ERISA-Seventh Circuit Rules That Investment In Employer Stock Resulted In A Breach of Fiduciary Duty Under ERISA And Liability For Damages; Still No Formal Adoption Of The Moench Presumption

In Peabody v. Davis, Nos. 09-3428, 09-3452, 09-3497, 10-1851, 10-2079, 10-2091 (7th Cir. 2011), the defendants were the Rock Island Corporation, its subsidiary, its retirement savings plan which is subject to ERISA (the “Plan”), and the Plan’s trustees, Andrew Davis and Robyn Kole (together, the “Defendants”). The district court ruled, among other matters, that the Defendants had breached their fiduciary duty under ERISA with respect to the Plan. The Defendants appealed. The Seventh Circuit Court affirmed the district court’s ruling of breach, and remanded the case to compute the amount of the damages.

The plaintiff, Jonathan Peabody (“Peabody”), was an employee of Rock Island Corporation (“RIC”). His account under the Plan had been invested in 835 shares of RIC stock (the “Shares”). When Peabody terminated his employment with RIC, RIC agreed to purchase all of the Shares. However, RIC’s obligation to pay for the Shares was embodied in a loan from RIC to Peabody in the amount $292,250 plus interest. Later, RIC told Peabody that it could not make any payments under the loan, and went out of business. Peabody then filed suit against the Defendants, claiming (among other things) breach of fiduciary duty under ERISA. This claim took the form of an action on behalf of the Plan against the Defendants, as ERISA fiduciaries, under section 502(a)(2) of ERISA.

In analyzing the case, the Court said that the remedy in an action on a plan’s behalf for breach of fiduciary duty is for the fiduciary to “make good” the loss to the plan, in accordance with section 409 of ERISA. The fiduciaries have a duty of prudence with respect to the Plan’s investment in employer stock under section 404(a)(1)(B) of ERISA. This obtains even though the Plan is an eligible individual account plan, and, under section 404(a)(2) of ERISA, the Plan is therefore exempt from ERISA’s diversification requirement (in section 404(a)(1)(C)) which would otherwise apply to the holding of employer stock.

The Court found that Defendants Davis and Kole breached their duty of prudence. The Plan did not require or encourage investment in RIC stock, so there was no barrier to divesting the Shares. A prudent investor would not have remained as heavily invested in RIC’s stock as did Peabody’s account under the Plan, given a sharp decline in profitability of RIC’s business over the applicable period. In general, a widely-known and permanent change in the regulatory environment had undermined RIC’s core business model, and consequently the Shares became an imprudent investment. The Plan did not comply with section 404(c) of ERISA, so that provision’s safe harbor for fiduciaries is not available here. The breach of duty obtains even though Peabody initially agreed to the investment of his Plan account in the Shares. The Court noted that the loan to Peabody constituted a prohibited transaction under section 406(a)(1)(B) of ERISA. However, neither Peabody nor the Plan suffered any loss as a result of this loan, so no separate damages result from the loan.

The Court continued by saying that damages resulted due to the breach of fiduciary duty. The Court remanded the case back to the district court to compute the amount of the damages. The Court provided some guidelines for this calculation, such as the assumptions that the divestment of the Shares had begun at the time that RIC’s profitability began to decline sharply, and that the divestment had been carried out in an orderly way.

On the Moench Presumption: The Court referred to, but did not formally adopt for the Seventh Circuit, the Moench presumption. This presumption was formulated by the Third Circuit in Moench v. Robertson, 62 F. 3d 553 (3rd Cir. 1995). The presumption applies when a defined contribution retirement plan has invested in employer stock. In such cases, the presumption is that the plan’s fiduciary has met the ERISA requirement of prudence when it has allowed the initial and continuing investment in employer stock by the plan. The Moench presumption has been adopted by the Fifth, Sixth and Ninth Circuits.

In this case, the Seventh Circuit said that Defendants Davis and Kole had breached their duty of prudence, even if the Court was using the Moench presumption. Thus, the Court did not need to adopt the presumption at this time. Practitioners are waiting to see if the Second Circuit will formally adopt the Moench presumption, particularly since it has been used by district courts in that circuit.

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