In Quan v. Computer Sciences Corp., Nos. 09-56190, 09-56248, 2010 WL 3784702 (9th Cir. Sept. 30, 2010), the Ninth Circuit joined the Third, Fifth, Sixth and Seventh Circuits in adopting the presumption of prudence first espoused in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), pursuant to which a plan fiduciary’s decision to permit investment in employer stock is reviewed for an abuse of discretion. The decision is important because two prior Ninth Circuit rulings had failed to endorse the presumption. With the Ninth Circuit now joining the fold, the prospects of a Circuit Court split on the issue are rapidly becoming more remote. However, the decision does not narrow the divide among the courts on other issues impacting stock drop litigation.
Computer Sciences Corporation (CSC) offered its employees the opportunity to invest in a participant directed 401(k) plan. The plan provided participants full discretion to allocate their contributions among fourteen diverse investment alternatives, one of which was required to be the CSC Stock Fund.
In their complaint, plaintiffs alleged that there were “material weaknesses in CSC’s stock option granting and tax accounting practices,” which ultimately caused the price of CSC stock to decline once disclosed. In support of their claims, plaintiffs pointed out that CSC’s stock price declined from $55.88 to $48.56 the day following announcements on June 29, 2006 that: (i) the Securities and Exchange Commission made an informal request for information about its stock option granting practices; and (ii) the company was no longer for sale and had decided to repurchase up to $2 billion of its common stock. The decline in the price of the stock was only temporary. The stock rebounded to $52.72 within a week, to $53.57 within two weeks, and to $61.79 approximately one year later. By this time, the SEC had issued new guidance on how the measurement date for stock options was to be determined, and CSC had established a special committee of directors to oversee an internal investigation of CSC’s stock option granting practices. Although, there was no wrongdoing found, the special committee identified over 9,000 stock option grants that needed to be re-priced and certain income tax deficiencies. After re-pricing its stock options and correcting the tax deficiencies, CSC restated its financial statements on June 13, 2007 and on January 11, 2008.
The Complaint alleged that CSC, the CSC Retirement Committee (Committee), and current and former officers and directors of CSC Plaintiffs alleged that all defendants breached their fiduciary duties under ERISA by imprudently investing 401(k) plan assets in CSC stock (prudence claim), negligently misrepresenting and failing to disclose material information about CSC’s financial condition to plan participants (disclosure claim) and failing to properly appoint, monitor and disclose information to the Committee and its members.
The Ninth Circuit’s Opinion
The Prudence Claim
With respect to plaintiffs’ prudence claim, the Ninth Circuit resolved a question left open in two of its prior decisions, Wright v. Oregon Metallurgical Corp., 360 F.3d 1090, 1098 (9th Cir. 2004) and In re Syncor ERISA Litig., 516 F.3d 1095, 1102 (9th Cir. 2008), by adopting the Moench presumption of prudence. The Court determined that the Moench presumption was consistent with ERISA’s statutory text and trust law principles, and that it struck the “appropriate balance between the employee ownership purpose of employee stock ownership plans and eligible individual account plans and ERISA’s goal of ensuring proper management of such plans.” The Court also stated that the presumption would alleviate the pressure on plan fiduciaries to “predict the future of the company stock fund’s performance” because it makes it “less likely that a plan fiduciary would be tempted to use insider information to divest the plan from company stock, since continued investment in the plan will be presumed prudent.”
The Court stated that it was not persuaded by either of the concerns about the Moench presumption raised in Wright. First, in response to the Wright Court’s observation that the Moench presumption was difficult to reconcile with ERISA’s diversification exemption under Section 404(a)(2), 29 U.S.C. § 1104(a)(2), the Court stated that it did not understand “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.” Second, the Court concluded that the Moench presumption did not, as the Wright Court suggested, encourage fiduciaries to engage in insider trading. Rather, Moench provides fiduciaries a safe harbor from failing to use insider information to divest from employer stock. The Court explained that if the burden to rebut the presumption of prudent investment was sufficiently heavy, plan fiduciaries would not be tempted to act on insider information to protect themselves from liability for decisions about continued investment in employer stock.
The Court next opined that in order to rebut the presumption, plaintiffs must “make allegations” that call into question the company’s viability as an ongoing concern or prove a “precipitous decline” in the company’s stock price in conjunction with evidence that the company is “on the brink of collapse” or “is undergoing serious mismanagement.” Additionally, the Court stated that plaintiffs must show that there were “publicly known facts that would trigger the kind of ‘careful and impartial investigation’ by a reasonable fiduciary” and that the plan’s fiduciary failed to perform that investigation.
Ultimately, the Court concluded that plaintiffs failed to provide evidence that it was unreasonable for plan fiduciaries to believe that CSC would withstand the issues associated with stock options pricing and income tax accounting in light of its internal investigation of those problems. The Court also rejected plaintiffs’ assertion that plan fiduciaries should have acted on insider information to divest the plan of company stock, stating that it need not address this issue because CSC did not encounter problems “grave enough to rebut the Moench presumption.” In any event, the Court stated, ERISA fiduciaries are not obligated to violate securities laws in an attempt to satisfy their fiduciary duties.
The Court also determined that plaintiffs failed to point to any evidence that generated a genuine issue of material fact that defendants failed to investigate the merits of continued investment in the CSC stock fund. First, the Court concluded that mere stock fluctuations, even those that trend downward, were insufficient to establish the requisite imprudence to rebut the Moench presumption. Second, the Court stated the district court did not engage in a faulty analysis by considering that defendants might have been sued if they ceased offering the CSC stock fund as an investment option under the plan. Third, the Court concluded that a one-day drop in CSC’s stock price was insufficient to show that defendants did not properly investigate the continued investment in the CSC stock fund. In so ruling, the Court observed that while “‘[a] violation may occur where a company’s stock did not trend downward over time, but was artificially inflated during that time by an illegal scheme about which the fiduciaries knew or should have known, and then suddenly declined when the scheme was exposed,” plaintiffs did not argue that any alleged problems in the handling of stock options, which purportedly caused the one-day drop in CSC’s stock price, amounted to an ‘illegal scheme.’” (Emphasis in original.) Fourth, the Court rejected plaintiffs’ assertion that defendants’ knowledge of problems associated with CSC’s stock option granting practices and accounting for income taxes showed that defendants failed to evaluate the merits of continued investment in the stock fund. The Court determined that defendants responded to any “red flag” issues by conducting an investigation and addressing the alleged problems. Fifth, the Court stated that plaintiffs failed to show a casual link between the failure to investigate or [divest] and the harm suffered by the plan.
The Disclosure Claim
With respect to plaintiffs’ disclosure claim, the Court concluded that even if CSC made misrepresentations with respect to its stock option pricing, the misrepresentations were at no point “material” because a reasonable participant would not have been misled by the statements in making a decision whether to invest in the CSC stock fund.
Award of Costs
Because the district court did not provide any explanation for its decision to deny defendants’ application for costs, the Ninth Circuit remanded this issue to the district court for further proceedings.
Now that the Moench presumption of prudence has been adopted by five Circuit Courts and rejected by none, we are hopeful that the issue of whether the Moench presumption of prudence should apply to a plan fiduciaries’ decision to allow investment in an employer stock fund can finally be put to rest. There remains some uncertainty, however, as to the type of evidence that will be sufficient to rebut the presumption and, correspondingly, the type of allegations that will be deemed sufficient to withstand a motion to dismiss. Hopefully, the courts will soon reach a consensus on these issues as well.