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CCH® PENSION — 07/02/12

Presumption of prudence shields fiduciaries from liability for continued investment in employer stock

The U.S. Court of Appeals in Atlanta (CA-11) has adopted the presumption of prudence standard for determining fiduciary liability attendant to continued investment in employer stock. However, the court also noted that rebutting the presumption does not require fiduciary knowledge of the company's imminent financial collapse.

Home Depot structured its plan as both an eligible individual account plan (EIAP) and an ESOP. The plan requires that one of the available investment funds be a Company Stock Fund that would be invested "primarily" in Home Depot Stock. The plan's SPD, however, incident to a discussion of investment risk, includes a graph and cautionary language that pointedly informs participants that the company stock fund is the riskiest of the plan's investment options.

Plan participants alleged that the company stock became an imprudent investment when, unknown to the public, company officials engaged in misconduct (return-to-vendor chargebacks) that inflated the company's earnings, profit margins, and stock price. The inflation of the company's earnings through the return-to-vendor chargebacks also led it to make inaccurate statements and material omissions in Form 10-Q and Form 10-K filings with the SEC. The filings were subsequently incorporated into the Form S-8 registration statement filed by the company and in a stock prospectus provided to plan participants.

Plan participants who had invested in the company stock fund brought suit, alleging violations by the company fiduciaries of their duties of prudence and loyalty. A federal trial court granted the fiduciaries' motion to dismiss.

Moench presumption of prudence standard

In affirming, the Eleventh Circuit adopted the presumption of prudence standard of judicial review. Pursuant to this standard, as initially articulated by the Third Circuit (in Moench v. Robertson, CA-3 (1995) 62 F.3d 553) and subsequently adopted by the Second, Fifth, Sixth, and Ninth Circuits, a fiduciary's decision to continue to invest in and hold company stock, in compliance with the directions of the plan is to be reviewed only for an abuse of discretion.

In applying the presumption of prudence, the main issue before the court was whether the fiduciaries could be found to have abused their discretion in buying and holding company stock only if they had knowledge that the company was on the "brink of financial collapse." The Eleventh Circuit rejected financial viability as the determinative factor in ascertaining whether a fiduciary acted with sufficient prudence. Relying on trust law, the court held that the applicable test for determining whether a fiduciary abused discretion by acting in compliance with the directions of the plan should be whether he "could not have reasonably believed that the settlor would have intended for him to do so under the circumstances."

Thus, the central question was whether the fiduciaries reasonably believed that the settlors would have intended that the plan instructions regarding company stock be followed under the circumstances of the case. The court concluded that the fiduciaries' actions were reasonable, explaining that nothing in the plan indicated an intent by the settlors for the fiduciaries to disregard plan instructions based on short term events and fluctuations in the market.

Finally, the appeals court noted that plan administrators assume fiduciary status only when and to the extent that they function in their capacity as plan administrators and not when they conduct business that is not regulated by ERISA. Accordingly, when filing Form S-8 registration statements, creating a stock prospectus, and providing it to plan participants, as required by securities law, company officials were not acting as plan fiduciaries, as they were conducting business that is not regulated by ERISA.

Source: Lanfear v. Home Depot, Inc. (CA-11).

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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