The Perils of Offering a Company Stock Investment Alternative: A Closer Look at the Ninth Circuit’s Decision in Harris v. Amgen
The Ninth Circuit, in Harris v. Amgen, has reinstated an ERISA class action alleging that the defendants breached their fiduciary duties by offering company stock in two employer-sponsored plans. The court held that the defendants knew, or should have known, that the stock was sold at an artificially inflated price due to material omissions and misrepresentations in connection with anemia-treating drugs and off-label sales of the drugs. The appellate opinion contains several rulings of interest in the ongoing wave of employer stock litigation under ERISA.
The plaintiffs are former and current employees of Amgen, Inc., and its subsidiary, Amgen Manufacturing, Limited, who participated in either the Amgen Retirement and Savings Plan (“Amgen Plan”) or the Retirement and Savings Plan for Amgen Manufacturing, Limited (collectively, the “Plans”). The Plans were both employee stock ownership plans (“ESOP”) that are eligible individual account plans, and they included the Amgen Common Stock Fund as one of the options available for participant directed investments under the Plans.
The lawsuit arose out of a significant price drop in Amgen stock caused by a controversy surrounding two anemia-treating drugs Amgen created before 2001. The two drugs were initially very successful and made up about half of Amgen’s $14.3 billion in revenue in 2006. However, several clinical trials started questioning whether these drugs were safe because data showed that patients taking these drugs died at higher rates than those who did not. Amgen denied these negative findings and reiterated that its drugs were safe and effective. For instance, one of the defendants, Kevin Sharer, Amgen’s president and the chairman of the board of directors, announced at an investor conference that these drugs were safe. Meanwhile, Amgen also began to aggressively market its drugs for off-label use which led the Food and Drug Administration (“FDA”) to issue a “black box” warning — the strongest warning the FDA can issue. As concern grew regarding the safety of the drugs and Amgen’s off-label marketing practices, two House of Representatives subcommittees opened an investigation into these issues. Consequently, the price of Amgen stock went from a high of $86.17 on September 19, 2005 to $57.33 on May 19, 2007.
The plaintiffs commenced litigation in August, 2007 following the approximate thirty-three percent drop in Amgen stock price. Plaintiffs subsequently amended their complaint in 2010, alleging that the defendants — Amgen, its subsidiary, nine directors of the Amgen Board, and the Plans’ Fiduciary Committees and their members — violated their fiduciary duties.
The district court dismissed all claims against Amgen, on the ground that it was not a fiduciary, and it also dismissed the remaining claims against the remaining defendants. The plaintiffs appealed the dismissal of the complaint.
The Ninth Circuit’s Analysis
The Ninth Circuit reversed the district court’s decision to dismiss all of the plaintiffs’ claims. The appellate court discussed several issues that it identified as essential to analyzing a fiduciary’s liability when offering employer stock as an investment option: (1) the plan language necessary to establish the so called “Moench” presumption of prudence for employer stock in an eligible individual account plan; (2) the relationship between securities law claims and ERISA breach of fiduciary claims; and (3) the proper plan language for delegating exclusive authority.
The Presumption of Prudence
Under the prudent person rule set forth in ERISA section 404, a fiduciary must act “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.” Section 404 also requires that fiduciaries diversify investments of a plan in order to minimize the risk of large losses. Congress, however, provided an exception to the diversification requirement for employer stock that is acquired or held in an eligible individual account plan. The Third Circuit Court of Appeal, in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), further extended protections to fiduciaries offering employer stock by establishing a “presumption of prudence” standard which provided that “an ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision.” The Ninth Circuit in Quan v. Computer Sciences Corp., 623 F.3d 870 (9th Cir. 2010), had joined the Third Circuit, and several other Circuit Courts, by adopting the presumption of prudence. Under this standard, a fiduciary is presumed to have made a prudent investment in employer stock when the terms of the plan require or encourage investment of plan assets primarily in employer stock.
In Harris, the Ninth Circuit reversed the district court’s decision dismissing the plaintiffs’ claim that the defendants were imprudent. It held that the presumption of prudence did not apply to the defendants’ actions because the Plans provided that contributions “shall be invested as provided under the terms of the Trust Agreement, which may include provision for the separation of assets into separate Investment Funds, including a Company Stock Fund.” In finding that this language did not require or encourage investment in Amgen stock, the Harris court joined the Second Circuit, which had previously held that almost identical plan language did not trigger the presumption of prudence. The court explained that the Plans’ language simply gave the defendants the discretion to offer Amgen stock as an investment alternative. Furthermore, because of this discretionary language, the court rejected the defendants’ reliance on Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243 (5th Cir. 2008), which noted that courts should be mindful of “the long-term horizon of retirement investing” and that “holding fiduciaries liable for continuing to offer the option to invest in declining stock would place them in an untenable position of having to predict the future of the company stock’s performance.”
The Harris court further stated that the defendants were not entitled to a presumption of prudence by noting other provisions of the Plans which, in the court’s view, discouraged, rather than encouraged, investment in Amgen stock. This included a provision limiting a participant’s holding in Amgen stock to fifty percent of the participant’s total holdings while none of the other available investment options had such limitations. The Plans also had provisions regulating the purchase, transfer, and distribution of Amgen stock.
Relationship between ERISA Breach of Fiduciary Duty Claims and Securities Law Claims
Throughout the Harris decision, the Ninth Circuit discussed the relationship between securities law claims and ERISA breach of fiduciary duty claims in assessing whether the plaintiffs had sufficiently alleged that the defendants violated their fiduciary duties under ERISA. The Ninth Circuit ultimately held that the plaintiffs had sufficiently stated a claim under ERISA because the plaintiffs in a parallel securities class action against Amgen had sufficiently stated claims under section 10(b) of the Securities Exchange Act of 1934, and by applying two securities law theories — the “fraud-on-the-market” theory and the “efficient market hypothesis.”
The court addressed the application of securities law to an ERISA action when it rejected Amgen’s argument that the decline in Amgen stock was insufficient to show an imprudent investment by the defendants. The Ninth Circuit rejected this argument because of the decisions in the parallel federal securities class action against Amgen — Connecticut Retirement Plans & Trust Funds v. Amgen — which was based on the same facts as alleged in Harris. In Conn. Ret. Plans & Trust Funds, the district court certified a class of Amgen stock investors and held that the plaintiffs had sufficiently alleged that Amgen and several of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by misstating and failing to disclose information regarding Amgen’s anemia treating drugs. The Ninth Circuit upheld the district court’s decision, and the U.S. Supreme Court affirmed. Amgen Inc. v. Conn. Ret. Plans & Trust Funds, — S. Ct. —-, 133 S.Ct. 1184 (2013). The Harris court relied on the findings in Connecticut Retirement Plans & Trust Funds and held that “[i]f the alleged misrepresentations and omissions, scienter, and resulting decline in share price in Connecticut Retirement Plans were sufficient to state a claim that defendants violated their duties under Section 10(b), the alleged misrepresentations and omissions, scienter, and resulting decline in share price in this case are sufficient to state a claim that defendants violated their more stringent duty of care under ERISA.”
The Harris court also explained that the defendants’ duty of care under ERISA is not less than the duties they owe to the general public under securities laws. Moreover, the court found there are no contradictions between securities law and ERISA. Instead, “these laws are complementary and reinforcing.” Although the Ninth Circuit in Quan had held that fiduciaries were not obligated to violate securities laws in order to satisfy their fiduciary duties, the Harris court clarified that compliance with ERISA would not have required the defendants to violate securities laws because, under ERISA, they were obligated to convey complete and accurate information to the plaintiffs. The court stated that this obligation was previously explained in Quan, which held that a “fiduciary has an obligation to convey complete and accurate information material to the beneficiary’s circumstances, even when a beneficiary has not specifically asked for the information.” Therefore, the Harris defendants could have simultaneously satisfied their duties under both securities law and ERISA if they had revealed material information in a timely fashion. Timely revelation would have allowed the general public, including plan participants, to decide whether to invest in Amgen stock. The court further explained that the defendants would not be violating securities laws if they had simply disallowed additional investments in Amgen stock during the artificial inflation period because there is no violation absent the purchase or sale of stock.
The Ninth Circuit also applied two theories used in securities law cases to the plaintiffs’ ERISA breach of fiduciary claims. First, the court used the “fraud-on-the market” theory in holding that the Harris plaintiffs, similar to defrauded investor plaintiffs in Section 10(b) actions, did not have to show actual reliance on the defendants’ omissions and misrepresentations to prove that the defendants violated their ERISA duty of loyalty and care. This presumption of reliance theory provides that, in an efficient securities market, the price of a stock reflects all public information, including a defendant’s material misrepresentation about the stock, and, thus, a plaintiff is presumed to have relied on these misstatements whenever he buys or sells such stock. The court further stated that even though the Harris defendants made material misstatements to the Securities and Exchange Commission in their corporate — not fiduciary — capacity, these statements were accounted for in the price of Amgen stock. Hence, the plaintiffs could use the defendant’s misstatements under the “fraud-on-the-market” theory to show that they presumptively and detrimentally relied on these misstatements.
Another securities law theory applied by the court in this ERISA case was the “efficient market hypothesis.” Using this hypothesis, the court rejected the defendants’ argument that if Amgen stock had been removed as an investment option, it would have caused a significant drop in stock price. This hypothesis assumes that, in an efficient market, stock prices incorporate and reflect all relevant information. Thus, even if removing Amgen stock as an investment option in the Plans sent a negative signal to the investing public resulting in a stock price drop, the court explained that, under the efficient market hypothesis, the drop would have been limited to the amount that was artificially inflated due to Amgen’s misstatements and omissions and off-label sales.
Ultimately, the Ninth Circuit concluded that the defendants were obligated to remove Amgen stock as an investment option under the Plans as soon as they knew, or should have known, that the share price was artificially inflated, and that the “defendants violated their fiduciary duties under ERISA at more or less the same time some of them violated their duties under the federal securities laws.”
Delegation of Exclusive Authority
In reversing the district court’s decision, the Ninth Circuit also held that Amgen was a fiduciary under ERISA because the Amgen Plan lacked language providing for delegation of exclusive authority from Amgen to other entities, such as the trustees and fiduciary committee. The Amgen Plan provided that “To the extent that the Plan requires an action under the Plan to be taken by the Company [Amgen], the [Fiduciary Committee] shall be authorized to act on behalf of the Company.”
When the court compared the Amgen Plan language to another plan which the Ninth Circuit had previously found to contain a clear delegation of exclusive authority, it concluded that the Amgen Plan lacked two key features present in the other plan. First, unlike the other plan, which delegated to the administrative committee the “responsibility for carrying out all phases of the administration of the Plan,” section 15.1 of the Amgen Plan delegated responsibility to the Fiduciary Committee “to the extent the Plan requires an action to be taken by the Company.” Second, the Amgen Plan did not provide the Fiduciary Committee the exclusive right to make decisions because the committee was only authorized to act on behalf of Amgen and did not have exclusive authority. Furthermore, Amgen was not precluded from acting on its own behalf. In contrast, the other plan stated that its administrative committee shall have the “exclusive right . . . to interpret the Plan and to decide any and all matters arising hereunder.” Consequently, the court concluded that the plaintiffs had properly pled Amgen as a fiduciary.
Implications for Plan Fiduciaries
As a result of the Harris appellate decision, plan fiduciaries should be aware of the potential increase in ERISA liability exposure when an eligible individual account plan provides employees with the option of investing in the employer’s stock. We recommend that plan fiduciaries review the terms of their plans to ensure that terms such as “must” or “shall” are used to convey that the plan is required to include employer stock as an investment option. Although this decision mentions other plan provisions that appear to discourage, rather than encourage, investment in employer stock, such as limitations on the amount of company stock a participant can hold in his or her account, plan fiduciaries should be most concerned about including language expressly making the company stock option mandatory rather than language that could be construed as discretionary. Furthermore, in order to limit the plan sponsor’s liability, plan fiduciaries should check their plans to ensure that their plans contain phrases signifying that the party responsible for administering the plan, such as an administrative committee, has “full responsibility for carrying out all aspects of Plan administration” and “exclusive authority or right to interpret the Plan terms and decide any matter arising hereunder.”
If you have any questions about the Harris decision or any fiduciary issues under ERISA, please contact Brad Huss or Angel L. Garrett.