In a case of first impression, a federal district court in the Southern District of Texas has ruled that a former parent company’s stock was not an “employer security” under section 407(d)(1) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).[1] As a result, the ERISA exemption from the duty to diversify and the duty of prudence (to the extent the latter requires diversification) were not available where a plan held former parent company stock in a legacy single-stock fund. Although in this case plaintiff participants’ claims were ultimately dismissed, the decision should be on the radar of fiduciaries of plans holding significant amounts of former employer securities.

As background, in 2012, Phillips 66 Company, Inc. (“Phillips 66”) spun off from ConocoPhillips Corporation (“ConocoPhillips”) and sponsored a new defined contribution plan with an employee stock ownership plan (“ESOP”) component, as had ConocoPhillips. In addition to newly issued Phillips 66 stock, however, Phillips 66’s new plan also held more than 25% of its assets in a frozen ConocoPhillips stock fund that was transferred from the old plan in connection with the Phillips 66 spinoff.

When the value of ConocoPhillips stock held by the Phillips 66 plan dropped, participants sued the plan’s investment committee and its members, along with the plan’s financial administrator, alleging imprudence and failure to diversify plan assets in violation of ERISA. In reply, defendants argued that ConocoPhillips stock was not subject to the duty to diversify, as those shares were “employer securities” when issued; ConocoPhillips was previously the employer of the participants. Therefore, defendants argued, ConocoPhillips stock remained exempt from the duty to diversify despite Phillips 66’s spin-off from the ConocoPhillips controlled group.

The court rejected this aspect of defendants’ argument, holding that stock does not indefinitely retain its character as “employer securities” for purposes of ERISA’s diversification and prudence requirements. Ultimately ruling in favor of defendants, the court held that ERISA’s diversification and prudence requirements were not violated because the plan’s investment lineup overall was diversified, public information on the risks of ConocoPhillips stock was reflected in its market price, and because the claims about procedural imprudence lacked factual support in the complaint’s allegations. The Schweitzer court also emphasized that participants were free to shift their ConocoPhillips holdings to other investment options under the plan.

Plaintiffs recently filed an appeal in this case,[2] arguing that the court’s ultimate decision was incorrect. In addition, at least one other federal district court case is pending featuring similar facts and claims, including the meaning of “employer securities” under ERISA.[3]

Finally, it should be also noted that the court’s decision is only an interpretation of “employer security” as defined in ERISA section 407(d)(1) and does not address numerous similar ESOP-related statutory terms, such as “employer securities” or “securities of the employer corporation,” as defined in section 409(l) and section 402(e)(4)(E) of the Internal Revenue Code of 1986, as amended, respectively. Those terms are addressed in the spinoff and reorganization contexts in numerous IRS rulings.

[1] Schweitzer v. Inv. Comm. of the Phillips 66 Sav. Plan, 312 F. Supp. 3d 608 (S.D. Tex. May 9, 2018).

[2] Brief of Appellants, Schweitzer v. Inv. Comm. of the Phillips 66 Sav. Plan, No. 18-20379 (5th Cir. July 31, 2018).

[3] Myers v. Admin. Comm., Seventy Seven Energy, Inc. Retirement & Sav. Plan, No. 17-cv-200-D (W.D. Okla.).