On May 8, 2012, the Eleventh Circuit adopted the Moench1 presumption of prudence in affirming the dismissal of employer-stock drop case Lanfear, et al., v. Home Depot, Inc., et al.2 The court likewise rejected the notion that allegedly inaccurate and incomplete public securities fi lings lead to plausible claims under ERISA. With these holdings, the Eleventh Circuit followed the majority of its sister courts,3 yet managed to keep the opinion anything but ordinary, regaling us with allusions from none other than Aesop and his famed fables.
The plaintiffs were employee-participants of Home Depot, Inc.’s 401k retirement plan, the Home Depot FutureBuilder Plan (“the Plan”). The Plan is both an eligible individual account plan (EIAP) and an employee stock ownership plan (ESOP) under the Employee Retirement Income Security Act of 1974 (ERISA). The Plan requires that one of the available investment funds be a “Company Stock Fund,” invested primarily in shares of Home Depot stock.4
In the wake of a drop in the price of Home Depot stock and alleged internal wrongdoing, the plaintiffs alleged the usual claims against the usual suspects—Home Depot, as well as Home Depot’s board of directors, two committees and various Home Depot directors and offi cers.5 The complaint included the standard duty of prudence claim based on a failure to sell Home Depot stock from the Company Stock Fund. Specifi cally, plaintiffs alleged that Home Depot stock became an imprudent investment when, unknown to the public, some offi cials and employees of Home Depot allegedly engaged in misconduct that infl ated the company’s stock price. According to the plaintiffs, some Home Depot stores were improperly using return-to-vendor chargebacks to charge vendors not only for defective merchandise, but also for merchandise that had been used or damaged in the stores, stolen or later sold to customers.6 In October 2004, Home Depot stopped the illicit return-to-vendor chargebacks, which allegedly resulted in an immediate drop in stock price. Home Depot stock fell from $42.02 per share to $35.09 per share over the course of a few months.7 The plaintiffs also complained about certain stock option practices that were made public, but as the court pointed out, the disclosure of such practices apparently had no impact on the price of the stock. The Eleventh Circuit commented that, while the ant in Aesop’s fable “The Ant and the Grasshopper” was able to store up for the winter without being protected by ERISA, the plaintiffs here claimed that violations of ERISA had damaged their efforts to stockpile savings for their winter years.8
The plaintiffs’ amended complaint also included “duty of loyalty” claims alleging that the defendants (1) provided inaccurate information to Plan participants in fi duciary communications and (2) did not disclose Home Depot’s “deceitful business practices” and the effect that those practices had on the prudence of buying or holding Home Depot stock.9
The District Court Dismissed All Claims
The Northern District of Georgia granted the defendants’ motion to dismiss in its entirety. In doing so, Judge Evans determined that the prudence claim was “at its core a diversifi cation claim” barred by § 404(a)(2). In the alternative, the district court held that because the Plan required investment in Home Depot stock, such investment decisions were immune from judicial review. Further, the court held that even if the defendants had discretion to not invest in Home Depot stock, the plaintiffs’ allegations were insuffi cient to rebut the Moench presumption of prudence because they did not allege Home Depot was on the “brink of fi nancial collapse.”10 While the district court analyzed the issues under Moench, it declined to adopt the presumption in the absence of controlling authority.
Regarding the disclosure/duty of loyalty claims, the district court concluded that the Home Depot offi cers did not make the SEC fi lings in their capacity as Plan fi duciaries and that incorporation of the SEC fi lings by reference into the Form S-8s and stock prospectuses did not give rise to ERISA liability. It also concluded there was no ERISA-imposed duty to disclose non-public corporate information.11
The Eleventh Circuit Affi rmed
Despite the image evoked by the court’s reference to an ant and his diminishing savings versus the alleged “big, bad” fi duciaries, the “ant” in this story does not fare as well as Aesop’s ant. On appeal, the Eleventh Circuit affi rmed the district court’s dismissal of all claims under Rule 12(b)(6). Most signifi cantly, the Eleventh Circuit joined the Second, Third, Fifth, Sixth and Ninth Circuits by explicitly endorsing the Moench presumption of prudence as the applicable standard of review with regard to a plan fi duciary’s decision to offer company stock as an investment option in eligible individual account plans.12 The Eleventh Circuit also held that the Moench analysis can be applied to dismiss a claim under Rule 12(b)(6), fi nding that it was not an evidentiary presumption.13 In so holding, it considered and rejected the Sixth Circuit’s recent decision in Pfeil v. State Street Bank & Trust Company14 and joined all other circuits that have addressed this issue.15
The Prudence Claim
Although the Eleventh Circuit affi rmed the district court’s dismissal of the plaintiffs’ prudence claim, it did so for entirely different reasons. First, the court disagreed with the district court’s conclusion that the prudence claim was a camoufl aged diversifi cation claim:
Although we agree that courts must keep an eye out for wolves in sheep’s clothing, we are convinced that the plaintiff’s prudence claim is instead a sheep in sheep’s clothing…the plaintiffs here allege that, even putting aside diversifi cation concerns, Home Depot stock was an imprudent investment and for that reason the defendants had a duty to divest the Plan of the stock and stop purchasing it. That is not a wolf in a wool sweater; it is a sure-enough sheep. It does not howl “diversify”; it bleats “prudence.”16
Second, the court disagreed with the district court’s alternative conclusion that the defendants “had no discretion not to invest in Home Depot stock.”17 The court noted that the Plan does provide the defendants with some discretion; it requires only that the Company Stock Fund be invested primarily (not exclusively) in Home Depot stock.18
Nonetheless, the Eleventh Circuit agreed with the district court’s third alternative holding that even if the defendants’ decisions were subject to judicial review, the plaintiffs’ allegations were insuffi cient to rebut the Moench presumption of prudence. However, it again reached this conclusion for entirely different reasons than the district court.
While adopting Moench’s abuse of discretion standard for review of ESOP plan fi duciaries’ investments in company stock, the Eleventh Circuit rejected the district court’s “brink of fi nancial collapse” test for determining whether the presumption is overcome. Instead, the Eleventh Circuit adopted the test of other circuits, stating that “a fi duciary abuses his discretion by acting in compliance with the directions of the plan only when the fi duciary could not have reasonably believed that the settlors would have intended for him to do so under the circumstances.”19 Thus, the standard for such claims in the Eleventh Circuit is whether the plan fi duciaries could reasonably believe the plan sponsor would want them to continue investing in the employer securities.
In applying this test to the facts of the case, the Eleventh Circuit looked at the alleged stock drop— approximately 16.5 percent over two months, followed by a rebound in the price a few months later— and held “there is nothing in this Plan to indicate that those who created it intended for fi duciaries to disregard their instructions based on short-term events and fl uctuations in the market.”20 In reaching this result, the Eleventh Circuit noted that participants “have no right to insist that fi duciaries who are corporate insiders use inside information to the advantage of the participants.”21
The Duty of Loyalty Claims
The plaintiffs also alleged that the defendants violated their fi duciary duty of loyalty in two ways. First, they alleged that the defendants made misrepresentations in their SEC fi lings that were incorporated by reference into plan documents. In responding to this claim, the Eleventh Circuit noted, “ERISA recognizes that a person may be a fi duciary for some purposes and not others.” Here, it was securities law that required the SEC fi lings and distribution of stock prospectuses. Thus, in making such fi lings, the defendants “were acting in their corporate capacity and not in their capacity as ERISA fi duciaries.” As such, any alleged misrepresentations in the SEC fi lings did not violate ERISA.22
For their second breach of the duty of loyalty claim, the plaintiffs alleged that the defendants had a duty to inform the Plan participants of Home Depot’s “deceitful business practices [involving the returnto- vendor chargebacks] and how these activities adversely affected Company stock as a prudent investment option under the Plan.” The Eleventh Circuit noted, “ERISA does not explicitly impose a duty to provide participants with nonpublic information affecting the value of the company’s stock.”23
The court agreed with opinions from the Second and Third Circuits, fi nding that warnings regarding the non-diversifi ed and thus highly risky nature of the stock fund in the summary plan description adequately informed participants regarding the fund as required by ERISA.24
As mentioned above, the Eleventh Circuit has now offi cially adopted the Moench presumption of prudence, thereby joining the Second, Third, Fifth, Sixth and Ninth Circuits. The Eleventh Circuit also joins those courts in applying the presumption at all stages of litigation (including the pleading stage). Further, the Eleventh Circuit adopted the “sponsor intent” test originally promulgated in Moench (rather than a viability or brink of collapse test). As such, we reiterate our prior recommendation that sponsors include an explicit statement of their intent regarding the employer stock fund.
The case is also a “win” for defendants in its recognition that incorporation by reference of public fi lings (10ks and 10Qs) into an S-8 and/or a prospectus is not a fi duciary act, so such public fi lings are not subject to ERISA. This affi rms again that plan fi duciaries wear multiple hats and are not acting as fi duciaries when making SEC fi lings. Nonetheless, we continue to recommend that clients separate their employer stock prospectus from the SPD, just to make it clear that any incorporation by reference of public fi lings is into a prospectus—not the SPD separate and apart from a prospectus.
Finally, the case is signifi cant for its rejection of a duty to disclose non-public information under ERISA. It is helpful that the court explicitly found that participants are not entitled to a market advantage over other shareholders and that disclosures to plan participants of inside information could not practically be done in a way that would benefi t them in any event. However, the court’s reliance on language in Home Depot’s summary plan descriptions as adequately informing participants of the inherent risks of the undiversifi ed employer stock fund may create problems for companies that do not have such aggressive warnings in their SPDs. As such, we recommend that clients review their SPDs and other information provided to participants regarding an employer stock fund and make sure they provide clear warnings regarding the undiversifi ed and risky nature of such a fund.
The case is Lanfear, et al. v. Home Depot, Inc., et al., No. 10-13002 (11th Cir. May 8, 2012).