The Second Circuit becomes the latest U.S. Court of Appeals to join the fray about whether to adopt what is known as a “presumption of prudence” under ERISA. The rule favors plan fiduciaries who allow investment in company stock in an employee stock ownership plan (ESOP), despite knowing that the company stock is very risky. In two divided opinions, the panel adopts the presumption of prudence over a sharply-worded dissent.
Gray v. Citigroup, Inc., No. 09-3804 (2d Cir. Oct. 19, 2011) and Gearren v. McGraw-Hill Cos., Inc., No. 10-792 (2d Cir. Oct. 19, 2011) : Over fifteen years ago, in the teeth of some notable collapses in ESOP plans, courts first faced the issue of what standard of liability ought to apply to plan fiduciaries who stood by while employees lost their life’s savings by investing their future in company stock. (The same risk inheres in eligible individual account plans, EIAPs, which also encourage investment in company stock.)
In Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), the Third Circuit became the first court to hold that an ESOP plan fiduciary’s decision to allow continued investment in company stock – even in the face of demonstrable risk – would only be reviewed for only “abuse of discretion” rather than the higher “prudent person” standard normally applied to fiduciary investment decisions. The reasoning, in a nutshell, was that Congress wanted to foster ESOPs – indeed, it specifically exempted such plans from the duty of diversifying – and that a prudent-person standard would discourage their development.
Over time, some courts adopted what is now widely termed the “Moench presumption,” though not every court agrees with what exactly this presumption means. (An thoughtful summary of the state of the law can be found in an upcoming student law-review comment, Meredith L. Gray, “A Presumption Without Prudence: Replacing Moench V. Robertson with a Prudent ‘When in Doubt, Don’t’ Standard for Esop and 401(k) Company Stock Fund Fiduciaries,” 2010 Wisc. L. Rev. 907 (2010)., though she evidently did not have the benefit of the more-recent Quan v. Computer Scis. Corp., 623 F.3d 870 (9th Cir. 2010), which apparently resolved the Ninth Circuit’s position on this issue – it, too, sided with Moench.)
Up until now the Second Circuit had not taken a side, but in today’s majority opinion (by Judge Walker, joined by Judge Cabranes) the court firmly grasps the Moench presumption, with Judge Straub voicing a harsh dissent.
The backdrop of today’s decision was the lead-up to the 2008 financial collapse, when Citicorp suffered a sharp decline in value owing to its heavy investment in the subprime-mortgage market. During 2007, the bank posted a loss of $18.1 billion and its stock value sank by nearly 50%. The ESOP participants at Citicorp lost a large part of their savings during this decline.
A class action suit was filed under ERISA for the damage caused to the retirement fund. The principal allegations are summarized:
“Count I of the Complaint (the ‘Prudence Claim’) alleges that the Investment Committee, the Administration Committee, Citigroup, and Citibank breached their fiduciary duties of prudence and loyalty by refusing to divest the Plans of Citigroup stock even though Citigroup’s ‘perilous operations tied to the subprime securities market’ made it an imprudent investment option. Plaintiffs argue that a prudent fiduciary would have foreseen a drop in the price of Citigroup stock and either suspended participants’ ability to invest in the Stock Fund or diversified the Fund so that it held less Citigroup stock. Count II (the ‘Communications Claim’) alleges that Citigroup, the Administration Committee, and Prince breached their fiduciary duties by failing to provide complete and accurate information to Plan participants regarding the Fund and its exposure to the risks associated with the subprime market.”
The district court dismissed the action at the complaint stage. The Second Circuit, 2-1, affirms.
The panel assumes for purposes of the opinion that all of the named defendants were, in fact, plan fiduciaries (some defendants disputed this), then reaches the merits of what standard of review applies to their supervision of the ESOP. The majority holds:
“[P]laintiffs’ claims are still met with two obstacles: (1) the Plan language mandating that the Stock Fund be included as an investment option and (2) the ‘favored status Congress has granted to employee stock investments in their own companies.’ Langbecker v. Elec. Data Sys. Corp., 476 F.3d 299, 308 (5th Cir. 2007). These obstacles lead us to conclude that the Investment and Administration Committees’ 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. We hold that plaintiffs have not alleged facts that would establish such an abuse.”
The panel majority explains that while ESOPs are “designed to invest primarily in qualifying employer securities,” 29 U.S.C. § 1107(d)(6)(A), an undiversified investment instrument, like an ESOP, is inherently risky. Placing fiduciaries at peril of individual liability for losses whenever a company’s stock tanks under a “prudent-person” standard would, by the panel majority’s lights, frustrate Congress’s policy preference of employee ownership.
The panel recognizes that the rule is a presumption only, and rebuttable under right circumstances, although the majority takes a hard line on this:
“We . . . cannot imagine that an ESOP or EIAP settlor, mindful of the long-term horizon of retirement savings, would intend that fiduciaries divest from employer stock at the sign of any impending price decline. Rather, we 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 [to hold company stock].”
Applying the presumption in this case, the panel majority holds on the face of the complaint that the plaintiffs do not state a claim in the absence of such a dire situation.
“[E]ven if we assume that an investigation would have revealed all of the facts that plaintiffs have alleged, the Investment and Administration Committees would not have been compelled to conclude that Citigroup was in a dire situation. While the Committee may have been able to uncover Citigroup’s subprime investments, the facts alleged by plaintiffs, if proved, are not sufficient to support a conclusion that the Investment and Administration Committees could have foreseen that Citigroup would eventually lose tens of billions of dollars.”
The dissent strongly disaffirms the Moench presumption (citations, footnotes omitted):
“In my view, the Moench presumption strikes no acceptable ‘accommodation’ between the competing ERISA values of protecting employees’ retirement assets and encouraging investment in employer stock. . . . [T]he Moench presumption precludes, in the ordinary course, judicial enforcement of the prudent man standard of conduct. In a case that was argued in tandem with the instant matter [McGraw-Hill], the Secretary of Labor noted that the Moench presumption relegates the duty of prudence to protecting employees only ‘from the complete loss of their assets in the wake of a company’s collapse,’ thereby ‘leaving them otherwise unprotected from the careless management of plan assets.’. . . ‘ERISA is paternalistic,’ and thus it is thus incongruous to deny participants meaningful judicial review on the ory that investment in employer stock should be encouraged.”
The same panel, with the same division, affirms (in a per curiam opinion) dismissal of another complaint in an EIAP case in the McGraw-Hill case, finding that case too failed to present sufficient “dire” circumstances to warrant ERISA liability against the fiduciaries for breach of the duty of prudence.