Alert December 14, 2011

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.