By: Ron Kramer and Jim Goodfellow
Recently, in White, et. al. v. Marshall & Ilsley Corp., the Seventh Circuit concluded that a claim against an Employee Stock Ownership Plan can be dismissed if a plaintiff does not overcome the Moench presumption. In what is becoming an all-to-common result for plaintiffs who bring “stock drop” lawsuits in this circuit, the Seventh Circuit concluded that there were no breaches of any fiduciary duties.
The facts of this case are straight forward. The named plaintiff was a participant in Marshall & Ilsley’s (“M & I”) ERISA governed retirement savings plan (the “Plan”). The Plan allowed the named plaintiff to choose how to distribute her savings among more than twenty investment funds with varying risk and reward profiles. These funds were selected by the Plan’s fiduciaries per the terms of the Plan.
One of the investment options available, as required explicitly by the Plan, was the M & I stock fund, which consisted of M & I common stock. This fund was an Employee Stock Ownership Plan (“ESOP”) under ERISA. The Plan required that the M & I stock fund be offered at all times, regardless of stock performance, “no matter how dire.” Indeed, the Plan recognized the likelihood of significant declines, but took a long-term view with respect to the stock’s value, and the benefit of aligning an employee’s interests with that of the company.
During the recession that followed the housing market collapse, M & I’s stock price dropped 54%, a drop that affected the value of the employees’ investment in the M & I stock fund.
The named plaintiff filed a putative class action and alleged that the Plan’s fiduciaries violated ERISA by continuing to offer the M & I stock fund as an investment option in spite of this precipitous drop in price. She alleged that the Plan’s fiduciaries violated their duty of prudence under ERISA by continuing to offer M & I stock as one of the investment options. The named plaintiff alleged that M & I expanded its business to include risky loans outside its normal scope of expertise. The stock price was pummeled as analysts repeatedly downgraded M & I bonds and stock. The named plaintiff alleged that these circumstances were dire, and thus gave rise to an investment that was untenably risky for retirement savings.
The district court disagreed and granted a motion to dismiss the named plaintiff’s claim under F.R.C.P. 12(b)(6). Plaintiff appealed, and the Secretary of Labor filed an amicus brief supporting plaintiff’s position and questioning the presumption of prudence most courts apply in such cases. Nevertheless, the Seventh Circuit affirmed. In its decision, the Seventh Circuit began by analyzing the tension between the fiduciary’s duty to select only prudent investments and the duty to act in accordance with the Plan’s documents. To analyze the named plaintiff’s claim, the Seventh Circuit applied the Moench presumption, which states that where a plan requires investment in company stock, such investment is presumed to be prudent unless the investment creates an excessive and unreasonable risk for employees. Generally speaking, investment risk is excessive and unreasonable when the company faces impending collapse. Thus, according to the Seventh Circuit, a plaintiff can overcome the Moench presumption only when no reasonable fiduciary would have thought that they were obligated to continue offering company stock.
In applying this standard, the Seventh Circuit rejected the Sixth Circuit’s standard, preferred by the named plaintiff and the Secretary of Labor, which states that the Moench presumption is overcome when a plaintiff can show that a reasonable fiduciary would have come to a different investment decision. For the Seventh Circuit, this sets the bar too low, in light of the conflicting position in which ESOP fiduciaries find themselves. Said the court, the purpose of the Moench presumption is to enable fiduciaries to carry out their dual roles and insulate them from short-term market volatility. The Sixth Circuit’s standard impedes the fiduciary’s ability to perform their duties.
Turning to the merits of the named plaintiff’s claims, the Court summarily disposed of her theories of liability. First, the named plaintiff argued that the investment was imprudent because the stock price was objectively overvalued, thus the investors were bound to lose money when the market corrected the price downward. Second, she argued that investment in the stock was risky because the stock was exposed to price swings that investors cannot tolerate. Thus, the stock price drop put the fiduciaries on notice that the investment choice was imprudent.
The Court swept aside these concerns because M & I stock is traded publically in an efficient market (which means that the participants were equally capable of observing market conditions and making independent judgments as to the stock’s value), and because the named plaintiff — and those she sought to represent — had other investment options from which they were free to choose based on their own level of risk tolerance. According to the Court, to find that the fiduciaries had breached their duties would create three unworkable consequences: (1) fiduciaries would be required to anticipate how their company stock would perform in the future, which would require omniscience and foresight; (2) fiduciaries may be required to use non-public inside information in violation of securities laws; or (3) fiduciaries would be required to beat a presumptively efficient market with their investment choices. The Court also noted the irony of plaintiff’s position, namely that in divesting the Plan of company stock to avoid liability with respect to the price drop, the Plan fiduciaries may expose themselves to liability with respect to the inevitable up-swing.
In sum, the Court found that an ERISA fiduciary is not a participant’s individual investment advisor. Rather, they must look out for the Plan as a whole. And in this particular case, the downswing in price was not indicative of impending collapse. Indeed, the Court noted that the M & I stock price trended along with that of its competitors’.
Interestingly, the Court recognized that its holding could be read to be the death knell for stock drop cases involving plans with employer stock accounts. The Court indicated that its decision was not to be read that broadly, but also stated that ERISA cannot be read such that fiduciaries are transformed into guarantors of employee retirement savings.