Jane Edgar, a former employee of Avaya Inc., filed a lawsuit against Avaya and several of its officers, claiming they breached their fiduciary duties under Section 404 of the Employee Retirement Income Security Act (ERISA) by allowing participants in three employee pension plans to invest in Avaya common stock. The basis for her complaint arose after the stock price fell from $10.69 to $8.01 per share, following an announcement that Avaya would not meet its projected earnings for fiscal year 2005. The court agreed with the District Court’s conclusion that Edgar did not sufficiently plead facts to demonstrate that the defendants acted imprudently in offering Avaya stock as an investment option or that they failed to disclose material information to plan participants. Consequently, the court affirmed the dismissal of Edgar's amended complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure. The background highlights that Avaya, formed in 2000 as a spin-off from Lucent Technologies, sponsors three ERISA-compliant pension plans aimed at providing retirement livelihood for participants, who can elect contributions and adjust their investment options among a variety of alternatives.
The Plans provide three asset classes: short-term investments, bond and stock funds, and asset allocation funds. Avaya selects the investment options, but participants can choose how their contributions are allocated among the twenty-three available options, including the Avaya Stock Fund, which primarily invests in Avaya common stock. Participants can adjust their investment choices and transfer existing investments. The Plans emphasize the risks and potential rewards associated with each investment option, highlighting that the Avaya Stock Fund's value fluctuates based on Avaya's performance and market conditions. By the end of December 2004, the Master Trust held $1.4 billion, with about 16 percent in the Avaya Stock Fund. Following a poor earnings forecast on April 19, 2005, Avaya's stock price dropped significantly. In July 2005, Edgar filed a class action lawsuit under ERISA, seeking damages and injunctive relief for participants who invested in the Avaya Stock Fund during the Class Period. The defendants moved to dismiss the case for lack of standing and failure to state a claim. The District Court granted the motion to dismiss without addressing the standing issue, leading to a timely appeal. The appellate court has jurisdiction and will review the dismissal under the standard that assumes the truth of the allegations in the complaint. The discussion will focus on Edgar's claims of breach of fiduciary duty regarding the offering of Avaya common stock and the duty to disclose the company's financial issues.
Section 404 of ERISA mandates that fiduciaries must act solely in the interest of plan participants and beneficiaries, employing a prudent man standard that necessitates care, skill, and diligence comparable to that of a prudent individual in similar circumstances. Fiduciaries are required to diversify investments to minimize the risk of significant losses unless it is clearly prudent not to do so, and they must act in accordance with the governing plan documents.
In the case involving Edgar's prudence claim, the District Court determined that the defendants' conduct should be assessed under an abuse of discretion standard. It concluded that Edgar did not provide sufficient facts to establish an abuse of discretion. The court's ruling was supported by the precedent set in Moench v. Robertson, which established that fiduciaries of Employee Stock Ownership Plans (ESOPs), while expected to invest primarily in company stock, are afforded judicial deference in their investment decisions. Although the plans in question were not ESOPs, the court applied the same deferential standard.
The Moench case involved a situation where an ESOP fiduciary faced a lawsuit for failing to diversify investments after a significant drop in stock price. The appellate court determined that fiduciaries retain some discretion regarding investment choices despite the plan's requirement to invest in employer stock. It clarified that while ESOP fiduciaries are exempt from certain diversification duties, they must still adhere to the general fiduciary obligations of loyalty and care. Ultimately, the prudent person rule applies closely to the investment decisions of fiduciaries, even with a strong preference for employer stock investments, reaffirming that judicial review of such decisions remains applicable.
To establish a balanced standard for Employee Stock Ownership Plans (ESOPs) functioning as both corporate finance mechanisms and retirement savings vehicles, the distinction in trust law between two types of directions is critical. If a trust mandates investment in its own interest, the trustee is protected from judicial inquiry; conversely, if it allows investment in specific stocks, the decision is subject to de novo judicial review. The case of Moench presented a unique situation where the defendants were not required but were more than merely permitted to invest in employer securities. An intermediate standard of abuse of discretion was determined to be appropriate. This led to a rebuttable presumption that an ESOP fiduciary investing in employer stock acted in accordance with ERISA, which could be challenged by the plaintiff proving abuse of discretion.
Edgar contends that Moench’s presumption of prudence does not apply to the plans in question since they are not ESOPs. However, it is clarified that the plans are categorized as Eligible Individual Account Plans (EIAPs) under ERISA, which include various types of plans, such as profit-sharing and employee stock ownership plans. EIAPs are designed to encourage investment in employer securities and share many exemptions with ESOPs, including the diversification requirement. Thus, EIAPs present similar risks to employee retirement assets as traditional ERISA plans. The court concludes that the rationale from Moench is applicable here, affirming that the abuse of discretion standard governs judicial review of the decision to include the Avaya Stock Fund as an investment option. Finally, the court dismisses Edgar’s argument based on the In re Schering-Plough Corp. ERISA Litigation, clarifying that the issues in that case do not contradict their current decision.
No opinion was expressed regarding the significance of § 1104(a)(2), which exempts Employee Investment Advisory Plans (EIAPs) from the duty to diversify. The amended complaint did not demonstrate an abuse of discretion, as the District Court found that Edgar failed to plead sufficient facts to support such a claim. To rebut the presumption of prudence in fiduciary investment in employer securities, a plaintiff must show that the fiduciary could not reasonably believe that following the ESOP’s direction aligned with the settlor's expectations of prudent management. Evidence can be introduced showing that unforeseen circumstances would undermine the trust's objectives. Edgar's claims included allegations of misrepresentation regarding the costs of a corporate acquisition and its negative impact on earnings, along with operational disruptions and declining demand for products, asserting that these factors negated any reasonable projections of revenue growth. However, the court determined that these allegations did not constitute a dire situation necessitating a deviation from the investment strategy outlined in the Plans. Divesting from Avaya securities during the Class Period could have exposed the defendants to liability for violating the Plans' terms. The court rejected the notion that fiduciaries must wait for imminent bankruptcy before divesting from employer securities. Furthermore, the allegations of wrongdoing were deemed insufficient to prove an abuse of discretion, especially since Avaya’s stock price had rebounded after an initial decline. Edgar's argument against the District Court's application of the Moench presumption in conjunction with the liberal pleading standards was also dismissed, as failure to articulate all essential legal claim elements necessitates dismissal under Rule 12(b)(6).
In Wright v. Oregon Metallurgical Corp., the Ninth Circuit determined that the plaintiffs' allegations did not support a claim under the Moench presumption, concluding that stock price fluctuations alone are insufficient to demonstrate imprudence by the defendants. The court affirmed the District Court's dismissal of Edgar's prudence claim, asserting that even if the allegations were true, Edgar could not show that the defendants abused their discretion in managing the pension plans.
Regarding the duty of disclosure, Edgar contended that the defendants were required to disclose adverse corporate developments before Avaya's April 19, 2005, earnings announcement. However, the court disagreed, noting that ERISA fiduciaries must not materially mislead participants but are not obligated to provide investment advice or opinions on stock conditions. The Summary Plan Descriptions adequately informed participants of the risks associated with investments in Avaya stock, emphasizing that they should investigate investment options themselves.
The court also explained that early disclosure of adverse information would have led to market adjustments, preventing the plans from selling at higher prices and resulting in similar losses. Furthermore, divesting the plans of Avaya stock based on non-public information could have exposed the defendants to insider trading liability. Therefore, the lack of prior disclosure did not constitute a breach of ERISA obligations. Ultimately, the court upheld the District Court's dismissal of Edgar's claims under Rule 12(b)(6).
