Compliance March 23, 2016

Another Review Doesn't Change Lehman Stock Drop Suit Result

The case was sent back through the courts following the U.S. Supreme Court's decision in Fifth Third v. Dudenhoeffer.
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A federal appellate court has again affirmed a decision that participants in Lehman Brothers’ retirement plan did not plausibly argue that the company breached its fiduciary duty by keeping company stock in the plan when it was not prudent to do so.

In 2013, the 2nd U.S. Circuit Court of Appeals upheld an earlier ruling by the U.S. District Court for the Southern District of New York to dismiss the case of Rinehart v. Akers. That ruling was based on the presumption of prudence established in a 1995 decision in Moench v. Robertson. However, following the U.S. Supreme Court’s decision in Fifth Third v. Dudenhoeffer, invalidating the presumption of prudence, the Supreme Court sent the case back to the 2nd Circuit, which then sent the case back to the district court.

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In 2015, the district court again found the plaintiffs failed to allege sufficiently that the Lehman Brothers’ plan committee violated their Employee Retirement Income Security Act (ERISA) duties. The 2nd Circuit affirmed the district court’s decision.

The appellate court noted that while the Supreme Court made clear in Fifth Third that there should be no special presumption of prudence for employee stock ownership plan (ESOP) fiduciaries, “allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or under-valuing stock are implausible as a general rule, at least in the absence of special circumstances.” In addition, for claims alleging a fiduciary breach based on non-public information, the high court held that plaintiffs must plausibly allege an alternative action fiduciaries could have taken and would not have viewed as more harmful to the plan than helpful.

NEXT: Arguments rejected

The plaintiffs in Rinehart argued their case included “special circumstances,” pointing to Securities and Exchange Commission (SEC) orders issued in July 2008 prohibiting the short-selling of securities of certain financial institutions, including Lehman. The 2nd Circuit rejected this argument, saying the orders speak only conditionally about potential market effects resulting from short-sales and do not purport to describe then-existing market conditions. It agreed with the district court that the only plausible inference supported by the plaintiffs’ complaint is that the market processed any risks identified in the SEC’s orders as it would have any public information.

The appellate court also rejected the plaintiffs’ argument that had the retirement plan committee conducted an appropriate independent investigation into the riskiness of Lehman stock, it would have uncovered non-public information revealing the imprudence of investing in the stock. The court said the case includes no specific allegations about what lines of inquiry would have revealed this information, or who would have disclosed it.

In addition, the 2nd Circuit agreed with the district court that the complaint does not plausibly plead facts that show a prudent fiduciary would not have viewed disclosure of non-public information or ceasing to buy Lehman stock as more likely to harm the plan than help it, as dictated by the Fifth Third decision.

The latest opinion in Rinehart v. Akers is here.

The Markets March 23, 2016

Taking the Pulse of Affluent Advisory Clients

More affluent clients of advisory firms often seek out the latest services and strategies—making the group a helpful barometer of investment industry trends and challenges. 
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Discussing a recent AMG Funds survey of affluent Americans with $250,000 in investable assets, Bill Finnegan, the firm’s chief marketing officer, says he hopes investors’ behavior in 2016 will prove to be as positive as their stated intentions.

“Despite the fact that the weeks leading up to our more recent survey brought significant turmoil in the broad equity markets, as represented by the S&P 500 Index falling by 12.2% at one point, investors have not widely hit the eject button on equities,” Finnegan tells PLANADVISER. Some assets moved out of the markets after a difficult January and February, he notes, but the outflows have been more muted than many expected so far this year, especially as equity performance turned more positive in March.

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“It’s still too soon to say what the first quarter will look like in terms of inflows and redemptions, but I think it’s fair to expect that investors will prove pretty resilient,” Finnegan says. “Nearly everyone surveyed, 96%, said they have accepted the fact that ‘moderate’ to ‘very high’ equity market volatility will be experienced in the years ahead. We just have to hope that their actions match their intentions.”

While affluent investors are concerned about short-term swings in equity pricing, they feel some optimism on the fundamentals, Finnegan adds. For example, a majority of those surveyed believe interest rates will rise (64%) and that inflation will increase (54%). While 58% agree that “large swings in the stock market make me very uncomfortable,” just about half (48%) say they accept that “there is no good way to significantly reduce volatility in a portfolio without compromising growth.”

There’s obviously still room for improvement in these stats, Finnegan says, but given the very small number of respondents—just 7%—who indicated they would “sell some or all equity exposure in response to a 20% drop in the market,” investors are apparently starting to absorb some of the lessons advisers have been pushing since the financial crisis—namely, avoiding buying high and selling low.

“Other findings from the survey should serve as a warning to advisers,” Finnegan warns. “Even affluent and engaged clients carry misconceptions and misunderstanding about investing concepts. We found there was some disagreement, for example, as to what it mean to be diversified in today’s markets.”

According to the survey, nearly 50% of investors believe owning a broad range of stocks is enough to provide adequate diversification for a portfolio. “As an adviser, it is important to help clients understand that diversification extends beyond simply investing in a broad range of stocks,” Finnegan explains. “Low correlation is the key to diversification and investors should rely on a variety of asset classes and investment strategies.”

NEXT: Other common misconceptions 

Another commonly used phrase that is widely misunderstood is “alternatives,” the survey results show.

“Just one-third of advised investors owning alternatives understood that they are good for minimizing downside risk,” Finnegan explains. “Nearly two-thirds of all respondents expressed a lack of understanding about alternative investing—and only 10% said they feel highly confident in selecting alternatives on their own.”

For that reason, he agrees with other defined contribution (DC) retirement plan industry commentators that the value of alternatives is best delivered in a pre-packaged and professionally managed context.

There is even some confusion about concepts most advisers will take to be very basic: “What does it mean to be a long-term investor?” On average, Finnegan says, investors defined a long-term investment as nine years, but to 21% of investors, a long-term investment is less than five years. Others cited other time frames as “long-term,” though few pointed to a decade or longer.

“This is discouraging because we know also know that investors tend to hold a given mutual fund, on average, for just a handful of years,” Finnegan explains. “One will always need to make adjustments even to a long-term portfolio, but it is important to set a strategy and stick to it, at least over a full market cycle.”

Also discouraging, Finnegan observes one quarter of all respondents “indicated they would need access to a significant portion of their investments as cash within the next five years,” implying lower growth prospects and other inefficiencies. “This seems consistent with other third-party studies, which show that mutual fund retention rates range between four to five years for equities—and even shorter for bonds.”

Finnegan concludes that, “even for engaged and affluent clients, it is important to make sure you are on the same page with regard to investment horizon, diversification and the other cornerstones of retirement readiness.”

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