Breach of fiduciary duty class actions under the Employee Retirement and Income Securities Act ("ERISA") are as common as the day is long. If an employee pension plan loses a lot of value, odds are good there will be a lawsuit.

Unsurprisingly, the federal courts have clamped down on these lawsuits over the years. As the United States Court of Appeals for the Third Circuit (Pennsylvania, New Jersey and Delaware) just reaffirmed,

in the context of an ERISA plan that offers employees the option of investing in a fund consisting solely of the employer’s own securities, there is a "presumption that a fiduciary acted prudently in investing in employer securities" and that, to rebut the presumption, "a ‘plaintiff must show that the ERISA fiduciary could not have believed reasonably that continued adherence to the [Plan’s] direction was in keeping with the settlor’s expectations of how a prudent trustee would operate.’"

Ward v. Avaya Inc., (3d Cir. 2008, November 13, 2008, Jordan, J.)(on appeal from the District of New Jersey). The Third Circuit again rejected that "a company to be on the brink of bankruptcy before a fiduciary is required to divest a plan of employer securities," but held, in essence, that if the plaintiffs cannot show the stock plummeting and staying in the gutter, then they cannot win as a matter of law. In holding the plaintiffs cannot overcome the presumption as a matter of law, the Court describes:

At the outset of the class period immediately following the spin-off on September 30, 2000, Avaya’s stock traded at $ 22.18 a share. As Ward takes pains to point out, it initially lost much of that value, and by August 2, 2002, after fluctuating significantly for some time, it reached a low of $ 1.15 a share. By April 25, 2003, the day after Ward’s Count II class period ended, Avaya stock was trading at $ 3.24 per share. Following the end of the class period, however, Avaya’s stock continued to rise and, by August 2003, was trading at around $ 10.00 a share. Between October and December 2003, the stock was trading between $ 12.00 and $ 14.00 a share. During 2004, Avaya stock usually closed at between $ 12.00 and $ 16.00 a share. Commensurate with its rising stock price, Avaya reported significant positive net income in 2003 and 2004. Further, like the plaintiff in Edgar and unlike the plaintiff in Moench, Ward’s complaint fails to point to anything other than Avaya’s financial struggles to support his breach of fiduciary duty claim.

The frustrating part here is that of course the plaintiff had no direct evidence, their case was dismissed under Fed.R.Civ.P. 12(b)(6) before they could conduct discovery. The message from the Third Circuit is thus loud and clear: if the company’s stock has regained a substantial portion of its value, don’t bother filing suit.

I have plenty of sympathy for the defendants here, directors who almost certainly did, in fact, believe they were simultaneously acting in the best interests of the company and the retirement plan beneficiaries. No could blame them for believing in the eventual success of their own company, and the company did, in fact, regain at least two-thirds of its prior market value, more than 10 times its lowest value just two years prior to that.

But that’s precisely the problem — of course the directors will believe in the eventual success of their own company. Indeed, aside from company officers, who could possibly be less objective about their own company? They’re supposed to believe in the company’s success, even against the odds.

The core problem, as the Third Circuit noted, is that "as the financial state of the company deteriorates … fiduciaries who double as directors of the corporation often begin to serve two masters. And the more uncertain the loyalties of the fiduciary, the less discretion it has to act." At what point should we expect that a "prudent" director will recognize their own lack of objectivity and step aside? The answer from the Third Circuit appears to be "never," at least not if the stock has regained substantial value.

Maybe, on balance, that makes the most sense, a "no serious harm, no foul" rule. The stock market is inherently unpredictable; if, for example, the directors had moved assets out of Avaya in the spring of 2003, the retirement fund likely would have missed out on Avaya’s dramatic rise in the fall and winter of 2003. You don’t invest your money in a 100% company fund to go willy-nilly at the first sign of trouble.

Nonetheless, though there are many plausible legitimate explanations, it’s troubling to see issues like that decided on a motion to dismiss, denying plaintiffs the chance to see what the explanation actually was. The directors here could have completely breached their fiduciary duties and, after getting ‘lucky,’ still have cost beneficiaries one-third of their pension’s value, potentially even more when compared to the fund’s hypothetical value if it had been managed properly. Yet, the case was over before it started, merely because the fund lost ‘only’ one-third of its value as compared to value on the plaintiff’s class certification date.

Finally, just how common are ERISA breach of fiduciary suits? So common that the Third Circuit held plaintiffs claims were also barred by a prior class action settlement in Reinhart v. Lucent Technologies, Inc., 327 F. Supp. 2d 426 (D. N.J.).