On June 25, 2014, the Supreme Court held in Fifth Third Bancorp v. Dudenhoeffer1 that fiduciaries of employee stock ownership plans (ESOPs) are not entitled to a “presumption of prudence” in determining whether the plan’s purchase and holding in employer stock satisfies ERISA’s fiduciary duty of prudence. This decision overturns well-established Circuit Court precedent developed in the avalanche of ERISA employer stock-drop cases that recognized, in various forms, a fiduciary-friendly presumption of prudence.
The Circuit Courts developed the presumption of prudence to address the tension between ERISA’s strict fiduciary duties and Congress’s well-documented intent to promote employee ownership through ESOPs and other individual account retirement plans.2 The Supreme Court, however, found no statutory basis for the presumption. Noting that pursuant to Section 404(a)(2) of ERISA Congress expressly provided ESOP fiduciaries with relief from some of ERISA’s fiduciary duties with respect to employer stock investments by exempting them from ERISA’s diversification requirement and prudence requirement (to the extent it requires diversification), the Supreme Court concluded that, except as provided by Section 404(a)(2), “ESOP fiduciaries are subject to the duty of prudence just as other ERISA fiduciaries are.”
Among the questions answered by the Supreme Court is whether a fiduciary is afforded protection from breach of fiduciary duty claims relating to the purchase and holding of employer stock where the plan by its terms requires investment in employer stock. The Supreme Court answered this question by noting that “the duty of prudence trumps the instructions of a plan document, such as an instruction to invest exclusively in employer stock even if financial goals demand the contrary.”
Although the decision is plaintiff-friendly in that it overturns the presumption of prudence, it does not leave fiduciaries empty-handed. The Supreme Court recognized, like the Circuit Courts, that Congress sought to encourage the creation of ESOPs, but determined that protection from meritless lawsuits against fiduciaries should come from “careful, context-sensitive, scrutiny” by the courts of the plaintiff’s breach of fiduciary duty claims, rather than from a presumption of prudence. This should raise the pleadings bar.
Helpfully for fiduciaries, the Supreme Court addressed some commonly-asserted breach of fiduciary duty claims relating to employer stock investments. The Supreme Court stated that, in the publicly traded context, allegations that a fiduciary should have recognized from publicly available information that the market was incorrectly valuing employer stock are, as a general matter, insufficient to state a claim. Further, the Supreme Court noted that, in order to state a breach of prudence claim on the basis of inside information, the complaint must “plausibly allege” an alternative action that the fiduciary could have taken that, among other things, would have been consistent with the securities laws. This settles the question as to whether a fiduciary with inside information might be required to sell employer stock on the basis of material inside information in violation of applicable securities laws. The Supreme Court also addressed situations where a complaint alleges that an ESOP fiduciary should have refrained from making additional purchases of employer stock on the basis of inside information or should have publicly disclosed the inside information to the markets. Here, the Supreme Court stated that “courts should consider the extent to which an ERISA-based obligation either to refrain on the basis of inside information from making a planned trade or to disclose inside information to the public would conflict with the complex insider trading and corporate disclosure requirements imposed by the federal securities laws or with the objectives of these laws.” The Court went on to state that courts should consider whether the complaint has “plausibly alleged” that a prudent fiduciary could not have concluded that taking any of those actions would have done “more harm than good to the fund by causing a drop in the stock price.”
Unfortunately for employers and ESOP fiduciaries, Dudenhoeffer is unlikely to bring the era of employer stock drop cases to an end. On the positive side, however, the Supreme Court’s emphasis on scrutinizing pleadings is helpful. In light of the decision, employers sponsoring ESOPs should consider reviewing the structure and membership of the committee(s) responsible for the investment of ESOP assets, applicable policies and procedures, and the potential costs and benefits of utilizing the services of an independent fiduciary.