P. v. State Street Corp., No. 1:09-10533-PBS, 2010 WL 122377 (D. Mass. Mar. 25, 2010).