Presumption of prudence did not apply absent plan terms requiring or encouraging investment in employer stock

Plan fiduciaries could not rely on the presumption of prudence with respect to the failure to remove artificially inflated company stock from the plan’s investment menu where the terms of the plan did not require or encourage investment primarily in employer stock, according to the U.S. Court of Appeals in San Francisco (CA-9). Absent the presumption of prudence, the court further determined that the plan participants sufficiently alleged that the fiduciaries violated their duty of care under ERISA.

Marketing practices lead to artificially inflated stock

A biotechnology company maintained two ESOPs that qualified as eligible individual account plans. Plan participants contributed a portion of their pre-tax compensation to individual investment accounts under the plans. Among the available plan investment options was a company common stock fund, consisting entirely of company stock.

During the class period, the value of the company stock declined from a high of $86.17 to a low of $57.33, primarily because of the public disclosure of allegedly illegal marketing practices and test results regarding drugs produced by the company. Plan participants who had invested in the company stock fund filed suit alleging that the plan and company officers breached fiduciary duties under ERISA. Specifically, the participants alleged that the fiduciaries breached their duties by continuing to offer company common stock as an investment option even thought they knew or should have known that the stock was being sold at an artificially inflated price.

A federal trial court, after determining that the company was not subject to suit as a fiduciary, applied the presumption of prudence to dismiss the suit for failure to state a claim. The appeals court reversed and remanded.

Application of presumption of prudence

The main issue on appeal was the application of the presumption of prudence. In Quan v. Computer Sci. Corp, the Ninth Circuit held that a fiduciary is entitled to a presumption that he has been a prudent investor “when plan terms require or encourage the fiduciary to invest primarily in employer stock.” Accordingly, the presumption applied in Quan because no evidence indicated that fiduciaries had discretion to halt purchases of the employer’s common stock or to invest plan assets that were required to be invested in the employer’s stock in other assets.

By contrast, the court determined that the plan at issue in the instant case did not require that a company stock fund be established as an available investment option. Nor did the plan contain language requiring that a company stock fund, once established, be continued as an available investment. The fiduciaries maintained that plan language encouraged them to provide the company stock investment option. However, the court held that, while the plan did specifically reference company stock as a permissible investment, the explicit statement that plan fiduciaries “may” offer company stock to participants, did not constitute encouragement. Relying on the opinion of the 2nd Circuit in Taveras v. UBS AG, the court explained that mere authorization of an investment does not allow for application of the presumption of prudence.

Violation of duty of care

Having determined that the presumption of prudence did not apply, the court turned to whether the plan participants had sufficiently alleged a violation of ERISA’s duty of care. The fiduciaries argued that the decline in the price of the employer stock did not establish the imprudence of the investment. The court, however, did not address the results of the investment, but looked at whether the fiduciaries used appropriate methods to investigate the merits of the transaction. The court then concluded that alleged misrepresentations and omissions and a resulting decline in share price that were determined, in a separate proceeding, to state a claim under SEC Act. Sec. 10(b), were sufficient to state a claim that fiduciaries violated their duties under ERISA.

Company as fiduciary

The company argued that it was not a fiduciary under the plan because it had delegated its discretionary authority to trustees and investment managers. The court noted, however, that, pursuant to plan terms, the trustees and investment managers did not have complete control over investment decisions. The plan, the court stressed, authorized the plan’s fiduciary committee to act on behalf of the company, but did not empower the committee with exclusive authority or preclude the company from acting on its own behalf. Absent a clear delegation of exclusive authority, the court would not remove the company from the suit as a non-fiduciary.

Source: Harris v. Amgen, Inc. (CA-9).

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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