• Fiduciary Presumption of Prudence Applied Early in Latest ERISA Stock-Drop Litigation
  • June 11, 2010
  • Law Firm: Quarles Brady LLP - Milwaukee Office
  • As a result of the economic climate, there has been an increase in stock-drop class litigation. Though courts nationwide differ on the various legal issues that arise in stock-drop cases, the United States District Court for the Southern District of New York recently issued a favorable decision for employers and plan fiduciaries in Gearren v. McGraw-Hill Cos., Inc., Nos. 08 Civ. 7890, 09 Civ. 5450, 2010 WL 532315 (S.D.N.Y. Feb. 10, 2010). In Gearren, McGraw-Hill was sued by a class of its former and current employees who alleged that Defendants breached their fiduciary duty under ERISA by:

    1. Offering McGraw-Hill company stock as an option under the company retirement plan at a time when they knew or should have known that the company's stock was likely to sharply decline in value; and

    2. Failing to disclose that information to plan participants.

    This lawsuit was filed after the company’s stock dropped 64.4 percent once it was revealed that McGraw-Hill's Financial Services Division Standard & Poors (“S&P”) gave residential mortgage-backed securities and collateralized debt obligations improperly high investment-grade ratings that concealed how truly risky the investments were. The Court concluded, however, that because Defendants offered company stock in accordance with the 401(k) plan agreement, the fiduciaries were entitled to a presumption of prudence, even at the pleading stage. Though allegations of a dramatic drop in company stock can suffice to state a claim for breach of fiduciary duty, Plaintiffs failed to overcome the presumption because drop in share price alone was insufficient as the stock had since rebounded. The Court also found that Plaintiffs failed to state a claim for breach of duty to disclose because under ERISA, Defendants had no duty to disclose information about the company's financial condition, only to disclose information about plan benefits. Any breach for filing SEC documents allegedly containing misrepresentations about the company's mortgage investment ratings should be remedied under securities law and not under ERISA, even though the fiduciaries incorporated the SEC filings by reference into summary plan descriptions.

    Q&B Key:In light of the resurgence of stock-drop cases, fiduciaries are encouraged to disclose to plan participants that investment choices vary in risk; advise participants to diversify their portfolios; and direct participants to consult with a financial planner or investment counselor before making investment decisions. After all, the fiduciary presumption of prudence does not provide plan fiduciaries with absolute immunity nor does it apply in all cases (e.g., where plans give fiduciaries unfettered discretion over whether to include company stock as an investment option). Moreover, even if applicable, some courts will not entertain a presumption of prudence argument until past the pleadings stage of the lawsuit, after the Plaintiffs have been given an opportunity to obtain evidence in their case.