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Two recent cases emphasized the importance of proper plan language to help protect fiduciaries from liability in employer stock drop cases. In Kirschbaum v. Reliant Energy, No. 06-20157 (5th Cir. 2008) the Fifth Circuit affirmed a lower court decision that the fiduciaries of a retirement plan had no duty to cease purchasing employer stock for the employer stock fund and to liquidate the fund when the employer stock decreased in value. In the case of In re RadioShack ERISA Litigation, 2008 WL 1808329 (N.D. Tex. 2008), a district court reached the same result in a similar case.

In Reliant, corporate earnings were artificially inflated because of suspect energy trading practices. In RadioShack, inventory was overvalued. When adjustments were made to the incorrect financial information, the value of the employer stock dropped fairly substantially.

Suits were filed with respect to the employer stock held by the ERISA covered retirement plans. The suits alleged that the plans' fiduciaries breached their obligations to plan participants by failing to take action when it appeared that the stock was an imprudent investment. It was also alleged that the fiduciaries breached their duties to participants by misrepresenting or failing to inform participants of the employers' true financial condition.

Both courts dismissed the claims, relying in part on the language of the relevant plans. The plans required that employer stock be one of the plans' investment choices. Because of this requirement, the courts applied a presumption that the investment in employer stock was prudent, which presumption was set forth by the Third Circuit in Edgar v. Avaya, 503 F.3d 340 (3d Cir. 2007) and Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995).

The courts noted that since the stock funds were mandated by the terms of the relevant plans, the fiduciaries generally owed no duties to participants as a result of the inclusion of the stock fund in the plans. This was a plan design decision that the fiduciaries were generally required to follow. Such a design decision does not ordinarily involve ERISA's fiduciary duties.

In spite of this general lack of fiduciary duties, the analysis did not end there. The courts did examine other avenues to see if duties might arise from other sources. The two sources in particular were other plan related documents, and a general responsibility on the part of a fiduciary to override any plan document insofar as it violates ERISA.

The primary issue that both courts examined was whether there was any fiduciary duty to override the terms of the specific terms of the plan that required investment in employer securities. The courts both concluded to apply the test first set forth in Moench. Under this test, a fiduciary of an ESOP that was required to invest in employer securities was entitled to a presumption that the investment in the employer securities was prudent. Edgar extended this rule to plans that contain employer stock, but are not ESOPs.

The courts also expounded on what the presumption meant. Reliant stated that the presumption would apply whether the cause of the drop in value was a result of artificial inflation of the stock or mere negative financial circumstances. The court added that the presumption is a “substantial shield,” and that even significant stock fluctuations are generally insufficient to rebut the presumption. The RadioShack court added that a downward fluctuation does not normally present the “dire situation” that would require a fiduciary to risk liability by disobeying clear plan terms.

In terms of the other issues, the Reliant court noted that the misrepresentation claims were in reality securities law claims. Accordingly, they were dismissed from the ERISA case, as there was no showing that the statements were made by a fiduciary. In particular, the S-8 filing for the plan was not incorporated into the SPD for the plan. The RadioShack court concluded that there was no reliance by the participants on the allegedly false misrepresentations of the employer's financial condition.

Finally, the investment policy was also examined by the Reliant court. The court concluded that it was possible that it could be interpreted to give more discretionary authority relative to plan investments. While the outcome of the case did not depend on the investment policy, it should be noted that it was still at least a potential source of fiduciary responsibility.

Insights and Commentary

Reliant and RadioShack are significant decisions for several reasons. They point out that employers that offer employer stock in their plans should seriously consider making the plan terms require such an investment choice. This will result in a significant presumption of prudence, which seems as though it can be overcome only in the most extreme cases.

It is also very important to note that the courts have allowed this defense to be raised at the pleading stage of litigation. This has the obvious advantage of possibly dissuading a case being brought, or more importantly, providing a procedural mechanism to possible end a case very quickly.

Finally, the cases indicate that even when the plan document requires the investment in employer securities, all relevant plan documents must be reviewed. The investment policy in particular will be important. Generalized language in terms of a fiduciary's responsibility for plan investment choices should be examined and possibly clarified with respect to the employer stock held by a plan. Plan fiduciaries must also consider whether to incorporate securities filings into the SPD.

For more information, in the Tax Management Portfolios, see Horahan and Hennessy, 365 T.M., ERISA -- Fiduciary Responsibility and Prohibited Transactions, and in Tax Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions.