Earlier this week, in a crowded Supreme Court courtroom, lawyers and justices debated the ERISA fiduciary duties of employers who sponsor employee stock ownership plans (ESOPs) and who are alleged to have “inside information” that should reasonably lead them to conclude that the stock will decline in value (a so-called “stock drop”). The justices heard argument from the plaintiffs, defendants and the U.S. Solicitor General in the case of Fifth Third Bancorp v. Dudenhoeffer.
The Court accepted the Dudenhoeffer case to consider the following question:
Whether the Sixth Circuit erred by holding that [participants] were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan abused their discretion by remaining invested in employer stock, in order to overcome the presumption that their decision to invest in employer stock was reasonable, as required by the Employee Retirement Income Security Act of 1974 * * * and every other circuit to address the issue.
Because many employers offer the option of investing in similar company stock funds, amicus briefs in support of Fifth Third Bancorp (Fifth Third) and urging reversal were filed by the U.S. Chamber of Commerce, the American Benefits Council, the ERISA Industry Committee, the National Association of Manufacturers and others. The Solicitor General and supporters of the plaintiffs’ ERISA bar — including AARP and the AFL-CIO — filed amicus briefs arguing that the Sixth Circuit’s decision should be affirmed.
Seven other circuit courts of appeal have held that the congressional policy of encouraging employee stock ownership requires that ERISA fiduciaries be given the presumption of prudence when offering participants an option to invest in company stock. These courts generally require allegations by the plaintiff that the company faced dire financial circumstances, not merely a drop in the company’s stock price, in order for the presumption to be rebutted and for plan fiduciaries to be subject to claims for breach of their ERISA fiduciary duties for continuing to allow the plan to hold employer stock.
In stark contrast, the Sixth Circuit held that whether a fiduciary acts prudently by offering an employer stock fund turns on whether a “prudent fiduciary acting under similar circumstances would have made a different investment decision.” Dudenhoeffer v. Fifth Third Bancorp, 692 F.3d 410, 418-19 (6th Cir. 2012), cert. granted, 82 U.S.L.W. 3364 (U.S. Dec. 13, 2013) (No. 12-751). The Sixth Circuit agreed that a presumption of prudence would be appropriate in these circumstances, but only at the summary judgment and trial stage of the lawsuit, after plaintiffs had the opportunity for extensive and expensive discovery against the fiduciaries.
Thus, the procedural question presented in Dudenhoeffer is of major significance in determining the viability of a stock-drop claim. As one amicus brief stated in arguing for reversal, “expensive and time-consuming discovery inexorably follows the failure to dismiss an unmeritorious claim, which pressures plan fiduciaries to settle regardless of the suit’s lack of merit.” Brief for Chamber of Commerce of the United States, the ERISA Industry Committee, the American Benefits Council, the Plan Sponsor Council of America and the National Association of Manufacturers, at p. 5.
Facts Alleged in Dudenhoeffer
The complaint in Dudenhoeffer made allegations common to most ERISA stock-drop cases.
Fifth Third maintained a Section 401(k) retirement plan that provided for participant-directed investments. The plan offered several investment options for participants, including the company stock fund and 17 mutual funds. As is frequently the case with such plans, particularly those sponsored by employers whose stock is publicly traded, the company stock fund was structured to qualify as an ESOP for purposes of ERISA and the Internal Revenue Code. The company matched 100 percent of the first 4 percent of an employee’s compensation with company contributions to the Fifth Third stock fund, but permitted participants to reinvest the matching contribution in other investment options.
Like many financial institutions, Fifth Third experienced a substantial decline in its stock price from July 2007 to September 2009, causing the stock fund to lose tens of millions of dollars. Plaintiffs argued in their lawsuit that the fiduciaries violated ERISA fiduciary duties by holding and purchasing shares of Fifth Third long after it ceased to be prudent to do so.
The district court dismissed the lawsuit, finding that the company was entitled to a presumption that its continued investment in company stock was reasonable. The Sixth Circuit reversed, reasoning that plaintiffs had sufficiently alleged that the fiduciaries had violated their fiduciary duty and caused the losses to the plan. The Sixth Circuit ruled that the presumption is not to be applied at the pleading stage of the lawsuit.
Supreme Court Argument
The justices surprised most observers by focusing much of the hour-long argument on what an ERISA fiduciary must do if it has inside information that employer stock held by an ESOP is overvalued. Except for a few brief references, the justices did not discuss the question presented of whether a presumption of reasonableness applies at the pleadings stage of a stock-drop lawsuit.
During the argument, justices questioned whether Fifth Third’s counsel was proposing a lower level of responsibility for ESOP fiduciaries (“coach-class” duties, as Justice Kennedy put it). Fifth Third’s counsel argued that duties of an ESOP fiduciary should be understood in the context of a congressional intent to encourage retirement savings through investment in company stock and that a fiduciary’s ERISA obligations to ESOP participants should not be defined in a way that thwarts that intent.
The justices questioned plaintiffs’ counsel as to actions a fiduciary with inside information concerning employer stock should take. Chief Justice Roberts questioned counsel as follows:
CHIEF JUSTICE ROBERTS: Well, can we talk concretely instead of just saying, well, they’ve got to do what a prudent fiduciary can do? Are they allowed to take into account the impact of a decision to stop buying on the beneficiaries? The stock is going down, if the trustee stops buying, that’s going to cause a drop in the value of the shares and that’s going to hurt the beneficiaries. So what does he do? Does he say, I shouldn’t buy any more because I think it’s going to go down some more? Or should he say, I should keep buying because otherwise all of the holdings, and this is all they are invested in, their holdings are going to go down?
MR. MANN: I think the obligation of the fiduciary at all times is to behave prudently in managing investment prudently. There might –
CHIEF JUSTICE ROBERTS: I asked for an answer to the question. And I — it doesn’t — it’s not going to help me to have this mantra as opposed to –
MR. MANN: Well, I don’t — I don’t believe that the question is whether they must sell or mustn’t sell. I think they have to decide would it be in the — based on the facts we know right now, do we believe that this is a short-term blip in the stocks and it will rise back up, in which case, we –
Official transcript of oral argument in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, April 2, 2014 (Transcript), pp 38-39.
During the Solicitor General’s argument (who supported the participants), the justices pressed the question of what actions a fiduciary with inside knowledge should take. The justices raised questions as to whether a fiduciary’s decision to merely stop purchasing more shares would be sufficient to protect participants’ interests, as the market would likely interpret that action as raising concerns over the value of employer stock.
Counsel for both sides debated the fundamental nature of ESOPs, with counsel for Fifth Third emphasizing the goal of employee ownership over the goal of providing retirement savings, a point that did not seem to impress the justices.
Justice Ginsberg flatly questioned the appropriateness of a presumption of prudence: “[Apart from no duty to diversify the ESOP], the statutory requirement on loyalty and prudence is undiluted. And so I don’t see where this presumption comes from.” Transcript, pp. 6-7.
Where Will the Court Go from Here?
On balance, it is hard to predict how the Court will decide this case. Some justices appear to appreciate the limited options that an ESOP fiduciary has in these circumstances and may understand why seven courts of appeal have adopted the presumption of prudence. However, the justices do not appear interested in providing ESOP fiduciaries with a lesser standard of diligence.
A majority of the justices seemed to be looking for a better solution than the presumption of prudence, but seemed dissatisfied with the proposals offered by plaintiffs’ counsel and the government. Justices Sotomayor and Ginsberg seemed inclined to the view that ESOP fiduciaries with potential inside information know they may have this dilemma and must suffer the consequences.
The Court is expected to issue an opinion in June. We expect a split decision.