It has been a few years now since the various permutations of the global financial crisis began to emerge and affect the equity markets. The share prices of many publicly traded financial services companies—particularly those tied in one way or another to the subprime lending and mortgage-backed securities markets—have suffered, assuming the companies survived at all. Prior to and during the turmoil, most of these companies sponsored retirement savings plans that offered employee-participants the option of allocating at least some portion of their retirement plan contributions to company stock. Some of the companies encouraged such employee allocations by offering matching employer contributions. Not surprisingly, with the substantial declines in the market capitalization of a number of these financial services companies, numerous class-action lawsuits have been brought on behalf of the company stock-holding participants in these Employee Retirement Income Security Act (ERISA)-governed plans. The plaintiffs’ basic refrain in these suits is that the plan fiduciaries (who, according to the plaintiffs, had the discretion to curtail investment in company stock regardless of the terms of the plan) either knew or should have known, at some point in time, that company stock was an imprudent investment, and they should have acted to avoid or minimize market losses.
As the courts have grappled with this rash of suits, certain trends have emerged. One of these trends is the application of the “Moench presumption” to resolve such suits at the pleading stage, before the parties proceed into costly discovery and further motions practice. In Moench v. Robertson, 62 F.3d 553, 571-72 (3d Cir. 1995), the U.S. Court of Appeals for the Third Circuit addressed the appropriate standard of review with respect to the discharge of an ERISA plan fiduciary’s responsibilities in administering a company’s employee stock ownership plan (ESOP). In arriving at an appropriate standard of review, the court attempted to reconcile the duties of loyalty and prudence that ERISA fiduciaries generally owe to plan participants and beneficiaries, Congress’s expressly stated goal of encouraging employee investment in company stock, and basic principles of trust law that were codified in and made applicable to ERISA. The Moench court reached a balanced solution that accommodates each of these concerns, holding that ESOP fiduciaries are presumed to act consistently with ERISA when investing in employer stock, but the presumption can be rebutted by showing that the fiduciary abused its discretion in doing so. The presumption thus deters costly suits of questionable merit, but it still protects plan participants when fiduciary imprudence can be established.
In 2007, the Third Circuit explicitly extended the Moench presumption beyond ESOPs to all ERISA-governed eligible individual account plans (EIAPs) that, by their terms, invest in qualifying employer securities (see Edgar v. Avaya, Inc., 503 F.3d 340 (3d Cir. 2007)) but are often part of a larger company retirement plan platform offering participants other investment options. Moreover, the Moench presumption has been applied in numerous district court decisions and adopted by several other circuit courts of appeals. While some courts have refused to apply it at the pleading stage, the presumption has been invoked on defendants’ motions to dismiss in several cases related to the recent financial crisis. The threshold application of Moench appropriately weeds out non-meritorious cases where the plaintiffs are unable to plead facts supporting a plausible claim to overcome the presumption of prudence.
The Moench Case and Relevant Holding
Charles Moench was a former employee of Statewide Bancorp and a participant in its ESOP. Moench, 62 F.3d at 559. Between July 1989 and May 1991, Statewide’s stock price fell in value from $18.25 to less than 25 cents per share. Id. at 557. During that time, bank regulators repeatedly expressed concern to Statewide’s board of directors (who were also members of Statewide’s ESOP committee) about Statewide’s financial condition. Statewide filed a voluntary bankruptcy petition under Chapter 11 in May 1991.
Moench filed a class-action lawsuit alleging, among other things, that Statewide’s ESOP committee breached ERISA fiduciary duties by continuing to invest in Statewide stock in the face of regulatory and financial problems and declining stock values. Id. at 559. The district court granted the committee’s motion for summary judgment, holding that the committee had no discretion under the terms of the ESOP plan to invest in anything other than Statewide stock. Id. at 560. The Third Circuit vacated the district court’s decision and remanded for further proceedings.
After finding that the terms of the Statewide ESOP “did not absolutely require the Committee to invest exclusively in Statewide stock” (id. at 568), the Third Circuit observed that the committee, in limited circumstances, could be liable under ERISA for continuing to invest in employer stock despite the plan’s primary purpose. However, the court held that, “in the first instance, an ESOP fiduciary who invests [plan] assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision,” but the presumption may be overcome “by establishing that the fiduciary abused its discretion by investing in employer securities.” Id. at 571. In this respect, the court further explained, “In attempting to rebut the presumption, the plaintiff may introduce evidence that owing to circumstances not known to the settlor and not anticipated by him the making of such investment would defeat or substantially impair the accomplishment of the purposes of the trust.” Id. (quoting Restatement (Second) of Trusts § 227 cmt. g (1959) (internal quotations and alterations omitted)).
Arriving at the Moench Presumption
The Third Circuit arrived at the Moench presumption by balancing several considerations. In sum, the court wrestled with marrying the fiduciary duties prescribed by ERISA, Congress’s stated goal of increasing employee ownership of company stock, and principles of trust law.
As the Moench court recognized, an ERISA fiduciary must “discharge his duties . . . solely in the interest of the participants and beneficiaries” and must act “with the care, skill, prudence, and diligence under the circumstances then prevailing.” Moench, 62 F.3d at 561 (citing 29 U.S.C. § 1104(a)(1)(B)). However, ESOP fiduciaries are statutorily exempt from the requirement to diversify investments, and “the prudence requirement (only to the extent it requires diversification) . . . is not violated by acquisition or holding of . . . qualifying employer securities.” Moench, 62 F.3d at 568 (citations omitted). ESOP fiduciaries are also exempt from ERISA’s strict prohibitions against dealing with a party in interest and against self-dealing. Id. The exceptions exist because, by their nature, ESOP plans place employee benefits at a much greater risk than a diversified plan, and, furthermore, ESOP fiduciaries were not “intended to guarantee retirement benefits.” Id. at 568 (citations omitted).
Further, the Moench court acknowledged that ESOPs were created by Congress to encourage employee ownership of company stock. Congress was “deeply concerned” that this goal would be “made unattainable by regulations and rulings which treat employee stock ownership plans as conventional retirement plans.” Id at 569 (quoting the Tax Reform Act of 1976). “[T]he policies behind ERISA’s rules governing pension benefit plans cannot simply override the goals of ESOPs, and courts must find a way for the competing concerns to coexist.” Id. at 570. Accordingly, the court determined that, “as a general matter, ESOP fiduciaries should not be subject to breach-of-duty liability for investing plan assets in the manner and for the purposes that Congress intended.” Id. at 571 (citations and internal quotations omitted). The court, moreover, observed that participants in ESOP plans “effectively became investors in Statewide and thus should have expected to run risks inherent in that role.” Id. at 570.
The court also looked to trust law because ERISA’s “fiduciary responsibility provisions . . . codif[y] and make applicable to [ERISA] fiduciaries certain principles developed in the evolution of the law of trusts.” Id. at 564 (quoting Firestone Tire and Rubber Co. v. Bruch, 489 U.S. 101, 110 (1989)). A trustee is generally not held to be liable for taking actions that it is directed to take. Id. at 571. In Moench, the court found that the committee was not absolutely required by the plan documents to invest plan assets exclusively in Statewide, but it was more than merely permitted to do so. In such instances, the court determined that “fiduciaries should not be immune from judicial inquiry, as a directed trustee essentially is, but also should not be subject to the strict scrutiny that would be exercised over a trustee only authorized to make a particular investment.” Id. at 571. Accordingly, the Third Circuit arrived at the middle ground of the Moench presumption. However, the court was also cognizant of the potential catch-22 for ESOP fiduciaries. Thus, the Third Circuit noted that, in determining whether the plan fiduciary has abused its discretion, courts should be aware that if, “in what it regards as an exercise of caution,” the fiduciary “does not maintain the investment in the employer’s securities, it may face liability for that caution, particularly if the employer’s securities thrive.” Id. at 572.
Other Circuits Adopt the Moench Presumption
In addition to the Third Circuit’s express extension of the presumption to all EIAPs, the U.S. Courts of Appeals for the Fifth, Sixth, and Ninth Circuits have adopted the Moench presumption. See Edgar v. Avaya, Inc., 503 F.3d 340, 347 (3d Cir. 2007) (“because one of the purposes of EIAPs is to promote investment in employer securities, they are subject to many of the same exceptions that apply to ESOPs”) (citing Wright v. Oregon Mettalurgical Corp., 360 F.3d 1090, 1094 (9th Cir. 2004)); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 256 (5th Cir. 2008) (also applying Moench presumption in reviewing EIAP fiduciaries’ conduct); Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995); Quan v. Computer Science Corp., 623 F.3d 870 (9th Cir. 2010). The Seventh Circuit has also cited the Moench presumption with approval. See, e.g., Howell v. Motorola, Inc., Nos. 07-3837, 09-2796, 2011 WL 183966, at *16–17 (7th Cir. Jan. 21, 2011); Pugh v. Tribune Co., 521 F.3d 686, 701 (7th Cir. 2008). Moreover, the court in Edgar affirmed that the Moench presumption was properly applied on a motion to dismiss. 503 F.3dat 349.
These appellate decisions also make clear that mere passing external events or corporate developments likely to have a negative effect on the value of the company’s stock do not, in and of themselves, constitute “the type of dire situation which would require [the fiduciaries] to disobey the terms of the Plans by not offering [employer stock] as an investment option, or by divesting the Plans of [employer] securities.” Edgar, 503 F.3d at 348. See also Kirschbaum, 526 F.3d at 256 (“One cannot say that whenever plan fiduciaries are aware of circumstances that may impair the value of company stock, they have a fiduciary duty to depart from ESOP or EIAP plan provisions. Instead, there ought to be persuasive and analytically rigorous facts demonstrating that reasonable fiduciaries would have considered themselves bound to divest.”); Quan, 623 F.3d at 882 (“To overcome the presumption of prudent investment, plaintiffs must . . . make allegations that clearly implicate the company’s viability as an ongoing concern or show a precipitous decline in the employer’s stock combined with evidence that the company is on the brink of collapse or is undergoing serious mismanagement.”) (citation and internal alterations omitted).
Finally, these decisions reinforced the original observation in Moench that a plan fiduciary should not be compelled to predict the company stock’s future performance—essentially being subjected to potential liability no matter what decision the fiduciary makes with respect to investment in company stock. See, e.g., Edgar, 503 F.3d at 348–49 (“had defendants divested . . . during the Class Period, they would have risked liability for having failed to follow the terms of the Plans”); Kirschbaum, 526 F.3d at 256 (“A fiduciary cannot be placed in the untenable position of having to predict the future of the company’s stock performance.”).
Application of the Moench Presumption
The financial crisis that swept the globe at the end of the last decade affected virtually every sector of the U.S. economy, but financial services companies were hit especially hard. Company stock prices dropped dramatically in many instances; some companies failed or were sold to other financial institutions at diminished prices; and several businesses received government assistance to forestall further difficulties or avoid collapse. As events unfolded, numerous cases were filed, ostensibly on behalf of participants in the retirement plans of these companies, alleging that it was imprudent for plan fiduciaries to continue to invest in company stock, given company exposure to some aspect of the financial crisis. See e.g, Dann v. Lincoln Nat’l Corp., 708 F. Supp. 2d 481, 483 (E.D. Pa. 2010) (“As financial markets struggled in 2008 and 2009, Lincoln National became increasingly exposed to heavy losses because of its investments in mortgage-backed securities, structured investment products, and other derivative securities. Dann contends that because Defendants knew or should have known of the Company’s exposure to investment losses, it was imprudent to continue investing in Company stock.”); Gearren v. McGraw-Hill Cos., 690 F. Supp. 2d 254, 260 (S.D.N.Y. 2010), appeal docketed, No. 10-792 (2d Cir. Mar. 4, 2010) (“Defendants knew or should have known that the investment-grade ratings that S&P was giving to residential mortgage-backed securities and collateralized debt obligations were widely off-base. As a result, Defendants should have known that McGraw Hill’s stock price was inflated. . . . Because the stock was inflated, it was imprudent for the fiduciaries . . . to present the Stock Fund as an investment option.”); Alvidres v. Countrywide Fin. Corp., No. CV 07-05810, 2008 WL 819330, at *1 (C.D. Cal. Mar. 18, 2008) (“The Complaint alleges that Defendants breached various fiduciary duties owed to Plan participants under ERISA by imprudently allowing the investment of the Plan’s assets in Countrywide stock. Plaintiff alleges that such investment was unduly risky given the company’s involvement in marketing and extending subprime mortgage loans on a ‘low documentation’ basis.”).
In turn, many courts have granted motions to dismiss based in whole or in part on the Moench presumption. See, e.g., In re Bear Stearns Cos. Secs. Derivative & ERISA Litig., No. 08 MDL 1963, 2011 WL 223540, at *136 (S.D.N.Y. Jan. 19, 2011); Dudenhoeffer v. Fifth Third Bancorp, No. 1:08-CV-538, 2010 WL 4970767, at *9 (S.D. Ohio Nov. 24, 2010); In re Am. Express Co. ERISA Litig., No. Civ. 10834, 2010 WL 4371434, at * 12 (S.D.N.Y. Nov. 2, 2010); In re Bank of Am. Corp. Secs. Derivative & ERISA Litig., No. 09 MD 2058, 2010 WL 3448197, at * 21 (S.D.N.Y. Aug. 27, 2010); McGraw Hill Cos., 690 F. Supp. 2d at 271; In re Lehman Bros. Secs. & ERISA Litig., 683 F. Supp. 2d 294, 303 (S.D.N.Y. 2010); In re Citigroup ERISA Litig., No. 07-civ-9790, 2009 WL 2762708, at *19 (S.D.N.Y. Aug. 31, 2009), appeal docketed, No. 09-3804 (2d Cir. Sept. 9, 2009). Applying Moench at the motion-to-dismiss stage is consistent with the Twombly/Iqbal pleading standard. In this context, it requires that a plaintiff plead sufficient facts, which, taken as true, could plausibly establish that the defendant abused its discretion in breach of its fiduciary duties under ERISA. See McGraw Hill Cos., 690 F. Supp. 2d at 270 (“When the presumption applies, the factual allegations in the complaint must make it plausible that the defendants could not have reasonably believed that continued adherence to the terms of the plan ‘was in keeping with the settlor’s expectations of how a prudent trustee would operate.’” (quoting Moench, 62 F.3d at 571)). Cf. Kirschbaum, 526 F.3d at 256 (“there ought to be persuasive and analytically rigorous facts demonstrating that reasonable fiduciaries would have considered themselves bound to divest”).
In several of the cases in which a motion to dismiss was granted, the courts held that the employers were not threatened with the “dire” circumstances that would trigger a fiduciary’s obligation to divest the plan of company stock under Moench. See, e.g., In re Citigroup, 2009 WL 2762708, at *18–19 (“[A] fifty-two percent decline in stock price is significant, but courts have held that declines of similar or greater magnitude were not enough to overcome the Moench presumption. . . . [T]he allegations in this action provide ‘no indication’ that, during the class period, Citigroup’s ‘viability as a going concern was ever threatened.’”) (citing Kirschbaum, 526 F.3d at 255) (emphasis in original; other citations omitted); In re Am. Express Co., 2010 WL 4371434, at *12 (“The complaint alleged that the price of American Express stock dropped 78% during the class period, but the company continued to have earnings and income and the stock price has subsequently rebounded significantly.”).
Other dismissals were granted because courts reasoned that it would have been impossible for fiduciaries to choose the time to divest, which would have required the fiduciaries to predict when a collapse was “imminent.” See, e.g., Lehman Brothers, 683 F. Supp. 2d at302; In re Bear Stearns, 2011 WL 223540, at *135. Cf. In re Bank of Am. Corp., 2010 WL 3448197, at *21 n.2 (noting that Bank of America stock price increased following the class period, up 145 percent from January 21, 2009, until December 4, 2009).
On the other hand, several courts have denied motions to dismiss. See, e.g., Veera v. AMBAC Plan Admin. Order Comm., No. 10 CV 4191, 2011 WL 43534, at *6 (S.D.N.Y. Jan. 6, 2011); Dann, 708 F. Supp. 2d at 492; In re Regions Morgan Keegan ERISA Litig., 692 F. Supp. 2d 944, 953–54 (W.D. Tenn. 2010); In re Morgan Stanley ERISA Litig., 696 F. Supp. 2d 345, 359 (S.D.N.Y. 2009); In re First Am. Corp. ERISA Litig., No. 07-01357, 2008 WL 5666637, at *5 (C.D. Cal. July 14, 2008); Alvidres, 2008 WL 819330, at *2. Of particular note, some of the denials concluded—albeit with little or no explanation—that Moench is an evidentiary presumption that cannot be applied at the motion to dismiss stage. See, e.g., In re Regions Morgan Keegan, 692 F. Supp. 2d at 953 (“It is improper, on a motion to dismiss, for the Court to apply evidentiary presumptions.”); Alvidres, 2008 WL 819330, at *2 (“the determination of whether Plaintiff can overcome this presumption is properly made at the evidentiary stage of the litigation, not at the pleading stage”). In contrast, other courts have correctly held that “the term ‘presumption of prudence’ is merely a shorthand way to refer to what the Moench court called a standard of review. The terminology should not be dispositive, and the use of the phrase ‘presumption of prudence’ should not necessarily trigger the rule that evidentiary presumptions are inapplicable at the motion-to-dismiss stage.” McGraw Hill Cos., 690 F. Supp. 2d at 269–70. Accord In re Bear Stearns Cos., 2011 WL 223540, at *134 (“the Moench presumption is not so much an evidentiary presumption but rather a ‘standard of review’ which can be applied at the motion to dismiss stage”). This interpretation is consistent with Iqbal, which requires plaintiffs to plead facts “that make it plausible that a breach of fiduciary duty actually occurred.” McGraw-Hill Cos., 690 F. Supp. 2d at 270. If and only if a plaintiff can pass that pleading test should the doors to full discovery be opened.
Finally, some courts unremarkably denied motions to dismiss because they found that the plaintiffs had alleged sufficient facts to state a plausible claim. See, e.g., Veera, 2011 WL 43534, at *5 n.2 (“Even were the Moench presumption applied here, this drop, representing a 99% decline, may represent a sufficiently ‘precipitous decline’ to overcome it.”); Dann, 708 F. Supp. 2d at 490–92 (finding that a precipitous decline in the price of employer stock (a 90.6 percent drop), specific allegations explaining why defendants knew or should have known that the value of the employer stock would seriously decline, and allegations that some defendants had conflicts of interest because their compensation was tied to the price of the employer stock, was sufficient to overcome the Moench presumption). Significantly, in Dann, the plan fiduciary had unfettered discretion to discontinue investing in company stock under the terms of the plan (id. at 489), which the court noted in denying the defendant’s motion to dismiss. Id. at 492. The plan documents at issue in Moench did not contain a comparable provision granting such latitude to the plan fiduciaries. Moench, 62 F.3d at 558. See also Quan, 623 F.3d at 883 (“A guiding principle . . . is that the burden to rebut the presumption varies directly with the strength of a plan’s requirement that fiduciaries invest in employer stock.”).
The Moench presumption strikes the appropriate balance between considerations implicit in the fiduciary duties imposed by ERISA, Congress’s stated intent to encourage employee stock ownership (including specific statutory provisions limiting fiduciary responsibility with respect to plans established to invest primarily in company stock), and principles of trust law. As the Moench court observed, investment in employer stock has inherent risks, and ERISA fiduciaries are not meant to be guarantors of such investments. The Moench presumption, moreover, is fittingly applied as a check on ill-founded cases at the motion-to-dismiss stage, particularly in light of Iqbal’s requirement that a plaintiff plead sufficient facts to support a claim that is plausible on its face.
(Editor’s note: As this article was going to press, another ERISA company stock case relating to the global financial crisis was dismissed at the pleadings stage based on the Moench presumption and the pleading requirements established by the Supreme Court in Twombly and Iqbal. See In re UBS AG ERISA Litig., No. 108-cv-06696-RJS, slip op. at 14 (S.D.N.Y. Mar. 24, 2011). Two UBS EIAP plans were at issue—one plan required that the UBS stock fund be offered to participants as an investment option; the other “strongly encouraged” it to be offered. Id. at 7–8. The court held that the Moench presumption applied with respect to both plans and that the plaintiff failed to allege sufficient facts to overcome the presumption. In particular, the court held that an alleged 69 percent drop in UBS’s share price during the class period was insufficient to overcome the presumption and that the plaintiffs had advanced no allegation that would make it plausible that UBS’s viability as a going concern was ever realistically in jeopardy. Id. at 11.)
Keywords: litigation, class actions, derivative suits, ERISA, stock-drop litigation, Moench presumption
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