In Moench v. Robertson, [1] the United States Court of Appeals for the Third Circuit adopted a presumption of compliance with ERISA when an employee stock ownership plan (ESOP) fiduciary invests in the employer’s stock. Last week, the Court of Appeals for the Sixth Circuit breathed new life into ERISA “stock-drop” claims against State Street Bank, holding that the Moench presumption of prudence does not apply to motions to dismiss.

In Pfeil v. State Street Bank and Trust Company, [2] the Sixth Circuit refused to follow the Second Circuit’s decisions last October in Citigroup [3] and McGraw-Hill [4] that applied the “presumption of reasonableness” in affirming motions to dismiss stock-drop class actions, claiming that fiduciaries breached ERISA duties in continuing to offer employer stock as an investment option in 401(k) plans. State Street highlights a split among the circuits that may not be resolved until the Supreme Court weighs in on the issue.

The Moench Presumption of Reasonableness in Stock-Drop Cases

The Third, [5] Fifth, [6] Sixth, [7] Seventh [8] and Ninth [9] Circuits have applied some version of the Moench presumption of reasonableness in stock-drop cases ESOPs and eligible individual account plans (EIAPs) that permit investment of plan assets in employer stock. In ERISA § 404(a)(2), Congress expressly exempted such employer stock holdings from the diversification standard set forth in ERISA’s fiduciary responsibility provisions, the prudence standard (only to the extent it requires diversification) and the limitations that otherwise apply to employer stock holdings.

Courts applying the Moench presumption recognize that employer stock is a presumptively-prudent investment for ESOPs and EIAPs. To defeat the presumption, plaintiffs must show the fiduciaries were aware of dire financial circumstances threatening the company’s viability as a going concern and creating the danger that company stock would become worthless. Some of these cases have applied this presumption of reasonableness at the summary-judgment stage, after the parties have been through discovery on the merits. Some courts, most recently the Second Circuit, have applied this presumption at the motion-to-dismiss stage, cutting off plaintiffs’ claims before discovery on the grounds that plaintiffs cannot plausibly state a claim of breach of ERISA fiduciary duty.

Second Circuit Applies Moench to Grant Motion to Dismiss

In Citigroup and McGraw-Hill, the Second Circuit applied the presumption of prudence in considering defendants’ motion to dismiss: “Where plaintiffs do not allege facts sufficient to establish that a plan fiduciary has abused its discretion, there is no reason not to grant a motion to dismiss.”

Following recent Supreme Court decisions establishing heightened pleading standards for civil lawsuits in the federal courts, [10] the Second Circuit in Citigroup reasoned that plaintiffs must plead a “plausible” breach-of-fiduciary duty claim to survive a motion to dismiss. The Second Circuit explained that this presumption of prudence provides “the best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.”

By applying the Moench presumption at the motion-to-dismiss stage, the Second Circuit decisions made stock-drop cases much easier to defend, at least where employers properly designed their plans to establish that company stock was a required investment alternative and avoided “dire financial circumstances” that could render such company stock worthless. By dismissing the claims before the expense of discovery, Citigroup and McGraw-Hill greatly reduced the plaintiffs’ leverage in seeking class action settlements and appeared to herald a decline in the viability of stock-drop claims.

Sixth Circuit Refuses to Apply Moench at Motion-to-Dismiss Stage

The Sixth Circuit has now thrown a bit of cold water on defendants’ hopes for the end of stock-drop litigation. In State Street, the Sixth Circuit reaffirmed its earlier ruling in Kuper v. Iovenko that the presumption of reasonableness applies in ESOP and EIAP stock-drop cases. Unlike the Second Circuit decisions in Citigroup and McGraw-Hill, however, the State Street court found that the presumption cannot be applied at the motion-to-dismiss stage. The Sixth Circuit stated:

The presumption of reasonableness [is] an evidentiary presumption, and not a pleading requirement.… [We apply] the presumption to a fully developed evidentiary record, and not merely the pleadings. As such, a plaintiff need not plead enough facts to overcome the presumption in order to survive a motion to dismiss.

State Street was an independent fiduciary for the salaried and hourly participant-directed 401(k) plans of General Motors Corporation (GM), which offered several investment options, including the General Motors Common Stock Fund (GM Fund). The plan documents required that the GM Fund be offered to participants and be invested exclusively in GM stock, unless State Street, as an independent fiduciary, determined in its discretion that “(A) there is a serious question concerning [GM’s] short-term viability as a going concern without resort to bankruptcy proceedings; or (B) there is no possibility in the short-term of recouping any substantial proceeds from the sale of stock in bankruptcy proceedings.”

By the summer of 2008, GM’s financial outlook looked bleak. In November 2008, GM’s auditors had “substantial doubt” regarding its “ability to continue as a going concern.” Plaintiffs alleged that State Street should have known by July 2008 that GM stock was no longer a prudent investment for the plans.

On Nov. 21, 2008, State Street suspended purchases of the GM Fund, but took no action to divest the more than 50 million shares of GM stock held by plan participants at that time. On March 31, 2009, State Street decided to sell off the plans’ holdings in GM stock and completed the sell-off April 24, 2009. GM filed for bankruptcy five weeks later. Plaintiffs filed a class action ERISA lawsuit one week after the bankruptcy filing, alleging that State Street breached ERISA fiduciary duties by failing to sell GM stock earlier.

The district court found that plaintiffs had sufficiently alleged a breach of fiduciary duty, but ultimately dismissed the complaint on the pleadings, concluding that State Street’s alleged breach did not proximately cause losses to the plans because participants retained control over their accounts and were able to move their funds out of the GM Stock Fund.

On appeal, the Sixth Circuit reversed and sent the case back to the district court for discovery and further proceedings. In addition to finding that plaintiffs had adequately alleged State Street’s breach of fiduciary duty, the court of appeals also held that the ability of participants to divest their accounts of GM stock was no defense for State Street because “State Street was obligated to exercise prudence when designating and monitoring the menu of different investment options that would be offered to plan participants.… State Street had a fiduciary duty to select and maintain only prudent investment options in the plans.” In addition, the court held that ERISA § 404(c) “does not provide a defense to the selection of the menu of investment options that the plan will offer.”

What Does State Street Mean for the Future?

After the Second Circuit’s decisions in Citigroup and McGraw-Hill, some speculated that stock-drop cases were on their last legs. State Street seems to keep a lot of these cases alive, at least in the Sixth Circuit, which may become the plaintiffs’ forum of choice for these cases. Other implications include: 

  • Unless it seeks and obtains Supreme Court review, State Street will face extensive discovery in the district court over its actions during 2008 and 2009, including production of documents and emails, and depositions of State Street’s key fiduciary players. The Sixth Circuit has said that the Moench presumption of reasonableness is applied to a “fully developed evidentiary record.” It will take time and expense to develop that record.
  • This case involved an independent fiduciary and reflects an arrangement that many employers have implemented in recent years to address the possibility of stock-drop lawsuits. Independent fiduciaries may reevaluate their willingness to enter into such engagements and seek greater contractual protections from employers in the event of litigation.
  • The Sixth Circuit’s decision is a win for the U.S. Department of Labor (DOL), whose amicus brief argued against application of Moench and ERISA § 404(c) at the motion-to-dismiss stage. The DOL has been filing plaintiff-friendly amicus briefs in many stock-drop cases. The DOL will trumpet State Street in future briefs.
  • On its facts, State Street is easy to distinguish from Citigroup and McGraw-Hill. After all, GM did file bankruptcy and its perilous financial situation in 2008 and 2009 arguably meets the test for rebutting the Moench presumption that GM stock was a prudent investment. The language of the Sixth Circuit goes far beyond this factual distinction, however.
  • Three stock-drop cases are now pending before the Eleventh Circuit Court of Appeals: Lanfear v. Home Depot Inc.; In re ING Groep, N.V. ERISA Litigation;and Fisch v. SunTrust Banks, Inc. In each case, the district court applied the Moench presumption of reasonableness in granting motions to dismiss on the pleadings. The DOL has filed amicus briefs in each case, arguing against application of the Moench presumption and will surely cite State Street as grounds for reversing these cases.
  • On Feb. 23, 2012, the Second Circuit denied plaintiffs’ petition for rehearing in Citigroup, in which the DOL filed an amicus brief supporting plaintiffs. The Citigroup plaintiffs may now petition for certiorari to the Supreme Court in light of the split of authority between the Sixth and Second Circuits over whether to apply Moench at the motion-to-dismiss stage.
  • If the Supreme Court grants review in Citigroup and/or State Street, there is no telling how the Supreme Court will decide these issues. The Supreme Court has lately shown a penchant for deciding ERISA cases on principles that lower courts have not considered.