A U.S. Supreme Court decision on whether to accept for review two ERISA cases could lead to a rush of participant lawsuits over company stock investment options in defined contribution plans.
“The outcome of these cases would have a palpable impact on the large percentage of the Fortune 1000 (companies) that have employer stock in their 401(k) plans,” said Jeremy Blumenfeld, an attorney in the Philadelphia office of Morgan, Lewis & Bockius LLP, which has handled many similar cases for pension plans, and filed an amicus brief in the Citigroup case.
“The risks are not just to employers, but to employees who may no longer be offered company stock in their plans if the risks are too great.”
The court on Oct. 11 reviewed the arguments for taking the cases this term. A decision on whether to review the cases is expected to be announced Oct. 15.
The petitions for review were brought by participants in 401(k) plans sponsored by Citigroup Inc. and The McGraw-Hill Cos., both in New York.
Both seek a ruling on separate lawsuits alleging their DC plans violated the Employee Retirement Income Security Act's fiduciary duty standard on several fronts, including the prudence of having company stock as an investment option, and whether there was adequate disclosure of conditions affecting that stock.
Representatives for plan executives say they are hoping that the court will take a pass, and instead let the lower court rulings stand, which could dampen enthusiasm for further challenges.
“We don't want our courts clogged every time a stock goes down, unless there is a reason,” said Scott Macey, president and CEO of The ERISA Industry Committee, Washington, which represents corporations on employee benefits issues. Cases involving stock declines, especially in volatile markets, “aren't abuses of discretion. You can't hold people liable for not knowing. We all know that stocks can go down.”
Despite their dismay at the proliferation of participant-led “stock-drop” lawsuits following the 2008-2009 financial crisis, plan executives are encouraged that most district and circuit courts have dismissed the cases in the early stages, Mr. Macey said.
The Citigroup suit was brought by several plaintiffs on behalf of 150,000 employees participating in two defined contribution plans with current assets of $7.2 billion. The McGraw-Hill plaintiffs participated in one of two defined contribution plans with current assets of $2 billion.
At issue in both cases is whether the companies misled plan participants who had in invested in their companies' own stock about the companies' exposures to subprime mortgage market losses — as a market participant in the case of Citigroup, and as a rating agency in the case of McGraw-Hill's Standard & Poor's unit, which allegedly gave improperly high ratings to mortgage-backed securities.
Separate rulings by U.S. District Court judges in the Southern District of New York originally dismissed the lawsuits, in 2009 for Citigroup and 2010 for McGraw-Hill, on the grounds that the companies did not breach their fiduciary duty to employees by offering company stock as an investment option.
In the Citigroup case, U.S. District Court Judge Sidney H. Stein upheld the offering of company stock as an investment option because it was required by the 401(k) plan, and therefore beyond the fiduciary control of the plan sponsor.
The judge also relied on an often-cited legal principle established in a 1995 class-action lawsuit, Moench vs. Robinson. In that case, an appellate court ruled that an employee stock-option plan fiduciary investing assets in company stock is entitled to a presumption of prudence, unless a breach of fiduciary duties can be shown or the company is in a dire economic situation.
Those decisions were later upheld by the 2nd U.S. Circuit Court of Appeals in New York, which found presumption of prudence to be “the best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Five other appeals courts deciding similar stock-drop cases have upheld the presumption of prudence reasoning as well.
But officials at the Department of Labor, which enforces ERISA, are not backing down from their argument that plan fiduciaries still have an obligation to ensure that the investment in employer stock is prudent. They declined, however, to comment on the Supreme Court petition.
Despite the lower court setbacks and numerous circuit rulings favoring retirement plans, the Citigroup and McGraw-Hill plaintiffs filed for Supreme Court review on June 22. Calls to the law firms representing the Citigroup and McGraw-Hill employees were not returned.
Both petitions ask whether plan fiduciaries “need do nothing to protect plan participants from foreseeable losses unless the employer is in a "dire situation'. The Citigroup petition explains that the case was started after company executives undertook “vast and undisclosed risks by over-investing” in subprime mortgages, and that while they knew and should have known of those risks, the executives “did nothing to discharge their duty solely in the interest of participants.”
ERISA experts expect a flurry of friend-of-the-court briefs to be filed if the Supreme Court accepts the cases.
And acceptance still leaves the door open for several distinct possible outcomes.
“It could open the door to more lawsuits, or it's just as likely that they want to make a statement to clarify the law” made so far, which has largely upheld plan sponsors' right to offer company stock, said ERIC's Mr. Macey.
If the Supreme Court takes the case and decides to alter the legal standards applied by courts so far, which have prevented stock-decline claims to proceed to the legal discovery phase, “that should be of real concern,” Mr. Blumenfeld of Morgan Lewis said in an e-mail.
“The real problem with these claims is not their merits. ... But if not nipped in the bud early, the litigation in these cases threatens to lead to a process that is time consuming, costly, burdensome and risks public disclosure of proprietary business plans — the last thing our country needs during difficult economic times.”
This article originally appeared in the October 15, 2012 print issue as, "Company stock suits await high court review".