Guest Article

(From the May 30, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Ninth Circuit Rejects Fiduciary Breach Claims in Employer Stock Case

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The Ninth Circuit Court of Appeals recently ruled a group of stock bonus plan participants could not go forward with claims against the plan's fiduciaries for refusing to deviate from the plan's terms by allowing them to sell all of their employer stock holdings when it would have been particularly advantageous to do so. Wright, et al. v. Oregon Metallurgical Corporation, et al., 360 F.3d 1090 (9th Cir. 2004). The plan allowed plaintiffs to sell up to 85 percent of their employer stock holdings each year, but the plaintiffs wanted to sell 100 percent when the stock reached an all-time high following a merger announcement.

Case Facts

The plaintiffs are a group of actively-employed participants in Oregon Metallurgical Corporation's ("Oremet") stock bonus plan (the "Plan"). Oremet established the Plan in 1987 as a stock bonus plan and employee stock ownership plan (ESOP). The Plan used a loan from Oremet to purchase approximately $17 million worth of publicly-traded Oremet common stock, which was allocated to participants' accounts as the Plan repaid the loan. During the ten-year period from 1987 through 1997 the Oremet stock price fluctuated between $3.624 and $33.875 per share. After the stock price enjoyed a steady rise in 1995, some participants asked for the ability to sell a greater percentage of their Oremet holdings than the Plan's terms would allow. The Plan's original terms permitted actively employed participants to sell up to 40 percent of the Oremet shares allocated to their accounts each year.

Concerned that employees might quit their jobs in order to be able to divest their Oremet holdings (participants no longer employed by Oremet could sell all of their Oremet stock at any time), the company amended the Plan in May 1996 to permit participants to sell up to 85 percent of their Oremet stock after July 30, 1996. The amendment also provided the Plan would cease to be an ESOP whenever the majority of plan assets were no longer invested primarily in Oremet common stock.

In 1997 Oremet announced plans to merge wit h Allegheny Teledyne. The Oremet share price jumped from $23.4375 per share on the day of the announcement to $33.875 as of closing on the first full trading day after the announcement. Hoping to take full advantage of this increase, a group of participants petitioned the Plan Advisory Committee to let them sell more than 85 percent of their Oremet stock. The Advisory Committee refused their request after learning Oremet management and the Union had agreed to not further liberalize the Plan's diversification rules until at least 2000.

The Plan's participants received 1.26 shares of Allegheny Teledyne stock for each share of Oremet stock they held when the merger was completed in March 1998. Pursuant to a reverse stock split in 1999 the Plan's participants receive one share of Allegheny Technologies stock (a new entity borne of the merger) for each two shares of Allegheny Teledyne stock. After the merger, the value of one pre-reverse split share of Allegheny Technologies stock fell from $28.94 to $7.94 per share.

Participants' Prudence Claim

The participants argued that Oremet and several other plan fiduciaries breached their duty of prudence by failing to investigate whether to sell the Plan's company stock at a premium when the merger was pending, and when the stock price started falling after the merger. Significantly, the fiduciaries would have violated the Plan's express terms by selling the stock at either time. According to ERISA section 404(a)(1)(B), a fiduciary with respect to a plan must discharge his duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." Additionally, ERISA fiduciaries must diversify a plan's assets "so as to minimize the risk of large losses." ERISA section 404(a)(1)(C).

Pursuant to a special exception, fiduciaries of certain individual account plans generally can acquire and hold employer stock without violating the 404(a)(1)(B) prudence rule, to the extent it would otherwise require diversification, or the 404(a)(1)(C) diversification rule. ERISA section 404(a)(2). However, the Third and Sixth Circuit Courts of Appeal have taken the position that individual account plan fiduciaries can be held liable under the prudence rule for failing to diversify their plans' employer stock holdings in certain circumstances. See Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) and Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995).

The Ninth Circuit indicated it was not sure it could reconcile this "intermediate prudence standard" with the specific exception provided by ERISA section 404(a)(2). But the court concluded it did not have to decide whether to accept or reject this standard because the plaintiffs in this case would lose under either scenario. If the court rejected the intermediate prudence standard the plaintiffs would lose because the statute clearly precludes a violation of the prudence rule in these circumstances. If the court accepted the Third Circuit's intermediate prudence standard the plaintiffs would still lose, according to the Ninth Circuit, because this case-- unlike Moench-- "does not present a situation where a company's financial situation is seriously deteriorating and there is a genuine risk of insider self-dealing."

Even under the Moench intermediate prudence standard, according to the Ninth Circuit, the plaintiffs would need to show more than "mere stock fluctuations" to overcome the presumption that the fiduciaries did not violate the prudence rule by refusing to sell the employer stock. "The Moench standard does not," the court concluded, "compel fiduciaries to permit further diversification of [individual account plans] upon each subsequent rise in share value attributed to a merger or, for that matter, any other major corporate development. It merely requires fiduciaries to act reasonably."

Effect on Employers

The outcome of this case is certainly favorable to the Plan's fiduciaries, but fiduciaries in general should be careful about reading too much into the Ninth Circuit's decision. Even though the court hinted it had doubts about the validity of the Moench intermediate prudence standard, it did not specifically reject it. Thus, the court left open the possibility it might embrace that standard in a future case involving more than "normal" stock price fluctuations.

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The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Tom Brisendine 202.879.5365, Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Mike Haberman 202.879.4963, Stephen LaGarde 202.879.5608, J. D. Lutz 202.879.5366, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5324, Tom Veal 312.946.2595, or Deborah Walker 202.879.4955. Copyright 2004, Deloitte.

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