By: Ron Kramer and Michelle Scannell

The Sixth Circuit has once again reversed the dismissal of a stock drop class action, this time rejecting claims that the presumption of prudence should apply at the pleading stage, that the ERISA Section 404(c) safe harbor should apply, and that the complaint generally failed to state a claim under Twombly and IqbalGriffin v. Flagstar Bancorp Inc., No. 11-1497 (6th Cir. July 23, 2012) (unpublished).


In Flagstar, participants of the Flagstar Bancorp Inc. (“Flagstar”) 401(k) Plan asserted breach of fiduciary duty claims against Flagstar and certain officials and fiduciaries, alleging that it was imprudent for the Plan to have offered Flagstar stock–which dropped 95% in value between January 2007 and April 2010–as an investment option for participant Plan accounts.

Defendants invoked the “presumption of prudence” and moved to dismiss the complaint on various grounds, including failure to state claims for relief and the ERISA Section 404(c) safe harbor protection based on the participant-directed nature of the accounts.

The district court relied on Kuper v. Iovenko, 66 F. 3d 1447 (6th Cir. 1995) and sister circuit jurisprudence in holding that the presumption of prudence is not exclusive to ESOPs and applies to all eligible individual account plans.  Griffin v. Flagstar Bancorp Inc., 51 EBC 1013, 1022 (E.D. Mich. March 31, 2011).  While noting that the Sixth Circuit had not offered guidance on the issue, the district court further determined that the presumption of prudence applied at the pleading stage, and dismissed the action after plaintiffs were unable to demonstrate that Flagstar was on the verge of collapse or other dire circumstances.  Id. at 1023.  The court also concluded that even if the presumption did not apply, plaintiffs failed to state a claim with sufficient clarity under Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), for breach of fiduciary duty because the participants had total control over their investments and Flagstar remained a viable institution despite the drop in its share price.

The Pfeil Decision

Nearly one year after Flagstar was dismissed, the Sixth Circuit held that the  presumption of prudence did not apply at the pleading stage.  Pfeil v. State Street Bank & Trust Co., 671 F.3d 585, 590 (6th Cir. 2012) (reversing dismissal of ESOP action and applying presumption of prudence as an evidentiary standard).  The Pfeil court also ruled that even if defendants met the requirements to invoke Section 404(c) as an affirmative defense, the safe harbor provision does not exempt fiduciaries from their duty to screen investments for participant-controlled accounts.  Id. at 597.  The Pfeil decision signals a divergence from other circuits that have viewed stock drop actions with increasing skepticism and applied the presumption of prudence at the pleading stage.  We blogged about some of those decisions here .

 Review of Flagstar Dismissal

On appeal, the Sixth Circuit relied heavily on the intervening decision in Pfeil and ruled that the presumption of prudence was evidentiary in nature and did not apply at the pleading stage.  The court also cited Pfeil in reiterating that ERISA Section 404(c) does not exempt fiduciaries from their duty to exercise prudence regarding investment options, such as in this case deciding to offer Flagstar stock to plan participants.  Lastly, the court found that the complaint stated a plausible claim for fiduciary breach under Twombly and Iqbal.  The complaint contained forty-seven paragraphs of factual allegations that went far beyond documenting a simple drop in stock price to recite announcements from Flagstar itself, statements by analysts and financial media publications, and actions taken by Flagstar suggesting a precarious financial situation.

Despite increasing judicial skepticism toward stock drop cases in other circuits, the Sixth Circuit appears more favorably inclined to permit these claims to be litigated.  At a minimum, stock drop cases in the Sixth Circuit will not be dismissed on safe harbor claims or the presumption of prudence.