Fiduciaries Showing no Compliance with 404(c) Breached Duties

April 21, 2011 ( – A U.S. appeals court has found that where Employee Retirement Income Security Act § 404(c) does not apply, fiduciaries can be liable for allowing retirement plan participants to select company stock as an investment if it is manifestly imprudent to allow them to do so.

In Peabody v. Davis,, the 7th U.S. Circuit Court of Appeals said Andrew Davis and Robyn Kole, trustees of Rock Island Corporation’s (RIC) retirement plan, made no effort to show that the plan complied with ERISA § 404(c), and consequently the question becomes whether carrying out the rollover of Jonathan F. Peabody’s external IRA assets into the plan and subsequently allowing Peabody to remain 98% invested in RIC stock during the company’s decline was consistent with the trustees’ fiduciary duties.  

The appellate court agreed with a district court that a prudent investor would not have remained so heavily invested in RIC’s stock as the company’s profit margins had declined by 70%-80% over a five-year period for reasons that foretold further and continuing declines. The court said “no one was better positioned to know of RIC’s prospects and the future of its stock value than Davis and Kole, who cofounded the company and set the share value.” 

The court noted that the defendants did not justify their failure to divest from RIC stock. “These facts are consistent with circumstances under which sister courts would find it imprudent to continue an investment in company stock,” the court opinion said.  

At the time Peabody rolled over his IRA assets into the plan, the stock was priced at $2,000 per share. When Peabody’s employment with RIC ended in January of 2004, the company gave him several choices for receiving his plan benefits: he could redeem his 835 RIC shares immediately for $215 per share, redeem them in 2005 for $300 per share or redeem them in 2007 for $400 per share. Not satisfied with any of these options, in April of 2004, Peabody entered into a loan agreement with RIC, which agreed to purchase all of his RIC stock for $350 per share in one year. However, when the time came for payment on the loan, RIC informed Peabody that it would be unable to pay.   

Sometime in 2005, RIC went out of business.  

The district court ruled that Davis had breached his fiduciary duty by offering only a loan in payment for the RIC stock and further, that this exchange constituted a “prohibited transaction” under ERISA § 406(a)(1)(B).  

The 7th Circuit’s opinion is here.