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9th Circuit narrows protection for administrators of ERISA-covered plans

The "presumption of prudence" doctrine does not apply if companies don't require investment in corporate stock, court rules

While he was an employee of Amgen Inc., Steve Harris participated in one of the drug maker’s employee pension plans, which invested part of plan participants’ funds in Amgen stock. In 2005, Amgen stock was trading at $86.17, flying high on strong sales of its anemia drug Aranesp, which the company was aggressively marketing.

But over the next three years, Amgen stock plummeted precipitously as allegations surfaced that Amgen had withheld results of tests that showed Aranesp was not as safe as initially thought, and the company had been illegally marketing the drug for off-label uses. Amgen stock lost a third of its value even before the company pled guilty to federal charges that it illegally marketed the drug for off-label uses and agreed to pay $150 million in criminal penalties and a $612 million civil settlement.

Harris and other employees whose retirement funds had been invested in Amgen stock sued on behalf of a proposed class. He alleged that Amgen’s pension plan administrators breached their fiduciary duties to plan participants by allowing the plans to purchase and hold Amgen stock while knowing that the stock price was artificially inflated. Harris and the other plaintiffs claimed that Amgen should be liable for their losses.

Amgen asserted that it should be free from liability under the “presumption of prudence” doctrine, which shields plan administrators from liability for investing employee funds in the employer’s stock if the plan encourages employee stock ownership. The 9th Circuit rejected the defense, and in doing so, has narrowed the defenses available to administrators of plans covered by the Employee Retirement Income Security Act (ERISA).

“The case deals with the tension inherent in ERISA-covered 401(k)s,” says Morrison Foerster Partner Paul Flum. “On one hand, the fiduciary has a duty to diversify and prudently invest, and on the other ERISA encourages employee stock ownership.”

Prudence Presumed

The first court to address that tension was the 3rd Circuit with its 1995 decision in Moench v. Robertson. In that case, the court established a rebuttable presumption—the “Moench presumption” or the “presumption of prudence”—that shields fiduciaries of employee stock ownership plans who invest employees’ funds in company stock. The Moench presumption provides that fiduciaries of employee stock ownership plans are insulated from potential liability for investing in company stock when the employer’s stock price drops. Courts in the 1st, 2nd, 5th, 6th, 7th, 9th and 11th circuits have all adopted some form of the presumption.

The 9th Circuit adopted a particularly strong form of the presumption in the 2010 case Quan v. Computer Sciences Corp. In that case, participants in an employee stock ownership plan alleged that the plan fiduciaries breached their duties when they continued to invest in the employer’s stock after the discovery of errors in the company’s pricing of stock options and accounting deficiencies that led to a large drop in the stock price, resulting in the loss of hundreds of millions of dollars in retirement savings to employees and retirees. The court rejected the claim, finding that fiduciaries’ investment in company stock is not a basis for liability unless it can be shown to be an abuse of discretion.

“In effect, a participant in a plan can’t sue for breaches of fiduciary duty under ERISA unless the plaintiff can show that the plan administrator knew or should have known that the company was on the brink of collapse,” Flum says.

Reversing Course

The 9th Circuit’s decision in Harris v. Amgen explains a limit on the applicability of the presumption of prudence. The court held that the presumption did not apply to the fiduciaries of Amgen’s plan because the plan documents did not “require or encourage” investment in Amgen stock.

The summary plan description for the investments at issue in Harris specified 25 different funds in which participants could invest, only one of which was a company stock fund. The plan also provided that plan participants could invest no more than half of their funds in the company stock fund. The default fund for employees who did not designate what fund to invest in was not the company stock fund, but rather a mutual fund with Fidelity. Based on this, the 9th Circuit found the presumption did not apply.

In light of Harris, fiduciaries of employee stock ownership plans must go back to the plan documents and determine whether the documents explicitly favor investment in company stock. If they don’t, the documents should be amended to clearly do so.

Harris narrows the applicability of the presumption,” says employment defense attorney Eli Kantor. “The court stated that where the plan documents permit investment in employer stock but don’t make it mandatory, the presumption will not apply.”

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