Alert June 28, 2012

District Court Dismisses Claims of Alleged Imprudence of Securities Lending Investments

On April 20, 2012, Judge Barbara Jones of the U.S. District Court for the Southern District of New York dismissed a putative class action alleging that it was imprudent for a securities lending manager to invest cash collateral held for ERISA plans in Lehman Brothers Inc. notes (the “Notes”). The case is Bd. of Trustees of Operating Engineers Pension Trust v. JPMorgan Chase, 2012 WL 1382274 (S.D.N.Y. Apr. 20, 2012).

The suit was brought by trustees of a multi-employer pension plan. The trustees had entered into a written securities lending agreement (“Agreement”) with the defendant bank, pursuant to which the plan participated in the bank’s securities lending program. Through the program, the bank facilitated loans of securities owned by the plan and those loans were secured by collateral posted by the borrowers. The bank had full discretion under the Agreement to invest some of the cash collateral on behalf of the plan. The Agreement also specified the terms of the bank’s compensation, allowing it to retain 30–40% of any investment profits but any losses would be borne solely by the plan. In addition to investing the collateral of the securities lending program in the Notes, the bank separately acted on its own behalf as a Lehman creditor and in that capacity in early 2008 began demanding additional collateral from Lehman. When Lehman filed for bankruptcy in September 2008, the value of the plan’s investment in the Notes dropped by 85%.

The trustees brought suit, asserting class claims of breach of ERISA duties of prudence and loyalty, and prohibited self-dealing, concerning investments in the Notes. The court dismissed the allegations of imprudence, holding that a claim is not sufficiently stated based solely “on news articles selected after the fact and references to financial modeling that reflected a supposed ‘market consensus’ that Lehman was headed for default.”  It emphasized that “the fiduciary duty to act prudently under the circumstances at the time of the decision precludes any judgment of a fiduciary’s actions from the vantage point of hindsight” (internal citation omitted). The court concluded that allegations that the bank was separately seeking additional collateral from Lehman on its own behalf (as creditor) were insufficient evidence that the bank knew continued investments in the Notes were “unduly risky,” so it did not need to reach the bank’s argument that information barriers existed between its various operations.  

The court also held that the fee arrangement between the plan and the bank was not actionable against the bank because a bank is not a fiduciary as to compensation that was agreed upon by it and the plaintiffs “freely and after arms’-length negotiations.”  The court further concluded that the bank was not acting in its ERISA fiduciary capacity when it made additional demands for collateral from Lehman, on its own behalf (as creditor), and thus could not have committed a prohibited transaction as to the plan with respect to such conduct.

After the case was dismissed, a further amended complaint was filed on May 14, 2012, purporting to cure the defects identified by the court.