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Home > controlled group liability > Fifth Circuit Upholds Dismissal of Diversification and Prudence Claims Targeting A Single Stock Fund in a 401(k) Plan

Fifth Circuit Upholds Dismissal of Diversification and Prudence Claims Targeting A Single Stock Fund in a 401(k) Plan

By Benjamin Flaxenburg, Russell Hirschhorn & Seth Safra on June 29, 2020

The Fifth Circuit in Schweitzer v. Inv. Comm. of Phillips 66 Sav. Plan dismissed claims against 401(k) plan fiduciaries related to allowing plan participants to hold a single stock that was not an employer security as a plan investment alternative.  No. 18-cv-20379, 2020 WL 2611542 (5th Cir. May 22, 2020).  The Court held that:  (i) 401(k) plan fiduciaries had a duty to ensure that the plan’s investment line-up was diversified, but no duty to ensure that participants actually diversified their portfolios; (ii) the Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), effectively foreclosed claims that the plan fiduciaries should have taken action on the basis of public information that suggested risk from holding the stock; and (iii) ERISA does not prohibit an individual account plan, like a 401(k) plan, from offering a single-stock fund.

As discussed below, the Court’s decision offers meaningful guidance to fiduciaries of participant-directed plans and, more specifically, to those evaluating what to do with a company stock fund after a spinoff or divestiture.

Background

ConocoPhillips maintained a 401(k) plan with two employer stock funds that invested in ConocoPhillips stock.  ConocoPhillips spun off certain operations to Phillips 66, which was not affiliated with ConocoPhillips.  The spinoff resulted in the transfer of over 10,000 ConocoPhillips employees to Phillips 66, and their 401(k) accounts were transferred to a separate plan sponsored by Phillips 66.

Many of the transferred employees had invested in the ConocoPhillips stock funds.  Those investments transferred in-kind to the Phillips 66 plan.  As a result, the Phillips 66 Plan held two funds with a single stock that was not an employer security.  The Phillips 66 plan’s fiduciaries closed the funds to new investments, and participants were allowed to sell at any time, but those who did not want to sell were allowed to hold their investments in the funds.  During the five-year period that followed the spinoff, ConocoPhillips’s share price increased significantly and then decreased just as significantly.

Participants in the Phillips 66 Plan filed a putative class action complaint alleging two ERISA breach of fiduciary duty claims:  breach of the duty of diversification by offering the ConocoPhillips stock funds; and breach of the duty of prudence for failing to remove the ConocoPhillips stock funds.  The participants pointed to the inherent risk of investing in a single stock and publicly available “red flags” that purportedly signaled additional risk.

The district court dismissed the complaint for failure to state a claim.  The district court first found that the diversification claim failed because participants could no longer invest in the ConocoPhillips stock funds and participants could remove their assets from the funds at any time.  The district court concluded that the claim was really an issue of prudence and whether the plan fiduciaries should have forced participants to divest their holdings from the funds.  The district court then evaluated the participants’ breach of the duty of prudence claim and concluded that it was foreclosed by the Supreme Court’s ruling in Dudenhoeffer.

The Fifth Circuit’s Opinion

The Fifth Circuit affirmed the district court’s dismissal of all claims.  To begin with, the Court concluded that the diversification claim failed because the complaint lacked any allegation that the fiduciaries failed to offer a diverse menu of investment options or otherwise warn the participants of the risk of assembling a non-diversified portfolio.  In so ruling, the Court rejected the participants’ reliance on authority addressing diversification requirements for defined benefit plans.  The court explained that, for a defined contribution plan, a fiduciary’s responsibility is to create a diverse menu of available investment options.  Individual options on the menu do not necessarily have to be diverse, and allocation of assets among the available options is the responsibility of each participant.

The Court next turned to the participants’ claim that the fiduciaries breached the duty of prudence by allowing participants to hold their investments in the ConocoPhillips stock funds after the spinoff.  First, the Court concluded that the Supreme Court’s decision in Dudenhoeffer precluded plaintiffs’ claim that the plan fiduciaries should have known from publicly available information that ConocoPhillips’ share price did not adequately reflect the stock’s risk.

Nevertheless, the Court noted that, under some circumstances, it could be imprudent to keep a single-stock fund on the investment menu.  The Court determined that Dudenhoeffer did not control here because this was not a claim about whether the plan fiduciaries should have taken action based on publicly available information and did not involve employer securities.  The Court concluded that the fiduciaries were not imprudent because they had closed the ConocoPhillips stock funds to new investments and adequately warned participants of the risks of not diversifying in the summary plan description.

Proskauer’s Perspective

The Fifth Circuit’s ruling approves a common approach for handling company stock funds after a spinoff or similar divestiture.  Nevertheless, plan fiduciaries should continue to monitor all investment options, and to keep investment disclosures up to date, to ensure that participants have the information necessary to make sound investment decisions.

Posted in Fiduciary Breach
Tags: 401(k) Plan, Breach of Fiduciary Duty, ConocoPhillips, Defined Contribution Plan Litigation, diversify, Dudenhoeffer, employer security, ERISA, individual account plan, Phillps 66, Prudence
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Photo of Benjamin Flaxenburg Benjamin Flaxenburg

Benjamin O. Flaxenburg is an associate in the Labor & Employment Law Department and a member of the Employee Benefits & Executive Compensation Group.

Prior to joining Proskauer, Ben served as an extern for the United States Attorney’s Office for the Eastern District…

Benjamin O. Flaxenburg is an associate in the Labor & Employment Law Department and a member of the Employee Benefits & Executive Compensation Group.

Prior to joining Proskauer, Ben served as an extern for the United States Attorney’s Office for the Eastern District of Louisiana and as a judicial extern to the Honorable Nannette Jolivette Brown at the United States District Court for the Eastern District of Louisiana. Ben was also a managing editor of the Tulane Maritime Law Journal, a member of the Tulane’s Moot Court Board and a member of Tulane’s Alternative Dispute Resolution Moot Court Team.

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Photo of Russell Hirschhorn Russell Hirschhorn

“Russell has strong subject matter expertise.”

“Russ is extremely responsive and practical. He listens to the client perspective and is hands on and engaged, while also delegating work as appropriate.” 

-Chambers USA

Russell L. Hirschhorn is co-head of Proskauer’s premier ERISA Litigation Group…

“Russell has strong subject matter expertise.”

“Russ is extremely responsive and practical. He listens to the client perspective and is hands on and engaged, while also delegating work as appropriate.” 

-Chambers USA

Russell L. Hirschhorn is co-head of Proskauer’s premier ERISA Litigation Group, which is a significant component of the firm’s ERISA Practice Center and globally renowned Labor and Employment Law Department.  Russell’s practice focuses on employee benefits issues arising under the Employee Retirement Income Security Act of 1974 (ERISA), including class action and complex litigation, U.S. Department of Labor and Internal Revenue Service investigations, and counseling clients on best practices to avoid litigation.

Russell has more than two decades of experience representing plan sponsors, fiduciaries, trustees, and service providers across the country.  His work on behalf of clients has included all types of plans, including 401(k) plans, 403(b) plans, defined benefit plans, employee stock ownership plans, executive compensation plans, health and welfare plans, multiemployer plans, multiple employer plans, and severance plans.  And, it has included the full gamut of claims arising under ERISA, including excessive investment and plan administration fees and investment underperformance claims; cash balance plan litigation; claims for benefits; company stock fund cases; claims for delinquent contributions; ERISA § 510 claims; ERISA statutory claims; ESOP litigation; executive compensation claims; independent contractor claims; independent fiduciary representations; multiemployer fund litigation; plan service provider claims; recoupment of plan overpayments; retiree benefits claims; severance plan claims; and withdrawal liability claims.

Deeply dedicated to pro bono work, Russell has been recognized on several occasions for his commitment to pro bono work including by President George W. Bush in receiving the U.S. President’s Volunteer Service Award.  His pro bono work has included serving as lead litigation counsel in several impact litigations: on behalf of social security recipients whose benefits were unlawfully suspended based on an outstanding warrant, deaf and hard of hearing prisoners in Louisiana prisons seeking disability accommodations, and Swartzentruber Amish in upstate New York to obtain religious exemptions from certain building code requirements. Russell also was a principal drafter of several amicus briefs for the Innocence Project, a legal non-profit committed to exonerating wrongly convicted people.

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Photo of Seth Safra Seth Safra

Seth J. Safra is chair of Proskauer’s Employee Benefits & Executive Compensation Group. Described by clients as “extremely knowledgeable, practical, and strategic,” Seth advises clients on compensation and benefit programs.

Seth’s experience covers a broad range of retirement plan designs, from traditional defined…

Seth J. Safra is chair of Proskauer’s Employee Benefits & Executive Compensation Group. Described by clients as “extremely knowledgeable, practical, and strategic,” Seth advises clients on compensation and benefit programs.

Seth’s experience covers a broad range of retirement plan designs, from traditional defined benefit to cash balance and floor-offset arrangements, ESOPs and 401(k) plans—often coordinating qualified and non-qualified arrangements. He also advises tax-exempt and governmental employers on 403(b) and 457 arrangements, as well as innovative new plan designs; and he advises on ERISA compliance for investments.

On the health and welfare side, Seth helps employers provide benefits that are cost-effective and competitive. He advises on plan design, including consumer-driven health plans with HSAs, retiree medical, fringe benefits, and severance programs, ERISA preemption, and tax and other compliance issues, such as nondiscrimination and cafeteria plan rules.

Seth also advises for-profit and non-profit employers, compensation committees, and boards on executive employment, deferred compensation, change in control, and equity and other incentive arrangements. In addition, he advises on compensation and benefits in corporate transactions.

Seth represents clients before the Department of Labor, IRS and other government agencies.

Seth has been recognized by Chambers USA, The Legal 500, Best Lawyers, Law360, Human Resource Executive, Lawdragon and Super Lawyers.

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