Saumer v. Cliffs Natural Res. Inc.

• Decision Date: 07 April 2017
• Docket Number: No. 16-3449,16-3449
• Citation: 853 F.3d 855
• Parties: Paul SAUMER; Walter A. Skalsky, individually and on behalf of all others similarly situated, Plaintiffs-Appellants, v. CLIFFS NATURAL RESOURCES INC., et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

853 F.3d 855

Paul SAUMER; Walter A. Skalsky, individually and on behalf of all others similarly situated, Plaintiffs-Appellants,

v.CLIFFS NATURAL RESOURCES INC., et al., Defendants-Appellees.

No. 16-3449

United States Court of Appeals, Sixth Circuit.

Decided and Filed: April 7, 2017

ON BRIEF: Edward W. Ciolko, Mark K. Gyandoh, Julie Siebert-Johnson, KESSLER TOPAZ MELTZER & CHECK, LLP, Radnor, Pennsylvania, for Appellants. John M. Newman, Geoffrey J. Ritts, Adrienne Ferraro Mueller, Emmett E. Robinson, JONES DAY, Cleveland, Ohio, for Appellees.

Before: MERRITT, COOK, and McKEAGUE, Circuit Judges.

OPINION

COOK, Circuit Judge.

The Employee Retirement Income Security Act ("ERISA") regulates employer-administered retirement plans. To safeguard employees' retirement assets, ERISA requires plan fiduciaries to, among other things, manage plan assets prudently and diversify investments "so as to minimize the risk of large losses." 29 U.S.C. § 1104(a)(1). For the past forty years, however, ERISA has also encouraged employee ownership of employer stock. To promote this goal, ERISA permits companies to offer an Employee Stock Ownership Plan ("ESOP")—a retirement option designed to invest primarily in employer stock. Id. § 1107(d)(6)(A). Because ESOPs are, by definition, not prudently diversified, Congress fashioned an exemption to these core fiduciary duties: "the diversification requirement ... and the prudence requirement (only to the extent that it requires diversification) of [§ 1104(a)(1)are] not violated by acquisition or holding of [employer stock]." Id . § 1104(a)(2).

This case requires us to reconcile ERISA's requirement that a fiduciary act prudently with its blessing of undiversified ESOPs.

I.

Cliffs Natural Resources ("Cliffs") is a publicly traded iron-ore and coal-mining company. Cliffs's business depends on the price of iron ore, which in turn depends on Chinese economic growth. In 2011, Chinese construction projects drove iron-ore prices to all-time highs. Betting on continued high prices, Cliffs financed the purchase of a mine located in Northern Quebec ("Bloom Lake Mine"). Projecting that the mine would increase cash-flow, Cliffs upped its stock dividend to double the S&P 500 average.

In 2012, a global demand slump halved the price of iron ore, cutting deeply into Cliffs's revenue. The Bloom Lake Mine quickly turned from the company's lifeblood to, in the words of Cliffs's CEO, "the cancer

that we have to take out." The mine's costs exceeded predictions, often by significant margins. And the company's decreased revenue and high costs exacerbated its financial weakness. The market responded: in 2013, Cliffs stock performed worse than any other company in the S&P 500. All told, Cliffs lost 95% of its value between 2011 and 2015 (compared to a roughly 50% gain for the broader market during the same period).

Plaintiffs are Cliffs employees who participated in the company's defined-contribution plan, commonly known as a 401(k). The plan allowed participants to invest in twenty-eight mutual funds, including an array of target-date, stock, and bond funds. The plan also offered an ESOP that invested solely in Cliffs stock. Employees enjoyed discretion about whether to invest their income and matching contributions in the ESOP. If the employee failed to choose an investment option, the fiduciary directed contributions into a money-market fund.

After Cliffs stock cratered, plaintiffs filed a class action claiming that the plan's fiduciaries—investment-committee members and corporate officers—imprudently retained Cliffs stock as an investment option. In particular, plaintiffs allege that it was imprudent to continue investing in Cliffs stock because 1) the company's "risk profile and business prospects dramatically changed from when the investment was introduced ... due to ... the collapse of iron ore and coal prices" and Cliffs's deteriorating financial condition, and 2) the fiduciaries possessed inside information showing that the stock was overvalued.

The defendants filed a motion to dismiss, which the district court granted. For the following reasons, we AFFIRM.

II.

We review de novo the district court's dismissal of a complaint for failure to state a claim. Bennett v. MIS Corp. , 607 F.3d 1076, 1091 (6th Cir. 2010) (citations omitted). We "accept all well-pleaded factual allegations as true and construe the complaint in the light most favorable to plaintiffs." Id. (citation omitted). To survive a motion to dismiss, the complaint must include sufficient factual allegations to state a plausible claim to relief. Ashcroft v. Iqbal , 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009).

III.

Courts have struggled to define a fiduciary's duties when administering an ESOP. To understand why, one must grasp the "efficient market hypothesis" and the importance of diversification to prudent portfolio construction.

The efficient market hypothesis posits that "a stock price on an efficient market reflects all publicly available information." Coburn v. Evercore Trust Co. , 844 F.3d 965, 969 (D.C. Cir. 2016). According to the theory, "a security price in an efficient market ‘represents the market's most accurate estimate of the value of a particular security based on its' " risk profile and expected future earnings. Id. (quoting Yesha Yadav, How Algorithmic Trading Undermines Efficiency in Capital Markets , 68 Vand. L. Rev. 1607, 1633 (2015) ). Fiduciaries may therefore rely on a "security's market price as an unbiased assessment of the security's value in light of all public information." Fifth Third Bancorp v. Dudenhoeffer , ––– U.S. ––––, 134 S.Ct. 2459, 2471, 189 L.Ed.2d 457 (2014) (quoting Halliburton Co. v. Erica P. John Fund, Inc. , ––– U.S. ––––, 134 S.Ct. 2398, 2411, 189 L.Ed.2d 339 (2014) ).

Because new information and changing circumstances can alter the market's assessment of a company's value—and cause extreme fluctuations in a security's price—ERISA requires fiduciaries to diversify their investments. See 29 U.S.C. § 1104(a)(1). By purchasing multiple securities, fiduciaries can mitigate company- and industry-specific risks. See Summers v. State St. Bank & Trust Co. , 453 F.3d 404, 409 (7th Cir. 2006). Furthermore, by investing in multiple asset classes (real estate, domestic stocks, foreign stocks, bonds) that respond differently to market-wide economic events—such as recessions, wars, or elections—a fiduciary can craft a portfolio with an acceptable expected rate of return and limited volatility. See Restatement (Third) of Trusts § 90 cmt. g (Am. Law Inst. 2007).

An investor's decision to eschew diversification and instead invest in only a single stock can be calamitous. Many blue-chip companies—Eastman Kodak, Lehman Brothers, General Motors, Enron, Delta Airlines, to name a few—have declared bankruptcy, resulting in staggering losses to shareholders. Many other well-known companies have suffered losses in excess of 80%, far worse than the losses that the overall market suffered during the Great Recession. (American Express, Amazon, Starbucks, Texas Instruments, Intel, Time Warner, Celgene, Cooper Tire, International Paper, JC Penney, General Electric, among many others, have suffered such losses since the turn of the century.) Among smaller companies, huge losses are even more common. For retirees regularly withdrawing money from their investments, such downturns—even if the stock's price eventually recovers—are financially devastating.

Because ESOPs invest primarily in a single stock, they expose participants to the risks inherent in an undiversified portfolio. And by investing primarily in their employer, participants take on even greater risk because their other sources of security—their income, health insurance, and if the company is a large regional employer, their home value—are intertwined with the employer's health.

Congress's imposition of strict prudential standards is therefore in tension with its blessing of undiversified ESOPs. On the one hand, the "central feature" of prudence is the reduction of risk through diversification, Restatement (Third) of Trusts § 90 cmt. g; on the other hand, investing primarily in one's employer exposes retirees to excessive company-specific risk.

IV.

Plaintiffs first contend that publicly available information revealed Cliffs's declining revenues, high operating costs, and unmanageable debt. Thus, plaintiffs argue that the fiduciary's decision to invest in "Cliffs stock was imprudent ... because its risk profile and business prospects dramatically" deteriorated during the class period. According to plaintiffs, even if the market accurately priced Cliffs stock, the company's "risk profile exceeded the reasonable bounds for a retirement option within a plan meant for retirement savings."

The Moench Presumption. In evaluating these types of claims, several courts, including the Sixth Circuit, reconciled ERISA's prudence requirement with its approval of ESOPs by applying a now-defunct presumption: "an ESOP fiduciary who invests the [retirement] assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision," Moench v. Robertson , 62 F.3d 553, 571 (3d Cir. 1995), abrogated by Dudenhoeffer , 134 S.Ct. at 2467, unless the "company faced ‘impending collapse’ or ‘dire circumstances' that could not have been foreseen by the founder of the plan," White v. Marshall & Ilsley Corp. , 714 F.3d 980, 989 (7th Cir. 2013) (collecting cases), abrogated by Dudenhoeffer , 134 S.Ct. at 2467. When circumstances present "unusually severe financial risks to participants," the fiduciary must ignore the ESOP-plan instructions and diversify the plan's holdings. Id. at 990 (citing Steinman v. Hicks , 352 F.3d 1101, 1106 (7th Cir. 2003) ); see also Kuper v. Iovenko , 66 F.3d 1447, 1459 (6th Cir. 1995) (adopting the Moench presumption), abrogated by Dudenhoeffer , 134 S.Ct. at 2467.

The Moench Presumption's Shortcomings. The Moench presumption failed to...