Eleventh Circuit Rules that the Moench Presumption of Prudence Applies at the Pleading Stage

ERISA Litigation Update

On May 8, 2012, the United States Court of Appeals for the Eleventh Circuit addressed what facts plaintiffs are required to plead to state a claim of fiduciary breach under the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1101, et seq., for permitting plan participants to invest in employer securities under an employer stock ownership plan (“ESOP”). The court ruled that allowing participants to continue investing in employer securities pursuant to the ESOP’s terms was presumptively prudent. Lanfear v. Home Depot, Inc., 2012 WL 1580614, No. 10-13002 (11th Cir. May 8, 2012). While the court did not adopt a specific standard for rebutting the presumption, the court held that plaintiffs failed to plead that Home Depot, the employer, suffered the requisite dire financial condition and affirmed the dismissal of their claims for breach of their duty of prudence. The Eleventh Circuit also dismissed plaintiffs’ claims that defendants breached a duty of loyalty by making misrepresentations or omissions, holding that statements made in SEC filings were not actionable under ERISA and defendants were not required to disclose non-public information regarding the company’s financial condition to plan participants.

Summary of Plaintiffs’ Allegations and Procedural Background The Lanfear plaintiffs were participants in an ESOP offered by Home Depot. By its terms, the ESOP was required to invest “primarily in shares of Company stock.” Plaintiffs brought a putative class action against Home Depot, its directors and officers, members of its board and other alleged fiduciaries of the plan. Plaintiffs alleged that defendants breached their fiduciary duties of prudence and loyalty under ERISA by, inter alia, (1) failing to liquidate employer securities from the plan when they knew that the stock price was likely inflated, and (2) misrepresenting and failing to disclose business practices that purportedly inflated the price of Home Depot stock. Plaintiffs argued that the company inflated its earnings and profit margins by improperly accounting for return-to-vendor chargebacks. After Home Depot released earnings data reflecting the effect of the chargebacks, the company’s stock price dropped by 16.5% over approximately two months. In addition, plaintiffs alleged that stock options had been impermissibly backdated and that the resulting correction led to a $227 million loss.

The U.S. District Court for the Northern District of Georgia dismissed the complaint in its entirety on several grounds. With respect to plaintiffs’ prudence claim, the court held that it was “at its core a diversification claim” and was thus barred as a matter of law by ERISA § 404(a)(2), which exempts ESOP fiduciaries from a duty to diversify. In the alternative, the court held that the ESOP’s express requirement to offer investment in employer stock stripped the fiduciaries of any discretion to divest employer stock from the plan. In the absence of such discretion, defendants could not be liable for fiduciary breach. Finally, the court held that even if defendants had the discretion to liquidate stock from the plan, plaintiffs’ allegations were insufficient to rebut the presumption of prudence (the Monech presumption), as articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) and other circuit courts, because plaintiffs failed to allege facts showing that Home Depot was on the “brink of financial collapse.” Lanfear v. Home Depot Inc., 718 F. Supp. 2d 1364, 1380-1381 (N.D. Ga. 2010).

With respect to the duty of loyalty claims, the district court held that alleged misrepresentations contained in SEC filings that were incorporated into Form S-8 registration statements and prospectuses were made in a corporate capacity, not in an ERISA fiduciary capacity, and thus did not give rise to ERISA liability. The court held that ERISA does not affirmatively require fiduciaries to disclose non-public financial information. The district court dismissed plaintiffs’ remaining claims of breach of the duty to monitor, co-fiduciary liability, and knowing participation in a fiduciary breach on the basis that those claims were derivative of plaintiffs' claims that the defendants breached their duties of prudence and loyalty.

Eleventh Circuit Affirms Dismissal, Holding that Presumption of Prudence Applies The Eleventh Circuit affirmed the dismissal of plaintiffs’ claim that Home Depot’s stock was an imprudent investment, holding that a presumption of prudence applies at the pleading stage and that plaintiffs failed to plead sufficient facts to overcome the presumption. The court held that where a fiduciary is required by the plan to invest in employer securities, the fiduciary’s decision to comply with the plan’s terms will be reviewed only for an abuse of discretion (i.e., will be presumed to be prudent) and will be upheld unless “the fiduciary could not have reasonably believed that the settlors would have intended for him to do so under the circumstances.” 2012 WL 1580614 at *11.

While the district court had used an “on the brink of financial collapse” standard for rebutting the Moench presumption, the Eleventh Circuit ruled that this was the wrong test. The Third Circuit in Moench “never said that the only circumstance in which a fiduciary could abuse its discretion by following an ESOP plan’s directions about company stock was when the fiduciary knew that the company was peering over the precipice into a financial abyss.” Id. at **9-10. Rather, a plaintiff can rebut the presumption by pleading that continuing to invest according to the plan’s terms would defeat or substantially impair the purpose of the plan and the fiduciary failed to “deviate from those terms to the extent necessary” to effectuate that purpose. Id. at *11.

The presumption of prudence is not an evidentiary presumption but a standard of review that applies at the pleading stage. “Unless a plaintiff pleads facts sufficient to raise a plausible inference that the fiduciary abused its discretion by following the plan’s directions, the complaint fails to state a valid claim and a motion to dismiss should be granted.” Id. “Mere stock fluctuations, even those that trend downward significantly, are insufficient to establish that a fiduciary abused its discretion by continuing to invest in or hold employer securities in compliance with the terms of the plan.” Id. at *12 (citations omitted). A “16.5% decrease in stock price over a period of more than two months, followed by a rebound in the price a few months later” (of which the court took judicial notice) did not constitute circumstances that “would require defendants to disobey the terms of the Plan.” Id. at *13.

The Eleventh Circuit declined, however, to adopt the district court’s alternative bases for dismissal. The complaint did not fall within the scope of ERISA § 404(a)(2)’s exemption from diversification because plaintiffs did not allege that “the Plan did not have enough different kinds of fruit in its investment basket or had only apples.” Rather, plaintiffs asserted that “defendants, knowing that apples were selling for more than they were worth, not only left them in the basket, but kept adding them to the basket.” Id. at *6. Nor was the ESOP required to be exclusively invested in employer securities. Instead, the plan required that it be “primarily” invested in employer stock. Because “[p]rimarily does not mean exclusively,” the fiduciaries had “some discretion” to liquidate employer stock. Id. at *7.

In addition, the Eleventh Circuit held that defendants were not liable for alleged misrepresentations contained within the company’s SEC filings, even if those filings had been incorporated into the company’s Form S-8 filings and prospectuses. Such filings constitute corporate communications under the federal securities laws and not ERISA fiduciary conduct or speech. The Eleventh Circuit also ruled that ERISA did not require defendants to disclose non-public information concerning the company’s business practices or their affect on the company’s stock price. Such a rule would improperly “convert[] fiduciaries into investment advisors.” Id. at *15.

The ERISA Litigation Practice of Sidley Austin LLP Sidley Austin LLP is a leader in the specialized issues presented by litigation over 401(k) plans. Our firm is representing companies in class action lawsuits throughout the United States involving both 401(k) plans and cash balance plans. In addition, Sidley is experienced in drafting such plans and counseling companies on the regulatory and legislative issues affecting such plans.

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