401(k) Plan Fiduciaries Did Not Breach Fiduciary Duties By Allowing Participants to Invest in Company Stock During the Company's Financial Decline: Fifth Circuit

Practical Law Legal Update w-013-1323 (Approx. 7 pages)

401(k) Plan Fiduciaries Did Not Breach Fiduciary Duties By Allowing Participants to Invest in Company Stock During the Company's Financial Decline: Fifth Circuit

by Practical Law Employee Benefits & Executive Compensation

Background

The plaintiffs in Singh represent a putative class of participants in RadioShack Corporation's 401(k) Plan (the plan) who held RadioShack stock in their 401(k) accounts after November 30, 2011.

The plan allowed participants to invest in over 20 investment options, including an ESOP that allowed participants to invest savings in RadioShack stock, which was held in the RadioShack Stock Fund (the fund). The plan's documents required that RadioShack stock be an investment option. The plan was administered by the plan's administrative committee (committee).

During the class period, RadioShack's stock price dropped from $11.48 per share to under $1 while the company experienced significant financial difficulties for several consecutive years despite implementing a business revitalization plan under a new chief executive officer (CEO).

In June 2014, the committee decided to send plan participants a targeted diversification letter. In the committee's eight previous meetings, it had reviewed RadioShack's stock performance but had not expressly considered limiting or removing it from the plan.

In July 2014, the committee met to determine whether the plan should continue offering RadioShack stock as an investment in light of a recent rating downgrade. The committee considered several options, including freezing or capping future contributions, removing the stock from the plan, and educating participants, and decided to freeze future plan participant investment in RadioShack stock "as soon as administratively feasible," which was September 15, 2014. The committee did not divest the stock because it thought doing so would force participants to sell their shares at an all-time low and would send a negative message about the company's prospects.

In February 2015, RadioShack filed for bankruptcy. Its stock continued to trade over the counter, but RadioShack warned that equity holders would likely not recover in bankruptcy and that it believed company stock "ha[d] no value." RadioShack's stock was cancelled in October 2015 in bankruptcy proceedings.

The plaintiffs then filed a class action lawsuit against:

The members of the committee, the board of directors, and the plan trustees.
The administrative committee and trustees of the RadioShack Puerto Rico 1165(e) Plan.

The US District Court for the Northern District of Texas consolidated the cases. The plaintiffs settled with the RadioShack Plan trustees. The district court granted the defendants' motion to dismiss the first complaint but granted the plaintiffs leave to file a second amended complaint.

The plaintiffs claimed that:

The committee breached the duty of prudence by failing to respond to public information about RadioShack's financial decline or insider information suggesting RadioShack's stock was overvalued.
All of the defendants violated the duty of loyalty (some by owning RadioShack stock and others by not owning it).
The director defendants failed to monitor the committee adequately.

Plaintiffs asserted each of these claims in relation to both the plan and the Puerto Rico plan.

The district court held that the second amended complaint failed to state a cause of action and dismissed all of the plaintiffs' claims and entered final judgment. The plaintiffs appealed to the US Court of Appeals for the Fifth Circuit.

Outcome

The Fifth Circuit affirmed the judgment of the district court. The Fifth Circuit held that the plaintiffs failed to overcome the defendants' motion to dismiss because:

The complaint did not plausibly state any fiduciary claims with respect to the plan.
The plaintiffs did not have standing to bring claims regarding the Puerto Rico plan.

Duty of Prudence Claim

Public Information

The plaintiffs claimed that the committee breached the duty of prudence by failing to respond to publicly available information that:

Showed RadioShack's financial decline.
Suggested that RadioShack stock was too risky to include in a retirement plan.

The plaintiffs argued that the US Supreme Court's decision in Dudenhoeffer does not apply to public-information claims that a stock was excessively risky, and that even if it applies, RadioShack's declining economic condition gave rise to special circumstances that entitled the plaintiffs to relief.

In Dudenhoeffer, the Supreme Court held that all fiduciaries of ERISA plans, including ESOP fiduciaries, are subject to the prudent person standard under ERISA Section 404(a) (29 U.S.C. 1104(a)), and no special presumption of prudence (that is, no Moench presumption) applies to ESOP fiduciaries (see Legal Update, Supreme Court Rejects Moench Presumption of Prudence). Under Dudenhoeffer, in the public company context, allegations that an ERISA fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, absent special circumstances.

The plaintiffs tried to distinguish Dudenhoeffer by arguing that it applies only to allegations that public information showed that a stock was overvalued, and not to the plaintiffs' claim that the RadioShack stock was excessively risky. The Fifth Circuit rejected this argument, stating that the distinction between claims that stock is overvalued and claims that stock is excessively risky is "illusory" because in an efficient market, market price accounts for risk.

The Fifth Circuit concluded that the plaintiffs' public information claims failed under the standard announced in Dudenhoeffer. The RadioShack plan fiduciaries did not breach the duty of prudence by relying on market price as a fair indicator of the value of RadioShack stock. The market price accounted for the publicly-available negative information about RadioShack's financial prospects, and therefore the public-information claims were implausible under Dudenhoeffer.

However, the plaintiffs argued that five potential special circumstances made the committee defendants' reliance on the market price of the stock imprudent:

The defendants withheld material information from the market, skewing the stock price.
RadioShack stated in March 2015 that its stock had no value.
Bond market indicators suggested RadioShack would default.
RadioShack was burdened with debt.
The defendants failed to investigate the continued prudence of investing Plan assets in RadioShack stock. In doing so, the plaintiffs argued, the defendants failed to meet their continuing duty to monitor the prudence of plan investments under Tibble v. Edison Int'l (135 S.Ct. 1823 (2015)), which made the stock price unreliable (see Legal Update, Supreme Court Holds that ERISA's Six-Year Statute of Limitations Triggered by Continuing Duty to Monitor).

The Supreme Court in Dudenhoeffer wrote that special circumstances affect the reliability of the market price as an unbiased assessment of the stock's value in light of all public information. (However, the Court has not yet defined special circumstances.) The Fifth Circuit held that the five factors identified by the plaintiffs do not qualify as special circumstances undermining the market price as a measure of RadioShack's value. Specifically, the Fifth Circuit held that:

The plaintiffs' allegations that the defendants withheld material information from the market are not special circumstances. Under Dudenhoeffer, the courts analyze insider-information claims under a separate standard.
RadioShack's March 2015 press release provided the market with new information. It did not make the market price of the stock unreliable.
Both the bond market indicators indicating an imminent default and RadioShack's debt levels were public information, which the stock market presumably incorporated into the price of RadioShack stock.
The purported failure to monitor plan investments cannot be a special circumstance under Dudenhoeffer. Dudenhoeffer held that plan fiduciaries may presumptively rely on market price as a measure of value unless a special circumstance casts doubt on the reliability of the price. The plaintiffs did not plausibly allege that the purported lack of investigation had any effect on the reliability of the market price, so it cannot be a special circumstance.

Inside information

The plaintiffs also alleged that the defendants violated the duty of prudence because the defendants had inside information that RadioShack would fail but made positive public statements about the company's future.

The Fifth Circuit affirmed the dismissal of this claim, as well, because all of the allegedly inside information about the company was available to the public. The court explained that it would have dismissed the non-public information claims even if the plaintiffs actually had insider information because the plaintiffs were unable to show that no prudent fiduciary could believe that the alternatives proposed in the complaint would do more harm than good. Therefore, their non-public information claims could not satisfy Dudenhoeffer.

Duty of Loyalty Claim

The Fifth Circuit upheld the dismissal of both duty of loyalty claims made by the plaintiffs.

First, the plaintiffs claimed that the committee defendants violated their duty of loyalty by declining to invest in RadioShack stock. The Fifth Circuit rejected this claim because fiduciaries need not personally invest in any particular asset in order to fulfill their duties.

Second, the plaintiffs claimed that the director defendants violated their duty of loyalty because certain executives and directors received bonuses in the form of RadioShack stock and options, and in doing so they artificially inflated the stock price to preserve their personal wealth. Specifically, the plaintiffs claimed that the defendants were concerned that freezing plan investment in RadioShack stock would send negative signals to the market and cause the stock price to decrease. The Fifth Circuit rejected this claim because:

The plaintiffs failed to point to any fact suggesting a conflict of interest other than the defendants' stock ownership.
The complaint did not allege facts that would give rise to a plausible inference that the defendants' concern about the stock price was self-serving.
The defendants' actions were equally consistent with protecting the plan's current holdings of RadioShack stock.
It would not adopt a rule that would make mere ownership of stock synonymous with a plausible claim of fiduciary disloyalty.

Other Claims

The Fifth Circuit affirmed the dismissal of the plaintiffs' duty to monitor claims against the directors of Radio Shack. The Fifth Circuit has never recognized a theory of ERISA fiduciary liability that would hold corporate directors personally liable for failing to monitor fiduciaries they have appointed.

Furthermore, the Fifth Circuit affirmed the dismissal of the plaintiffs' claims against the Puerto Rico plan. The named plaintiffs did not participate in the plan and did not suffer injury related to that plan. Therefore, they lacked standing to bring claims on behalf of participants in the Puerto Rico plan.

Practical Implications

Sponsors and administrators of 401(k) plans operating in the Fifth Circuit should be mindful of the Singh decision. It is instructive on the issue of identifying special circumstances that could affect the reliability of the market price as an unbiased assessment of the stock's value in light of all public information; as the Fifth Circuit explained, plaintiffs cannot evade Dudenhoeffer's general implausibility rule by disguising claims based on public information as "special circumstances."

To learn more about Dudenhoeffer, see these resources:

End of Document

Resource ID w-013-1323

Published on 13-Feb-2018

Resource Type Legal update: archive

Jurisdiction

United States