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Emanual Schmalz, Individually, and On Behalf of All Others Similarly Situated v. Sovereign Bancorp

April 17, 2012


The opinion of the court was delivered by: Ditter, J.


This class action involves an employee stock ownership plan and the contention that its participants should not have been offered their employer's stock because of the company's deteriorating financial condition. It is before me on the defendants' motion to dismiss. For the reasons that follow, I will dismiss all but Count IV of plaintiffs' complaint.


The plaintiffs were participants in defendant Sovereign Bancorp, Inc.'s ("Sovereign") employee retirement savings plan. The Plan held Sovereign stock as an investment. The plaintiffs have brought this class action under ERISA §§ 502(a)(2) and (a)(3) on behalf of the Plan and similarly situated participants of the Plan. They allege the defendants breached various fiduciary duties in administering and managing the Plan and its assets during the class period of January 1, 2002 through the present.

The participants were able to choose how their contributions were invested among numerous options, one of which was an employee stock ownership plan ("ESOP"), which invested "primarily in Sovereign stock." The plaintiffs suffered substantial losses which they say are due to the defendants' decision to permit the Plan to hold and acquire Sovereign stock, which lost over 90% of its value in the class period.

More specifically, the plaintiffs claim that defendants breached their fiduciary duty to prudently manage the Plan by continuing to offer Sovereign stock (Count I), failing to provide participants with complete and accurate information (Count II), failing to monitor, remove or replace the Plan fiduciaries (Count III), breaching their fiduciary duty of loyalty by charging an unreasonable rate of interest in connection with the Plan's purchase of Sovereign stock (Count

IV), breaching their fiduciary duty of loyalty by furthering their personal interests at the expense of the Plan (Count V), and breaching their duty as co-fiduciaries (Count VI).

The defendants have moved to dismiss the amended complaint arguing that: (1) the plan required investment in company stock and therefore bars a claim for a breach of fiduciary duty;

(2) the defendants are entitled to a presumption of prudence for their decision to continue to offer the company stock that plaintiffs cannot overcome; (3) plaintiffs fail to allege a disclosure claim;

(4) the interest payments were not prohibited; (5) the fiduciaries did not knowingly act contrary to the best interests of the participants and beneficiaries, and (6) because there is no underlying breach of fiduciary duty, the derivative claims of a breach of co-fiduciary duties and the duty to monitor fail.


A. The parties

The lead plaintiffs in this case, Emmanuel Schmalz and Gail Wentworth, are former employees of Sovereign who were participants in the Sovereign Plan*fn2 and held company stock in their retirement investment portfolios during the class period.

The defendants fall into three classes: the Sovereign Defendants, the Director Defendants, and the Committee Defendants.The Sovereign Defendants include Sovereign Bancorp, Inc., and Fay A. Knabb. Sovereign was the Plan Sponsor and allegedly exercised authority over the management and administration of the Plan and its assets. Knabb was an employee of Sovereign and is alleged to have served as "the Plan Administrator." She and each of the individual Director Defendants*fn3 are alleged to have "exercised discretionary authority with respect to the management and administration of the Plan and/or [had] authority or control over the management and disposition of the Plan's assets." Am. Compl. ¶¶ 16-30.

The Committee Defendants include two committees: the Compensation Committee and the Retirement Savings Plan Committee ("Retirement Committee"). The Compensation Committee is alleged to have administered the "equity compensation programs, including the Plan" through its members: Director Defendants Ehlerman, Fry, Hard, Heard, Heras, Hove, Moran, Ramirez, Rodriguez and Whitworth. The Retirement Committee was charged with administering and monitoring the Plan, approving the Plan's investment policies and guidelines, reviewing the performance of investments, and appointing and retaining trustees for the Plan. It acted through its members: Director Defendants Ehlerman, Fry, Hard, Heard, Heras, Ramirez, Rodriguez, Rothermel, Sidhu, and Troilo.

B. The Structure And Terms Of The Plan

The Plan is a defined contribution plan that covers eligible employees of Sovereign and its subsidiaries. It is actually a combination of two plans, a 401(k) Retirement Savings Plan adopted in 1987, and an Employee Stock Ownership Plan ("ESOP") adopted in 1990. The ESOP is a plan "designed to invest primarily in common stock of [Sovereign]." It was merged with the 401(k) plan, effective November 1, 2004, to form the Sovereign Bancorp, Inc. Retirement Plan at issue here ("the Plan"). The Plan was adopted and maintained "for the benefit of [Sovereign's] employees" to help participants build income for retirement.

1. Administration of the Plan

The Plan explicitly defines the "Duties and Responsibilities of Fiduciaries," assigning Sovereign, by way of its Board of Directors, "sole responsibility for making the contributions provided for under this Plan, and shall have the sole authority to appoint and remove the Trustee,*fn4 and to amend or terminate, in whole or in part, this Plan or the Trust." Plan § 10.1. In addition, Sovereign had "discretionary, final authority to construe and interpret the Plan documents . . . Any construction, interpretation, or application of the Plan by the Company shall be final, conclusive and binding." Plan §§ 10.14, 12.1, 14.1.

In addition, Sovereign had "the sole responsibility for the administration of this Plan," but was permitted to "appoint an Administrative Committee to discharge its duties as Plan administrator." Plan § 10.1. Sovereign did appoint such a committee: the Retirement Committee.*fn5

All of the contributions under the Plan were to be paid to the Trustee to be deposited into the Trust Fund and retained for the exclusive benefit of the participants and beneficiaries. The Retirement Committee was granted the power to direct the Trustee's purchase of Company Stock. In addition, if a Participant chose not to direct the balances in his or her Accounts, the amounts were "invested in an investment vehicle selected by the [Retirement Committee]." Plan § 8.2.

2. Investing Under the Plan

The Plan allows participants to build income in their Plan accounts from two sources: 1) pre-tax deferrals (the amount participants contribute to the Plan on a pre-tax basis); and 2) matching contributionsthat may be made by Sovereign.

a. Pre-Tax Deferral Investments Options

Participants had "the right to elect from among one or more separate and distinct investment vehicles designated by the Company and made available from time to time including the Company's common stock." Plan § 8.2. The Plan offered Participants fifteen investment options, including Sovereign Common Stock.

Plan Participants were expressly notified of the risk of investing in the Sovereign Stock Fund. In the Plan's "Risk of Investment" section, it cautioned: "Each Participant and Beneficiary shall assume all risk connected with the fluctuation in value of the balances in his Account."

Plan § 11.5. The Summary Plan Description*fn6 ("SPD"), provided to all participants, further warned participants: "[T]he Sovereign Stock Fund is different from the Plan's other investment funds. It invests only in one security -- Sovereign common stock -- instead of a diversified portfolio of investment like the other funds. If you hold investments in the Sovereign Stock Fund, you should be aware that there is a risk to holding substantial portions of your assets in the securities of any one company, as individual securities tend to have wider price swings, up and down, in shorter periods of time than investments in diversified investment funds." SPD at 16.

The Plan also stated that "[t]o the extent a Participant exercises control over the assets in his Accounts," there can be no breach of fiduciary duty for any loss that "results from such Participant's exercise of control and investment direction." Plan § 8.3.

Sovereign stock represented a major portion of the total invested assets of the Plan throughout the Class Period.

b. Matching Contributions

Sovereign made a matching contribution of 100% of the first 3% of eligible compensation contributed to the Plan, plus 50% of the next 2% of a participant's contributed compensation. Plan § 3.1(c). The Plan states that Sovereign "may contribute cash or shares of Company Stock, or both, in such amounts as may be determined by the Board of Directors." Plan § 3.1(e). The SPD explains that "[c]ontributions to your Sovereign ESOP Contribution Account are primarily invested in shares of Sovereign common stock," and that the contributions "are invested in the Sovereign Stock Fund when they are initially contributed to the Plan.

SPD at 18. After match contributions are deposited into your Account, you may elect to transfer the contributions into the Plan's other investment funds, subject to certain limitations . . ." SPD at 15 (emphasis added).*fn7

The SPD states that "Sovereign currently contributes the matching contribution in the form of Sovereign common stock." SPD at 11. The Board of Directors amended the Plan on June 19, 2002, to state that "[t]he matching contribution will be made in the form of Employer common stock." Res. Of Bd. Of Dir. (June 19, 2002) at ¶ 9 (emphasis added).

C. Company Activity in the Class Period

In May 2006, Sovereign began expanding its auto-loan business from the Northeast into the Southeast and Southwest. In addition to this expansion, Sovereign acquired Independence Community Bank Corp. ("Independence") in June 2006. Through Independence, Sovereign created its Metro New York segment in an attempt to expand its operations to the New York City metropolitan area.

By the end of 2007, Sovereign wrote off $76.2 million in charges for auto loans. Sovereign reported that it lost $1.6 billion, or $3.34 per share, in the fiscal fourth quarter of 2007, and $1.3 billion, or $2.85 per share, in the full 2007 fiscal year. Am. Compl. at ¶ 143. In January 2008, Sovereign announced it would end its auto-loan operations in nine states. The following month, Sovereign announced that the goodwill impairment charge (the write off of intangible assets) for its Metro New York segment was $943 million. Id. at ¶ 93 Over the same time period the value of Sovereign's stock declined. "The price of Sovereign stock fell from $26.42 on February 20, 2007 to $2.33 on September 29, 2008 (a 91.2% drop) . . .." Opp. to MTD at 5-6. In addition to this decline in stock value, on April 23, 2008, Moody's Investors Service lowered Sovereign's credit rating two levels from an A3 to a Baa2.

On October 13, 2008, Sovereign's Board of Directors approved the sale of the company to Banco Santander Central Hispano. That same day, Sovereign filed an SEC report noting a net loss of $982 million.


A. Pleading Standards

The initial complaint was filed on February 21, 2008, and the amended complaint was filed on July 23, 2008. At the time of both filings, the Third Circuit had ruled that the pleading standards set forth in Twombly were not limited to the anti-trust context. The plaintiffs are therefore required to meet the Twombly standard, which "'does not impose a probability requirement at the pleading stage,' but instead 'simply calls for enough facts to raise a reasonable expectation that discovery will reveal evidence of' the necessary element." Phillips v. County of Allegheny, 515 F.3d 224, 234 (3d Cir. 2008) (quoting Bell Atl. Corp. v. Twombly, 127 S. Ct. 1955, 1965 (U.S. 2007)).

Generally, claims for breach of fiduciary duty under ERISA are governed by Federal Rule of Civil Procedure 8(a). I must accept as true all of plaintiffs allegations, but I am not required to credit conclusory statements of law. To survive a motion to dismiss, the plaintiffs cannot rest on a "formulaic recitation of the elements" or mere "labels and conclusions," but must set forth a plausible claim for relief. Twombly, 127 S. Ct. at 1964-65.

To the extent that the complaint sets forth claims that sound in fraud, such as plaintiffs' allegations of false and material misstatements, they are subject to the heightened pleading requirement of Federal Rule of Civil Procedure 9(b). See, e.g., Johnson v. Radian Group, Inc., No. 08-2007, 2009 U.S. ...

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