Judicial Comments in 9th Circuit ESOP Case Give Fiduciaries Wider Latitude

In Wright, Buchanan, and Hagen. v. Oregon Metallurgical Corporation, No. 02-3583, Civ.-01-00325-BR (9th Circ. Ct. of Appls., 3/1//04), the court denied an appeal by plaintiffs against the fiduciaries of Oregon Metallurgical of a lower court ruling holding that plan fiduciaries did not have a duty to further diversify Oremet stock in the company's ESOP.

Oremet established its plan in 1987. The plan required a minimum percentage of each participant's account to be in Oremet stock. The plan originally allowed employees to diversify up to 40% of their Oremet stock each year while still employed. Oremet was on the NASDAQ, and its stock fluctuated from $3.62 to as much as $22.88 between 1987 and 1997, rising quickly in 1995 and 1996. Oremet's management wanted to allow employees to further diversify in order to prevent employees from leaving to get their stock. In 1996, the plan was amended to allow employees to diversify 85% of their stock, at which point the plan would cease to be an ESOP and become a stock bonus plan. The plan was amended from requiring that plan assets be invested primarily in company stock to be "invested as provided in the trust agreement." The agreement provided that up to 100% of the assets could be invested in company stock. The union, however, opposed further diversification.

In 1997, Allegheny Teledyne merged with Oremet and Oremet shareholders got Allegheny shares. Stock went up from $23 to $38.87 immediately after the merger. In 1998, a group of employees petitioned to allow them to diversify 100% of their stock. The plan committee responded it would have to get direction from the board and the union. After the merger, Allegheny stock dropped as low as $7.94 per share. The fiduciaries did not allow further diversification. In 2001, plaintiffs sued, claming both the plan's trustee (Key Bank) and the union were co-fiduciaries. They alleged the fiduciaries violated ERISA's exclusive purpose rule, which directed them to diversify company stock if financial conditions warranted it.

The district court ruled against the plaintiffs. The 9th Circuit upheld the decision, saying that even if the standard, as in Moench v. Robertson controlled (a case where plaintiffs successfully sued ESOP fiduciaries for not diversifying in the face of compelling evidence the stock would fall), there was no evidence here that the fiduciaries could or should have known the stock would do poorly as there were no serious financial problems with the company at the time.

Perhaps more interesting, however, are comments made by the court concerning eligible individual account plans (EIAPs), such as ESOPs and stock bonus plans, intended to be primarily invested in company stock. The court said that under the Moench standard, "the plaintiff must show that the ESOP fiduciary could not have believed reasonably that continued adherence to the [plan's terms] was in keeping with the settlor's expectation's of how a prudent trustee would operate." The 9th Circuit said that this standard is difficult to reconcile with ERISA's statutory text exempting EIAPs from the prudence requirement concerning diversification. "Interpreting ERISA's prudence requirement to subject EIAPs to an albeit tempered duty to diversify arguably threatens to eviscerate Congressional intent and the guiding rationale behind EIAPs themselves." This is perhaps the broadest language an appeals court has used in exempting fiduciaries from fiduciary obligations on diversification. The decision emphasized, however, that this argument was not necessary to apply in this case as the facts did not meet even the Moench standard.