[author, Laura R. Westfall, New York, +1 212 556 2263, firstname.lastname@example.org.]
Defined contribution retirement plans (such as 401(k), profit sharing and employee stock ownership plans) that invest in qualifying employer securities have a special exemption from a requirement to diversify plan investments. Until recently, Federal courts have applied this exception generously for employers and fiduciaries, setting up a presumption in their favor, often referred to as the “Moench presumption.” However, several recent pro-participant decisions by the U.S. Court of Appeals for the Sixth Circuit (which covers Kentucky, Michigan, Ohio and Tennessee) result in a split in how the presumption is applied by the Federal Circuit Courts and sets up the possibility of U.S. Supreme Court review.
Section 404(a)(1)(C) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) generally imposes a duty to diversify pension plan investments so as to minimize the risk of large losses (unless under the circumstances it is clearly prudent not to do so). However, Section 404(a)(2) of ERISA provides an exception from the diversification requirement for “eligible individual account plans” (“EIAPs”), such as 401(k), profit sharing and employee stock ownership plans (“ESOPs”).
In 1995, the U.S. Court of Appeals for the Third Circuit addressed whether fiduciaries of an ESOP violated ERISA’s prudence requirement by continuing to invest solely in employer stock during a period when the employer deteriorated financially and its stock declined in value. Moench v. Robertson. The terms of the ESOP made clear that the ESOP was designed to invest “primarily” in such securities. The Third Circuit held that an ESOP's fiduciary is presumed to have acted consistently with ERISA where the fiduciary invests in employer stock in accordance with the ESOP's terms. This presumption is known as the Moench presumption. The court held that a plaintiff in a suit for breach of fiduciary duty may overcome this presumption by showing unforeseen circumstances that would defeat the purpose of offering employer stock in the ESOP. The Moench case dealt specifically with ESOPs; however, Federal courts have since extended the Moench presumption to cases involving other EIAPs, including 401(k) plans that offer employer stock as an investment option.
Employers who offer EIAPs that permit investment in employer stock often are subjected to lawsuits when there is a substantial decline in the employer's stock price (often referred to as “stock drop” cases). One of the key bases for dismissal of these “stock drop” cases at the pre-trial stage is the Moench presumption of prudence, which was at issue in several cases out of the U.S Court of Appeals for the Sixth Circuit. The basic Moench presumption first detailed in the Third Circuit decision has since been adopted by the Second Circuit, the Third Circuit, the Fifth Circuit, the Sixth Circuit, the Ninth Circuit, and most recently, by the Eleventh Circuit (in Lanfear v. Home Depot).
The Sixth Circuit originally embraced the Moench presumption as established by the Third Circuit in 1995, Kuper v. Iovenko, but two 2012 cases appear to pit the Sixth Circuit against other Circuits as to how the presumption is applied.
In Pfeil v. State Street Bank & Trust Co., the Sixth Circuit held that in order to rebut the Moench presumption, plaintiffs must prove that a prudent fiduciary acting under similar circumstances would have made a different investment decision, rather than demonstrate other “unique circumstances” or prove the employer’s impending collapse or similar dire straits. Also in contrast to the holding in other Circuit Courts that have adopted the Moench presumption, the Sixth Circuit held that the Moench presumption did not apply at the pleadings (motion to dismiss) stage of a lawsuit.
In Griffin v. Flagstar Bancorp, the District Court had dismissed participants' lawsuit alleging that Flagstar Bancorp, Inc. (“Flagstar”) and certain other fiduciaries had breached their fiduciary duties by offering Flagstar stock as an investment option during a period when Flagstar's financial condition deteriorated and the price of its stock declined significantly. The District Court applied the Moench presumption and dismissed the lawsuit. On appeal, the Sixth Circuit found that participants had a plausible claim that prudent fiduciaries would have stopped offering employer stock and sent the case back to the district court for further proceedings.
State of the Moench Presumption After Flagstar in Various Circuits
The U.S. Circuit Courts that have embraced the Moench presumption apply it differently. The Second, Fifth, Ninth, and Eleventh Circuits require the plaintiffs to show some proof of “dire circumstances” or the “impending collapse” of the employer to rebut the presumption. In the Sixth Circuit, however, plaintiffs simply must prove that a prudent fiduciary acting under similar circumstances would have made a different investment decision. Further, in the Sixth Circuit only, the Moench presumption does not apply at the pleadings (motion to dismiss) stage of a lawsuit.
Employers headquartered or doing business in the Sixth Circuit (Kentucky, Michigan, Ohio and Tennessee) should be aware that Federal courts in that circuit will apply the Moench presumption differently. As a result, employers and fiduciaries defending a “stock drop” case brought in the Sixth Circuit will likely be forced to litigate the matter through discovery and plaintiffs will have a lower standard to overcome the Moench presumption later in the lawsuit.