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Employee Benefits Alert: Plan sponsors of ESOPs and 401(k)s take note

On February 22, 2012, the Sixth Circuit issued a ruling in Pfeil v. State Street Bank and Trust Co., reversing the district court’s dismissal of the case and allowing it to proceed. In so doing, the Sixth Circuit held that the Kuper/Moench presumption of prudence does not apply at the motion to dismiss stage, and that ESOP fiduciaries must do more than allow participant control over a variety of investment options in order to rely on the ERISA Section 404(c) safe harbor defense. These holdings by the Sixth Circuit distinguish it from the rulings of other Circuit Courts, and include potential lessons to be learned by ESOP and 401(k) fiduciaries. 

Facts of the Case

General Motors (GM) offered employee stock ownership plans (ESOPs) as retirement options to its employees. The plans offered participants several investment options, including mutual funds, non-mutual fund investments, and the General Motors Common Stock Fund. Participants had control over how their funds were invested. The plans imposed no restrictions on the participant’s allocation of assets among the investment options and gave participants the discretion to change their allocation in any investment on any business day.

The plans invested each participant’s funds by default in the Pyramis Strategic Balanced Fund. Plaintiffs allege that the plans invested between $1.45 billion and $1.9 billion in plan assets in GM stock from July 15, 2008 through April 24, 2009. The plan documents provided that the General Motors Common Stock Fund must be invested exclusively in GM $1–2/3 par value common stock without regard to diversification of assets, the risk profile of the investment, the amount of income provided by the stock, or fluctuations in the market value of the stock. The plans also provided, however, that these restrictions did not apply if an independent fiduciary, in its discretion, determined from reliable public information that there was a serious question concerning GM’s short-term viability as a going concern without resort to bankruptcy proceedings, or there was no possibility in the short-term of recouping any substantial proceeds from the sale of stock in bankruptcy proceedings. In the event either of these conditions were met, the plan documents directed the independent fiduciary to divest the plans’ holdings in the General Motors Common Stock Fund.

Plaintiffs allege that when State Street became fiduciary for the plans on June 30, 2006, GM was already in serious financial trouble. They allege that State Street should have recognized as early as July 15, 2008, that GM was bound for bankruptcy and that GM stock was no longer a prudent investment for the plans. On November 21, 2008, State Street informed participants that it was suspending further purchases of General Motors Common Stock Fund. Plaintiffs allege, however, that State Street took no further action to divest over 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 company stock and completed the sell-off on April 24, 2009. General Motors filed its bankruptcy petition on June 1, 2009. Plaintiffs filed a putative class action on June 9, 2009, alleging State Street’s breach of fiduciary duty in violation of ERISA Section 409(a) by failing to prudently manage the plan’s assets thereby breaching its fiduciary duty defined in ERISA Section 404. State Street filed a motion to dismiss the complaint for failure to state a claim, which the district court granted on September 30, 2010.

Lessons to be Learned by Fiduciaries

Be prepared to wait to rely on the Kuper/Moench presumption until there is a fully Developed Evidentiary Record.

According to a presumption of reasonableness for ESOP fiduciaries, which is often referred to as the Kuper/Moench presumption, a fiduciary’s decision to remain invested in employer securities is presumed to be reasonable; however, a plaintiff may rebut the presumption by showing that a prudent fiduciary acting under similar circumstances would have made a different investment decision. In this case, the Sixth Circuit addressed whether a plaintiff must plead enough facts to overcome the Kuper/Moench presumption in order to survive a motion to dismiss. The Sixth Circuit found that because the Kuper/Moench presumption is an evidentiary standard and concerns questions of fact, applying the presumption at the pleadings stage, and determining whether it was sufficiently rebutted, would be inconsistent with the Rule 12(b)(6), motion to dismiss standard.

As a result of the Sixth Circuit’s ruling in this case, ESOP fiduciaries may not be able to rely on the Kuper/Moench presumption at the motion to dismiss stage. Such fiduciaries may have to wait to rely on the presumption until there is a fully developed evidentiary record. Consequently, ESOP fiduciaries should be prepared to demonstrate prudence and reasonableness in their decisions surrounding the ESOP’s investment in company stock. If you are a fiduciary of an ESOP that has invested in company stock which has declined in value, you should generally be prepared to show the following if a lawsuit alleging fiduciary liability arises:

  • The ESOP did not pay more than fair market value for the stock initially purchased
  • It was prudent and reasonable to continue to invest in company stock despite the decline in its value
  • The performance of fiduciaries to whom certain responsibilities were delegated was adequately monitored
  • No false or misleading statements were made about company stock to participants

Other circuits have held that the Kuper/Moench presumption should in fact be considered at the pleadings stage; however, the Sixth Circuit found these decisions distinguishable because such circuits adopted more narrowly-defined tests for rebutting the presumption than the test the Sixth Circuit announced in Kuper v. Iovenko. According to the Sixth Circuit, because the standard in Kuper v. Iovenko for rebutting the presumption is not as narrowly defined, it should not be applied to the pleadings on a motion to dismiss.

Be prepared to show more than participant control over a variety of investment options to rely on Section 404(c) safe harbor defense.

In this case, the district court held that the ERISA Section 404(c) safe harbor defense prevents a trustee from being held liable for any loss caused by any breach which results from the participant’s exercise of control over plan assets. According to the Sixth Circuit, however, the fact that a plan participant or beneficiary exercises control over plan assets does not automatically trigger the ERISA Section 404(c) safe harbor defense. ERISA Section 404(c) provides that a fiduciary is not liable for losses incurred by a participant who has control over his or her investment decisions provided certain requirements are met. The Sixth Circuit explained that the Department of Labor (DOL) regulations include over 25 requirements that must be met before a fiduciary may be protected by the ERISA Section 404(c) safe harbor defense.

The Sixth Circuit held that the ERISA Section 404(c) safe harbor defense does not apply in this case because it does not relieve fiduciaries of the responsibility to monitor investments. It stated that if the purpose of the ERISA Section 404(c) safe harbor defense is to relieve a fiduciary of responsibility for decisions over which it had no control, then it follows that the safe harbor defense should not prevent a fiduciary from being held liable for a decision which it did control, such as the selection of plan investment options.

Alternatively, the Fifth Circuit has held that a fiduciary may be able to rely on the ERISA Section 404(c) safe harbor defense when presented with claims that it improperly selected and monitored plan investment choices. According to the Fifth Circuit, a plan fiduciary may have violated the duties of selection and monitoring of a plan investment, but ERISA Section 404(c) recognizes that participants are not helpless victims of every error.

As a result of the Sixth Circuit’s ruling in this case, an ESOP fiduciary may not be able to rely on this defense by simply showing that participants and beneficiaries had control over a variety of investment options. In order to rely on this defense and to minimize fiduciary exposure, ESOP fiduciaries should be prepared to show that they comply with ERISA Section 404(c) and that they meet the relevant requirements listed in the DOL regulations. Some of these requirements are easy to meet, while others may prove to be more challenging. These requirements include:

  • Stating that the plan is intended to be an ERISA 404(c) plan
  • Explaining that this will relieve plan fiduciaries of liability for losses resulting from the participant’s investment directions
  • Offering a broad range of investment alternatives only if the available investment alternatives are sufficient to provide the participant or beneficiary with a reasonable opportunity to materially affect the potential return on amounts in his individual account and the degree of risk to which such amounts are subject.
  • One of the more challenging requirements is the requirement that the participant or beneficiary be provided, or have the opportunity to obtain, sufficient information to make informed investment decisions with regard to investment alternatives available under the plan.

To find out more about the implications of Pfeil v. State Street Bank and Trust Co., or the issues surrounding the Kuper/Moench presumption or the ERISA Section 404(c) safe harbor defense, please contact:

Dale R. Vlasek

Meredith R. Fergus

Employee Benefits

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© 2012 McDonald Hopkins LLC All Rights Reserved. This Alert is designed to provide current information for our clients, friends and their advisors regarding important legal developments. The foregoing discussion is general information rather than specific legal advice. Because it is necessary to apply legal principles to specific facts, always consult your legal advisor before using this discussion as a basis for a specific action.