Duty to Investigate
The two fundamental duties of a fiduciary under the common law of trusts are the duties of loyalty and of prudence. With respect to the latter, a plan fiduciary under the Employee Retirement Income Security Act (ERISA) must act with “the care, skill, prudence and diligence under the circumstances that a prudent man would use.”
That is a flexible standard and is context-specific, but some recent cases have drilled down a bit further to ask whether a prudent fiduciary would have taken a specific action. For example, because ERISA’s prudence requirement focuses upon process, rather than results, courts have uniformly held that there is a duty to investigate, research and review a plan’s investment options—and, as ERISA counsel will advise, to document such investigation. In a context such as an employee stock ownership plan (ESOP) in which it is possible to question a fiduciary’s loyalty, fiduciaries are obligated “to engage in an intensive and scrupulous independent investigation of their options to ensure they act in the best interest of their clients.” Such a standard still leaves open, however, what specific actions may be required, an issue discussed in the following cases.
In the ERISA securities litigation involving Lehman Brothers stock, plaintiffs alleged that plan fiduciaries had breached their fiduciary duty by failing to pursue inside information held by others. According to plaintiffs, had the plan committee honored its fiduciary obligation to conduct an independent investigation into the riskiness of Lehman stock, it would have uncovered nonpublic information about the imprudence of continuing to invest in the stock. As the district court wrote, in elaboration on this theory, plaintiff’s premise was that there was a quantum of negative information about Lehman stock troubling enough that a prudent person would have made further inquiries of corporate insiders.
Whether such a duty exists will, however, need to be decided at some future date, because the district court held, and the Court of Appeals for the 2nd Circuit affirmed, that even if such a duty existed, the plaintiffs could not establish a breach of fiduciary duty. To establish a breach of the duty of prudence in this context, the plaintiffs would need to establish that an adequate investigation would have revealed to a reasonable fiduciary that the investment was improvident.
In this case, the plaintiffs failed to explain in a nonconclusory fashion how the defendant’s hypothetical investigation would have uncovered the alleged inside information. There were no specific allegations about what lines of inquiry would have revealed the information or who, in fact, if pressed, would have disclosed it to the defendants.
In Dudenhoeffer v. Fifth Third Bancorp, the Supreme Court held that absent “special circumstances,” a fiduciary “is not imprudent to assume that a major stock market provides the best estimate of the stocks traded upon it.” To attempt to avoid the strict pleading standards of Dudenhoeffer, plaintiffs in Saumer v. Cliffs Natural Resources Inc. alleged that the fiduciaries’ failure “to engage in a reasoned decisionmaking process regarding the prudence of Cliffs stock” constituted a “special circumstance.”
The Court of Appeals for the 6th Circuit disagreed, holding that a fiduciary’s failure to investigate the merits of investing in a publicly traded company does not count as a “special circumstance.” In explaining why a fiduciary’s failure to independently verify the accuracy of the market’s pricing was not a special circumstance, the 6th Circuit indicated that the Supreme Court had specifically stated that an ERISA fiduciary could assume that stock markets provide the best estimate of a security’s value. Furthermore, Dudenhoeffer had reasoned that an investor’s inquiry into a publicly traded company is unlikely to reveal a company’s true value, much less the future course of its stock price. Finally, plaintiff’s theory suffered from the same type of pleading deficiencies as were present in the ERISA securities litigation.
The 6th Circuit explained, while a fiduciary generally must investigate the merits of an investment, its failure to investigate an investment decision alone is insufficient to show that the decision was not reasonable. That is, there must be a link between the failure to investigate and harm to a plan.
Marcia Wagner is an expert in a variety of employee benefits and executive compensation areas, including qualified and nonqualified retirement plans, and welfare benefit arrangements. She is a summa cum laude graduate of Cornell University and Harvard Law School and has practiced law for 31 years. Wagner is a frequent lecturer and has authored numerous books and articles.