By Pension and Benefits Editorial Staff
Participants in an ESOP maintained by a privately held photography company were not able to establish with the requisite level of particularity that plan fiduciaries breached their duty of prudence by manipulating data to fraudulently inflate the price of the company's stock, according to a federal trial court in Minnesota. In addition, the fact the company's stock value dropped by $840 million, causing individual investors to incur an average loss of $22,000, did not, the court ruled, suggest that the company had been on the verge of collapse and, thus, an imprudent investment that needed to be discontinued.
Evolving market conditions cause stock drop
Lifetouch, a privately-held photography company focused on school pictures, maintained an ESOP, which was primarily invested in the stock of the company. Under the plan, Lifetouch made cash distributions from the ESOP to plan participants upon their retirement. In the event of a distribution, Lifetouch stock was repurchased at fair market value, as determined by plan trustees (company executives appointed by the company's board of directors) on the June 30 immediately preceding the repurchase date. Because Lifetouch was privately held, the trustees appointed and relied on independent appraiser to determine the stock's fair market value.
Beginning in 2015, the company suffered a series of financial setbacks as it attempted to adjust to changes in digital photo technology and the market for its services. In response to the financial struggles, the trustees valued the company's stock at $93 per share on June 30, 2015 and $88 per share on June 30, 2016. However, the value of the stock declined to $56 per share on June 30, 2017.
Eventually, citing the lack of cash necessary to finance an investment in new technology, the company agreed to be acquired by Shutterfly in January 2018 for $825 million. The sale effectively terminated the plan and triggered the distribution of plan proceeds to participants.
Plan participants, noting that the company's stock price declined by over $840 million during the 2015-2018 period, resulting in an average individual loss to the plan's 16,000 participants of $22,000, subsequently brought suit against plan fiduciaries, including individual members of the board of directors and plan trustees. Specifically, the participants charged that the trustees and senior executives breached their duties under ERISA by manipulating data to provide inaccurate and misleading information to the individual appraiser in order to inflate the value of the company's stock in 2015 and 2016. According to the participants, the fiduciaries should have investigated the evident disparity between the 2015 and 2016 valuations and the reality of Lifetouch's financial condition and then removed the imprudent investment. By instead allowing and contributing to the inflated stock price, it was alleged that the fiduciaries effectively allowed select company officers to retire and cash out their stock at an inflated level.
The fiduciaries countered that the participants' complaint did not establish with the required level of particularity that they artificially inflated the company's stock value. Moreover, the company's stock drop in 2017 did not plausibly suggest that the fiduciary overvalued the company's stock in 2015 and 2016. The court agreed and dismissed the participants' claim with prejudice.
Fraud-based allegation must be pled with particularity
Initially, the court explained that, under the Rule 9(b) of the Federal Rules of Civil Procedure, allegations of fraudulent data manipulation must be pled with “particularity.” The participants' claim failed to satisfy the required particularity standard, the court ruled, because it did not: identify the individual executives involved in the charged fraudulent behavior, indicate that the independent appraiser relied on the data provided by the trustees to determine stock price, or establish that the allegedly fraudulent manipulation of certain data (e.g., photo shootings) violated accounting rules or was otherwise improper.
Failure to investigate and remove imprudent investments
The participants further charged that the fiduciaries failed to regularly monitor the prudence of the plan's continued investment in Lifetouch, despite contemporaneous evidence of its declining financial status, Accordingly, the fiduciaries allowed the plan to invest in an excessively risky stock.
In dismissing the claim, the court first found the fiduciaries did regularly monitor the plan's investment and annually determined the fair market value of the company's stock with the opinion of an independent appraiser. More significantly, however, the court concluded that the Lifetouch stock was not so risky as to make the stock an imprudent investment.
According to the court, employer stock is excessively risky when the company is on the “verge of collapse.” In support of its claim that continued investment in Lifetouch was excessively risky, the participants noted that: the company's stock value dropped over 50 percent from 2014 to 2017, the company closed brick and mortar photo studio locations and a production facility, laying of over 200 employees, and many senior executives retired. The court, however, explained that, while such circumstances demonstrated financial hardship, they did not indicate that Lifetouch was on the verge of collapse. In support of its conclusion that Lifetouch was not an imprudent investment, the court further stressed the fact that Lifetouch was sold for over $800 million in 2018.
SOURCE: Vigeant v. Meek (DC MN).
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