Second Circuit Rules for Lehman Brothers In Participants' Stock-Drop Lawsuit

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By Jacklyn Wille  


Participants in Lehman Brothers Holdings Inc.'s Section 401(k) plan failed to overcome the presumption of prudence that protects plan fiduciaries who invest in employer stock, the U.S. Court of Appeals for the Second Circuit ruled July 15, affirming the dismissal of the participants' stock-drop lawsuit (In re Lehman Bros. ERISA Litigation, 2d Cir., No. 11-4232-cv, 7/15/13).

Judge Richard C. Wesley, writing for the court, found that the participants failed to allege facts sufficient to show that Lehman Brothers' benefit committee knew or should have known that the company was in a “dire situation” based on information that was publicly available during the class period.

In so ruling, the court held that the participants' imprudent investing claims could not be based on material, nonpublic information. Rejecting the position taken by the Department of Labor in an amicus brief, the court ruled that fiduciaries of Employee Retirement Income Security Act plans “are under no obligation to either seek out or act upon inside information in the course of fulfilling their duties under ERISA.”

Jonathan K. Youngwood, a partner in Simpson Thacher & Bartlett's New York office and counsel for the benefit committee members, praised the Second Circuit's analysis.

“We're pleased with today's Second Circuit decision affirming the district court's dismissal of the case,” Youngwood told BNA July 15. “The Second Circuit conducted a detailed and proper analysis of the allegations of the complaint, applying the Moench presumption of prudence as adopted in Citigroup,” he said.

Counsel for the participants could not be reached for comment.

District Court Dismisses Stock-Drop Claims

Lehman Brothers, once a leading investment banking company, filed for bankruptcy in September 2008. In the months leading up to and following the bankruptcy filing, several ERISA class actions were filed by company employees who alleged they lost millions of dollars in retirement savings through their investments in Lehman Brothers stock.

The lawsuits--which were ultimately consolidated--alleged that participants in Lehman Brothers' 401(k) plan lost nearly all of their investment in the Lehman Stock Fund (LSF) when the company collapsed due to its heavy involvement in the underwriting of securities backed by subprime mortgages. The LSF was an employee stock ownership plan in which assets of the Section 401(k) plan were invested.

The consolidated amended complaint targeted Lehman Brothers' former directors and Wendy Uvino, who chaired the plan's administrative committee. The plaintiffs claimed that these defendants breached their ERISA fiduciary duties because they knew of the company's deteriorating condition during the class period but imprudently failed to protect the plan by removing LSF from the plan. In February 2010, the U.S. District Court for the Southern District of New York dismissed the claims against the directors and Uvino (22 PBD, 2/4/10; 37 BPR 320, 2/9/10; 48 EBC 1838).

The participants amended the consolidated complaint, adding six other committee members as defendants and setting March 16, 2008--the date when Bear Stearns was sold to JP Morgan Chase--as the date by which the committee members knew or should have known that Lehman Brothers was in a dire situation. According to the participants, the combination of Bear Stearns's collapse, Lehman Brothers' status as the most highly leveraged of the remaining investment banks, and marketwide subprime risks put Lehman Brothers in an “obviously dire situation.”

In October 2011, the district court dismissed the participants' claims against the plan committee members, finding that the participants failed to overcome the presumption of prudence that protects the fiduciaries of ERISA plans that invest in employer stock. The district court also dismissed the participants' disclosure claims, ruling that the committee members had no affirmative duty to disclose information pertaining to the bank's financial condition (195 PBD, 10/7/11; 38 BPR 1867, 10/11/11; 51 EBC 2823).

Second Circuit Affirms Moench

In evaluating the participants' imprudent investing claim, the Second Circuit looked to the Moench presumption, which requires plaintiffs to point to a plan sponsor's impending collapse or other dire circumstances to show that a reasonable plan fiduciary would have divested the plan of employer stock. The Moench presumption, articulated by the U.S. Court of Appeals for the Third Circuit in Moench v. Robertson, 62 F.3d 553, 19 EBC 1713 (3d Cir. 1995), is frequently cited as a grounds for dismissal of employer stock-drop cases.

The Second Circuit adopted the Moench presumption in its 2011 decision In re Citigroup ERISA Litigation, 662 F.3d 128, 51 EBC 1737 (2d Cir. 2011) (203 PBD, 10/20/11; 38 BPR 1961, 10/25/11). In the instant case, the Second Circuit summarized Citigroup as holding that, “when an ERISA fiduciary is torn between following the terms of a plan requiring investment in employer stock and the provisions of ERISA requiring prudent management, we will presume that the fiduciary acted prudently unless the plaintiff-participant pleads 'facts sufficient to show that [fiduciaries] either knew or should have known that [the employer] was in the sort of dire situation that required them to override Plan terms in order to limit participants' investments in [employer] stock.'”

Using this standard, the Second Circuit found that the Lehman Brothers plan language was sufficient to warrant applying the Moench presumption to the plan fiduciaries' actions. The participants pointed to plan language giving the benefit committee the right to “eliminate or curtail investments in Lehman Stock…if and to the extent that the Committee determines that such action is required in order to comply with” ERISA, but the court was not persuaded. “The Plan here merely states the law: Fiduciaries must comply with the applicable tenets of ERISA,” the Second Circuit said.

No Duty to Seek Out Nonpublic Information

After concluding that the Moench presumption applied, the Second Circuit next considered whether the participants could claim that the benefit committee knew or should have known that Lehman Brothers stock was an imprudent investment “based on material, nonpublic information.” In an amicus brief in support of the participants, the Department of Labor argued that they could, taking the position that an objectively prudent fiduciary would have uncovered the relevant, nonpublic information and acted upon it.

On this point, the Second Circuit found that “[s]everal other Circuits have confronted, and rejected, similar arguments.” Following suit, the Second Circuit held that “[f]iduciaries are under no obligation to either seek out or act upon inside information in the course of fulfilling their duties under ERISA.”

Adam J. Wasserman, a partner in Dechert's New York office and counsel for many of the Lehman Brothers corporate directors, applauded the court's ruling on this point.

“We are very pleased with the court's well-reasoned decision rejecting the contention that directors have a duty to provide plan managers with inside information,” he told BNA July 15.

Moench Protects Benefit Committee Members

The court then considered whether the participants pleaded facts sufficient to overcome Moench. It said that, contrary to the participants' position, “the forced sale of Bear Stearns alone does not show that Lehman specifically was in serious danger.” In fact, the court said, “given that Bear Stearns was (effectively) bailed out by the government, the events of March 16, 2008 could be construed to cut against Plaintiffs' claims because the Benefit Committee Defendants may have believed that Lehman would be saved as well.”

The participants also argued that the benefit committee members should have been aware of Lehman Brothers' “high leverage ratio” and its “broad exposure to the subprime mortgage market” by virtue of their “expertise and their positions at Lehman.” However, the Second Circuit agreed with the district court that these allegations were “conclusory” and “merely show that the members of the Benefit Committee would have possessed comparable knowledge to the market analysts and investors who helped maintain Lehman's substantial market capital even immediately prior to the company's bankruptcy.”

The participants raised a number of other arguments, but the Second Circuit rejected each one. It concluded that “[m]arket fluctuations and an above-water price immediately in advance of bankruptcy would not have put a prudent investor on notice that Lehman had reached a 'dire situation.' We understand that the risk-tolerance of participants in an ESOP may differ from the risk-tolerance of the market as a whole, but…[w]e cannot penalize fiduciaries who allow plan-participants to invest in Congressionally-encouraged ESOPs absent very strong indications that fiduciaries knew or should have known that participants no longer desired to remain invested.”

Disclosure, Monitoring Claims Fail

The Second Circuit also affirmed the district court's dismissal of the participants' disclosure claim. The participants alleged that the benefit committee violated its disclosure duties by incorporating statements from Lehman Brothers's SEC filings into plan documents. Although the Second Circuit agreed that the disclosures were made in a fiduciary capacity, it nevertheless found that the participants “have not identified any specific portions of Lehman's SEC filings that the Benefit Committee Defendants knew were false or misleading--or that even are false or misleading.”

Finally, the Second Circuit agreed with the district court that Lehman Brothers's corporate directors did not breach their duties to monitor, appoint, and inform the plan fiduciaries. The Second Circuit found that the district court properly dismissed these claims as either “inadequately pled” or “derivative of the failed prudence claim.”

Senior Judge Robert D. Sack and Judge Alison J. Nathan, sitting by designation from the U.S. District Court for the Southern District of New York, joined in the decision.

The participants were represented by Mark C. Rifkin of Wolf Haldenstein Adler Freeman & Herz, New York, and Thomas McKenna of Gainey McKenna & Egleston, New York. The Lehman Brothers directors were represented by Andrew J. Levander, Kathleen N. Massey, and Adam J. Wasserman of Dechert, New York. The Lehman Brothers benefit committee members were represented by Jonathan K. Youngwood of Simpson Thacher & Bartlett, New York. Richard Fuld was represented by Patricia M. Hynes and Todd S. Fishman of Allen & Overy, New York.

By Jacklyn Wille  

The full text of the opinion is at

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