By Pension and Benefits Editorial Staff
Plan fiduciaries were not required to force plan participants to divest from a single-employer stock fund following a corporate spin-off, according to U.S. Court of Appeals in New Orleans (CA-5). ERISA, the court explained, does not prohibit individual account plans from offering single-employer stock funds, where participants have been provided diversified fund options and cautioned against the risks of not diversifying account holdings.
Single-stock fund after corporate spin-off. Phillips 66 was spun-off from its parent company, ConocoPhillips (CP), in 2012, resulting in nearly 12,000 former CP employees becoming employees of the new, separate and independent company. In connection with the spinoff, Phillips, in May 2012, established an individual account defined contribution plan for its employees. Assets of the former CP employees that were held in participant accounts under the CP plan were transferred to the Phillips plan. Among the transferred assets were shares of CP stock that were originally contributed by CP to an ESOP and held in CP Funds, which were invested exclusively in CP stock. After the spinoff, the shares became part of the CP Funds in the Phillips plan.
The CP Funds were closed to new investment after the spinoff. In addition, participants in the Phillips plan could “exchange” out of the Funds at any time. However, the plan had more than 25 percent of its assets invested in the CP Funds at the beginning of the class period.
Citing the heavy investment in CP stock, participants in the Phillips plan brought suit under ERISA, alleging that the plan fiduciaries, in retaining the CP Funds and failing to properly diversify the plan’s investment options, breached the duties of diversification and prudence, resulting in tens of millions of dollars of losses. The fiduciaries maintained that they were exempt from ERISA’s diversification requirements because the CP shares retained their character as employer securities following the spinoff. Moreover, the fiduciaries argued that the participants failed to plead facts sufficient to state a claim for breach of the duty of prudence or the duty to diversify plan investments.
A federal trial court in Texas ruled that, while the stock no longer was exempt from ERISA’s diversification requirements as qualified as employer securities, the participants failed to alleged special circumstances that would have undermined the fiduciaries’ reliance on market price in evaluating the prudence of the investment. The Fifth Circuit affirmed the result but focused less on the application of the Dudenhoeffer pleading standard than alleged inherent imprudence of a plan retaining a single-stock fund.
CP shares did not remain employer securities. The appeals court agreed with the trial court’s reasoning that the CP Funds would be qualifying employer stock only if they were issued by the acting employer, Phillips. As the stock was not issued by Phillips, the CP Funds were not employer securities after the spin-off and were no longer exempt from the diversification conditions of ERISA Sec. 404(a)(1).
Fiduciaries provided sufficient investment options. In addressing the failure to diversify claim, the appeals court explained that DC plan fiduciaries need only provide investment options that enable participants to create diversified portfolios. Fiduciaries, the court stressed, are not obligated to ensure that the participants actually diversify their portfolios. As the participants did not allege that the fiduciaries failed to offer sufficient investment options or to warn them of the risk of a concentrated portfolio, their claim under ERISA Sec. 404(a)(1)(C) for failure to diversify could not stand.
Fiduciaries not obligated to force plan participants to divest from single-stock fund. The central issue in the case, was not diversification, but the prudence of the fiduciaries’ decision not to force the divestiture of the CP stock. The participants charged that single-stock funds are inherently imprudent because they expose investors to extreme volatility and risk. Accordingly, they argued that the fiduciary duty of prudence requires that each individual fund in a plan to be diversified.
The appeals court, initially, affirmed the trial court’s ruling that Dudenhoeffer effectively foreclosed the claim that the fiduciaries should have known from publicly available information that the stock market underestimated the risk of holding ConocoPhillips stock. However, the court further noted that Dudenhoeffer, which involved employer securities, and are exempt from the duty of prudence to the extent that it requires diversification, does not address the participant’s second argument, that the holding a single-stock fund is imprudent because of the risk inherent in failing to diversify.
Although the participants’ duty of prudence claim was not foreclosed by Dudenhoeffer, the court proceeded to find that the retention of the stock did not constitute a breach of fiduciary duty. First, the court stressed that ERISA does not prohibit individual account plans from offering single-stock funds. Fiduciaries are only required to include in each participant benefit statement an explanation of the importance of a well-balanced and diversified investment portfolio, including a caution of the risks attendant holding more than 20 percent of a portfolio in the security of one entity.
While conceding that the participants had plausibly alleged that the CP Funds, by its resulting concentration of investment, became an imprudent investment following the spinoff, the court stressed that the fiduciaries were not obligated to force plan participants to divest from the funds. The plan participants had the freedom and responsibility for investing their retirement assets. By providing plan participants with warnings against holding more than 20 percent of their portfolios in the security of one entity, highlighting the risks of holding a single-stock fund, and by closing the CP Funds to new investments immediately after the spin-off, the court ruled, the fiduciaries satisfied their obligation to ensure that participants were not offered imprudent investment options.
Source: Schweitzer v. The Investment Committee of the Phillips 66 Savings Plan (CA-5).
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