In their continued efforts to combat the rising tide of employer stock-drop lawsuits, plan fiduciaries have frequently relied on a defense based on ERISA § 404(c), 29 U.S.C. § 1104(c). In relevant part, Section 404(c) provides that pension plan fiduciaries will be relieved of liability resulting from participants' decisions related to their plan investments where a pension plan provides for individual accounts, permits participants to exercise control over the assets in their accounts and participants actually exercise such control. Thus far, Section 404(c) has generally proven to be an ineffective means for dismissing stock-drop lawsuits at the early stages of litigation, for one or more of the following three reasons. First, some courts have declined to evaluate Section 404(c) defenses on a motion to dismiss because those courts decline to reach an affirmative defense at this stage of the litigation. See, e.g., In re Regions Morgan Keegan ERISA Litigation, No. 08-CV-2192, 2010 WL 809950 (W.D. Tenn. Mar. 9, 2010). Second, some courts have found that there were factual issues as to whether the requirements for Section 404(c) status were satisfied; including whether the disclosures concerning the investment options were adequate enough to enable participants to effectively take control of their investment decisions. See, e.g., In re Enron Corp. Securities, Derivative & ERISA Litigation, 284 F. Supp. 2d 511, 576 (S.D. Tex. 2003). Third, led by the Fourth Circuit's decision in DiFelice v. U.S. Airways, Inc., 497 F.3d 410 (4th Cir. 2007), and relying on a footnote to the preamble in a regulation promulgated by the U.S. Department of Labor (DOL), some courts have determined that Section 404(c) does not provide a defense to claims challenging a plan fiduciary's selection of investment options, as opposed to the participants' decision as to how to invest their assets among these options, thus rendering the defense ineffective to the basic claim for imprudent selection/maintenance of an employer stock fund. Id. at 418 n.3 (citing 57 Fed. Reg. 46,906, 46,924 n.27 (Oct. 13, 1992) ("limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function")).
For the second time in as many years, the U.S. District Court for the Northern District of Illinois, in Rogers v. Baxter 'International Inc., No. 04-CV-6476, 2010 WL 1780349 (N.D. Ill. May 3, 2010), bucked this trend and relied on Section 404(c) as the basis for dismissing, on motion for summary judgment, claims relating to the imprudent maintenance of an employer stock fund as an investment option in a 401(k) plan. See also Lingis v. Motorola, Inc., 649 F. Supp. 2d 861 (N.D. Ill. 2009). If either decision is upheld on appeal or followed by other courts, they may provide additional grounds for companies to dismiss stock-drop suits.
Summary of Claims Asserted and the District Court's Ruling
Plaintiff David Rogers alleged that defendants breached their fiduciary duties of prudence and disclosure by continuing to offer Baxter stock as a plan investment during a two year period when Baxter allegedly overstated its expected returns. The district court granted summary judgment in favor of defendants on all of Rogers' claims, concluding first that the Section 404(c) safe harbor applied to Rogers' claims that defendants breached their fiduciary duties by allowing 401(k) plan assets to be invested in Baxter common stock even though the value of the stock was allegedly artificially inflated (Count I); by continuing to offer plan participants the opportunity to invest in Baxter stock (Count II); and by allowing more than ten percent of the Plan's assets to be invested in Baxter common stock (Count VI). Next, the district court concluded that it did not need to determine whether Section 404(c) applied to Rogers' claim that defendants misrepresented certain facts and failed to disclose others to plan participants (Count III) because this claim failed on its merits. Finally, the district court concluded that Rogers' secondary liability claim based on the duty to monitor the conduct of other fiduciaries (Count V) failed because all of his principal claims failed.
Criteria For ERISA § 404(c)'s Safe Harbor Defense
The district court first reviewed the requirements for satisfying Section 404(c). In pertinent part, Section 404(c) provides that where a pension plan provides for individual accounts, i.e., a 401(k) plan, and permits a participant to exercise control over the assets in the account, and that participant actually exercises such control, no person who is otherwise a fiduciary shall be liable for breach of fiduciary duty for any loss that results from the participant's exercise of control. 29 U.S.C. § 1104(c)(1). Regulations promulgated by the DOL provide that, in order to qualify as a Section 404(c) plan and fall within its safe harbor, a plan must meet five requirements, several of which have numerous sub-requirements. 29 C.F.R. § 2550.404c-1(b) & (d)(2)(ii)(E)(4).
The district court observed that the parties did not dispute that the plan satisfied four of the five criteria; namely, that a plan must: (i) provide for individual accounts; (ii) allow participants the opportunity to exercise control over their accounts; (iii) provide participants with the opportunity to choose from a broad range of investment alternatives; and (iv) provide additional safeguards where the plan offers qualifying employer securities.
With respect to the fifth requirement, that a plan must give participants sufficient information to make informed investment decisions, the regulations set forth nine criteria, all of which must be satisfied for the participant to be considered to have sufficient investment information. Participants must be given: (i) an explanation that the plan is intended to be a Section 404(c) plan; (ii) a description of the plan's investment options; (iii) an identification of investment managers; (iv) an explanation of the circumstances under which participants may give investment instructions; (v) a description of transaction fees and expenses; (vi) the contact information of the plan fiduciary responsible for providing information to participants; (vii) a description of confidentiality procedures related to the purchase or sale of employer stock; (viii) materials regarding investment alternatives subject to the Securities Act of 1933; and (ix) materials related to voting, tender, and similar rights incidental to the holdings in their accounts. 29 C.F.R. § 2550.404c-1(b)(2)(i)(B)(1)(i)-(ix). In addition, each participant must be provided, on request, "extensive information on the operating expenses of the investment alternatives, copies of relevant financial information, and other similar materials." 29 C.F.R. § 2550.404c-1(b)(2)(i)(B)(2).
The only one of the nine requirements disputed by the parties was Rogers' assertion that the plan documents failed to describe the Baxter stock fund in sufficient detail (requirement (ii) above). Rogers contended that the description was deficient because it did not disclose that "Baxter had been repositioned from a value to a growth company, a material fact as to risk." The district court rejected Rogers' argument, finding, among other things, that the regulation only requires a "general description" of the investments, not a list of all material facts about the investment alternative. In so ruling, the court departed from the views expressed by other courts that declined to rule on Section 404(c)'s application because of factual issues as to whether the disclosures were adequate.
Applicability of Section 404(c) to Rogers' Claims
Having failed to convince the district court that the plan should not be able to take advantage of Section 404(c)'s safe harbor defense, Rogers next argued that the defense did not apply to his prudence claims because these claims asserted liability for losses "result[ing] from" defendants' actions, i.e., the selection of investment options and the Baxter stock fund in particular, not from plan participants' exercise of control over the investment of their assets in one or more of these investment options. The district court concluded that the safe harbor applied to Rogers' prudence claims, including the claim that the defendants "failed to prevent the wasting of Plan assets" (part of Count I), because any waste was the result of individual participants' acquisitions of Baxter common stock, not of defendants' conduct. In so ruling, the district court observed that three appellate courts had stated that the Section 404(c) safe harbor defense could be applied to particular claims of imprudent investment selection, even though they did not render a definitive ruling on the question:
First, in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), pet. for reh'g and reh'g en banc denied, Hecker v. Deere & Co., 569 F.3d 708, 710 (7th Cir. 2009), the Seventh Circuit held that Section 404(c) provided an alternative basis for dismissing plaintiffs' disclosure and imprudence claims, both of which turned on allegations that defendants failed to negotiate lower fees for the investment options available under the plan. In denying plaintiffs' motion for rehearing, the Circuit emphasized that its holding was limited to the complaint before it and that it had "refrained from making any definitive pronouncement" on whether Section 404(c) applied more generally to a fiduciary breach claim relating to the selection of investment funds. Unlike the Fourth Circuit in DiFelice, the Seventh Circuit declined to defer to the footnote in the preamble to the DOL's regulations. Hecker v. Deere & Co., 569 F.3d at 710.
Second, in Langbecker v. Electronic Data Systems Corp., 476 F.3d 299, 310-11 (5th Cir. 2007), the Fifth Circuit vacated the district court's order granting class certification of plaintiff's fiduciary breach claim related to the maintenance of the EDS stock fund and concluded that it should have first considered whether the plan qualified as a Section 404(c) plan. Here too, the court declined to defer to the footnote in the preamble to the DOL's regulations because, even if it was entitled to Chevron deference, it was not a reasonable interpretation of Section 404(c).
Finally, in In re Unisys Savings Plan Litigation, 74 F.3d 420, 445 (3d Cir. 1996), the Third Circuit determined that there were genuine issues of material fact as to whether the defendants were entitled to Section 404(c)'s protections with respect to plaintiffs' imprudent investment claim and thus vacated the district court's decision granting defendants' motion for summary judgment. The DOL's regulations were not at issue in this case because the transactions at issue occurred prior to the regulation's effective date.
The Baxter court also acknowledged the Fourth Circuit's decision in DiFelice, which in dicta suggested that the Section 404(c) safe harbor may not be available as a defense to a claim for imprudent selection of investment options under an individual account plan. See DiFelice, 497 F.3d at 418 n.3 (citing 57 Fed. Reg. 46,906, 46,924 n.27 (Oct. 13, 1992)). The Baxter court observed that Rogers did not urge application of DiFelice in this case and, in any event, application of DiFelice would have been inconsistent with Hecker v. Deere.
Next, the district court determined that it was unnecessary to decide whether the safe harbor applied to Rogers’ disclosure claim (Count III) because that claim failed on its merits. According to the court, the SPD and other plan documents adequately described the Baxter stock fund. Furthermore, the district court concluded that the plan fiduciaries could not have disclosed material facts to plan participants, but not to the public as a whole, without violating the insider trading prohibitions in federal securities laws. Finally, with respect to Rogers’ claim that defendants acquired and held more than ten percent of plan assets in employer securities in violation of ERISA's prohibited transaction rules (Count VI), the district court concluded that the evidence and relevant regulations indicated that any acquisitions that violated the ten-percent rule were caused by the sum of individual participants' choices in exercise of their control over their individual accounts, not from defendants' conduct and, as such, the safe harbor applied.
In short, the court found each of the prudence claims dismissible on the strength of the safe harbor defense, and dismissed the disclosure claim on independent grounds.
The district court's decision is potentially significant because it is one of the first decisions to conclude that the Section 404(c) safe harbor provides protection to plan fiduciaries with respect to a participant's claim that the plan fiduciary breached his duty of prudence by maintaining an employer stock fund as an investment option in a 401(k) plan. If appealed, the ruling may well present the Seventh Circuit with an opportunity to address the issue it declined to address squarely in Hecker v. Deere. Although plaintiffs in Lingis v. Motorola have already appealed the district court’s decision in that case, it is unclear whether the Seventh Circuit will reach the Section 404(c) issue in light of the district court’s alternative holding that plaintiffs’ imprudent investment claim failed on its merits. A decision from the Seventh Circuit affirming the district court's opinion would likely create tension with the Fourth Circuit’s dicta, given the ruling in DiFelice that, consistent with the DOL's regulations, Section 404(c) should not provide plan fiduciaries with a defense to such claims. For that reason, we would expect that the appeal would draw amicus briefs from the DOL, as in Lingis v. Motorola (see http://www.dol.gov/sol/media/briefs/lingis(A)-05-14-2010.htm), as well as from pro-employer organizations that are looking for new opportunities to rely on the Section 404(c) defense.
At the root of the debate is the meaning and function of Section 404(c). If Section 404(c)'s status is conditioned on satisfying disclosure requirements beyond those imposed by the Section 404(c) regulations, or if the DOL's view prevails, and fiduciaries retain ongoing responsibility for evaluating the prudence of participants' decisions to invest in an employer stock fund, then the statute will have little impact on the defense of stock drop suits. As a practical matter, adjudication of the Section 404(c) defense will occur in conjunction with a determination of the underlying prudence and disclosure claims. But if the disclosure requirements and the DOL's view are rejected, as they appear to have been in Baxter, then Section 404(c) could substantially enhance the opportunity for dismissal, before trial, of stock-drop complaints.