The Second Circuit Curbs ERISA “Stock Drop” Class Actions: Following Other Circuits, the Second Circuit Adopts the Moench Presumption of Prudence, Which Limits Liability of ERISA Fiduciaries for Losses Suffered in Employer-Sponsored Retirement Plans

Sullivan & Cromwell LLP - October 25, 2011

In the wake of the financial crisis, the plaintiffs’ bar has increasingly brought so-called ERISA “stock drop” actions against issuers, particularly financial institutions, that suffered large stock losses. Often brought as “tag alongs” to putative shareholder securities class actions, these ERISA cases allege that defendants—usually, the company, its officers and various ERISA plan investment committees—breached their fiduciary duties by giving company employees the option to invest in the company’s stock through employer-sponsored 401(k) plans. Generally, plaintiffs allege that these defendants “knew or should have known” that the company would face financial difficulty, and, therefore, that ERISA’s fiduciary duty of prudence required defendants to (i) remove company stock from among plan participants’ investment options, and (ii) divest participants’ existing holdings in company stock (“Prudence Claim”). Plaintiffs also often allege that defendants breached their fiduciary duties by failing to provide “complete and accurate information” about the company’s financial condition to plan participants (“Disclosure Claim”).

Last week, in a closely watched pair of rulings, the United States Court of Appeals for the Second Circuit affirmed two lower court decisions in Citigroup ERISA Litigation and Gearren v. McGraw-Hill (October 19, 2011), thereby limiting the ability of the plaintiffs’ bar to bring ERISA “stock drop” actions. Specifically, the Second Circuit adopted the “presumption of prudence” first propounded in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), and since adopted by the Fifth, Sixth and Ninth Circuits. Applying this presumption, the Second Circuit held that a Prudence Claim can survive a motion to dismiss only if the plaintiff pleads that the company faced a “dire” financial situation; otherwise, the fiduciaries generally cannot be said to have abused their discretion in retaining the company stock investment option. The Second Circuit also effectively foreclosed any future Disclosure Claims, holding that ERISA’s “duty of loyalty” does not include “a duty to provide participants with nonpublic information pertaining to specific investment options.”