In PBGC. v. Morgan Stanley Investment Management, Inc., No. 10-4497-cv (April 2, 2013), the Second Circuit held that a complaint’s allegations of "a decline in a security’s market price does not, by itself, give rise to a reasonable inference that the holding of the security was or is imprudent." The court concluded that an ERISA complaint asserting imprudence regarding plan investments in securities must plausibly allege that the process utilized by the relevant fiduciary in deciding to acquire and hold the securities was imprudent.
District Court Decision in PBGC
As described in our analysis of the district court opinion, in PBGC a plan sponsor claimed that the manager of the plan’s fixed-income portfolio had imprudently caused the plan to invest excessively in securities backed by subprime mortgages. When the value of those securities dropped following the subprime real estate crash in 2007 and 2008, the portfolio allegedly lost $25 million. (The Pension Benefit Guaranty Corporation ("PBGC") was substituted as appellant after the plan was terminated and assumed by the PBGC.) The district court dismissed the plan sponsor’s complaint, reasoning that under ERISA a fiduciary’s "actions are not to be judged from the vantage point of hindsight."
The Test for Prudence
In affirming that dismissal, the Second Circuit emphasized that the test for prudence focuses on process rather than simply investment results. The court of appeals noted that, because the complaint contained no allegations directly relating to the manager’s "knowledge, methods, or investigations" regarding the challenged investments, it could survive a motion to dismiss under FRCP 12(b)(6) only if it alleged facts and circumstances that gave rise to a reasonable inference that an adequate investigation would have revealed to a reasonable fiduciary that the investment at issue was improvident.
According to the court, this standard could be satisfied by allegations showing that the relevant investments were "so plainly risky" that appropriate investigation would have revealed their imprudence, or that an adequate review would have uncovered a "readily apparent" superior alternative investment.
The Second Circuit ruled that the complaint in PBGC failed to meet this standard. The court noted that PBGC pointed to certain "warning signs" regarding the relevant securities alleged in the complaint – e.g., that some issuers of the securities disclosed large losses in 2007 and 2008. The complaint, however, "fail[ed] to connect the alleged ‘warning signs’ to any specific characteristics of the securities in the [plan’s fixed-income] portfolio."