By Pension and Benefits Editorial Staff
Plan fiduciaries remained subject to liability for failing to diversify the concentration within the plan of the risky and volatile stock of an oil and gas company from which the plan sponsor had been spun-off, according to a federal trial court in Oklahoma. The stock of the former parent company did not constitute qualifying employer securities for purposes of the generally applicable exemption to the duty to diversify. Claims against the plan’s directed trustee, however, were dismissed as it was not subject to the duty to diversify.
Plan of spinoff company funded with “volatile” stock of parent. Seventy Seven Energy, Inc. (SSE) is a spinoff of Chesapeake Energy Corporation (Chesapeake) that was formed on June 30, 2014 from a wholly-owned subsidiary, Chesapeake Oilfield Operating, LLC. Following the spinoff, the two corporations operated as independent, privately traded companies. Chesapeake retained no ownership interest in SSE and the companies were not affiliates of one another.
The Seventy Seven Energy Inc. Retirement & Savings Plan was established on July 1, 2014, as a spinoff from the Chesapeake Energy Corporation Savings and Incentive Stock Bonus Plan. The plan, which was limited to SSE employees, was initially funded by a transfer of assets (valued at $196,210,229) from the parent plan. The transfer included Chesapeake common stock (valued at $87,038,874), which constituted 44.3 percent of plan assets.
SSE employees were automatically enrolled in the plan, initially deferred 4 percent of their pay, and automatically increased contributions in subsequent years of employment. SSE was allowed to match participants’ contributions, up to a maximum percentage, and make discretionary contributions to an ESOP component of the plan in the form of SSE common stock. Chesapeake stock could not be held in the ESOP.
The plan offered 22 core investment options. However, neither SSE stock nor Chesapeake stock were investment options available to plan participants.
SSE established a trust fund to hold and distribute the plan’s assets. Principal Trust Company (Principal) was appointed the fund’s directed trustee, pursuant to an agreement that described its limited duties and powers.
Following a drop in the market price of Chesapeake stock from $29 per share to $7 per share in October 2015, plan participants brought suit against the Committee administering the plan, alleging that it breached its fiduciary duties by: (1) allowing the plan to buy and hold Chesapeake stock in the ESOP; (2) imprudently investing in and maintaining the investment in Chesapeake stock even though they knew or should have known that the stock was “historically risky and volatile,” and was not and had never been a suitable investment for the plan; (3) failing to diversify plan investments; and (4) failing to adequately disclose the extent of the plan’s investment in Chesapeake. The participants further charged that Principal breached its fiduciary duties by allowing the alleged ERISA violations to occur and by imprudently permitting to plan to own Chesapeake stock.
According to the participants, the plan should have been divested of the Chesapeake stock immediately following the spinoff. The fiduciaries’ failure to divest (and additional purchases of the stock), the participants maintained, caused a substantial portion of the losses suffered from the foreseeable decline in the value of the Chesapeake stock.
The Committee fiduciaries filed a 12(b)(6) motion to dismiss, arguing that the decision to retain the Chesapeake stock was exempt from ERISA’s general diversification requirement because the stock was a “qualifying employer security.” Alternatively, the Committee fiduciaries argued that, even if the diversification requirement applied, the plan offered multiple investment options and the concentration of the Chesapeake stock in the plan was the function of individual participant elections.
Principal also filed a motion to dismiss, stressing that it was a directed trustee and, thus, obligated to follow the reasonable directions of the Committee fiduciaries. In addition, Principal maintained that the Chesapeake stock was a permissible investment under the plan and the directed trustee agreement, regardless of whether it was a qualifying employer security.
Chesapeake stock was not a qualifying employer security. The initial issue addressed by the court was whether the Chesapeake stock was a “qualifying employer security.” ERISA Sec. 404(a)(2) exempts qualifying employer securities from the statute’s generally applicable diversity requirements. ERISA Sec. 407(d) further defines an employer security as a security issued by “an employer of the employees covered by the plan, or by an affiliate of such employers.” The statutory definition would seem to expressly exclude stock issued by a former employer with no relation to employees covered by the plan of a separate, spun-off company. The Committee fiduciaries argued, however, that the determinative factor of whether a stock was “issued by an employer” should be the date on which the stock was issued, stressing that the Chesapeake stock was issued at a time when the plan participants were employed by Chesapeake.
The court found that the argument of the Committee fiduciaries required a “strained, unworkable reading” of ERISA definition of an employer security. Moreover, the court noted, plan-related documents, including the Summary Plan Description and the prospectus, identify only SSE stock as employer securities. Thus, the shares of Chesapeake stock transferred to the plan were not employer securities after the spinoff.
Breach of the duty to diversify. Having determined that the exemption under ERISA Sec. 404(a)(2) did not apply, the court next addressed whether the participants sufficiently alleged that the Committee fiduciaries breached their duty to diversify and Principal violated its duty to correct such breach. Stressing that the transfer of the Chesapeake stock from the employees’ former ESOP to the SSE plan resulted in an asset fund that had over 40 percent of its value concentrated in one “extremely volatile” stock, the participants argued that a prudent fiduciary would have sold the Chesapeake stock at the time of the spin-off (and avoided any subsequent purchases of the stock) in order to properly diversify the plan’s assets.
The Committee fiduciaries countered that the plan’s investments as a whole were diversified and that the plan’s concentrated holdings of Chesapeake stock were attributable to the decisions of plan participants to retain the stock in their individual accounts. However, the court noted that the plan continued to purchase additional Chesapeake stock after the spinoff, even though the plan participants were not allowed to elect such an investment. Thus, the lack of diversification in the plan was not attributable to participant choice. Accordingly, the participants sufficiently stated a claim that the Committee fiduciaries breached their duty to diversify the plan’s assets.
Directed trustee not responsible for plan investments. The participants, however, failed to state a claim for breach of fiduciary duty against Principal for its alleged failure to divest the plan of the Chesapeake stock and to prevent additional investments in the stock. The directed trustee agreement expressly stated that Principal was not responsible for choosing, recommending, or investigating plan investments. Thus, the court explained, the participants were attempting to hold Principal to a putative duty which, as a directed trustee, it did not owe to the participants. The directed trustee’s limited role, the court further noted, did not encompass the activities being alleged as a breach of fiduciary duty. Accordingly, the complaint did not state a claim based on the failure to diversify plan assets.
SOURCE: Myers v. Administrative Committee, Seventy Seven Energy. Inc., Retirement & Savings Plan (DC OK).
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