By: Ward Kallstrom and Michelle Scannell
The Ninth Circuit recently grappled with whether the presumption of prudence, which normally protects fiduciaries in stock drop class actions, applies where the plan permits, but doesn’t require or encourage, the fiduciaries to offer employer stock as an investment option. In Harris v. Amgen, 55 EBC 2093, the court held that the fiduciaries’ actions in continuing to offer the stock fund option were not cloaked with the presumption of prudence. This case, and a similar recent Second Circuit decision on the issue, may signal an increased uphill battle for fiduciaries in stock drop cases in some circuits.
The Presumption of Prudence
There’s an inherent tension between Congress’ mandate in ERISA that fiduciaries act prudently in making investment decisions, and its desire to permit employers to provide loyalty incentives such as employee stock ownership. In an attempt to reconcile this tension, federal circuits have applied a “presumption of prudence” first articulated by the Third Circuit in Moench v. Robertson, to fiduciary investments in employer stock. 62 F.3d 553 (3d Cir. 1995). Where the presumption applies, it means that a fiduciary’s decision to invest a plan in employer stock, or offer to plan participants the option to so invest, is a presumptively prudent decision that is reviewed only for an abuse of discretion. In Quan v. Computer Sciences Corp., the Ninth Circuit, adopting Moench, held that the presumption of prudence is triggered “when plan terms require or encourage the fiduciary to invest primarily in employer stock.” 623 F.3d 870 (9th Cir. 2010).
Harris v. Amgen
In Harris, current and former employees of pharmaceutical company Amgen and one of its subsidiaries participated in two defined contribution plans (“Plans”) whose investment choices included a company stock fund (the “Amgen Fund”). (Oddly, the court called them “employee stock ownership plans” — but they were not ESOPs, because ESOPs are required by law to be invested primarily in employer stock, and the Plans did not mandate stock fund investments.) After the value of the Amgen stock fell, allegedly because of safety concerns about some of Amgen’s products, the employees sued. They alleged, among other things, that the Plan fiduciaries breached their duty of care by continuing to provide Amgen stock as an investment option when they knew or should have known that the stock price was artificially inflated.
Defendants moved to dismiss the complaint, asserting that the presumption of prudence applied to the continued offering of Amgen stock throughout the class period. The district court held that the presumption of prudence shielded the Plan fiduciaries from liability.
On appeal, defendants asserted four arguments to support their claim that they were entitled to a presumption of prudence. First, they claimed that the Plans encouraged investment in Amgen stock in that they referred expressly to it as a permissible investment. The court disagreed, finding that plan language stating that fiduciaries “may offer a stock” did not equate to “encourag[ing]” investment in the stock.
Importantly, the court also pointed to the Second Circuit’s recent decision in Taveras v. UBS, which refused to apply the presumption of prudence to a plan that merely permitted investment in employer stock, but applied the presumption for a plan that required investment in employer stock. 708 F.3d 436 (2d Cir. 2013). The Taveras court noted that if the presumption of prudence was triggered for every plan that simply permitted rather than required investment in employer stock, it would be “hard pressed” to imagine that any such plan would not be entitled to a presumption of prudence. The court thought that such an outcome would be contrary to Moench. It cited Moench’s reasoning that the presumption exists “primarily in instances where a fiduciary ‘has an explicit obligation to act in accordance with plan provisions by offering employer stock. . .’” (emphasis added). It also noted that the tension between Congress’ competing concerns underlying the presumption was “weak at best, if not absent entirely,” where a plan does not mandate investment in employer stock.
Second, defendants argued that the Plans encouraged investment in Amgen stock by their provisions regulating the purchase, transfer and distribution of Amgen stock, and ensuring voting rights to participants who invested in the Amgen Fund. The court rejected this notion, commenting that it thought that a Plan provision stating that participants may not allocate more than 50% of their holdings in the Amgen Fund actually discouraged investment in Amgen stock. The court failed to observe that this type of clause, common in all stock fund plans except ESOPs, is intended not to discourage investment but to ensure that participants diversify their investments and that fiduciaries fulfill their duties of loyalty and care.
Third, defendants claimed that the Plan documents evidenced a “longstanding practice and intent” to include Amgen stock as part of the Plan design. The court disagreed, noting that the cited Plan language took effect after the lawsuit was filed.
Fourth, defendants argued the Plans encouraged investment in Amgen stock because defendants would have to amend the Plans to make Amgen stock unavailable to Plan participants. The court found no evidence to support this contention.
The court thus held that the district court erred in applying the presumption of prudence. The court held that the fiduciaries’ actions should be evaluated under the normal prudent man standard, which requires that a fiduciary act “with the care, skill, prudence, and diligence under the circumstances then prevailing such that a prudent man acting in a like capacity and similar with such matters would use” in similar circumstances. 29 U.S.C. § 1104(a)(1)(B).
Although broad application of the presumption of prudence may still sound a death knell for stock-drop claims in some circuits, the Ninth Circuit’s (like the Second Circuit’s) restrictive application of the presumption has laid fertile ground for continued stock-drop litigation. Given ERISA’s venue rules, the reasoning of the Harris and Taveras courts demonstrates that fiduciaries may need to be prepared to clear a high hurdle in establishing that a plan that merely permits investment in employer stock “encouraged” its fiduciaries to so invest. These cases highlight the importance of “hard-wiring” stock funds in defined contribution plans by mandating in the plan documents that the participant investment options include an employer stock fund.