Following the spectacular collapse of Enron in 2001, a cottage litigation industry was created in which a handful of plaintiffs’ firms now routinely rush to bring ERISA class actions whenever a pension plan invests in the stock of the corporate sponsor and the stock price declines significantly. Known as “stock drop cases,” these actions allege that the affected company and its officers and directors breached their ERISA fiduciary duties by permitting employees who were 401(k) and employee stock ownership plan (ESOP) participants to continue to hold and invest plan assets in company stock during the period of decline. In the vast majority of these cases, the litigation pattern is the same. Defendants respond to the complaint with a motion to dismiss for failure to state a claim. If the motion is denied in whole or in substantial part, most defendants promptly settle. Thus, successfully defending such suits at the 12(b)(6) stage has become crucial. In recent years, district courts have been more willing to grant such dismissals, but there have been few appellate decisions examining the propriety of a grant of 12(b)(6) relief.
This is perhaps why the Second Circuit’s decision in In re: Citigroup ERISA Litigation, 662 F.3d 128 (2d Cir. 2011) (as well as in Gearren v. McGraw-Hill Co., Inc. (Case No. 10-792) issued the same day) was so highly anticipated. This respected appeals court was not simply being asked to articulate the standard of review applicable to ERISA fiduciary conduct in the context of stock drop claims, but also to determine the pleading requirements sufficient to allow such complaints to proceed.
In a 2-1 opinion, the Second Circuit affirmed the lower court’s dismissal of the complaint. The decision is very favorable to the employer-fiduciary community. First, the Second Circuit officially adopted the Moench presumption, becoming the fifth appellate court to do so. The so-called Moench presumption was established by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), and it provides that there is a presumption of compliance with ERISA when a fiduciary invests ESOP assets in the employer’s stock. Second, the court held that the Moench presumption applies to defined contribution individual account retirement plans. Third, the court held that the Moench presumption is a standard of review applicable at the pleadings stage and not an evidentiary presumption. Fourth, the court held that the presumption is a “substantial shield” against ERISA fiduciary attack and that a stock drop complaint must allege facts sufficient to show that the employer was in a “dire situation” in order to overcome the presumption. Finally, the court held that there is no ERISA fiduciary requirement to provide plan participants with nonpublic information pertaining to an employer stock investment option or any other investment option.
The Citigroup decision is unquestionably significant. Plaintiffs’ counsel in stock drop litigation invariably take these cases on a contingent fee basis, and it is crucial they can overcome a motion to dismiss and elicit a settlement. The Second Circuit’s adoption and application of Moench reduces the risk that the remaining appellate courts will adopt a rule less favorable to employers. The decision may not amount to a tolling of the funeral bells for stock drop litigation, but it surely moves such litigation down a moribund path.
The Citigroup claims followed the standard formulation in stock drop cases. Plaintiffs claimed that defendants breached their fiduciary duty to act prudently by allowing continued investment in employer stock when they should have known that the company would be negatively impacted by its involvement in the subprime mortgage market. Plaintiffs also claimed defendants breached their duty of loyalty by failing to disclose to participants nonpublic information regarding the expected performance of Citigroup stock.
The Second Circuit’s Adoption and Application of Moench. The Second Circuit chose to join its sister circuits in adopting Moench on the ground that it “provides the best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” In re Citigroup, 662 F.3d at 138. Borrowing from Quan v. Computer Sciences Corp., 623 F.3d 870, 883 (9th Cir. 2010), the court adopted the “guiding principle” that “judicial scrutiny should increase with the degree of discretion a plan gives its fiduciaries to invest.” Id. In other words, attacks on fiduciary decisions to continue to allow participants to hold and invest in company stock will be presumed to be prudent and will only be overturned if the fiduciary “abused its discretion.” The court also provided a partial victory to those who argued that a “hard-wired” plan was safe from review because the fiduciaries had no discretion to remove the stock option from the plan. The court concluded that to best meet the competing obligations of Congressional intent in permitting investment in employer stock and Congressional regulation of retirement savings, if the formal pension plan documents “hard wire” the requirement of company stock, the presumption will be harder to overcome than if the plan did not require employer stock.
In applying the Moench presumption, the court confirmed that the presumption is a “substantial shield” for fiduciaries and determined that it could be overcome only if the complaint pleaded facts to show that there were “dire circumstances” affecting the company. Id. at 140. Unfortunately, the Second Circuit offered little concrete guidance on what constitutes a “dire situation,” implying that one can have a dire situation without an impending collapse, id. at 140-41, but that mere stock fluctuations and bad business decisions do not qualify as creating a dire situation. For the majority, losses amounting to scores of billions were insufficient to cause a dire situation for a company “with a market capitalization of almost $200 billion.” Id. at 141. Because the plaintiffs failed to allege facts that would support a conclusion that the defendants could have predicted that Citigroup would lose significant amounts of money, the court affirmed dismissal of their claim.
The Second Circuit’s Refusal to Expand Fiduciary Duty to Disclose. The plaintiffs also alleged that certain defendants breached their fiduciary duties by failing to provide complete and accurate information regarding Citigroup stock. The court held that fiduciaries do not have a general fiduciary duty to disclose nonpublic information regarding employer stock. Id. at 142. The court found that an imposition of a more stringent obligation would turn fiduciaries into investment advisors. Id.
The court also analyzed plaintiffs’ claim that the defendants engaged in misrepresentations. The plaintiffs claimed that even if there were not an affirmative duty to disclose information, there was a fiduciary duty not to misrepresent the expected performance of Citigroup stock. Id. at 143. The court explained that in order to have a potential claim, a plaintiff would have to demonstrate that the defendant was acting as a fiduciary when making the misrepresentation. The court concluded that neither the company nor the CEO was the plan administrator and that they were therefore not fiduciaries and were not responsible for communications with plan participants. They thus spoke to participants in their employer capacity and could not be liable for a breach of fiduciary duty.
The court also found that the plaintiffs could not maintain a claim against the Administration Committee because there were no allegations they knew the information about Citigroup stock included in the summary plan descriptions (SPDs) was false. Id. at 144-45. The court found that it would be unreasonable to require plan fiduciaries to investigate the veracity of all SEC filings. The court noted that the SEC was already tasked with overseeing SEC filings, implying that any violations related to the accuracy of SEC filings will be left to the securities laws.
The Dissenting Opinion. Judge Straub dissented from all material parts of the majority opinion. His dissent is notable for its length and for the unprecedentedly broad legal duties it would impose on fiduciary insiders respecting company stock in 401(k) plans. The dissent rejected the Moench presumption as unsound, id. at 147, and refused to acknowledge any of the policy considerations that the majority believed counseled for a narrower fiduciary rule. Judge Straub concluded instead that there should not be special treatment for ESOPs, regardless of the policy reasons supporting the establishment of ESOPs on which Moench relied.
The dissent asserted that there is an obligation to communicate with participants, contrary to what the majority held based on a perceived “duty to disclose material, adverse information regarding an employer’s financial condition or its stock, where such information could materially and negatively affect the expected performance of plan investment options.” Id. at 160. This assertion, however, conflicts with all the other courts of appeals that have addressed this issue in the stock drop context.
Open Questions in Second Circuit after Citigroup. While the court is firm in its holding that Moench provides a strong presumption of prudence, particularly when the plan documents require that the plan offer employer stock as an investment option, it is less clear with respect to the standard applied when the stock option is not “hard-wired” into the plan. There are several instances in the opinion where the court implies that the standard of review might not be quite as deferential in some circumstances as it is when the stock option is "hard-wired" into the plan. For instance, the court states that “judicial scrutiny should increase with the degree of discretion a plan gives its fiduciaries to invest” and that therefore “a fiduciary’s failure to divest from company stock is less likely to constitute an abuse of discretion if the plan’s terms require – rather than merely permit – investment in company stock.” Id., at 138. At the same time, the court stated that as long as a fiduciary’s decision with respect to employer stock is reasonable, it cannot be second-guessed, implying a low level of judicial scrutiny regardless of how much discretion the fiduciaries have in offering employer stock as an investment option. Id. at 139. It’s not clear what circumstances would be reasonable where the stock was "hard-wired" but unreasonable where it wasn’t. While Citigroup is a very favorable decision for defendants in stock drop cases, the boundaries of reasonableness, particularly when the stock option is not "hard-wired," as well as the parameters of “dire circumstances,” remain undefined. Although there is no question that Citigroup should serve as a nail in the coffin for many stock drop suits, it has not foreclosed them entirely.
 The plaintiff has petitioned for rehearing en banc and the Department of Labor has filed an amicus brief in support. If the petition is denied, plaintiffs will likely petition for certiorari, especially in light of the unusually long dissenting opinion.
 The Second Circuit joined three other circuits in adopting the Third Circuit’s Moench presumption. See Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995); Kirschbaum v. Reliant Energy Inc., 526 F.3d 243 (5th Cir. 2008); and Quan v. Computer Sciences Corp., 623 F.3d 870 (9th Cir. 2010).
Sara Pikofsky is a Partner at Jones Day. She has extensive experience with all phases of litigation focusing on violations of ERISA’s fiduciary duty and prohibited transaction provisions. In addition, Ms. Pikofsky represents independent fiduciaries appointed by the courts and by benefit plans in a variety of matters, including compliance with U.S. Department of Labor Prohibited Transaction Exemption 2003-39.