Employees of failed banks who have lost their retirement savings are, in theory, not without a remedy. Many employees of failed banks who have lost their retirement savings have filed suits for breach of fiduciary duty under the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. §§ 1101 et seq. Congress passed ERISA to protect retirement and other employee benefit plans, establishing strict fiduciary duties applicable to the trustees responsible for those plans—fiduciary duties that courts have repeatedly described as the “highest known to the law.” But those protections sometimes provide scant returns. While some bank workers have recovered part of their losses through breach of fiduciary duty suits, others, including employees at the largest financial institutions in the country, are encountering legal and practical obstacles that suggest that their lost retirement savings may remain among the casualties of the economic downturn.
Bank Workers and the Financial Crisis
ERISA suits for breach of fiduciary duty have been filed in many cases involving the banks whose failures grabbed headlines, including Countrywide, Washington Mutual (WaMu), IndyMac, Colonial Bank, and Huntington Bancshares, Inc., among others. Another group of cases has arisen from turmoil in the financial institutions that economists have termed the “shadow banking system,” such as Bear Stearns, Citigroup, and Lehman Brothers. The ERISA cases have sometimes been filed in conjunction with securities fraud suits, and they have sometimes been filed independently.
The claims at the core of the complaints usually allege that the fiduciaries of the retirement plan, who are those charged with discretionary authority over plan investment decisions, breached their duties of prudence by continuing to allow the investment of plan assets in bank company stock when the fiduciaries knew or should have known that the investment posed an unacceptable risk to plan participants. Cases may also allege fiduciary misrepresentation and/or failure to disclose complete and accurate information. In cases involving publicly traded companies, the ERISA allegations may overlap with securities fraud allegations, as filings with the Securities and Exchange Commission (SEC) can sometimes be considered fiduciary communications if they are incorporated by reference into communications by the employee benefit plan. Defendants have a wide range of responses, including challenging the facts alleged in the complaints and whether they are sufficient to state claims under ERISA.
Readers may be familiar with ERISA suits involving imprudent investment in company stock from the Enron and WorldCom debacles. The Enron and WorldCom cases are widely considered to be among the first individual account cases alleging breach of fiduciary duty (often termed “stock drop” cases by the defense bar because of the drop in the value of company stock that is one of the core allegations in such suits). In January 2002, when Enron went bankrupt, many employees simultaneously lost their jobs and much of their retirement savings. As was widely reported, before the final collapse in the stock’s value, 62 percent of the assets in the Enron 401(k) plan were invested in shares of Enron stock. In the ERISA litigation that followed Enron and WorldCom’s collapse, complaints survived motions to dismiss, and some plan participants recovered significant benefits. There was widespread publicity and congressional hearings about the risks and dangers of over-investing in employer stock.
Just as the Enron and WorldCom cases did, the current failed-bank cases shine a light on policy issues related to corporate business practices and our current retirement system. Although the issue at the heart of the bank workers’ ERISA suits is not mismanagement of the banks themselves or macro trends in the economy, but rather specific mismanagement of the employees’ retirement funds, the complaints in the ERISA failed-bank cases read like a road map to the current financial crisis. Written from the perspective of the bank employee plaintiffs, the allegations describe a vicious cycle of subprime lending paired with inadequate financial controls, improper valuation of the housing market and overvaluation of bank assets, promotion of risky new financial products like mortgage-backed securities, and misleading disclosures by corporate executives. Their charges are similar to those made at a more general level by the recent Federal Crisis Inquiry Commission report, at least the version signed by a majority of members that denounced “dramatic failures of corporate governance and risk management” and concluded that “a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis.”
The bank workers’ situations are particularly poignant in that they illustrate two trends that have made the economic recession so devastating for so many and that continue even 10 years after they first gained widespread attention in the Enron case: the shift from defined benefit plans to individual account plans and investment in company stock as a vehicle for retirement savings.
While a defined benefit plan promises a certain amount in benefits after retirement (an example is a traditional pension), defined-contribution plans provide a retirement benefit based on annual contributions to an individual account (an example is a 401(k)). According to the Employee Benefits Security Administration of the Department of Labor, the number of active participants in defined-benefit plans fell from about 27 million in 1975 to approximately 19 million in 2007, whereas the number of active participants in defined-contribution plans grew from about 11 million in 1975 to 67 million in 2007. It is well known that this trend signifies a massive transfer of investment risk from employers to employees as employers attempt to shed responsibility for prudently investing retirement-plan assets by putting employees in charge of their retirement savings portfolios.
Workers whose retirement assets are held in a defined contribution plan magnify their investment risks when those assets are largely held in their employer’s own stock. While overall investment in company stock has declined since the Enron scandal, it remains significant. According to the Employee Benefits Rights Institute, in 2008, approximately 10 percent of employees with the option to do so invested in company stock through their 401(k)s, down from 20 percent in 1996. On the other hand, 28 percent held more than 20 percent of their account balances in company stock, while 7 percent held more than 8 percent of their account balances in company stock. Participation in ESOPs, meanwhile, is increasing, according to the National Center for Employee Ownership (NCEO), an organization that promotes ESOPs. The NCEO estimates that 10,800 ESOPs exist with a total of over 12 million participants—up from 9,600 ESOPs with a total of over 11 million participants in 2003.
The economic crisis of the past three years has highlighted the exceptional “double dependence” risk of this retirement savings practice, and bank workers in particular have acutely felt the sting. Not only were bank workers’ day-to-day incomes dependent on the health of their employer, so, too, were their long-term retirement savings. Unlike the case with defined-benefit plans, no government-sponsored institution—such as the Pension Benefit Guaranty Corp.—exists to insure these workers’ retirement savings against the catastrophic financial failure of their employer. Thus, the bank worker 401(k) cases shine a bright spotlight on the unnecessarily inadequate nature of federal protection for employee retirement savings in the defined-contribution era.
ERISA Protects Participants’ Retirement Savings
ERISA is designed to protect plan participants, including individual account plan participants, against undue risk. Indeed, the recognized congressional purposes underlying ERISA include, as the Fourth Circuit has stated, safeguarding employee benefit plans that affect the “well-being and security of millions of employees and their dependents,” which “are of paramount importance to the national economy, and . . . the financial security of the Nation’s work force.” Chao v. Malkani, 452 F.3d 290, 293 (4th Cir. 2006).
ERISA does not impose strict liability or guarantee the security of retirement funds, but it does provide that managers with discretionary authority over employee benefit plans maintain what the Supreme Court has called “strict standards” of conduct, including meeting stringent fiduciary duties of prudence and loyalty. Cent. States, Se. & Sw. Areas Pension Fund v. Cent. Transp., Inc., 472 U.S. 559, 570 (1985). As part of the duty of prudence, fiduciaries are required to make plan investment decisions as would a prudent person in like circumstances, which courts have noted is a higher standard than the business-judgment rule applicable to the decisions of corporate directors.
While the language of ERISA is highly protective, there are many challenges for bank workers who seek to recover their savings through suits alleging breach of fiduciary duty. In some of the cases emerging from the recent financial crisis, ERISA suits have survived motions to dismiss and have resulted in bank employees recovering at least some portion of their lost retirement savings. Examples include a $55 million settlement in Countrywide that received final approval on November 16, 2009; a $49 million settlement in the WaMu case that received final approval on January 7, 2011; and a $7 million settlement in IndyMac that received final approval on January 19, 2011. While this may seem like a record of incipient success, many other cases have been dismissed, with some being re-filed and others being appealed.
How the present batch of employer-stock ERISA cases fare for plaintiffs may set future standards for the ability of workers to protect themselves and recover retirement savings lost as a result of corporate mismanagement that was beyond their knowledge and control.
ERISA cases are an attractive option for employees because other types of litigation may provide little if any redress against a failed bank. Securities fraud suits are the other most significant form of potential litigation, and some have proceeded beyond the motion to dismiss stage. Securities fraud cases may include retirement plan participants among their class members but require sufficient allegations to establish scienter. For banks in FDIC receivership, the FDIC has standing to bring claims against the bank’s corporate decision-makers or to allocate the failed bank’s assets to redress retirement savings losses, but, as a practical matter, the FDIC has shown little interest in these sorts of efforts and understandably devotes the bulk of its efforts to its primary mission: protecting depositors. Insurance issues can also pose challenges for nonemployee investors in failed banks, as director & officer (D&O) coverage may have conduct exclusions or may be written so as to be eliminated in cases of FDIC receivership.
ERISA cases pose their own challenges to recovery. Naturally, plaintiffs must adequately plead and then prove the allegations required to show a breach of fiduciary duty under the statute. For most of the claims brought in the failed-bank cases filed on behalf of the plan itself under ERISA sections 409 and 502(a)(2), this requires pleading and establishing that a defendant is a fiduciary with discretionary authority over plan investment decisions, that he or she breached his or her fiduciary duty, and that the breach resulted in losses to the plan. Insurance issues also loom large; sometimes the fiduciaries of a plan have no liability insurance specifically for potential breaches of fiduciary duty, and often the insurance they do have is far too little to protect against the catastrophic losses that can result from excessive investment in employer stock.
Beyond meeting the statutory elements of their claim, the current round of litigation has presented a barrier to recovery that is emerging as an issue of critical import to the outcome of bank worker cases: whether or not plan fiduciaries are entitled to a presumption that they acted reasonably when they continued investments in company stock and what it takes to rebut that presumption.
The Moench Presumption
The Moench presumption was first established by the Third Circuit in a 1995 case involving a failed bank holding company ESOP in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). Much of the current failed-bank litigation involves argument over its application and meaning.
In Moench, plan participants brought suit for breach of fiduciary duty when a New Jersey bank was put into FDIC receivership and the bank holding company’s ESOP collapsed. The district court ruled for the plan fiduciaries, holding that they could never be liable where the ESOP provided that its primary purpose was to invest in employer securities. The Third Circuit rejected this absolutist approach, but in so doing, it held that “an ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA.” A plaintiff could overcome that presumption by “establishing that the fiduciary abused its discretion by investing in employer securities.” In other words, the plaintiff was required to show that “owing to circumstances not known to the settlor and not anticipated by him,” continued investment in employer securities “would defeat or substantially impair the accomplishment of the purposes of the trust.” Moench reversed summary judgment based on the facts alleged, including a steep decline in the bank stock’s value, plan committee members’ knowledge of its impending collapse, and their inherently conflicted positions as both corporate managers and fiduciaries; the court remanded for further proceedings.
As the basis for its presumption, the Third Circuit cited the need to reconcile congressional desire to promote ESOPs while holding the fiduciaries to their statutory duties of prudence and loyalty. The tension observed by the Third Circuit exists in ERISA, which provides for the creation of ESOPs and establishes a limited exception to the 10 percent cap on the amount a plan may otherwise hold in employer securities but does not exempt them from the duties of prudence or loyalty.
In the 15 years since Moench was decided, other circuits, including the First, Fifth, Sixth, and most recently the Ninth, have adopted some version of its presumption, but its adoption has been slow. While some district courts have rejected Moench, others have accepted it. Whether it will be adopted by other circuits or whether there will be a circuit split remains dependent on the outcome of pending appeals, including several in failed-bank cases.
There is significant ongoing litigation over the applicability and relevance of the Moench presumption. Plaintiffs—supported by the Department of Labor, which has filed numerous amicus briefs in pending appeals—contend that Moench is inconsistent with the statutory prudence standard and has no basis in the statute. Defendants, however, argue that Moench is supported by the exception for diversification and point to its increasing adoption by various circuits.
There is also argument over whether Moench can be applied at the motion-to-dismiss stage, with many plaintiffs and some courts agreeing that it is an evidentiary presumption that should only be applied at a later stage, as was true in Moench itself. Defendants respond that Moench is not an evidentiary presumption, but rather a standard of review. Further, they contend, particularly when combined with recent Supreme Court decisions that seem to require heightened pleading standards, the Moench presumption requires plaintiffs to plead sufficient facts to demonstrate that it can plausibly be overcome.
Perhaps the most critical argument involves precisely how dire circumstances need to be to rebut Moench and thus to show that the plan fiduciaries should have divested the stock. Plaintiffs argue that they must show that a prudent fiduciary under similar circumstances would have made a different decision and that it is sufficient to identify artificial inflation in the stock’s value, excessive risk, corporate impropriety, and/or fraud. Defendants, meanwhile, insist that the presumption can only be rebutted where plaintiffs show that the fiduciaries knew of an imminent collapse, a threat to long-term viability of the company, and/or an illegal scheme. As is so often the case in litigation, the difference between factual scenarios that do and do not meet the test is often a matter of argument.
Application of Moench
Cases from around the country illustrate the varying applications of the duty of prudence in failed-bank cases, including the varying applications of Moench. A few examples make the point. For instance, the Western District of Tennessee, in litigation involving an ESOP sponsored by Regions Bank and its affiliates, denied a motion to dismiss where the company was alleged to have, among other things, overinvested in risky and undiversified residential and commercial loans as well as in subprime, mortgage-backed securities, and to have engaged in improper accounting for its loan losses and imprudent credit-risk management. The court also specifically rejected application of the Moench presumption at the motion-to-dismiss stage. See In re Regions Morgan Keegan ERISA Litigation, 692 F. Supp. 2d 944, 952-54 (W.D. Tenn. 2010).
As another example, in Dann v. Lincoln National Group, the Eastern District of Pennsylvania applied Moench on a motion to dismiss but held the presumption overcome where the plaintiffs alleged that Lincoln National had become increasingly exposed to heavy losses because of its investments in mortgage-backed securities, structured investment products, and other derivative securities. Their stock had fallen over 90 percent in value, and plaintiffs further alleged both that the fiduciaries knew or should have known the value of the stock would seriously deteriorate and that there were conflicts of interest on the part of some defendants, including among other reasons because their compensation was tied to the price of the company stock. See Dann v. Lincoln Nat’l Group, 708 F. Supp. 2d 481, 490 (E.D. Pa. 2010).
On the other hand, several Southern District of New York cases have granted motions to dismiss based on Moench, including in the ERISA cases involving Citigroup, Lehman Brothers, Bank of America, and Bear Stearns company stock plans. The court did so despite allegations of large drops in stock price, allegations of conflicts of interest on the part of the fiduciaries, and allegations that the fiduciaries knew or should have known the financial institutions in question faced dire financial circumstances. In each case, the court seemed influenced by the fact that the company stock had not lost all value, and, particularly interesting in the Bank of America case, reasoned that the decline in value should be viewed in the context of the global financial crisis. See In re Citigroup ERISA Litig., 2009 WL 2762708 (S.D.N.Y. Aug. 31, 2009); Lehman Bros. Securities & ERISA Litig., 683 F. Supp. 2d 294 (S.D.N.Y. 2010); In re Bank of America Corp. Securities, Derivative & ERISA Litig., ___ F. Supp. 2d ___, 2010WL 3448197 (S.D.N.Y. Aug. 27, 2010); In re Bear Stearns Companies, Inc. Securities, Derivative, and ERISA Litig., 2011 WL 223540 (S.D.N.Y. Jan. 19, 2011).
The Second Circuit appeal in the Citigroup case has attracted particular attention, including the filing of numerous amicus briefs. On the plaintiffs’ side, both the Department of Labor and the AARP have weighed in. While the Department of Labor argues that the Moench presumption has no statutory basis, AARP focuses on the district court’s holding that the governing plan documents provided no discretion to anyone to decide whether or not to include the Citigroup stock in the plan. With this reasoning, the AARP argues, “[a]stonishingly, this might leave $2.5 trillion of pension funds effectively unregulated and more than 75 million participants unprotected,” because “[q]uite simply, the district court’s decision leaves plan participants with no one minding the plan.” On the defense side, the ERISA Industry Committee and the American Benefits Council jointly filed a friend-of-the-court brief supporting Citigroup, arguing the district court’s interpretation of Moench should be upheld to prevent unwarranted challenges to ERISA fiduciaries of defined-contribution plans.
From this plaintiffs’ lawyer’s perspective, while there is no doubt that Moench created a more deferential standard of review for the decisions of ESOP fiduciaries to continue investing in employer securities, four aspects of the case caution against reading it in too exculpatory a manner. First, the Third Circuit declined to defer to the plan committee’s purported interpretation of the plan that investment in employer securities was mandatory and that they were prevented from diversifying, in part because such a reading would be inconsistent with their duties to act in the best interest of the participants and in part because there was no evidence that the committee had actually deliberated or reached any such decision prior to the litigation. Second, Moench cited trust law that even where investments were mandatory rather than permissive, the trust should still not continue investments where “compliance would be impossible . . . or illegal,” or where a “deviation is otherwise approved by the court.” Third, Moench observed that in evaluating the fiduciaries’ decision-making, the courts should be attuned to their conflicting loyalties and specifically held that “if the fiduciary cannot show that he or she impartially investigated the options, courts should be willing to find an abuse of discretion.” The court cited favorably the familiar requirement that “the prudent person standard requires [a fiduciary to] make a careful and impartial investigation of all investment decisions.” Fourth and finally, it should be remembered that Moench held that the facts alleged in its case could amount to an abuse of discretion.
The cases involving bank workers who lost their retirement savings when their employers failed to run financially viable businesses, like the Enron and WorldCom cases of the previous decade, are reflective of broader social and economic trends. Those trends illustrate the retirement insecurity that can result when a widespread financial crisis hits a retirement system in which investment risk has been shifted to individual account holders and those account holders have been explicitly and implicitly encouraged to adopt a risky, undiversified portfolio that is heavily dependent on the continued success of their employer.
As courts make decisions in the numerous pending cases, they will continue to define the contours of ERISA’s protections. While defendants may applaud the careful scrutiny of ERISA claims and the restrictive application of liability, ERISA was designed as a prophylactic statute. Barriers that are imposed on participants’ efforts to recover their lost retirement savings should only be those that Congress intended.
ERISA itself was passed when Congress determined that the previous legal protections in effect for retirement savings, at the time largely contained in trust law, were inadequate. If new barriers are erected that deprive too many plan participants of protection for their retirement savings, new solutions may be necessary.
Keywords: litigation, class actions, derivative suits, ERISA, employees