When a corporation makes its own stock available as an investment option in a retirement plan and the stock declines in value, the plan’s fiduciaries sometimes face claims that they violated their duty to act prudently in the management of the plan. Such "stock drop" cases illustrate the tension between two of ERISA’s primary goals:
● The protection of employee retirement funds by imposing fiduciary duties on plan managers; and
● The encouragement of employee ownership through special status provided to eligible individual account plans (EIAPs), including employee stock ownership plans (ESOPs).
ESOPs are intended, by definition, to encourage investment in qualifying employer securities. Courts recognize that, as a result, they "place employee retirement assets at much greater risk than does the typical diversified ERISA plan." Martin v. Feilen, 965 F.2d 660, 664 (8th Cir. 1992).
Congress has granted special status to retirement plans that offer investment in employer stock by creating a qualified exemption from the prudence requirement imposed on plan fiduciaries. "In the case of an [EIAP], the diversification requirement … and the prudence requirement (only to the extent that it requires diversification) … is not violated by acquisition or holding of … qualifying employer securities …." 29 U.S.C. § 1104(a)(2).
Even so, fiduciaries of ESOPs may face allegations that they acted imprudently by not divesting plans of employer stock when the stock value declines, or when the employer faces significant financial problems.
ERISA requires fiduciaries to act "in accordance with the documents … governing the plan insofar as such documents … are consistent with the provisions [of ERISA]." 29 U.S.C. § 1104(a)(1)(D). But when a plan requires investment in employer stock, ERISA does not say when such a requirement might become inconsistent with the Act’s fiduciary requirements.
When, for example, might a fiduciary be required to disobey the requirements of the plan and halt the purchase of employer stock? Or required to sell employer stock?
Presumption of Compliance with ERISA
Several circuit courts have addressed the standard by which ESOP fiduciaries are to be judged in such circumstances. Beginning with the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), these courts have adopted a presumption of compliance with ERISA when a fiduciary invests retirement assets in the employer’s stock.
In Moench, the ESOP fiduciary continued to invest in company stock after the share price dropped from $18.25 to $0.25 over a two-year period. Applying what has become known as the Moench presumption, the Third Circuit held:
[A]n ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision. However, the plaintiff may overcome that presumption by establishing that the fiduciary abused its discretion by investing in employer securities.
That presumption was adopted by the Sixth, Fifth, and Ninth Circuits in Kuper v. Iovenko, 66 F.3d 1447, 1459 (6th Cir. 1995) ("the purpose of ERISA and the nature of ESOPs requires that we review an ESOP fiduciary’s decision to invest in employer securities for an abuse of discretion"); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008) ("The Moench presumption … applies to any allegations of fiduciary duty breach for failure to divest an … ESOP of company stock."); and Quan v. Computer Scis. Corp., 623 F.3d 870, 881 (9th Cir. 2010) (the presumption "is consistent with the statutory language of ERISA and the trust principles by which ERISA is interpreted").
Second Circuit Applies Deferential Review
More recently in In re: Citigroup ERISA Litigation, 2011 U.S. App. LEXIS 21463 (2d Cir. Oct. 19, 2011), the Second Circuit came to the same conclusion, holding that an ESOP fiduciary’s decision to continue offering retirement plan participants the opportunity to invest in Citigroup stock should be reviewed for an abuse of discretion, and that no abuse of discretion was shown.
The case involved two retirement plans which offered the Citigroup Common Stock Fund as an investment option, among 20 to 40 other options available to plan participants. After a sharp drop in the price of Citigroup stock, a class action lawsuit was filed.
The plaintiffs alleged that Citigroup’s participation in the subprime mortgage market caused the stock drop, and that the plan fiduciaries breached their duties of prudence and loyalty by refusing to divest the plans of Citigroup stock, even though the company’s "perilous operations tied to the subprime securities market" made it an imprudent investment option.
Plaintiffs argued that a prudent fiduciary would have foreseen the stock drop and either suspended the participants’ ability to invest in the stock fund or diversified the fund so that it held less company stock.
The plan documents, however, mandated that the Citigroup Common Stock Fund be included as an investment option, along with at least three other investment funds. Therefore, the fiduciaries argued that they had no discretion to eliminate Citigroup stock as an investment option.
The district court agreed and held that, even if the fiduciaries had been given the discretion to eliminate the company stock fund as an option, they were entitled to a presumption that investment in the fund, as required by the plan’s terms, was prudent. The court further held that the facts alleged by the plaintiffs were insufficient to overcome that presumption. 2009 U.S. Dist. LEXIS 78055 (S.D.N.Y. Aug. 31, 2009).
The Second Circuit also agreed and held that the fiduciaries’ "decisions not to divest the Plans of Citigroup stock or impose restrictions on participants’ investment in that stock are entitled to a presumption of prudence and should be reviewed for an abuse of discretion, as opposed to a stricter standard."
Moench Presumption Applied to EIAPs and ESOPs
"We now join our sister circuits in adopting the Moench presumption," the court wrote, "and we do so with respect to both EIAPs and ESOPs – because, as those courts have recognized, it provides the best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock."
"This presumption may be rebutted if an EIAP or ESOP fiduciary abuses his discretion by continuing to offer plan participants the opportunity to invest in employer stock," the court said. "We endorse the ‘guiding principle’ endorsed in Quan that judicial scrutiny should increase with the degree of discretion a plan gives its fiduciaries to invest."
Here, the Citigroup plan required that the company’s stock fund be included as an investment option. "Thus," the court said, "a fiduciary’s failure to divest from company stock is less likely to constitute an abuse of discretion if the plan’s terms require – rather than merely permit – investment in company stock."
The Second Circuit cited Moench for the proposition that fiduciaries should override plan terms requiring investment in company stock only when "owing to circumstances not known to the [plan] settlor and not anticipated by him," maintaining the investment "would defeat or substantially impair the accomplishment of the purposes of the [Plan]." 62 F.3d at 571.
"[W]e believe that only circumstances placing the employer in a ‘dire situation’ that was objectively unforeseeable by the settlor could require fiduciaries to override plan terms," the court said. "The test of prudence is, as the dissent points out, one of conduct rather than results, and the abuse of discretion standard ensures that a fiduciary’s conduct cannot be second-guessed so long as it is reasonable."
The court noted that during the class period, Citigroup stock dropped in price from $55.70 to $28.74 per share, a loss of just over 50 percent. "Other courts have found plaintiffs unable to overcome the Moench presumption in the face of similar declines," the court said, citing Kirschbaum, 526 F.3d at 247 (40% drop), Kuper, 66 F.3d at 1451 (80% drop), and Edgar v. Avaya, Inc., 503 F.3d 347, 344 (3d Cir. 2007) (25% drop).
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