In Pfeil v. State Street Bank and Trust Co., No. 10-CV-2302, 2012 BL 39978 (6th Cir. Feb. 22, 2012), the Sixth Circuit decided three issues that it had not previously confronted in employer stock-drop ERISA litigation. Unfortunately for ERISA plan sponsors and fiduciaries, the Court’s ruling on each issue may increase plaintiffs’ ability to survive a motion to dismiss within the Sixth Circuit. First, the Court stated that the presumption of prudence applicable to a plan fiduciary’s decision to invest in an employer stock fund should not be applied on a motion to dismiss. Second, based on what would appear to reflect a lack of understanding of the modern portfolio theory, the Court ruled that plaintiffs adequately pled loss causation by alleging that the offering of a company stock fund was imprudent, without regard to the plan’s other investment alternatives. Lastly, the Court ruled that safe harbor available to plan fiduciaries pursuant to ERISA § 404(c) should not be evaluated on a motion to dismiss and, in any event, would not, in its view, eliminate a plan fiduciary’s responsibility for making imprudent investment options available in 401(k) plans.
BACKGROUND & PROCEDURAL HISTORY
General Motors (GM) sponsored two defined contribution 401(k) plans, one for hourly employees and one for salaried employees (GM Plans). The GM Plans offered participants several investment options, including mutual funds, non-mutual fund investments, and the GM Stock Fund (GM Fund). The Plans documents explained that the purpose of this stock fund was “to enable Participants to acquire an ownership interest in General Motors and is intended to be a basic design feature” of the Plans. The Plans further provided that this fund “shall be invested exclusively in [General Motors stock]” without regard to diversification of assets, the risk profile of the investment, the amount of income provided by the stock, or fluctuations in the market value of the stock. The Plans documents stated, however, that these restrictions would not apply if the Plan fiduciary:
in its discretion, using an abuse of discretion standard, determines from reliable public information that (A) there is a serious question concerning [General Motors'] short-term viability as a going concern without resort to bankruptcy proceedings; or (B) there is no possibility in the short-term of recouping any substantial proceeds from the sale of stock in bankruptcy proceedings.
In the event either of these conditions were met, the Plan documents directed the Plan fiduciary to divest the Plans’ holdings in the GM Fund.
On June 30, 2006, GM appointed State Street Bank and Trust Company (State Street) as the independent fiduciary of the Plans. Plaintiffs alleged that, at that time, GM already was in “serious financial trouble” and that the prevailing view was that bankruptcy protection was “virtually a certainty” for the company. In fact, according to plaintiffs, on July 15, 2008, GM’s Chief Executive Officer announced that the company needed to implement a restructuring plan to combat second quarter 2008 losses, which he described as “significant.” Plaintiffs alleged that under these circumstances, State Street should have recognized as early as July 15, 2008 that GM was bound for bankruptcy and that GM stock was no longer a prudent investment for the Plans.
It was not, however, until November 21, 2008 that State Street informed participants that it was suspending further purchases of GM stock, citing “GM’s recent earnings announcement and related information about GM’s business.” State Street did not take any action to divest the over fifty million shares of GM stock held by Plan participants until March 31, 2009. GM filed a bankruptcy petition on June 1, 2009.
Plaintiffs filed a complaint alleging that State Street breached its fiduciary duties under the Employee Retirement Income Security Act of 1974, as amended (ERISA) by failing to prudently manage Plan assets. In particular, plaintiffs asserted that State Street should have recognized that GM was destined for bankruptcy, GM stock was no longer a prudent investment option to be offered under the Plans, and State Street should have divested the GM Plans’ investments in the GM Fund much sooner.
On September 30, 2010, the district court granted State Street’s motion to dismiss, finding that while plaintiffs sufficiently pled that State Street breached its fiduciary duty by continuing to offer the GM Fund as an investment option under the Plans, plaintiffs failed to plausibly allege that State Street’s alleged breach proximately caused losses to the GM Plans. In so ruling, the district court reasoned that Plan participants could have, without penalty, divested their own accounts of the GM Fund and reinvested their assets in other investment options offered under the GM Plans. Thus, according to the district court, State Street could not be held liable, as a matter of law, for the losses to the Plans.
THE SIXTH CIRCUIT’S DECISION
— APPLICATION OF PRESUMPTION OF PRUDENCE
First espoused by the Third Circuit and since followed by the Second, Fifth, Sixth, Seventh and Ninth Circuits, courts routinely have reviewed a plan fiduciary’s decision to invest in an employer stock fund for an abuse of discretion.1 Three of these Circuits and most (but not all) district courts have applied this presumption of prudence at the motion to dismiss stage. In so ruling, these courts generally have reasoned that the presumption of prudence is not an evidentiary standard, but rather a standard of review by which a plan fiduciary’s conduct must be evaluated. According to these courts, if plaintiffs are unable to plead a plausible set of facts to overcome that presumption of prudence by, for example, pleading that the company was in a dire situation or facing impending collapse, these courts have concluded that a plan fiduciary should not be required to further defend the merits of his decision to invest in an employer stock fund.
The Sixth Circuit concluded that it need not decide whether the presumption of prudence should be applied at the motion to dismiss stage because the district court concluded that plaintiffs pled sufficient facts to rebut the presumption of prudence, particularly insofar as the complaint contained detailed allegations of GM’s “precarious financial situation” during a time when State Street decided to continue holding GM stock as a Plan asset. Nevertheless, the Court decided to “take this opportunity” to decide whether the presumption should apply at this stage, and concluded that it should not. The Court reasoned that the presumption of prudence is an evidentiary standard that concerns questions of fact and thus not appropriately evaluated on a motion to dismiss. Although several Circuits have reached the opposite conclusion, the Sixth Circuit distinguished those authorities on the grounds that those Circuits adopted “more narrowly-defined tests for rebutting the presumption than the test this Court announced in [Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995)].” In particular, the Sixth Circuit observed that the rebuttal standard adopted in Kuper requires plaintiffs merely to prove that “‘a prudent fiduciary acting under similar circumstances would have made a different investment decision’” whereas other Circuits have required that the participants demonstrate that the company was in a “dire situation” or faced “impending collapse.”
— LOSS CAUSATION
To establish a causal connection between State Street’s alleged fiduciary breach and losses to the Plans, the Sixth Circuit ruled that plaintiffs must only show “a causal link between the [breach of duty] and the harm suffered by the plan,” i.e., “that an adequate investigation would have revealed to a reasonable fiduciary that the investment [in GM stock] was improvident.” The Sixth Circuit observed that, according to the complaint, GM stock ceased to be a prudent investment on the date (July 15, 2008) that GM announced its restructuring plan in response to its “significant” second quarter losses, and State Street did not make the decision to divest the Plans of GM stock until March 31, 2009. State Street’s delay, according to plaintiffs, caused the Plans to suffer hundreds of millions of dollars in losses. Based on these allegations, the Court disagreed that plaintiffs’ complaint should be dismissed for the failure to plead that State Street’s alleged breach of duty was “a proximate cause for the losses suffered by the Plans.”
In so ruling, the Court determined that the district court “erroneously relied” on the fact that the Plans were participant-directed and had the ability to divest their Plan accounts of GM stock on any given business day and that, as a result, plaintiffs had not pled loss causation. As the Plan fiduciary, “State Street was obligated to exercise prudence when designating and monitoring the menu of different investment options that would be offered to plan participants.” According to the Sixth Circuit, State Street could not avoid liability for offering an imprudent investment merely by including it alongside a larger menu of prudent investment options. The Court explained that “[m]uch as one bad apple spoils the bunch, the fiduciary’s designation of a single imprudent investment offered as part of an otherwise prudent menu of investment choices amounts to a breach of fiduciary duty.” Lastly, the Court determined that State Street could not avoid responsibility by asserting at the pleadings stage that plaintiffs themselves caused the losses to the Plans by choosing to invest in the GM Fund, as such a rule would improperly shift the duty of prudence to monitor the menu of plan investments to plan participants.
— ERISA § 404(C) DEFENSE
In ruling that plaintiffs failed to adequately plead causation, the district court relied in part on the safe harbor provision found in ERISA § 404(c), 29 U.S.C. § 1104(c). Section 404(c) provides, in relevant part, that a plan fiduciary is not liable for any losses caused by any breach which results from a participant’s exercise of control over those assets. The Sixth Circuit ruled that Section 404(c) is an affirmative defense that is not properly evaluated on a motion to dismiss, and that, consistent with the U.S. Department of Labor’s view, it does not relieve fiduciaries of the responsibility to select and make available prudent investment options.
Although the plaintiffs’ bar may view the Sixth Circuit’s decision as having given new life to employer stock-drop ERISA litigation, there are at least two reasons why that is not likely to be the case, at least outside the Sixth Circuit. First, the Court’s ruling that the presumption of prudence is inapplicable on a motion to dismiss is clearly dicta and thus is not binding even on district courts in the Sixth Circuit. Even if followed by district courts within the Sixth Circuit, there is no basis for applying the Sixth Circuit’s view that the presumption of prudence is an evidentiary standard elsewhere. Indeed, the Sixth Circuit recognized that other courts viewed the presumption of prudence to be a standard of review and thus capable of being evaluated on a motion to dismiss. It distinguished its decision on the grounds that other courts had adopted more narrowly defined tests for rebutting the presumption than it announced in Kuper. Thus, a reversal of the trend favoring the application of the presumption of prudence at the motion to dismiss stage would require other Circuits to adopt the Sixth Circuit’s definition of the presumption, in lieu of the definition that has been widely adopted elsewhere.
Second, insofar as the Sixth Circuit refused to accept as a defense to the plan’s offering of a large menu of investment options alongside the stock fund, its ruling seems to misunderstand or turn a blind eye to the modern portfolio theory. That theory, which is widely recognized, permits plan fiduciaries to include high yield/high risk investments as part of a diversified portfolio because the risk of a particular investment should not be evaluated independently of the other investments.
It remains to be seen what, if any, impact this decision will have on the future of employer stock fund ERISA litigation. It would seem likely, however, that the Sixth Circuit will become a venue of choice for plaintiffs filing stock drop lawsuits.
Mr. Hirschhorn is a senior counsel and Mr. Cacace is an associate in Proskauer Rose’s Employee Benefits, Executive Compensation & ERISA Litigation Practice Center, resident in Proskauer’s New York office.
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