Insider information could not be used to rebut presumption of prudence

Plan fiduciaries were not required to use material, nonpublic information regarding a company’s financial situation in determining whether to continue an investment in company stock, according to the U.S. Court of Appeals in New York City (CA-2). The public information available to the fiduciaries, the court further ruled, was insufficient to rebut the applicable presumption of prudence.

Company stock fund

Participants in a retirement savings plan maintained by an investment bank were allowed to allocate up to 20% of their plan contributions to an ESOP that was, pursuant to plan terms, to be exclusively invested in the stock of the bank. However, the Benefits Committee responsible for administering the plan, was empowered to “eliminate or curtail” investments in the stock of the bank to the extent the Committee determined such action to be required to comply with ERISA’s fiduciary duty rules. Despite this authority, the Benefits Committee maintained the company stock fund as an investment option through the Spring and Summer of 2008, when the bank’s stock price significantly declined, dropping to less than $4 per share on the last trading day before the company declared bankruptcy on September 15, 2008.

Plan participants brought suit in a federal trial court, alleging that the Benefits Committee breached its fiduciary duty under ERISA to prudently manage the plan by failing to curtail or eliminate the participants’ investment in company stock during the class period. According to the participants, a reasonable investigation by the Committee would have revealed information indicating the company’s precarious financial condition.

The trial court dismissed the complaint, ruling that the participants failed to allege sufficient facts to show that members of the Benefits Committee knew or should have known that continued investment in the stock of the company was improvident. The Second Circuit affirmed.

Presumption of prudence

On appeal, the Second Circuit initially explained that, under the applicable presumption of prudence, the fiduciaries would be presumed to have acted prudently absent the pleading of facts sufficient to show that fiduciaries knew or should have known that the employer was in the “sort of dire situation” that required the overriding of plan terms in order to limit participants’ investment in employer stock. The participants, however, charged that the power of the Benefits Committee to eliminate or curtail investment in the company stock fund negated or weakened application of the presumption.

The court found the participants’ argument unpersuasive, noting that the Committee’s authority to eliminate or curtail investment in the company’s stock was conditioned on a finding that such action was required in order to comply with ERISA’s fiduciary rules. The plan terms, the court explained, merely explicitly stated the generally applicable rule, pursuant to which fiduciaries are required to follow plan terms only to the extent they are consistent with ERISA. The plan language, the court stressed did not empower the Benefits Committee with the added discretion to divest the plan of company stock. Material, nonpublic information may not establish imprudence.

Having established the applicability of the presumption of prudence, the court addressed whether the Benefits Committee knew or should have known that the company stock was an imprudent investment based on material nonpublic information. The participants maintained that the Committee had a duty to investigate whether the company was in a dire situation. A reasonable investigation, the participants contended, would have revealed material, nonpublic information (e.g., the use of improper accounting methods and private conversations with the bank’s CEO and the federal government about selling the company or obtaining a capital infusion) sufficient to confirm that the company was on the verge of collapse.

The Second Circuit, however, joined the 5th, 7th, and 9th Circuits in ruling that fiduciaries are under no affirmative obligation to seek out or act upon inside information pertaining to plan investments in the course of fulfilling their duties under ERISA. The prudent man, the court stressed, does not commit insider trading.

The court next concluded that the participants failed to rebut the presumption of prudence because they did not allege facts sufficient to show that the Benefits Committee knew or should have known that the company was in a dire situation based on information that was publicly available during the class period. The forced sale of another investment bank and the collective information known (or knowable) to the Committee did not counter the presumption that the fiduciaries acted prudently.

Finally, the court dismissed the participants’ argument that the alleged facts should have “incited” the fiduciaries to conduct an investigation that would have revealed the imprudence of maintaining the investigation. According to the court, any reasonable investigation undertaken by the Committee would not have revealed additional facts sufficient to break the terms of the plans because the Committee could not have based prudent investment choices on the material, nonpublic information that allegedly indicated that the company was failing. The public information available to the fiduciaries (e.g., market fluctuations) did not indicate that the company was in a dire situation and, thus, was insufficient to overcome the presumption of prudence.

Source: In re Lehman Bros. ERISA Litigation (CA-2).

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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