Justices Deny Review in ‘Stock Drop' Cases, Leaving Existing Rulings for Plan Fiduciaries

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The U.S. Supreme Court Oct. 15 declined to review two decisions of the U.S. Court of Appeals for the Second Circuit adopting the rebuttable “presumption of prudence” standard in Employee Retirement Income Security Act “stock-drop cases,” leaving intact rulings that shield plan fiduciaries from ERISA claims by participants in employee stock ownership plans and other defined contribution plans that offer company stock as an investment (In re Citigroup ERISA Litig., U.S., No. 11-1531, cert. denied 10/15/12; Gearren v. McGraw-Hill Cos. Inc., U.S., No. 11-1550, cert. denied 10/15/12).

In separate split decisions issued last October, the Second Circuit joined with the U.S. Courts of Appeals for the Third, Fifth, Sixth, and Ninth circuits and ruled that the prudence presumption standard applies in cases in which employers offer the company's own stock in their defined contribution plans ( 662 F.3d 128, 51 EBC 1737 (2d Cir. 2011); 660 F.3d 605 (2d Cir. 2011); 29 HRR 1138, 10/24/11).

The presumption originated with the Third Circuit's decision in Moench v. Robertson ( 62 F.3d 553, 19 EBC 1713 (3d Cir. 1995)) and is frequently cited by the defense bar as grounds to dismiss stock-drop lawsuits.

Citigroup and McGraw Hill Employees Had Sued.

The Citigroup lawsuit was brought by Citigroup employees who alleged the company had invested extensively in subprime mortgages and securities related to subprime mortgages in the mid-2000s. When the subprime mortgage market collapsed, Citigroup lost tens of billions of dollars in its subprime mortgage-related investments. As a result, Citigroup's stock lost 52 percent of its value during the period covered by the class claims, falling from a high of $55.70 per share to a low of $26.94 per share.

The employees alleged Citigroup and the plans' investment and administration committees knew the company would sustain heavy losses from the subprime mortgage investments but failed to inform employees and investors about the company's loss exposure. The employees further alleged Citigroup's chief executive officer breached fiduciary duties by failing to provide complete and accurate information to plan participants regarding the company stock fund and its exposure to the risks associated with the subprime market.

The McGraw-Hill class action alleged that McGraw-Hill Cos. and its leadership knew or should have known that the company's stock was likely to decline sharply in value once it was revealed that the company's financial services division, Standard & Poor's, had given improperly high credit ratings to complex financial instruments such as residential mortgage-backed securities and collateralized debt obligations. From Dec. 31, 2006, through Dec. 5, 2008, McGraw-Hill's stock price declined from $68.02 per share to $24.23 per share--a drop of 64.4 percent.

The plans in both Citigroup and McGraw-Hill required that company stock be offered as an investment option.

A federal district court in New York dismissed the complaints. Affirming the dismissal of both cases on appeal, the Second Circuit said the presumption of prudence applied with respect to both eligible individual account plans and employee stock ownership plans (ESOPs). The appeals court said the presumption could be overcome only through a showing of “dire circumstances” that were objectively foreseeable.

The Second Circuit also determined that the presumption could apply at the pleadings stage because the Moench presumption is not an evidentiary presumption--it is a standard of review applied to an ERISA fiduciary's decision.

ERISA Protections Undermined, Petitioners Argue.

In their petition for review, the Citigroup plaintiffs argued that ERISA imposes a “clear and unqualified obligation on plan fiduciaries” who know or should have known that a stock held by the plan is “substantially overvalued or otherwise imprudent” to divest the plan of those stock holdings or at least inform participants about the dangers of holding the stock.

The Second Circuit's decision essentially creates an exemption to ERISA's prudence requirement for the employer's own stock, in conflict with a Sixth Circuit decision and the views of the Labor Department, which joined the Citigroup plaintiffs in seeking rehearing by the appeals court, the Citigroup petitioners said.

The National Employment Lawyers Association and the Pension Rights Center were among those filing amicus briefs in support of the Citigroup plaintiffs' petition for review.

In their separate petition for review, the McGraw-Hill plaintiffs added that if a “presumption of prudence” by plan fiduciaries does exist, it is an evidentiary standard that does not apply at the motion to dismiss stage. The McGraw-Hill petitioners pointed out that in Moench, the Third Circuit was reviewing an appeal from a grant of summary judgment, not a motion to dismiss.

Briefs Opposing Review.

In its brief opposing review, Citigroup said the Second Circuit concurred with every other federal circuit court that has ruled on the issue in holding an “abuse of discretion” standard applies when a court reviews whether a fiduciary's compliance with a plan's requirement to offer company stock as an investment option meets ERISA's ordinary prudence rules.

The Second Circuit correctly held that in order to state an ERISA claim, “a plaintiff must plausibly allege that the plan fiduciary's conduct amounted to an abuse of discretion,” Citigroup said.

Also opposing review, McGraw-Hill said the Second Circuit's decision in its case would be “a particularly unsuitable case” for reviewing the correctness of the Moench presumption, even if the Supreme Court were inclined to do so.

The “undisputed facts” make it impossible for the petitioners to satisfy the “demanding standard” of showing that the underlying company was in poor financial shape, McGraw-Hill asserted.