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The Presumption of Prudence Persists: In re UBS ERISA Litigation

In 1995 the Third Circuit Court of Appeals broke new ground in the area of fiduciary liability under ERISA when it found that an action of a fiduciary "should be presumed to be reasonable" if the terms of a retirement plan "require or strongly encourage" the fiduciary to take such an action. Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The case that gave rise to this so-called "presumption of prudence" involved the investment of plan assets in an employee stock ownership plan, which is expressly designed to invest in employer stock. But fiduciaries quickly sought to apply this defense in the context of other "eligible individual account plans" under ERISA (and stock drop cases in particular) and federal judges have been receptive to the argument.

Most recently, the Southern District of New York found that the fiduciaries of two UBS retirement plans were entitled to the Moench presumption of prudence regarding their decision to continue to offer the UBS stock fund to employees after the firm suffered serious financial losses at the beginning of the financial crisis. In re UBS AG ERISA Litig.,08 CIV. 6696 RJS, 2011 WL 1344734 (S.D.N.Y. Mar. 24, 2011). The UBS case didn't break new ground in the disposition of claims alleging breaches of fiduciary duty. In fact, plan fiduciaries have done well defending themselves in stock drop cases, especially in federal courts in New York. See e.g., In re Bear Stearns Co., Inc. Sec., Derivative, & ERISA Litig., 08 MDL 1963, 2011 WL 223540 (S.D.N.Y. Jan. 19, 2011); In re Lehman Bros. Sec. & ERISA Litig., 684 F. Supp. 2d 485 (S.D.N.Y. 2010); Herrera v. Wyeth, 08 CIV 4688 (RJS), 2010 WL 1028163 (S.D.N.Y. Mar. 17, 2010); and In re Citigroup ERISA Litig., 07 CIV. 9790, 2009 WL 2762708 (S.D.N.Y. Aug. 31, 2009). But the UBS case is noteworthy because it serves as a recent and dramatic example of the considerable strength of the presumption of prudence.

In order to apply the Moench presumption of prudence in a stock drop case a court must make one crucial threshold finding: that the plan document either requires or strongly encourages the plan fiduciaries to offer the employer stock fund as an investment option to plan participants. (Remember: the establishment, design and termination of a plan are all "settlor functions" to which the fiduciary standards of ERISA do not apply and an employer is entitled to apply its business judgment in making these decisions.)

In the UBS case the Court found that one of the UBS plans expressly provided that the employer stock fund would be included in the fund line up. The other UBS plan did not include explicit language mandating the inclusion of the fund, but references to the stock fund appear throughout the document and effectively presupposed that the fiduciaries would make the fund available to participants. These provisions were sufficient, in the Court's view, to warrant applying the presumption because the fiduciaries lacked the effective ability to remove the funds as a matter of discretion. Put another way, at least in the case of one UBS plan, a plan amendment would be necessary to remove the fund.

Once the presumption of prudence is triggered a plaintiff must meet a very high standard to defeat it. The Court in the UBS case adopts the standard articulated in earlier Second Circuit cases, stating that in order to overcome the presumption an aggrieved participant must be able to show that "a reasonable fiduciary would have considered himself bound to divest in the employer stock fund." In essence, the facts would have to demonstrate that by continuing to make an employer stock fund available under a plan, the fiduciaries abused their discretion by failing to remove the fund. Though the plaintiffs in the UBS case were able to point to plan language that generally gave the fiduciaries the authority to select or eliminate investment funds from time to time, that language was not strong enough to counter the provisions designed to strongly encourage employee ownership of employer stock. Indeed, even the undisputed facts that the price of UBS stock dropped by 69% over the period at issue and the fiduciaries were well aware of the troubles facing UBS did not "rise to the level of the catastrophic failure necessary to overcome the presumption of prudence."

There are probably a number of conclusions one can draw from the UBS case and its predecessors, but one conclusion is inescapable: courts continue to draw a fairly bright line between fiduciary and non-fiduciary functions. Employers, as "settlors" for their retirement plans, are free to design their plans to suit their business objectives (subject, of course, to the legal and technical requirements of the Internal Revenue Code and ERISA), and plan fiduciaries are constrained within that framework. Thus, the fiduciaries in the UBS case (like their counterparts at Bear Stearns, Lehman Brothers, and elsewhere) could credibly argue that their hands were tied by provisions hard-wired into the plan document. It's worth noting, of course, that in the UBS case (like all the cases cited here) the participants did have complete control over the investment of their plan accounts. This would present a hurdle for plaintiffs in almost any case. Nevertheless, the DOL would argue (as they have in other cases) that the design of the UBS plans essentially allowed the fiduciaries to apply a lower standard to the employer stock fund than one would expect a prudent expert generally to apply when the person has knowledge of material facts suggesting a given investment option should be removed. The presumption of prudence does not, of course, absolve fiduciaries of their duties. Think of it this way: if the Acme Rocket Sled Company 401(k) Plan offered a special fund consisting of common stock in Lehman Brothers, Bear Stearns, Merrill Lynch, UBS and Citigroup, and the Plan's investment fiduciary failed to dump that fund in 2008 (when the financial crisis began in earnest), that fiduciary would have to fend off claims without the benefit of the presumption of prudence.

Topics: Fiduciary Duties, Retirement Plans