In Quan v. Computer Sciences Corp., after their employer’s stock dropped 12% in one day, a group of 401(k) plan participants sued the plan’s fiduciaries, alleging that by investing plan funds in the stock, they had breached their fiduciary duties.
Quan is the latest case in the “stock drop” litigation trend that has emerged over the past decade since the Enron and Worldcom debacles, giving a litigious outlet to 401(k), ESOP and other individual investment account plan participants who are unhappy with their plan’s investment in employer stock that has dropped in value.
To consider the fiduciaries’ investment decisions, the court first had to choose the appropriate standard of review. It joined the Third, Fourth and Sixth Circuits by adopting the “Moench presumption,” which presumes that fiduciaries act prudently and consistent with ERISA in their decisions to invest plan assets in employer stock. The Moench presumption is viewed as a shield protecting fiduciaries against participant claims. The presumption, though, has limited application, and is used only in cases when a fiduciary’s decision to invest in or retain employer stock is challenged. It does not apply to claims challenging the decision to divest a fund of employer stock, or to claims that challenge the diversity of investments within a fund. This limited application has given voice to Moench critics who question its use in only a single type of ERISA malfeasance case when all cases are similar, but has not stopped courts growing acceptance.
Participants can overcome the Moench presumption, but to do so they must make allegations that “clearly implicate the company’s viability as an ongoing concern” or show “a precipitous decline in the employers stock . . . combined with evidence that the company is on the brink of collapse or is undergoing serious mismanagement.” It is not enough to prove only that the stock was not a prudent investment or that fiduciaries ignored a decline in stock price. Rather, to rebut Moench, participants must show publicly known facts that would trigger the kind of careful and impartial investigation by a reasonable fiduciary that the plan’s fiduciaries failed to perform.
Considering the participants’ allegations, the court found that they presented insufficient evidence to rebut the Moench presumption. Though the fiduciaries were aware of issues that may have affected the company’s stock price, including an informal request for information from the Securities and Exchange Commission, the court found that they responded appropriately by establishing a special committee of directors to oversee an internal investigation into company stock granting practices and hiring a law firm and an accounting firm to participate in the investigation. The court refused to adopt the participants’ argument that the one day stock price drop was itself sufficient to show that the fiduciaries did not adequately investigate the company stock because the participants were unable to link the price drop with an illegal scheme that the fiduciaries knew of or should have known about. The stock drop may have raised “red flags” after the fact, but the court found that the fiduciaries responded appropriately by investigating and addressing problems discovered. Within a year of the price drop, the stock had rebounded and made gains and the court relied on this more than the one day price change.
Fiduciaries of plans with individual investment accounts that offer employer stock investment options certainly benefit from the Quan decision as it reflects growing acceptance of the Moench presumption. The Ninth Circuit had previously declined an opportunity to adopt the Moench presumption, making its decision to do so now all the more significant in terms of measuring the trend. The decision is, however, also an important reminder that not all courts recognize the presumption, and even in those that do, the presumption can be rebutted and fiduciaries must actively monitor their investments, investigate any problems and respond reasonably if problems are confirmed.