In the last few years, 401(k) and other retirement plans that allow investment in the employer’s stock have faced a wave of “stock drop” litigation. In these cases, a drop in the company’s stock price is followed by a class action under the Employee Retirement Income Security Act of 1974 (ERISA) on behalf of plan participants, seeking to recover market losses based on alleged violations of ERISA fiduciary duty by plan fiduciaries, such as imprudently maintaining employer stock as an investment option, or failing to provide participants with relevant information about the employer stock.

Responding to these “stock drop” cases, employers that sponsor plans that allow investment in employer stock have considered measures including appointing an independent fiduciary to monitor the employer stock fund, or even eliminating the employer stock investment option.

So what happens if the employer stock investment option is eliminated from the plan and the stock then increases in price? Plan fiduciaries may face a “stock rise” suit, which alleges, with perfect hindsight, that it was imprudent to eliminate the employer stock investment option, and that this led to a loss of the market gains that participants would have reaped on their investment in employer stock. We are aware of two court cases which have considered this issue, one of them quite recently, and both have dismissed the participants’ claims on the basis that the plan fiduciaries involved in the process acted prudently, and thereby fulfilled their duty under ERISA.

These cases underscore the importance of ERISA plan fiduciaries engaging in a careful procedural process when they are engaged in the operation or administration of a plan. In the recent “stock rise” case, Bunch v. W.R. Grace & Co., No. 04-11380-WGY, 2008 WL 281516 (D. Mass., Jan. 30, 2008), the 401(k) plan engaged an independent fiduciary, which had its own legal and valuation counsel, to manage the employer stock fund. The independent fiduciary’s engagement instructed it to sell the employer stock only if it determined that “the continued holding of the stock was inconsistent with ERISA.”

The independent fiduciary made such a determination and sold all employer stock held in the plan. In rejecting the participants’ challenge to this decision, the court determined that the independent fiduciary properly considered various factors, and that its analysis “showed a potential for loss of value . . . comparable to knowledge of an impending collapse.” Even though the company’s prospects (and stock price) later improved, the independent fiduciary had engaged in a prudent process to make the decision it had been charged to make: the test under ERISA, the court said, was not whether the fiduciary “got the best possible return on the investment, but whether it considered all relevant factors in deciding the prudence of divesting the investment.” See also, Noa v. Keyser, 519 F. Supp. 2d 481(D.N.J. 2007).

Plan sponsors and fiduciaries cannot prevent litigation under ERISA, but good fiduciary processes and procedures may enable them to defend and defeat such suits, as illustrated here.