On June 25, 2014, the Supreme Court overruled the Sixth Circuit by holding that ERISA "does not create a special presumption favoring ESOP fiduciaries" that invest in employer stock and that "the same standard of prudence applies to all ERISA fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP's holdings." Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, 2014 U.S. Lexis 4495 *16 (June 25, 2014). The presumption of prudence was first announced inKuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995), followed closely byMoench v. Robertson, 62 F.3d 553 (3d Cir. 1995), and subsequently adopted by the Second, Fifth, Seventh, Ninth and Eleventh Circuits. Although the Court rejected the presumption of prudence in what is commonly known as "stock drop" cases, it nonetheless provided lower courts with important guidance to help them determine the plausibility of fiduciary breach claims in these types of cases.
Like many employers, Fifth Third Bancorp sponsored a 401(k) Plan with 20 separate investment funds, including an ESOP. Dudenhoeffer, 2014 U.S. Lexis 4495 *7. Plan participants directed their own investments into any one of the 20 investment options. Id. Although Fifth Third provided a 4% match that was initially invested in the ESOP, participants were able to redirect their matching contribution to any of the other 20 investment options. Id. The Plan requires that the ESOP's funds be "invested primarily in shares of common stock of Fifth Third." Id.
Former Fifth Third employees and ESOP participants filed a class action in federal district court in Ohio alleging that Plan fiduciaries violated their ERISA duties of prudence and loyalty when they knew or should have known the stock was overvalued and continued to allow investments in the ESOP. The complaint alleged that the fiduciaries should have been on notice that the stock was overvalued for two reasons. First, publicly available information such as newspaper articles provided early warning signs that subprime lending in which Fifth Third was heavily invested would soon impact investors because the housing market was near collapse. Second, the Plan fiduciaries had nonpublic information.
The District Court and Sixth Circuit Rulings
The district court began by concluding that where a lawsuit challenges ESOP fiduciaries' decision to invest in company stock, the plan fiduciaries start with a presumption that their decision to remain invested in company stock is prudent. Dudenhoeffer v. Fifth Third Bancorp, 757 F. Supp. 2d 753, 758 (S.D. Ohio 2010.) It then concluded that the rule was properly applied at the pleading stage and dismissed the case because the allegations in the complaint failed to overcome the presumption of prudence. Id. at 758-762.
Although the Sixth Circuit agreed that ESOP fiduciaries were entitled to a presumption of prudence, it viewed the presumption as an evidentiary standard to be applied at the motion for summary judgment stage and reversed the district court for improperly applying the standard at the motion to dismiss stage. Dudenhoeffer v. Fifth Third Bancorp, 626 F. 3d 410 (2012). Its ruling that the presumption should not apply at the motion to dismiss stage conflicted with every other circuit that had addressed the issue; namely the Second, Third, Seventh and Eleventh Circuits. The Supreme Court granted certiorari to resolve the split, and in the process rejected the rule entirely.
The Supreme Court's Decision
The Supreme Court reversed the Sixth Circuit and every other circuit that had addressed the issue for that matter. The Court concluded that nothing in the statutory language of ERISA supported a special presumption of prudence in the context of fiduciary investment decisions in ESOPs.Dudenhoeffer, 2014 U.S. Lexis 4495 *16-17. The court noted that although ESOP fiduciaries were exempt from the diversification requirements of ERISA, they were nonetheless subject to ERISA's prudence standard to the same extent as other fiduciaries. Id. at 17.
The Court, however, provided some additional helpful guidance. It noted that as a rule where stock is publicly traded, allegations that publicly available information indicating that the stock is over- or undervalued, without any other evidence, do not state a plausible claim for relief, absent special circumstances. Id. at *29. The Court also reasoned that fiduciaries should be entitled to rely on the market price "as an unbiased assessment of the security's value in light of all public information." Id. (quoting Halliburton Co. v. Erica P. John Fund, Inc., ___ U.S. ___, 20'4 U.S. LEXIS 4305 at *27 (2014)).
The Court also rejected the plaintiff's assertion that plan fiduciaries should act on insider information in deciding whether to sell or buy company stock. The Court held that:
[t]o state a claim for breach of the duty of prudence on the basis of inside information, a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.
Id. at *32.
The Court resolved some very important issues in the stock drop cases. It unambiguously held that fiduciaries may rely on the market price of the stock as providing an unbiased assessment of the company stock. It also made clear that fiduciaries with negative inside information do not have to trade on that basis or publicly disclose the information. Both allegations have been pivotal allegations in stock drop cases. Bottom line: the Court overturned the presumption of prudence, but provided guidance that will make it very difficult for plaintiffs to win stock drop cases absent evidence of the company purposefully manipulating the value of the stock.