Stock Drop Litigation - An Overview

Many employers sponsor company stock retirement plans (i.e., ESOPs) or defined contribution plans (i.e., 401(k) plans) that offer company stock as an investment option. Although there are substantial benefits to be gained in offering company stock as an investment option, company stock funds that suffer significant losses due to a drop in the price of the employer's stock are lightning rods for lawsuits alleging, among other things, that plan fiduciaries breached their duties under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Since the collapse of Enron in 2001, there has been a substantial increase in the filing of these so-called "stock drop" lawsuits, and a new round of lawsuits recently has been brought in connection with the recent economic downturn, including lawsuits against financial sector giants such as Lehman Brothers, AIG, Bear Stearns, Countrywide Financial, and Citigroup.

The specific claims have evolved over the years, but plaintiffs in stock drop lawsuits generally allege that plan fiduciaries violated ERISA by continuing to offer a company stock fund as the price of the company's stock declines and, in particular, when the defendants knew (or should have known) of the company's underlying financial troubles. Defendants in these suits often rely on the presumption adopted by many courts - referred to as the "Moench presumption" because it originated in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995) - that a plan fiduciary's decision to maintain the company stock as an investment option was presumptively prudent. Thus, plaintiffs bear the burden of alleging facts in the complaint that are sufficient to overcome the presumption. For example, courts have dismissed lawsuits where the company suffered only short-term financial difficulties. The courts, however, have allowed plaintiffs to go forward with their claims in many cases.

Defendants have prevailed in each of the four stock drop lawsuits that have gone to trial. Many of the lawsuits, of course, have been settled short of trial. For example, Merrill Lynch, Tyco, and Countrywide Financial paid $75 million, $70.5 million, and $55 million, respectively, to settle stock drop cases. In light of such substantial settlements, additional stock drop lawsuits will continue to be filed in the coming years. Thus, plan sponsors and fiduciaries offering a company stock fund to employees should carefully consult with counsel as to steps that can be taken to minimize the litigation risk.

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Andrew Banducci
Groom Law Group