Moench, the DOL and the Future of Stock Drop Litigation

I had the pleasure yesterday of presenting the September Advisor Success Webinar for BrightScope, in which I discussed the law and practice of fiduciary liability and exposure in detail. Its for subscribers only and not publicly available, but for those of you in the Boston area who are in the insurance industry, I will be touching on some of the same points when I speak as a member of a panel next month at a meeting of the Professional Liability Underwriting Society; more details on that to follow.

For now, though, I thought I would comment on one particular issue that seemed to strike a chord yesterday, which is the current status and likely future direction of stock drop litigation under ERISA. To date, stock drop litigation has not, as a general statement, been terribly successful, as least not from the perspective of those seeking to represent classes of participants; its been pretty darn successful for those representing plan sponsors and fiduciaries. The reason, as many readers already know, is the famous - or infamous, depending on which side of the “v.” you sit on - Moench presumption, which in essence imposes a powerful presumption that allowing substantial amounts of employer stock to be held in a defined contribution plan cannot constitute a breach of fiduciary duty unless the company was in severe financial distress, with severe meaning something more than just a significant decline in the stock price (courts' exact phrasing on this point can vary).

What was of interest in the webinar was the question of whether this presumption will remain effective, or will instead fall by the wayside, which would open the door to more suits and likely as well to greater liability as a result of electing to offer employer stock as an investment option. The answer is that it will fall by the wayside, resulting in an increase of these types of suits and a rebirth of interest in this theory among the class action bar, if the Department of Labor has its way. In an amicus brief filed before the Second Circuit in the case of Gearren v. McGraw-Hill, the Department has outlined its position in this regard, which is, in a nutshell, that the presumption is inconsistent with ERISA’s mandates, and that, with regard to employer stock, the only exception to the generally high duties of care imposed on fiduciaries is the removal of any duties related to diversification of investment options. A Second Circuit ruling adopting this viewpoint will unquestionably expand stock drop exposure and increase lawsuits based on stock drop claims, by allowing the participants to focus on proving as a factual matter through discovery that it was not prudent to include employer stock, rather than being forced to prove that the company was under the level of severe financial distress needed to trump the Moench presumption before ever being able to investigate and prove that thesis. You can find a copy of the Department’s brief on this issue here.