ERISA imposes a duty on fiduciaries to invest plan assets as a prudent person would do by diversifying investments of the plan so to minimize the risk of loss. ERISA sets forth an exemption to this standard for investments in employee stock ownership plans ("ESOP") which are intended for employees to become stakeholders in the success of the company. Under the ERISA exemption, when investing in an ESOP, fiduciaries are not required to diversify their investments outside of company's stock to meet the prudent person standard. In fact, Congress has encouraged fiduciaries to invest solely in the employer's stock. The conflict that has arisen between these two ERISA provisions is that fiduciaries are required to act prudently when determining whether or not to invest ERISA plan assets in the plan participant's employer's stock, although under the exemption there is not an option as to whether to invest in the employer's stock. In order to reconcile these two standards, the Third Circuit established in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), the "Moench presumption." In Moench, the Third Circuit concluded that despite the statutory language that states the primary purpose of ERISA investments is to invest in employer's stock, in limited circumstances, fiduciaries could be liable when it was found they acted imprudently. The Moench presumption presumes that the fiduciary acted consistently with ERISA in its investment in employer's stock, and the participants are required to rebut the presumption by establishing that based on the circumstances the fiduciary abused its discretion by continuing to invest in the employer's stock.
The Ninth Circuit recently had an opportunity to apply the Moench presumption for the first time. In Quan, the Ninth Circuit reviewed a district court's decision granting summary judgment to the fiduciaries in an ERISA investment employer's 401(k) Matched Asset Plan against a class action of participants. The participants alleged that the fiduciaries imprudently invested plan assets in the employer's stock arising from material weaknesses and errors in the stock options and tax accounting practices. Specifically, the participants alleged that the fiduciaries continued to invest in the employer's stock after the discovery of 9,000 errors in pricing of stock options, deficiencies related to accounting for income taxes, a one-day 12% drop in the employer's stock price, and an alleged loss of hundred of millions of dollars in retirement savings to the company's employees and retirees.
In officially adopting the Moench presumption, the Ninth Circuit held that the presumption strikes the appropriate balance between the purpose of employer's stock ownership plans and ERISA's goal of ensuring proper management of the plans. The Ninth Circuit made it clear that participants are not without a remedy under the Moench presumption. Participants may rebut the presumption by establishing that the fiduciary abused its discretion by continuing to invest in employer's stock. Although the Ninth Circuit did not set forth any factors that would assist in determining whether the fiduciary abused its discretion, the Ninth Circuit stated there must be evidence of an abrupt decline in the employer's stock combined with evidence of insider trading or that the company was on the brink of collapse.
By applying this abuse of discretion standard, the Ninth Circuit found that none of these events existed. The company was not self-deteriorating and there was no risk of insider self-dealing. Furthermore, evidence of fiduciaries not making a prudent investment or deliberately ignoring a decline in stock prices was not sufficient to rebut the presumption. The Ninth Circuit recognized that these factors would make the Moench presumption difficult to rebut. Accordingly, the Ninth Circuit upheld the district court's dismissal of the participants' claims of imprudent investments.
This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the U.S. Supreme Court. These events would render the opinion unavailable for use as legal authority.
To read an analysis of the Court's decision, please click here.
This and other case bulletins, as well as other publications of Gordon & Rees LLP, may be found at www.gordonrees.com.