Continued plan investment in mutual fund with ownership interest in sponsor’s parent company sufficient to sustain claim for fiduciary breach

Plan participants adequately stated a claim for fiduciary breach against their employer for allowing the continued investment of participant contributions in an underperforming investment fund that was heavily invested in the employer’s parent company, according to the U.S. District Court in Nebraska.

Plan mutual fund heavily invested in high risk stock

National Indemnity provided participants in its employee retirement savings plan with a variety of investment options. Included in the investment options was the Sequoia Fund, a non-diversified, long-term growth mutual fund. Among the companies in which Sequoia invested was Berkshire Hathaway, the parent company of National Indemnity.
Sequoia maintained a “value policy” pursuant to which it invested in common stock with the potential for growth. Under the policy, the stocks were to be sold when the company showed any deteriorating fundamentals or had a market value that appeared excessive relative to its expected future earnings.
Despite Sequoia’s value policy, the Fund made a concentrated investment in the high risk stock of Valeant Pharmaceuticals. During the course of the investment, Valeant’s business strategy and its “cash earnings per share” accounting method, which overstated its net income, raised “red flags” among investors. Suspicions peaked when Valeant’s stock price attained a trade value of nearly 98 times its previous year’s earnings, which would seem to trigger caution under Sequoia’s value policy.
Subsequently, Valeant’s share price cratered and the company lost nearly $65 billion in market value. As a consequence, Sequoia, which had continued to increase its concentration in Valeant stock, lost nearly 25 percent of its value.
Plan participants who had sustained major losses as a consequence of investing in Sequoia, filed suit against National Indemnity, alleging fiduciary breach. Specifically, the participants charged the company: (1) failed to prudently manage the plan by offering “shortsighted” investment options, such as the Sequoia Fund; and (2) failed to avoid conflicts of interest by selecting an investment option with a close relationship to its parent company.

Breach of duty of prudence

National Indemnity argued that the employees’ breach of prudence claim needed to be dismissed because the complaint did not allege with specificity how the company’s purportedly inadequate procedures resulted in the claimed injury. The employees’ complaint charged that National Indemnity failed to have any meaningful procedures or processes in place to monitor the prudence of the plan’s investment options, citing the “red flags” surrounding the Sequoia Fund (including violations of the value policy) that a reasonable review process or monitoring system would have revealed.
The court found the employees’ charges sufficient to state a claim for breach of the duty of prudence. The allegations, if substantiated, would support a finding that National Indemnity failed to conduct a regular review of the plan’s investment options, the court reasoned.
Note: The court, in a footnote, explained that the employees’ focus on National Indemnity’s imprudence and failure to monitor distinguished the case from the Fifth Third Bancorp v. Dudenhoeffer (U.S. Sup Ct (2014) 134 S. Ct. 2459). Under Dudenhoeffer, allegations that a fiduciary should have recognized from available public information that the market was over- or undervaluing a publicly traded stock are implausible, absent special circumstances. However, the employees’ complaint against National Indemnity went beyond the circumstances subject to the Dudenhoeffer pleading standards.

Multiple investment options are not a liability shield.

National Indemnity alternatively maintained that any failure to adequately monitor the plan’s funds (thereby allowing investment in a high risk fund) was not sufficient to state a claim for breach of prudence because the plan offered multiple investment options in which participants could invest their contributions. The court, however stressed that the availability of multiple investment options does not absolve a fiduciary of the duty of prudence or insulate it from liability. Thus, the fact that the plan offered 18 investment options was not dispositive of the employees’ breach of prudence claim.

Sufficient evidence to indicate breach of loyalty

The employees’ claim for breach of the duty of loyalty was based on the substantial Sequoia Fund investment in National Indemnity’s parent company. National Indemnity countered that “no plausible inference” of disloyalty could be drawn from Sequoia’s ownership interest in Berkshire Hathaway, maintaining that any breach of loyalty claim needed to allege that the removal of the Fund as an investment option, or placing plan participants’ contributions in an alternative fund, would adversely affect Berkshire Hathaway. In addition, National Indemnity argued that the complaint needed to allege how the Fund’s investment in Berkshire Hathaway impacted the company’s decision to offer the investment option.
In rejecting the company’s argument, the court, noted that, at the motion to dismiss stage, the employees were not required to rebut the possibility of alternative explanations for the company’s maintenance of Sequoia as an investment option. All that the employees needed to do was allege sufficient facts to support an inference that, in offering and then failing to remove the Fund as investment option, National Indemnity failed to act in the sole interest of plan participants and beneficiaries. The allegation that the Sequoia Fund was more expensive and underperformed alternative funds that were not invested in high risk stock, such as Valeant, the court concluded, was sufficient to support the charge that the company’s actions benefitted Berkshire Hathaway more than the participants.

Source: Muri v. National Indemnity Co. (DC NE) 8:17-CV-178, February 26, 2018
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