Pension & Benefits News Continued investment in risky stock of financially unstable company did not breach fiduciary duty
Wednesday, September 12, 2018

Continued investment in risky stock of financially unstable company did not breach fiduciary duty

By Pension and Benefits Editorial Staff

Plan fiduciaries did not breach their duties of prudence and loyalty under ERISA by allowing for the continued investment of plan assets in a financially unstable company in which the fiduciaries held stock, according to the U.S. Court of Appeals in New Orleans (CA-5). As explained by the court, the risk of the investment was reflected in its valuation and the alleged fraud of the fiduciaries in using inside information to inflate the stock price was not a sufficient special circumstance to render reliance on the market valuation imprudent.

Plan investment in failing company stock. Following a spinoff from Verizon in 2006, Idearc sponsored an individual account plan for its employees. The plan offered a variety of pre-selected investment options, including Idearc stock.

During the period November 2006-March 2009, Idearc (similar to most of the other companies in the yellow pages industry) began to experience financial difficulties, resulting in a precipitous decline the company's stock price. Eventually, the company was delisted from the New York Stock Exchange and declared Chapter 11 bankruptcy.

Plan participants filed suit, alleging that the plan fiduciaries breached their: duty of substantive prudence by allowing plan participants to continue to invest in company stock despite public information about the company's financial instability; duty of procedural prudence by failing to consider actions in response to the long-maturing deterioration of the company's financial condition; and duty of loyalty by pursuing a pattern of behavior that benefitted the company and the fiduciaries, to the detriment of the employees. A federal trial court dismissed the action, and the participants appealed.

Special circumstances did not establish breach of substantive due process. Initially, the appeals court, relying on the standard articulated by the U.S. Supreme Court in Fifth Third Bancorp. v. Dudenhoeffer (134 S Ct. 2459 (2014) noted that allegations that a fiduciary should have recognized from publicly available information alone that a market was over- or undervaluing company stock are generally implausible absent special circumstances. Thus, fiduciaries may prudently rely on market price as a fair assessment of a stock's value.

Attempting to avoid Dudenhoeffer, the participants maintained that the riskiness of a stock investment should be considered separately from its valuation. However, noting that the stock price reflects the riskiness of an investment, the court explained that Dudenhoeffer also applies to public information claims based on excessive risk.

Forced to comply with Dudenhoeffer, the participants alternatively argued that the fraud of the fiduciaries in using inside information to inflate the market price of the stock constituted a special circumstance sufficient to undermine the reliability of the market price. However, because the participants did not address how the inside information would affect the reliability of the market price as an unbiased assessment of the stock's value in light of all public information, the court did not view the alleged fraud as being the type of special circumstance envisioned by Dudenhoeffer.

Failure to cite alternative cause of action negates procedural prudence claim. The participants further charged that the fiduciaries breached their procedural duty of prudence by the “lethargic failure” to meet and discuss a possible course of action regarding the plan's investment in the failing company stock. In dismissing the claim, the court first explained that a fiduciary may be liable only for losses to the plan resulting from the breach. The participants, however, failed to allege facts supporting the conclusion that the fiduciaries would have acted differently had they engaged in proper monitoring. Accordingly, without citing an alternative course of action that the fiduciaries could have taken to prevent the plan's losses, the procedural duty of prudence claim could not stand.

Ownership of company stock did not establish breach of duty of loyalty. The participants, finally, charged that the fiduciaries participated in a concerted scheme to hide adverse information about the company in order the benefit their personal interests and those of the company. In rejecting the charge, the court noted that the fiduciaries' actions in protecting the value of the company stock were consistent with their obligation to protect the plan's investment in the stock. The potential conflict of interest stemming merely from the fiduciaries' ownership of the company stock, the court emphasized, was not “synonymous with a plausible claim of fiduciary disloyalty.”

Source: Kopp v. Klein (CA-5).

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