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Defined contribution plan trustees breached their duty of prudence toward a participant when they permitted his individual account to remain invested almost exclusively in employer stock, despite a predictable plunge in the stock's value, the U.S. Court of Appeals in Chicago (CA-7) has ruled in Peabody v. Davis.
Securities firm
The employer was a closely-held securities firm that derived much of its revenue from commissions. In 2000, the Securities and Exchange Commission (SEC) issued rules that had the effect of diminishing the profit margins yielded by commissions on trades. By 2004, the employer's profit margins had decreased by 80%; by 2005, it was out of business.
The participant first invested in the employer's DC plan in 1999. He and the employer's management (who were also the plan's trustees) agreed that if he rolled over an external IRA (worth nearly $168,000) into the DC plan, he could receive a cash bonus instead of employer stock, as was the company's ordinary bonus practice. This left the participant's account 98% invested in employer stock. He never asked the plan to change this investment allocation.
In 2005, the participant filed suit against the employer, the plan, and the plan trustees, alleging multiple theories of fiduciary breach, including breach of fiduciary duty under ERISA §502(a)(2). The district court found for the participant and awarded damages of approximately $500,000.
Duty of prudence
The appellate court began by explaining that while the plan was exempt under ERISA §407(d)(3) from the duty to diversify with respect to employer securities, the duty of prudence still applied. Further, even if the court were to apply the so-called "Moench presumption" (the Third Circuit's rule that for certain plans there's a presumption of prudence attached to investing in employer stock), in this situation the duty of prudence was breached. A widely-known and permanent change in the regulatory environment undermined the employer's business model and consequently the stock became an imprudent investment.
Remand on damage award
The appellate court found the district court's method for calculating damages to be erroneous. On remand, the district court should proceed on the theory that the trustees were required to divest employer stock as the profitability of the company declined sharply. The value of the participant's initial investment ($168,000) should be considered in these calculations. (The appellate court suggested that the district court used a single valuation of employer stock to calculate damages, and thus its award was too high.)
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