On April 12, 2011, US Court of Appeals for the Seventh Circuit issued an opinion in the case of Peabody v. Davis. The key litigated issue was whether the trustees of an eligible individual account plan (EIAP) breached their fiduciary duty under ERISA by allowing an employee's plan account to remain primarily invested in company stock, as the company's profits continuously declined.

Peabody, the plaintiff, was an employee of the defendant Rock Island Corporation (RIC), a closely-held corporation in the securities industry, from 1998 to 2004. In 1999, he rolled over an IRA with investments worth $167,819 into RIC's defined contribution plan, an EIAP, in exchange for receiving a cash bonus from RIC. Due to this arrangement, RIC stock constituted 98% of Peabody's EIAP account. Because RIC was a closely-held corporation, there was no market to price the value of the company's stock. However, the company's internal valuations, which priced the original shares that Peabody purchased at $2,000 per share, reflected a continuous decline in the value of RIC's shares beginning in early 2000.

After Peabody left RIC in January 2004, RIC agreed to buy all of Peabody's shares in his account for a price of $350 per share (or $292,250 plus interest) in one year. In 2005, when the loan was due and Peabody formally requested a distribution, RIC informed Peabody it was unable to pay. Later in 2005, after several years of declining profits, RIC went out of business. (The SEC had issued a new regulatory rule in 2000 which adversely affected RIC's business and caused its profits to decline.)

Peabody sued RIC and the plan trustees under ERISA, alleging a breach of fiduciary duty. The district court held that the trustees violated their fiduciary duty of prudence by maintaining Peabody's plan investment in company stock and failing to distribute Peabody's benefit under the plan during the period when RIC's profits continually and precipitously declined.

On the issue of fiduciary duty, the Seventh Circuit affirmed the District Court's holding, ruling that the trustees breached their fiduciary duty of prudence by allowing Peabody's retirement account to continue to be comprised almost entirely of RIC stock during a lengthy period of declining company profits.

ERISA's fiduciary duty of prudence requires plan trustees to manage investments "with the care, skill, prudence, and diligence under the circumstances then prevailing," which generally includes the requirement that plan assets be diversified. (ERISA § 404(a)(1)(B)). EIAPs are exempt from ERISA's diversification duty, but the duty of prudence still applies.

The Seventh Circuit held that a prudent trustee would not have allowed the Peabody's plan account to remain so overwhelmingly invested in RIC stock during five years of sharp profit declines. ERISA fiduciaries can be liable for allowing participants to select (and to continue to invest) company stock for their retirement plan if it would be "manifestly imprudent" to do so. Therefore, Peabody did not waive his claim under ERISA even though he:

Under ERISA's fiduciary duty of prudence, plan trustees of an EIAP cannot allow plan participants to remain invested in company stock when it is no longer a prudent investment, even if the plan participant originally agreed to such investments and never requested a change in the investment allocation of his plan account.

For more information, see Standard Document, Investment Policy Statement for Defined Contribution Plan Document: Drafting Note: Funding Policy.