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Many 401(k) plans, employee stock ownership plans and other pension plans known as eligible individual account plans (EIAPs) under the federal law that regulates them—the Employee Retirement Income Security Act (ERISA)—provide for the investment of plan assets in the sponsoring employer’s stock. Some EIAPs direct their fiduciaries to invest a portion or all of the sponsor’s plan contributions in the sponsor’s stock. Others direct the fiduciaries to offer the sponsor’s stock among the investment options (typically mutual funds) in which participants can invest their own plan contributions. Often EIAPs do both. ERISA shelters EIAPs and their fiduciaries from the asset-diversification requirements that would otherwise forbid their concentrated holdings of sponsor stock. Pension plans may not ordinarily hold more than 10% of their assets in their sponsor’s stock. But ERISA exempts EIAPs from this prohibition altogether. Fiduciaries must diversify plan investments “so as to minimize the risk of large losses.” But EIAP fiduciaries need not do so when they invest in their plan sponsor’s stock. These exemptions reflect Congress’ decision to encourage employees to become shareholders of their employers, even if ownership limits the diversification of pension holdings. Suits challenge investments in employer stock ERISA’s special solicitude for EIAP investment in employer stock would seemingly make such investments an unlikely target for legal challenge. And in fact they were seldom targeted during the bull market of the 1990s. Yet in just the last few years, with stock prices dropping, the federal courts have seen an unprecedented spate of lawsuits challenging EIAP investment in employer stock. Many large companies have been targeted. Notables include Enron, Kmart, Honeywell, Lucent Technologies, R.J. Reynolds, Sprint, Tyco, Xerox and Worldcom. These suits usually cast a wide net: Most name as defendants not only the plan-designated fiduciaries responsible for investment decisions but also, under one theory or another, the sponsor’s directors and top officers. It is too soon to predict what will become of these suits, and whether they will lead EIAP sponsors to rethink plan investment in employer stock. Few have yet even to proceed to summary judgment, let alone to trial. Several have been dismissed, many have moved on to discovery and a few have settled (including the Enron suits, at a cost of $85 million to Enron’s insurer carriers). Already there are signs, though, that the federal courts do not quite know what to do with these suits. Typically, the principal claim alleged is that the plan fiduciaries violated ERISA’s duty of prudence by continuing to invest plan assets in the sponsor’s stock, rather than diversifying the investment, when circumstances made it objectively imprudent to do so. Plaintiffs in some cases have based the claim of imprudence on the fiduciaries’ alleged knowledge of imminent threats to the sponsor’s viability as a result of serious corporate malfeasance in which the fiduciaries are themselves alleged to have engaged in their nonfiduciary roles as corporate executives. In other cases they have based the claim of imprudence on little more than a drop (sometimes temporary by investment standards) in the price of the sponsor’s stock. The allegations in most cases fall somewhere in between. Fiduciaries have raised two principal defenses: first, that prudence does not require divers- ification because ERISA specifically says it does not; and second, that fiduciaries do not violate ERISA when they invest plan assets in the sponsor’s stock as the plan requires. The first argument has met little success. Courts have pointed out that ERISA exempts EIAP fiduciaries from the duty of prudence when investing in the sponsor’s stock only insofar as prudence per se requires diversification. It does not exempt them from that duty altogether. Prudence may sometimes require fiduciaries to diversify plan holdings in the sponsor’s stock; or, if it does not, it at least requires them to stop investing in the stock. The second defense has given the courts a good deal more trouble, and for this reason: EIAP investment in employer stock is seldom a discretionary fiduciary act. Rather, it is usually the result of a plan provision directing the investment in one form or another. (An EIAP that does not direct the investment would not qualify for ERISA’s diversification exemption in the first place.) ERISA commands plan fiduciaries to obey the terms of the plans they administer. It qualifies this command, however, with the caveat that fiduciaries must do so only “insofar” as their actions comport with the rest of ERISA. Most courts have held that the fiduciary duty of prudence may sometimes require EIAP fiduciaries to disregard plan provisions directing investments in employer stock. The hard question is: When must they follow the plan’s investment directives and when must they disregard them? That question has reached two circuits post-Enron: the 9th U.S. Circuit Court of Appeals in Wright v. Oregon Metallurgical Corp., 360 F.3d 1090 (9th Cir. 2004), and the 1st Circuit in LaLonde v. Textron Inc., 369 F.3d 1 (1st Cir. 2004). Both cases involved appeals of district court orders dismissing the plaintiffs’ complaints. The 9th Circuit affirmed the dismissal; the 1st Circuit reversed. (Both courts affirmed dismissals of claims against the “directed trustees” who carried out the fiduciaries’ instructions.) The 9th Circuit ruled that it need not decide what circumstances, if any, trigger an EIAP fiduciary’s duty to stop investing in the sponsor’s stock because the plaintiffs’ allegations fell well short of stating a claim under any acceptable approach. The plaintiffs alleged that the sponsor’s stock lost 27% of it value following a corporate merger, but they also alleged that the sponsor “remained” profitable throughout. Not even a pronounced decline in the stock, the court held, justified the imposition of liability given the sponsor’s financial condition. The 1st Circuit was considerably less sure as to where it stood than the 9th. In a cursory opinion reversing the district court’s dismissal of the case, the 1st Circuit contented itself with the observation that it would “run a high risk of error were” it to “lay down a hard-and-fast rule . . . based only the statute’s text and history, the sparse pleadings, and the few and discordant judicial decisions discussing the issue we face.” It then concluded that the plaintiffs had pleaded enough to survive the defendants’ motion to dismiss. They had alleged not only that the sponsor’s stock declined by over 70%, but also that the sponsor had “artificially inflated its stock” price by “concealing” corporate malfeasance. Most district courts adopt an intermediate standard A dozen or so district courts have now also addressed the issue post-Enron, most in response to motions to dismiss. All but a few have adopted the “intermediate standard” mapped out by the 3d Circuit a decade ago in a pre-Enron case, Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). Moench holds that EIAP fiduciaries who invest in the sponsor’s stock are entitled to a “presumption” of legality. (The case leaves open the possibility that fiduciaries whose plans leave them no discretion to invest plan assets except in the sponsor’s stock may enjoy immunity from suit beyond a mere presumption.) To rebut the presumption, a plaintiff must show that the fiduciaries “abused their discretion” by continuing to invest in the sponsor’s stock. The Moench approach has yielded mixed results in recent district court decisions. Plaintiffs have, on the whole, fared better than defendants, especially as of late. A few courts have dismissed complaints, usually upon concluding that merely alleging a decline in the price of a viable sponsor’s stock, whatever losses participants may have suffered, will not support a claim. Most courts, though, have taken a more cautious approach. Some have found allegations of declining stock prices sufficient to survive a motion to dismiss when coupled with allegations (however vague) of the fiduciaries’ knowledge of corporate malfeasance-in some instances, without asking what relationship the alleged malfeasance bore to the decline in stock price. Still others have refused to subject allegations to any scrutiny. These courts have held that the Moench presumption does not operate against plaintiffs until the court receives evidence; it does not provide a yardstick to measure the sufficiency of complaint allegations when defendants file motions to dismiss. Many defense counsel are now asking whether the presumption will, in practice, confine fiduciary liability to a narrow range of circumstances if plan fiduciaries must first submit to settlement-inducing discovery before they can even invoke it. That is as far as the law has developed. Whether companies will continue to make employer stock an important component of their EIAPs may well depend on whether the courts give fiduciaries cover from suit when they carry out the sponsor’s investment directives—and, if so, how much cover and at which stage in the litigation process they get it. Answers to these questions are at least several years away. Matthew Lee Wiener is a partner in the litigation department of Dechert, in its Philadelphia office, and a member of its labor and employment group. Brian T. Ortelere is a partner in the labor and employment practice group of Morgan, Lewis & Bockius, in its Philadelphia office. He represented the appellee in Wright v. Oregon Metallurgical Corp., a case discussed in this article. Joseph J. Costello, a partner in that Morgan Lewis office, who heads the firm’s ERISA litigation team, contributed to this article.

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