By Patricia A. Smith, Esq., Brian M. Pinheiro, Esq., and Erin K. Clarke
Ballard Spahr LLP, Cherry Hill, NJ, and Philadelphia, PA
The U.S. Supreme Court recently refused to grant certiorari for two 2011 Second Circuit stock drop decisions that had adopted the "Moench presumption" for determining whether fiduciaries imprudently invested assets in employer stock. In embracing the Moench presumption, the Second Circuit joined the Fifth, Sixth, Ninth, and Eleventh Circuits, all of which have adopted the Third Circuit's Moench analysis, first articulated in 1995 in Moench v. Robertson.
The Moench presumption presumes compliance with the Employee Retirement Income Security Act of 1974 (ERISA) when employee stock ownership plan (ESOP) fiduciaries invest plan assets in employer stock. The presumption may be overcome only by proof the fiduciary abused his discretion in doing so. As extended to 401(k) plans, this presumption makes it more difficult for a plaintiff to prevail in a lawsuit against a plan fiduciary based on claims that the fiduciary acted imprudently in offering employer stock as an investment option in a 401(k) plan.
ERISA imposes a duty on plan fiduciaries to invest plan assets as a "prudent person" would do. Although ERISA ordinarily requires a fiduciary to act prudently by "diversifying the investments of the plan so as to minimize the risk of large losses," the statute also exempts in eligible individual plan accounts the "acquisition or holding of qualifying employer real property or qualifying employer securities" from the obligation to diversify.
In both Second Circuit cases, the plans mandated that company stock be offered as an investment option. In Gearren v. McGraw-Hill Cos., McGraw-Hill employees brought a class action and alleged that the company 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 knowingly gave improperly high credit ratings to financial products linked to the subprime-mortgage market. The plaintiffs claimed that the public's discovery of these ratings practices led to a sharp drop in McGraw-Hill stock.
In Gray v. Citigroup Inc., the plaintiffs, participants in 401(k) plans for Citigroup employees, alleged that the company invested extensively in subprime mortgages and securities related to such mortgages. The plaintiffs alleged that the company downplayed its exposure to that market, even though it recognized the need to limit that exposure. Thus, the plaintiffs argued that Citigroup knew or should have known that the company would incur substantial losses from the subprime investments, but failed to notify employees about the company's exposure.
The District Court for the Southern District of New York dismissed both complaints. The Second Circuit affirmed the dismissals by applying the Moench presumption of prudence with respect to both eligible individual account plans as well as to ESOPs. The court further held that the presumption could apply at the pleading stage because it is a standard of review applied to an ERISA fiduciary's decision.
For more information, in the Tax Management Portfolios, see Kaplan, Brown, and Granados, 354 T.M., ESOPs, Horahan and Hennessy, 365 T.M., ERISA - Fiduciary Responsibility and Prohibited Transactions, and Wagner, Bianchi, and Marathas, 374 T.M., ERISA - Litigation, Procedure, Preemption and Other Title I Issues.
© 2012 by Ballard Spahr LLP.
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