By: Ian Morrison, Nadir Ahmed and Sam Schwartz-Fenwick

Recently, many courts have dismissed ERISA “stock drop” cases at the pleadings stage, finding plaintiffs’ allegations insufficient to overcome the presumption of prudence which many courts find applies to the decision to offer qualifying employer securities as a plan investment option.  In the face of recent dismissals, several plaintiffs have sought leave to amend their complaints in an effort to plead around these deficiencies.  A recent decision from the Southern District of New York rejected such an attempt. 

On October 5, 2011, in In re Lehman Brothers Securities and ERISA Litigation (Case No. 09-MD-02017-LAK), the United States District Court for the Southern District of New York dismissed for the second time a complaint alleging that the defendant directors and/or plan administrators failed to prudently and loyally manage the Lehman Brother’s Savings Plan’s  assets, misstated and omitted material information about the company’s financial condition, and breached their duty of loyalty by failing to avoid conflicts of interest and monitor the committees appointed to administer the Plan.  In so deciding, the Court affirmed the high threshold necessary to rebut the presumption that a fiduciary’s decision to offer company stock as a plan investment option is consistent with his or her ERISA obligations.

In the wake of Lehman’s collapse, plan beneficiaries sued Lehman’s former directors and a member of the Plan Committee alleging that they knew of Lehman’s deteriorating condition but failed to protect the Plan by continuing to “hold and invest in Lehman’s stock before, during and after Lehman’s collapse.”  After the Court dismissed the original complaint, the plaintiffs filed a second pleading in which they named six more Plan Committee defendants, alleged that the defendants knew or should have known that Lehman was in a dire situation after March 16, 2008, when Bear Stearns was sold to JP Morgan Chase for $2 per share, and added fifty pages of new allegations.  The new allegations, included: (1) that an investment consulting company made presentations regarding a potential credit crunch and the Lehman’s Stock Fund’s poor performance; and (2) that the defendants were aware of the original complaint.

The Court dismissed the new complaint for a number of reasons.  First, the Court found the new allegations insufficient to overcome the so-called Moench presumption of prudence, which attaches when an employee stock ownership plan fiduciary follows plan terms that mandate offering the opportunity to invest in employer stock. Generally, plaintiffs may overcome this presumption by pleading that the fiduciary knew of an imminent corporate collapse or other dire situation indicating that continuing to offer employer stock as an investment would be inconsistent with the intent of the plan’s sponsor.  Here, the Court rejected plaintiffs’ argument that knowledge of the first complaint placed the defendants on notice of such dire circumstances, finding instead that the original complaint was composed of allegations, not evidence, and that the first complaint had not even alleged a claim upon which relief could be granted.  Likewise, the Court found that the presentations related to a credit crunch in the broader market and Lehman’s stock’s poor performance were equally insufficient to serve as notice of a dire situation, since even significant downswings can be expected.  Second, the Court rejected plaintiffs’ affirmative disclosure claim because ERISA only requires defendants to provide disclosures related to plan benefits, and the Second Circuit, unlike other Circuits, has not extended disclosure obligations to include information about a company’s financial condition.  Finally, the Court found that the complaint failed to allege a primary breach of fiduciary duty.  Specifically, the complaint did not plead facts demonstrating that: (1) the Director Defendants were fiduciaries for the purpose of exercising control and authority over the plan, (2) the defendants had any conflicts of interest that would violate ERISA’s duty of loyalty, and/or (3) the defendants appointed unqualified plan fiduciaries. 

 This decision reinforces the increasing degree to which courts are skeptical of stock drop claims and will insist on specific pleadings setting forth that the defendants knew of circumstances plainly rendering employer stock imprudent as an investment.  Courts no longer will find conclusory allegations, speculation, or inferences sufficient to allow a stock drop claim to proceed.