Pension & Benefits News Continued investment of “value” fund in “growth” stock was consistent with plan documents
Wednesday, April 24, 2019

Continued investment of “value” fund in “growth” stock was consistent with plan documents

By Pension and Benefits Editorial Staff

Plan fiduciaries did not breach their obligations under ERISA by retaining as a plan investment option a mutual fund that made a substantial investment in a high risk stock, according to the U.S. Court of Appeals in San Francisco (CA-9). Although the participants charged that the fund was intended to invest in conservative “value” stocks, the court concluded that the investment and concentration in the allegedly high risk stock was “facially consistent” with plan documents.

Loss following decline in value of high risk stock. Walt Disney Company (Disney) maintains a participant-directed 401(k) plan that provides plan participants an investment menu of 26 different funds. Among the funds is the Sequoia Mutual fund, in which plan participants have invested over $500 million (12 percent of all assets not invested in Disney stock).

Plan participants believed Sequoia to be a conservative “value” fund. However, beginning in 2010, the Fund invested $250 million (7.96 percent of the Fund’s net assets) in Valeant Pharmaceuticals International, Inc., which, based on its aggressive acquisition strategy and business model, qualified as a “growth” stock. The Fund continued to invest in Valeant, so that by July 2015, over 28 percent of the Fund’s net assets were invested in the company.

In August 2015, Valeant stock closed at $262 per share, a trade value that was 98 times higher than earnings. However, despite the soaring stock price, the company was shadowed by concerns regarding its account practices and investment strategy. By November 2015, Valeant’s stock price declined to less than $70 per share, a loss of over $65 billion in market value. The drop in the value of the Valeant stock resulted in a corresponding loss to the Sequoia Fund equal to nearly 25 percent of its value.

Plan participants who had invested in Sequoia brought suit, alleging that the plan fiduciaries imprudently continued to offer the Fund as a plan investment option despite widespread public disclosures indicating the riskiness of the Valeant investment. A federal trial court dismissed the complaint, finding that the participants alleged no facts plausibly suggesting that the plan had any reason (prior to the decline in Valeant’s stock price) to investigate the prudence of retaining Sequoia as an investment option.

The participants subsequently brought an amended complaint, maintaining that the fiduciaries, pursuant to their duty of prudence, should have removed Sequoia as an investment option because it invested in a growth stock, despite holding itself out as a value investor. According to the participants, a reasonably prudent fiduciary would have carefully monitored the Sequoia Fund to ensure that it adhered to its purported investment strategy as described to investors in general and to plan participants in particular.

The trial court dismissed the amended complaint, agreeing with the plan that the distinction between a “growth” and a “value” investment was immaterial to a determination of whether plan fiduciaries acted prudently in continuing to offer the Sequoia Fund as an investment option. Moreover, the court found that investment in the Sequoia Fund was consistent with reports made by the fiduciaries to plan participants.

Investment consistent with plan documents. On appeal, the participants again stressed that Sequoia’s investment in Valeant was a material shift in its investment strategy from a focus on conservative value stock to risky growth stocks. The shift in investment strategy, the participants averred, was inconsistent with plan documents and, therefore, plan fiduciaries breached their ERISA duties by failing to discover and inform participants of the modified focus. The appeals court, relying on the pleading standard set forth in Fifth Third Bancorp v. Dudenhoeffer (U.S. Sup. Ct (2014) 134 S. Ct 2459) rejected the charge, finding it unsupported by evidence other than the general allegation that the stock was excessively risky in light of its market price.

The court further ruled that Sequoia’s investment and concentration in Valeant was “facially consistent” with the governing plan documents. The plan’s SPD and Sequoia’s 2015 prospectus indicated the Sequoia was non-diversified and further cautioned of the risks associated with the Fund’s investment strategy.

Value and growth terms did not describe investment strategy. In addition, the appeals court agreed with the trial court that, to the extent the plan documents distinguished between value and growth investments, the terms merely described Sequoia’s investments, and did not convey the Fund’s overall investment strategy. To conclude that the plan document’s use of the terms imposed material limitations on Sequoia’s investment strategy, the court stressed, would require the drawing of “unreasonable inferences.”

Leave to amend denied. Finally, the appeals court ruled that the trial court did not err in denying the participants another opportunity to amend their complaint. Any amendment would be futile and would not save the participants’ cause of action, the court advised.

SOURCE: Wilson v. Fidelity Management Trust Co. (CA-9). 

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