On Wednesday, the Supreme Court issued a unanimous decision in the Fifth Third Bancorp v. Dudenhoeffer case. The landmark decision held that ESOP fiduciaries are not entitled to any special presumption of prudence when purchasing or holding company stock. The Supreme Court’s ruling is a substantial departure from the presumption widely accepted by the U.S. Circuit Courts of Appeals, commonly referred to as the “Moench presumption.”
The Moench presumption was first applied by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). Under the Moench presumption, a plan fiduciary’s decision to continue offering company stock as an investment option was considered prudent under ERISA unless the plaintiff could show that the employer abused its discretion by continuing to offer the stock. The plaintiff had to show that the employer was on the brink of collapse, under extraordinary circumstances, or experiencing a similar dire situation. Prior to this Supreme Court decision, the plaintiff was usually required to make this showing during the motion-to-dismiss stage. This presumption is difficult for the plaintiff to overcome and has historically protected plan fiduciaries from liability.
The Dudenhoeffer case involved Fifth Third Bancorp, a public company, that had a 401(k) plan with an ESOP component. The employer matching contribution under the plan was made in Fifth Third stock; participants could invest contributions in a number of investment options, including Fifth Third stock. Over a two-year period, Fifth Third stock dropped 74%, at a time when Fifth Third was involved in subprime lending. The plaintiffs argued that the plan fiduciaries should have reacted to the risk associated with this business practice when evaluating the appropriateness of the investment option, and failed to provide participants with sufficient and accurate information about the riskiness of the investment.
Applying the Moench presumption, the district court dismissed the complaint for failing to state a claim, holding that the plaintiffs failed to plead facts sufficient to justify a finding of abuse of discretion. The Sixth Circuit reversed. Although the Sixth Circuit agreed that ESOP fiduciaries were entitled to a special presumption of prudence, it held that the presumption was an evidentiary one that did not apply at the motion-to-dismiss stage. The court reasoned that the presumption required a fully developed evidentiary record that did not exist at the pleading stage.
The Supreme Court’s Decision
The Supreme Court held that a plaintiff is no longer required to overcome the special Moench presumption of prudence that has been historically applied to ESOP fiduciaries in stock-drop cases. Instead, ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they are not subject to the diversification requirements.
Q&B Key: Key takeaways from the Supreme Court’s opinion, as well as open issues that have been left on the table for the lower courts to decide, include:
- The Supreme Court notes that the general duty of prudence under ERISA trumps the instructions of a plan document, such as an instruction to invest solely in company stock. Thus, hard-wiring company stock fund language in the plan document may not provide much, if any, fiduciary protection.
- The Supreme Court recognizes that fiduciaries may be “between a rock and a hard place.” If a fiduciary continues to invest in company stock and the price goes down, the fiduciary may be sued for acting imprudently. On the other hand, if a fiduciary stops investing in company stock and the price goes up, the fiduciary may be sued for not following the terms of the plan document that require investments in company stock, in violation of ERISA.
- Although the Supreme Court agrees “that Congress sought to encourage the creation of ESOPs,” careful balancing of Congress’ desire to protect employees on the one hand, and to encourage the creation of ESOPs on the other, is necessary. The presumption at issue in Dudenhoeffer is not “an appropriate way to weed out meritless lawsuits or to provide the requisite ‘balancing’.”
- Where stock is publicly traded, plan fiduciaries may rely on the market price as being accurate, unless there are special circumstances that would make this reliance imprudent. The lower courts will need to determine what special circumstances affect the reliability of the market price that would make reliance imprudent.
- The Supreme Court provides a roadmap for purposes of determining whether a plaintiff has sufficiently stated a claim for breach of the duty of prudence where the fiduciary has access to inside information:
- First, the duty of prudence does not require an ERISA fiduciary to take actions that would break federal securities laws, such as divesting company stock on the basis of inside information.
- Second, when determining whether, based on inside information, a fiduciary should have refrained from making additional company stock purchases or should have disclosed that information to the public, the lower courts must consider how an ERISA-based obligation to refrain from making purchases or to disclose information to particpants may conflict with complex insider trading and corporate disclosure laws or with the objectives of those laws.
- Third, the lower courts need to consider whether stopping purchases or disclosing negative information might do more harm than good by causing a drop in the stock price, negatively affecting the value of participants’ account that contain stock.
- Lower courts must realize that plan fiduciaries may focus on long range investment goals, consistent with a retirement strategy, and should not be judged on short-term performance — barring unusual business conditions.
Impact on ESOPs
Although the Moench presumption of prudence no longer applies in the wake of this decision, the Supreme Court’s opinion does not completely pull the rug out from under ESOP fiduciaries. The Supreme Court vacated the Sixth Circuit’s earlier decision and remanded the case back to the Sixth Circuit for further proceedings. It is now up to the Sixth Circuit to consider the open issues addressed in the Supreme Court’s opinion, and determine whether the case meets the pleading standard to proceed to trial.
Some employers with stand-alone ESOPs or 401(k) plans with an ESOP component rely on independent fiduciaries to make certain decisions relating to investments in company stock. Depending on how the Sixth Circuit ultimately decides, employers may want to consider the option of an outside independent fiduciary who will evaluate the company stock, monitor its continued performance, and make recommendations to the plan’s trustee or investment committee.