D&O Liability - Fifth Circuit Affirms Dismissal of ERISA Stock Drop Lawsuit
On April 25, 2008, the United States Court of Appeals for the Fifth Circuit affirmed the district court’s summary judgment for the defendants in the ERISA lawsuit captioned Brad Kirschbaum v. Reliant Energy, Inc., et al.,
No. 06-20157 (5th Cir.). The Court held that (i) recovery on the diversification claim was precluded because ERISA exempts Eligible Individual Account Plans (“EIAP”) from the duty to diversify; (ii) plaintiff failed
to rebut the Moench presumption of prudence, which “cannot be lightly overcome;” and (iii) plaintiff failed to demonstrate that any of the alleged misrepresentations were made in a fiduciary capacity.
Plaintiff brought ERISA claims on behalf of himself and other investors in the Reliant Energy Saving Plan (the “Plan”) after the disclosure that some Reliant Energy, Inc. (“REI”) employees had engaged
in “round-trip” sham energy trades. The disclosure of the round-trip trading allegedly caused the value of REI stock to decline by about forty percent within the span of one week. Plaintiff’s Fourth Amended Complaint
stated three counts. In Count I, plaintiff alleged that the REI defendants should have diversified the Plan’s holdings because the Plan held too much REI common stock in light of the company’s transformation into a
speculative energy trading operation – an inherently risky investment. In Count II, plaintiff alleged that the REI defendants knew or should have known that REI stock was not a prudent investment based on the nonpublic information
available to the REI defendants regarding the round-trip trading activity. In Count III, plaintiff alleged that the REI defendants breached their fiduciary duties by negligently misrepresenting REI’s financial condition to
Plan participants.
The United States District Court for the Southern District of Texas had reasoned, with respect to Counts I and II, that the REI defendants could be fiduciaries only to the extent they exercised discretionary control over the Plan.
The district court went on to hold that, because the Plan afforded the REI defendants no discretion to terminate the fund or halt investments therein, the REI defendants had no fiduciary duty to do so. With respect to Count III,
the district court held that the alleged misrepresentations were made by REI in its corporate capacity – not its fiduciary capacity – and, therefore, were not actionable under ERISA.
On appeal, the Fifth Circuit affirmed summary judgment on all three counts. First, the Court found that Count I – which did not claim that REI stock was an imprudent investment per se but, rather, was too risky to
be held in large quantities – “clearly states a failure to diversify.” Because the Plan was an EIAP, which ERISA exempts from the duty to diversify with regard to the purchase or holding of company stock, recovery
under Count I was precluded.
Second, with respect to Count II, the Court noted that the Plan mandated that almost all of its investments be in REI stock. Accordingly, “neither REI nor the Benefits Committee were given express discretion to halt the purchase
of REI common stock or invest Fund assets in other holdings.” The Court held that the REI defendants were under no fiduciary duties other than to follow the terms of the Plan. The Court expressly rejected plaintiff’s
contention that the REI defendants had an obligation to override the mandatory investment provisions of the Plan. In this regard, the Court adopted the abuse of discretion standard set forth in Moench v. Robertson, 62 F.3d
553, 571 (3d Cir. 1995). The Court cited Moench for its conclusion that “a fiduciary of this sort of plan is entitled to a presumption that his decision to invest in the employer’s securities was prudent.”
The Court held that plaintiff had failed to rebut the Moench presumption of prudence, noting that “[t]here is no indication that REI’s viability as a going concern was ever threatened, nor that REI’s
stock was in danger of becoming essentially worthless.” The Court went on to clarify:
The presumption…is a substantial shield….One cannot say that whenever plan fiduciaries are aware of circumstances that may impair the value of company stock, they have a fiduciary duty to depart from ESOP or EIAP plan provisions. Instead, there ought to be persuasive and analytically rigorous facts demonstrating that reasonable fiduciaries would have considered themselves bound to divest.
Finally, with respect to Count III, the Court agreed with the district court that plaintiff had failed to allege that any of the alleged misrepresentations was made in anything other than a corporate capacity. The Court pointed out that the alleged misrepresentations were made in securities filings, which REI was required to file as a part of its corporate duties under the securities laws.