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Defined Contribution

Huge hurdle established for stock-drop suits

High court ruling cited as factor in fewer filings

David Levine said the barrier is higher than just contending the stock should have been sold.

More than three years after a unanimous U.S. Supreme Court ruling offered guidance on stock-drop lawsuits, plaintiffs are encountering a high bar for challenging the use of company stock as an investment option in defined contribution plans.

Several settlements of stock-drop cases have been made since the June 2014 ruling in Fifth Third Bancorp et al. vs. Dudenhoeffer et al., but the litigation landscape has been dominated by dismissals in federal district courts.

Among the stock-drop cases this year, federal district court judges have dismissed complaints against IBM Corp., Wells Fargo & Co., Target Corp., Peabody Energy Corp. and Arch Coal Inc., citing the Supreme Court ruling.

The Dudenhoeffer ruling has made it harder for plaintiffs, said Kivanc Kirgiz, a vice president at Cornerstone Research, a Washington-based economic and financial consulting firm that tracks stock-drop cases. "The number of cases being filed is much lower than four or five years ago," he said.

Lawsuits against DC plan sponsors of publicly traded companies have been in single digits since 2012, with only two filed in 2016, the latest year for which Cornerstone Research data are available. Five were filed in 2014 and two were filed in 2015.

However, in each year between 2002 and 2011, the number of stock-drop lawsuits reached double digits, with peaks of 37 in 2008 and 34 in 2002.

Mr. Kirgiz said the decline in ​ recent years could be attributed in part to a rising stock market as well as to the barriers erected by the Supreme Court.

Path for challenges

After the Dudenhoeffer ruling, some members of the defined contribution plan community feared the court had created a path for more successful challenges to DC plans that had kept company stock as an option even when the stock and company performance plunged.

The Supreme Court ruling invalidated a key legal principle — the Moench presumption — that gave sponsors the benefit of the doubt in offering company stock in a DC plan investment lineup. The Moench presumption was based on a 1995 decision by a federal appeals court in Philadelphia, in Moench vs. Robertson, saying that because Congress encouraged employee stock ownership, DC sponsors are entitled to a presumption that they acted prudently in offering it.

"The Moench presumption made sponsors feel better," said Thomas Clark Jr., a St. Louis-based partner for the Wagner Law Group. "When the court took that away, people were scared."

However, the Supreme Court's guidelines "got to the same place using existing legal theories," said Mr. Clark, referring to hurdles that plaintiffs' attorneys face in getting a stock-drop case to trial.

Mr. Clark, like others interviewed for this article, represents defendants in ERISA cases.

"There was a knee-jerk reaction to losing Moench," said Andrew Oringer, New York based partner of Dechert LLP. "Dudenhoeffer was misunderstood when it was decided. It's clear to me that Dudenhoeffer is not a panacea for the plaintiffs' bar. This is not going to be an easy path."

The Supreme Court has consistently rebuffed efforts to reopen or expand upon the Dudenhoeffer ruling. Since last year, the justices have declined to hear appeals of lower-court dismissals involving State Street Bank & Trust Co. as the fiduciary for General Motors Co. stock in two GM 401(k) plans, Lehman Brothers Holding Inc. and Citigroup Inc.

In January 2016, the Supreme Court reversed a pro-plaintiff ruling by the 9th U.S. Circuit Court of Appeals involving company stock in two plans run by Amgen Inc. The appeals court had reversed a federal district court's dismissal of the complaint. Commenting on the case originally filed in 2007, the justices wrote that plaintiffs did not produce "sufficient facts and allegations to state a claim for breach of the duty of prudence."

Same strategy

Although each case is different, the strategy for sponsor-defendants is the same — convince a judge to dismiss a stock-drop complaint to avoid extra expenses of pre-trial discovery, a trial, a settlement or a pro-plaintiff ruling.

Some settlements reached in recent years represent lawsuits that had been filed five or more years ago. The Dudenhoeffer case, for example, was settled last year for $6 million with no admission of wrongdoing by Fifth Third Bancorp. Participants sued in August 2008.

"Don't assume that if a company settles that it had a bad case," said Mr. Oringer, noting that he, like other ERISA attorneys, wasn't commenting on a specific case. "Companies have different levels of risk aversion. Each sponsor has a different risk appetite."

ERISA attorneys say the Supreme Court left it up to lower courts to interpret guidelines that have proven to be as strict as, if not stricter than, the Moench presumption.​

"Simply pleading that the stock went down and the plan should have sold it is not enough" to convince judges, said David Levine, a partner in the Groom Law firm. "There's a high barrier."

One hurdle is the requirement that plaintiffs prove "special circumstances" to convince lower courts to let a lawsuit proceed. As noted in the Arch Coal case, even impending bankruptcy isn't automatically considered a special circumstance.

"Plaintiffs' allegations of Arch Coal's 'serious deteriorating condition' and 'overwhelming debt' are evidence of the company's slide into bankruptcy but do not establish a special circumstance under Dudenhoeffer," St. Louis-based U.S. District Judge Carol E. Jackson said in an Aug. 4 opinion dismissing the complaint against Arch Coal and the plan's trustee, Mercer Fiduciary Trust Co.

The biggest hurdle for plaintiffs is convincing lower courts that an alternative action by a prudent fiduciary to keeping company stock in a DC plan wouldn't do more harm than good.

For example, the "more harm than good" standard was cited by U.S. District Judge William H. Pauley III in New York on Sept. 29 in dismissing a suit against IBM. "The complaint is bereft of context-specific details to show how a prudent fiduciary would not have viewed the proposed alternatives as more likely to do more harm than good," he wrote.

The standard also was cited by U.S. District Judge Joan Ericksen of Minneapolis on July 31 in dismissing a complaint against Target, in which 401(k) plaintiffs said managers could have taken other steps to keeping company stock.

"Nobody knows what 'special circumstances' mean and what 'more harm than good' means," said Nancy Ross, a Chicago-based partner at the Mayer Brown law firm, adding the Dudenhoeffer standards make it "exceptionally difficult to get things past the motion to dismiss."

The "more harm than good" is especially vexing, she added, because "that's asking fiduciaries to be prescient" in assessing alternatives to keeping company stock in a 401(k) plan.

None of her clients has dropped company stock from their 401(k) plans due to fears of litigation. "I tell clients to listen to their employees" because they "are still providing company stock if their employees want it," she said.