By Adrienne L. Robertson
Decision provides a useful roadmap for plan fiduciaries.
Fiduciaries of Employee Stock Ownership Plans (ESOPs), defined contribution plans that include an ESOP, and plans that include employer stock have generally been able to rely on a special “presumption of prudence” when challenged in court over their decisions to continue to buy employer stock or offer that investment option if the stock has substantially declined in value. In Fifth Third Bancorp v. Dudenhoeffer (573 U.S. ___ (2014)), the U.S. Supreme Court held that there is no special presumption of prudence applicable to fiduciaries with respect to employer stock. The Court has, however, provided a roadmap to the lower courts to use in evaluating whether a claim can proceed, the threshold for which may not be particularly easy for plaintiffs to meet. This roadmap also serves as guidance to plan fiduciaries in connection with employer stock investments.
In the Fifth Third case, former employees brought suit against Fifth Third Bancorp. The plaintiffs alleged, in a “stock drop” case, that the fiduciaries of the ESOP sponsored by Fifth Third breached their ERISA duty of prudence by continuing to invest in employer stock that the fiduciaries either knew or should have known was inflated in value, and which subsequently lost almost three-quarters of its value. The district court dismissed the case on the grounds that the plaintiffs’ allegations were insufficient to overcome the special presumption of prudence. The Sixth Circuit reversed that decision, reasoning that the presumption of prudence did not apply at the pleading stage.
The Supreme Court took the Fifth Third case in order to consider whether a presumption of prudence applies to ESOP fiduciaries (sometimes called the “Moench presumption” for an oft-cited Third Circuit ruling). It evaluated several arguments set forth by Fifth Third. Specifically, the Court considered whether the presumption of prudence should apply because 1) it is consistent with the intent of Congress in fostering employee ownership of employer stock; 2) the terms of the Fifth Third ESOP plan document commanded the ESOP fiduciaries to invest in employer stock, effectively waiving the duty of prudence with respect to investment in employer stock; 3) enforcement of a duty of prudence without the protection provided by a presumption of prudence would create an inherent conflict with prohibitions on insider trading; and 4) without a presumption of prudence, frivolous lawsuits would abound, which would deter companies from offering ESOPs.
No Special Presumption of Prudence
The Court unanimously agreed that there is no special presumption of prudence uniquely applicable to fiduciaries with respect to ESOPs or the decision to offer an employer stock investment alternative. It ruled that ERISA narrowly alleviates only the duty to diversify within an ESOP and alleviates the duty of prudence only with respect to diversification. These narrow provisions do not give rise to a greater presumption of prudence. With respect to the argument that the plan document mandated an investment in employer stock and that the fiduciaries could not act contrary to the document, the Court found that the documents cannot excuse fiduciaries from their duties under ERISA.
Drinker Biddle Note: Fiduciaries should be aware that provisions within plan documents that expressly require investment in employer stock do not eliminate the duty of fiduciary prudence with respect to continued investment in employer stock. Sponsors of plans that state that fiduciaries must invest in employer stock may wish to revisit the wording of this provision.
The Court also considered the argument that, without a presumption of prudence, fiduciaries, who are often company insiders, will be faced with conflicts regarding their responsibilities under securities laws. For example, an officer with insider information who believes that continued investment in employer stock may not be prudent could not act on that information without violating the insider trading prohibitions. The Court found that this was a legitimate consideration, but not one that created the necessity of a presumption of prudence. Finally, with respect to the argument that absent a presumption of prudence participants might be more inclined to bring meritless lawsuits, the Court acknowledged that this is also a legitimate concern and that district courts could address this through careful scrutiny of the complaint’s allegations, rather than a presumption of prudence.
A Roadmap for the Lower Courts and for Plan Fiduciaries
In vacating the Sixth Circuit’s decision and remanding the case for reconsideration, the Court provides a roadmap of the elements of judicial consideration in determining whether plaintiffs have stated a plausible claim. The Court instructed the lower court to use the pleading standard established in prior cases (that only a complaint that states a plausible claim for relief can survive a motion to dismiss, and that determining whether a complaint states a plausible claim for relief is context-specific).
The Court laid out key considerations to be taken into account in determining whether a claim alleging a breach of the duty of prudence in the context of a stock drop scenario will meet the “plausible claim” pleading standard:
Publicly available information: Where a stock is publicly traded, allegations that a fiduciary should have recognized, from public information alone, that the marketplace was either over- or under-valuing employer stock are “implausible as a general rule,” absent special circumstances. As a result, generally a fiduciary will be not considered imprudent when assuming that the market value of employer stock on a major exchange provides the best estimate of the stock’s value. The Court did not elaborate on what circumstances might give rise to a situation where reliance on the stock price as set on a public exchange is not considered prudent.
- Insider information: A claim for the breach of the duty of prudence on the basis of inside information will not withstand a motion to dismiss unless the plaintiff plausibly alleges another course of action that the fiduciary could have taken. To be plausible, the course of action must be must be one that does not violate or conflict with securities laws. Also, the course of action must be one that a prudent fiduciary in the same situation would not have viewed as more likely to harm the employer stock fund than to help it (e.g., could a prudent fiduciary have concluded that ceasing investment in employer stock, or selling stock, would have caused or worsened a decline in the value of the stock). The Court suggested that SEC input on this aspect may be relevant to the analysis.
The Court observed that the Sixth Circuit had not referenced any special circumstances in the Fifth Third case that would have rendered the fiduciaries’ reliance on the market price of the Fifth Third stock imprudent. It also noted that, to the extent the Sixth Circuit was basing its decision on the theory that the fiduciaries should have sold Fifth Third stock based on insider information, the denial of dismissal was erroneous because ERISA’s duty of prudence cannot require an ESOP fiduciary to perform an action, such as selling employer stock on the basis of insider information, that would violate federal securities laws. This suggests the possibility that, upon remand, the Fifth Third case may not survive the motion to dismiss.
Drinker Biddle Note: Since plan fiduciaries can no longer rely on a presumption of prudence with respect to the investment in employer stock, they should have procedures in place to regularly review the prudence of acquiring or retaining employer stock. Fiduciaries should ensure those procedures are being followed and the process documented. Fiduciaries will also need to determine how best to evaluate the value of employer stock.
The elimination of the presumption of prudence should not discourage employers from including or retaining employer stock in their retirement plans. The Court’s decision should prove to be of benefit in creating a functional roadmap for both courts and plan fiduciaries. Plan document language mandating investment in employer stock will not be enough. Future court challenges will likely provide some guidance as to what special circumstances are relevant with respect to reliance on publicly available information. In the meantime, fiduciaries that have not already done so will need to develop and follow processes for monitoring employer stock, and the process should be documented.