In Quan v Computer Sciences Corp, __ F3d __, 2010 US App Lexis 20199 (9th Cir 2010), the Ninth Circuit held that the presumption of prudence first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) applies to claims in the Ninth Circuit that a fiduciary of an employer retirement plan governed by the Employee Retirement Income Security Act ("ERISA") acted imprudently by investing plan assets in employer stock. In doing so, the Ninth Circuit has made it much more difficult for a plaintiff to prevail in a lawsuit against a plan fiduciary based on claims relating to a fiduciary's decision to continue offering company stock as an investment option in a 401(k) plan. The Quan opinion brings the Ninth Circuit in line with the Third, Fifth and Sixth Circuits in holding that the Moench presumption applies to such claims. Gibson, Dunn & Crutcher LLP represented defendant Computer Sciences Corporation in this matter.
Section 404(a)(1) of ERISA imposes a duty on Plan fiduciaries to invest plan assets as a "prudent man" would do. 29 U.S.C. § 1104(a)(1)(C). This standard requires plan fiduciaries to diversify "the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly not prudent to do so." Id. However, Section 404(a)(2) of ERISA expressly exempts "acquisition or holding of qualifying employer real property or qualifying employer securities" from the diversification requirements. 29 U.S.C. § 1104(a)(2). It was the interaction of these statutes with the Moench presumption that the Ninth Circuit addressed in Quan.
Quan involved claims by participants in the participant-directed Matched Asset 401(k) Plan (the "Plan") of defendant Computer Sciences Corporation ("CSC"). The plaintiff alleged that the Plan fiduciaries imprudently invested the Plan's assets in CSC's own securities, negligently failed to disclose material information about CSC's finances and operations, and failed to properly appoint, monitor and inform the Plan's committee and its members. Quan, 2010 U.S. App. Lexis 20199, at *1-2.
The Plan gave participants full discretion to invest their funds (and move their money between) fourteen different investment alternatives, one of which was a non-diversified fund holding CSC stock (the "CSC Stock Fund"). This fund was intended to give participants a chance to "own part of the company for which [they] work." Id. at *3. CSC matched 50 cents for every dollar invested in the Plan up to 3% of the employee's salary. Id. at *3-4. Before January 2007, these matching funds were allocated to the CSC Stock Fund, and participants could only re-allocate them to other funds in the Plan once they had met certain requirements. Id. at *4. After January 2007, this requirement was eliminated, and Plan participants could re-allocate these matching funds to any fund in the Plan. Id.
Plaintiffs, a class of current and former employees of CSC who participated in the Plans (the "Participants") sued CSC, the Plan Committee and current and former officers and directors of CSC, who were alleged to be either named or de facto fiduciaries of the Plan. Id. at *5. The Participants claimed that material weaknesses existed in CSC's stock option granting and tax accounting practices. Id. The Participants alleged that these weaknesses, which they claimed resulted in errors in CSC's pricing of stock options, deficiencies relating to accounting for income taxes, two restatements of CSC's financial statements within seven months, and a one-day 12% drop in the price of CSC's stock, caused them to lose hundreds of millions of dollars in retirement savings invested in the CSC Stock Fund as a result. Id.
The United States District Court for the Central District of California (the "District Court") granted the Defendants' motion for summary judgment as to all claims asserted by the Participants. Id. at *10-11. Based upon the undisputed facts, the District Court concluded that the Participants had presented no evidence that the Plan fiduciaries failed to use the care, skill, prudence and diligence that a prudent man would use in the conduct of an enterprise of a like character and with like aims. Id. In the alternative, the District Court applying the Moench presumption concluded that the Participants had failed to rebut the presumption that the Plan fiduciaries acted consistently with ERISA in their decision to offer CSC stock as an investment option in the plan because the Participants had presented no evidence that a prudent investor under the circumstances would not have followed the Plan's mandate to have employer securities as an investment option. Id.
The Ninth Circuit reviewed the District Court's grant of summary judgment de novo and found that the Participants had failed to demonstrate that there were genuine issues of material fact that made summary judgment improper. In doing so, the Ninth Circuit considered whether to adopt the Moench presumption. Id. at *16. In Moench, the Third Circuit addressed the question, "[t]o what extent may fiduciaries of [ESOPs] be held liable under [ERISA] for investing solely in employer common stock, when both Congress and the terms of the ESOP provide that the primary purpose of the plan is to invest in the employer's securities?" Moench, 63 F.3d at 566. The Third Circuit held that "the most logical result is that the fiduciary's decision to continue investing in employer securities should be reviewed for an abuse of discretion . . . [A]n ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision." Id. at 571.
Before Quan, however, the Ninth Circuit had twice declined to adopt the Moench presumption. See In re Syncor ERISA Litig., 516 F.3d 1095, 1102 (9th Cir. 2008); Wright v. Oregon Metallurgical Corp., 360 F.3d 1090, 1098 (9th Cir. 2004). In fact, the court had previously criticized Moench because the court believed that the Moench presumption was inconsistent with Section 404(a)(2) of ERISA and because "[t]he Moench standard seems problematic to the extent that it inadvertently encourages corporate officers to utilize inside information for the exclusive benefit of the corporation and its employees." Wright, 360 F.3d at 1198, n.4.
However, in Quan, the Ninth Circuit adopted the presumption, finding that the presumption is "fully reconcilable with ERISA's statutory text and does not encourage insider trading, when properly formulated." Quan, 2010 U.S. App. Lexis 20199, at *20. The Ninth Circuit held that the court's concern in Wright that adopting the Moench presumption would override Congress' exemption of plans holding qualified employer securities from the prudence requirements in Section 404(a)(2) was inapposite because "[w]e do not read the Moench presumption to apply to a 'diversification' claim, because a presumption of prudence is unnecessary where fiduciaries are not subject to a prudence requirement to begin with. On the other hand, where employer stock is only one of the possible plan investments, and plaintiffs assert a claim that the fiduciary should have divested the plan of employer stock, the fiduciaries would be entitled to the presumption that investment in employer stock was prudent." Id. at *21-22. Thus, the court held that "the Moench presumption does not run afoul of the exemption from diversification in § 1104(a)(2)." Id. at *22. The court also dismissed the Wright court's concern that the Moench presumption encourages plan fiduciaries to use insider information, finding instead that Moench "gives fiduciaries a safe harbor from failing to use insider information to divest from employer stock." Id. at *22-23.
Thus, the Ninth Circuit adopted the Moench presumption "because it provides a substantial shield to fiduciaries when plan terms require or encourage the fiduciary to invest primarily in employer stock. Fiduciaries are not expected to predict the future of the company stock's performance." Id. at *24. However, the court noted that "[t]he presumption does not entirely insulate a fiduciary from a breach-of-fiduciary-duty claim because it may be rebutted by a showing that the fiduciary abused its discretion by investing in employer stock." Id. at *25. To overcome the presumption, the court held that "plaintiffs must therefore 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.'" Id. at *26-27. Thus, the presumption can only be rebutted "by showing publicly known facts that would trigger the kind of 'careful and impartial' investigation by a reasonable fiduciary that the plan's fiduciary failed to perform." Id. at *27. Thus, the court held that "mere stock fluctuations, even those that trend downward significantly,' do not give rise to the inference that the fiduciary did not properly investigate the merits of continued investment in employer stock." Id. at *27-28. The Moench presumption, the court concluded, "would be difficult to rebut." Id. at *30.
Applying the Moench presumption to the facts of that case, the Quan court held that "the Participants did not generate a genuine issue of material fact sufficient to rebut the Moench presumption that continued investment in CSC stock was prudent." Id. at *31-32. The court held that even assuming the Plan fiduciaries knew about the problems with stock option granting practices and income tax accounting, it cannot be said that they had a fiduciary duty to cease investing Plan assets in CSC stock. Id. at 32. "The Participants here have presented no evidence that it was unreasonable for the Fiduciaries to believe that CSC would overcome its problems with stock options pricing and income tax accounting." Id. And with respect to the Participants' misrepresentation claim, the court held that "the Participants failed to generate genuine issues of material fact that each of the communications in question was a misrepresentation that was material." Id. at *39.
The Ninth Circuit's adoption of the Moench presumption brings it in line with the Third, Fifth and Sixth Circuits and makes it more difficult for Plan participants to claim that Plan fiduciaries acted imprudently by investing Plan assets in employer stock. Thus, the fiduciaries of plans that may invest in employer stock will be more insulated from claims that they imprudently caused the plan to invest assets in the stock of the employer.