Last week, in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, the Supreme Court sketched a new legal landscape for ERISA "stock drop" litigation. In an opinion by Justice Breyer, the Court unanimously held that fiduciaries of an employee stock ownership plan (ESOP) are not entitled to a "presumption of prudence" in connection with their decision to invest in employer securities. Rather, the Court ruled that ESOP fiduciaries are subject to the same standard of prudence that applies to all ERISA plan fiduciaries, except that they are under no duty to diversify the plan's investments. In so ruling, the Court effectively overturned the "presumption of prudence" for ESOP fiduciaries that had previously been adopted by nearly every Court of Appeals to address the issue. The Supreme Court nevertheless held that Fed. R. Civ. P. 12(b)(6) provides a vehicle for disposing of meritless ERISA claims challenging plan investments in employer securities following a drop in the employer's stock price.
ERISA "stock drop" claims often accompany securities fraud class actions and generally allege that ESOP plan fiduciaries breached their duties under ERISA by investing in, or maintaining investments in, employer stock. The so-called "presumption of prudence" for ESOP fiduciaries was first articulated by the Third Circuit nearly 20 years ago in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). ERISA expressly provides that ESOP fiduciaries - unlike fiduciaries of traditional pension plans who must diversify investments of the plan - are not liable for losses that result from a failure to diversify. See 29 U.S.C. § 1104(a)(2). ERISA imposes a "prudent person" standard of care on plan fiduciaries, and courts prior to Fifth Third Bancorp applied that standard using a presumption that the fiduciaries' decision to remain invested in employer securities was reasonable. The Supreme Court's opinion in Fifth Third Bancorp unanimously rejected that presumption, explaining that "the law does not create a special presumption favoring ESOP fiduciaries."
But, while eliminating the "presumption of prudence," the Court also recognized the importance of "weeding out meritless" claims against ESOP fiduciaries, and highlighted the high hurdles that plaintiffs continue to face at the pleading stage through the application of the standards set forth in Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). Specifically, the Court held that "allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances." In other words, ESOP fiduciaries are not expected to "outsmart" the market and - absent a "special circumstance rendering reliance on the market price imprudent" - can assume that the market provides the best estimate of the security's value. Moreover, where a claim is based on the fiduciaries' failure to act on nonpublic information, a plaintiff must plausibly allege "an alternative action that [ ] could have [been] 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." In such cases, the Court offered three important points of analysis: (i) ERISA does not require fiduciaries to violate securities laws; (ii) where a complaint faults fiduciaries for failing to refrain from making additional stock purchases or failing to disclose information to the public, courts should consider the extent to which ERISA obligations conflict with complex insider trading and corporate disclosure requirements; and (iii) courts should consider whether plan fiduciaries "would do more harm than good" by taking "alternative action," such as halting the purchase of employer stock or publicly disclosing negative information.
The Supreme Court's rejection in Fifth Third Bancorp of the presumption that ESOP fiduciaries act prudently by investing in company stock may initially result in some additional ERISA stock drop litigation. At the same time, the Court provided significant guidance on the high pleading standards plan participants must meet in order to survive a motion to dismiss - a powerful tool for defendants to weed out meritless claims. Thus, Fifth Third Bancorp is unlikely to increase the ultimate liability of defendants in such actions.