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The Sixth and Second Circuits Widen Circuit Split Concerning Pleading Standards for “Stock Drop” and Misrepresentation Claims Under ERISA

September 27, 2012

In two recent decisions, the United States Courts of Appeals for the Second and Sixth Circuits addressed allegations that retirement plan fiduciaries had breached their duties under the Employee Retirement Income Security Act (“ERISA”) by offering allegedly imprudent investments in employer securities and by misrepresenting or concealing material information about the company. Applying different standards to reach opposite outcomes, the Second Circuit affirmed the dismissal of such claims, while the Sixth Circuit reversed dismissal and remanded, thereby widening a circuit split over pleading standards for such claims.

Dudenhoefer v. Fifth Third Bank (Sixth Circuit)

In Dudenhoefer v. Fifth Third Bancorp, 2012 U.S. App. LEXIS 18622 (6th Cir. Sept. 5, 2012), the Sixth Circuit reversed the dismissal of claims alleging that Fifth Third Bank, its President and Chief Executive Officer, and the investment committee for the bank’s 401(k) plan breached their fiduciary duties of prudence by offering the bank’s stock as a plan investment option when it was allegedly imprudent to do so. The court also reversed the dismissal of claims for breach of the duty of loyalty arising from alleged misrepresentations in the company’s SEC filings, which had been incorporated by reference into the summary plan description.

The 401(k) plan included an Employer Stock Ownership Plan (ESOP) component that was required to be “invested primarily” in Fifth Third stock (along with short-term liquid assets to accommodate trading), as well as a company matching account that was required to invest in Fifth Third stock. Participants could redirect their matching contributions into other investment options. Despite these provisions, the Sixth Circuit held that the plan terms did not require the ESOP to “invest solely in Fifth Third Stock and [did] not limit the ability of the Plan fiduciaries to remove the [ESOP] or divest [its] assets” from Fifth Third stock “as prudence dictates.” Although the court recognized that a “fiduciary’s decision to remain invested in employer securities is presumed to be reasonable,” following its recent decision in Pfeil v. State Street Bank & Trust Co., 671 F.3d 585, 591 (6th Cir. 2012), it held that the presumption does not apply on a motion to dismiss. In distinguishing the contrary holdings of other courts of appeals that have applied the presumption at the pleading stage, the court reiterated Pfeil’s rationale that the Sixth Circuit’s test to rebut the presumption—whether a “prudent fiduciary acting under similar circumstances would have made a different investment decision”—is not as narrow as the tests in other circuits, where proof of a “dire situation, something short of the brink of bankruptcy or an impending collapse” is required. The court further noted that its “unembellished standard makes sense” because it “closely tracks” ERISA’s statutory language in section 404(a)(1)(B) (the duty of prudence) and holds ESOP fiduciaries to the same standard as other fiduciaries.

Because the presumption did not apply, the plaintiffs needed only to plead facts showing “that an adequate investigation would have revealed to a reasonable fiduciary that the investment [in employer stock] was improvident.” The court held that the plaintiffs had done so based on allegations that (1) the bank had invested heavily in the subprime real estate market; (2) defendants were aware of the risks of those investments based on, for example, published articles and “warnings by industry watchdogs,” and (3) the “closure of several mortgage companies” due to losses in investments in subprime mortgages. In addition, the company’s stock price had dropped 74 percent during the class period and the bank had participated in the U.S. Government’s Troubled Asset Relief Program, or “TARP.”

With respect to the duty of loyalty claims, the Sixth Circuit reversed the district court’s ruling that the alleged misrepresentations and omissions in the bank’s SEC filings were not made in an ERISA fiduciary capacity. Noting that “no circuit court has answered the question of whether the express incorporation of SEC filings into an ERISA-mandated [summary plan description] is a fiduciary communication,” the court distinguished other cases where SEC filings had been incorporated into an SEC Form S-8 or a Form 10(a) stock prospectus, which were required communications under the securities laws but were not disseminated to plan participants. The Sixth Circuit then held that by incorporating SEC filings into the summary plan description, defendants had intentionally intertwined the SEC filings with an ERISA fiduciary communication and had thus engaged in fiduciary conduct.

In re Glaxosmithkline ERISA Litigation (Second Circuit)

In contrast, in In re Glaxosmithkline ERISA Litigation, 2012 U.S. App. LEXIS 18552 (2d Cir. Sept. 4, 2012), the Second Circuit affirmed dismissal of claims that plan investment committees and their members had breached their fiduciary duties of prudence by offering Glaxosmithkline stock in the company’s 401(k) plan when the stock was an imprudent investment option. The plaintiffs alleged that problems with the safety and efficacy of some of the company’s flagship drugs had led to criminal prosecutions, civil settlements and a 30 percent drop in share price. The court also dismissed claims that the same fiduciaries had breached their duty of loyalty by misrepresenting or omitting material information about those problems in company newsletters, SEC filings and summary plan descriptions that incorporated certain of those filings.

With respect to the prudence claim, the court rejected the contention that the fiduciaries had “unfettered discretion” whether to offer the company’s stock in the plan, holding that even though the plan’s terms did not require investment in employer securities, they “strongly favor[ed]” such investment. Specifically, plan provisions making employer securities the default investment for company matching contributions and other provisions concerning, for example, reinvestment of dividends, “pre suppose a [company] Stock Fund option” and would be “confusing if not incoherent” if the fiduciaries were allowed to eliminate that investment option “without restrictions.” Accordingly, the court’s decision in In re Citigroup ERISA Litigation, 662 F.3d 128 (2d Cir. 2011), was controlling, and the fiduciaries’ decision to abide by the plan’s stated preference for investment in employer securities was “afforded a presumption of prudence.” “[O]nly circumstances placing the employer in a ‘dire situation’ that was objectively unforeseeable by the settlor could require fiduciaries to override plan terms.”

Applying that rule, the court held that the “sole inquiry is how the alleged negative events affected the suitability of GSK stock as a long-term retirement investment for employees.” Because the alleged business problems and stock price decline did not plausibly indicate the type of unforeseen “dire situation” that would compromise the stock’s long-term prospects, the court affirmed dismissal.

With respect to the duty of loyalty claims, the court held that alleged misrepresentations in the newsletters and SEC filings were not actionable because they were not made in a fiduciary capacity. The court noted that, to the extent those statements mentioned retirement benefits, they were not “closely linked” to the allegedly misleading statements about the company’s viability.

The court further held that the incorporation of the SEC filings into the summary plan descriptions did not suffice to allege actionable misrepresentations because the “generalized allegation” that the benefits committee “should have known of the material misrepresentations and omissions” did not give rise to a plausible inference that those defendants, who were “Human Resources and Information Technology employees,” made “intentional or knowing misstatements.”

Petitions for Certiorari

The precedents underlying the decisions in Dudenhoefer and GlaxosmithklinePfeil v. State Street Bank (6th Cir.) and In re Citigroup ERISA Litigation (2d Cir.), respectively—are the subject of petitions for certiorari currently pending before the Supreme Court.


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