The Sixth Circuit recently issued its latest opinion in Pfeil v. State Street Bank & Trust Company, an ERISA stock-drop case that has weaved its way up and down the federal court system since June 2009, shortly after General Motors (GM) filed for bankruptcy protection. A split three-judge panel held that the fiduciary’s continuous and extensive monitoring and review of the plan’s investment in GM stock constituted a “prudent process” and therefore the fiduciary satisfied its duty of prudence as a matter of law. The decision should serve as a reminder for fiduciaries of plans offering a company stock fund to engage in a diligent process for monitoring and reviewing that investment.
GM employees alleged that State Street Bank & Trust Company (State Street), the independent fiduciary for the company stock fund in GM’s 401(k) plan, breached its duty of prudence when it failed to halt purchases of GM stock, and delayed divesting the GM Common Stock Fund of GM stock, as the company headed toward bankruptcy. The employees argued that State Street failed to follow a prudent process in allowing plan participants to continue to invest in GM stock because State Street did not recognize − in response only to public announcements about GM’s future − that the market was not valuing GM stock correctly. The panel ultimately sided with State Street in the Sixth Circuit’s first stock-drop decision since the Supreme Court announced its “special circumstances” standard for evaluating imprudent investment claims based on publicly available information in Fifth Third Bancorp v. Dudenhoeffer.
The Supreme Court made clear in Dudenhoeffer that “where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances,” because fiduciaries do not act imprudently by failing to “outsmart a presumptively efficient market.” Fifth Third Bancorp v. Dudenhoeffer, 134 S.Ct. 2459, 2471-72 (2014). The Sixth Circuit found Dudenhoeffer’s directive to be the beginning and end of Pfeil’s claims, as he “failed to show a special circumstance such that State Street could not have relied on market pricing.”
Rather than identifying “special circumstances,” Pfeil identified four specific dates on which State Street should have sold the plan’s GM stock in light of the company’s deteriorating financial condition. The panel strongly disagreed, characterizing Pfeil’s argument as resting on a sleight of hand, hindsight analysis. The fact that State Streetcould have made a different investment decision does not mean that its decisions were imprudent, as courts evaluate a fiduciary’s conduct as of “the time it occurred,” not “post facto.”
The Sixth Circuit also took issue with a “logical problem” underlying Pfeil’s argument. Pfeil criticized State Street’s decision not to act on each of the four dates, which led the panel to rhetorically wonder why Pfeil stopped at four dates: “In a sense, an ESOP fiduciary is always deciding not to divest.” Pfeil did not offer any “legal reason” why the four dates he chose should have triggered State Street to engage in a formal reevaluation process. The observation that the stock decreased in value after each of the chosen events is insufficient to establish “special circumstances” because it involves forbidden post-hoc inquiry.
The Sixth Circuit went on to evaluate State Street’s conduct under a “prudent-process standard,” which in a stock-drop case requires determining whether − at the time the conduct occurred − the fiduciary employed appropriate methods to investigate the merits of investing in company stock. Although the panel split on the overall outcome of the case, the majority held that State Street’s process was prudent as a matter of law.
State Street employs a formal, three-tiered structure and process to monitor and evaluate company stock funds, which includes monthly consideration of nine company-specific categories of information: (1) the company’s current situation; (2) current stock analyst recommendations and comments concerning the company stock; (3) the company’s debt ratings; (4) company description; (5) background; (6) company performance; (7) State Street’s role; (8) the company legal environment; and (9) a recommendation on whether to keep the company stock on State Street’s stock review list. The panel found it important that State Street’s three committees discussed and evaluated the plan’s investment in GM stock fifty-eight times between January 2008 and March 31, 2009, during which State Street considered the performance of GM’s stock and business and any factors that may have affected performance, often culminating in votes. State Street also utilized outside legal counsel and financial advisors. The panel also noted that other fiduciaries decided to hold GM stock on the four dates chosen by Pfeil. The panel ultimately concluded that State Street’s detailed processes demonstrated prudence, and that the decision of other fiduciaries not to divest on the same dates State Street chose not to divest underscored “the reasonable nature of those decisions.”
The Supreme Court and the Sixth Circuit have yet to identify any “special circumstances” that would render reliance on market pricing imprudent. Where claims are based on publicly available information, it appears that simply alleging, in hindsight, that a fiduciary could have made a different investment decision or that the stock price declined after specific events will not suffice.
The Sixth Circuit’s approval of the prudent process employed by State Street is instructive for public companies offering a company stock fund in their 401(k) plans. Engaging an independent fiduciary, which employs a multi-level structure to monitor the performance of the company and its stock, evaluate the plan’s investment in company stock, and utilize the guidance of outside counsel and financial advisors, all demonstrate a concerted effort to follow a prudent process. While this formula will not prevent Monday morning quarterbacking, implementing it now is a good game plan for fending off opportunistic plaintiffs armed only with benefit of hindsight.