On June 25, 2014, the U.S. Supreme Court, in an unanimous decision, held that employee stock ownership plan (“ESOP”) fiduciaries are not entitled to a special presumption of prudence. Instead, ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, except that they need not diversify the fund’s assets. Fifth Third Bancorp v. Dudenhoeffer, No. 12-751.
The plaintiffs, former Fifth Third employees and ESOP participants, filed suit against Fifth Third and several of its officers. The complaint alleged that the defendants were ESOP fiduciaries and breached their duties of loyalty and prudence to the plan imposed by ERISA. Specifically, the plaintiffs claimed that the defendants should have known—on the basis of both publicly available information and inside information—that Fifth Third stock was overpriced and excessively risky. The plaintiffs further alleged that a prudent fiduciary would have responded to this information by either: selling the ESOP’s holdings of Fifth Third stock before the value declined, refraining from allowing the ESOP to purchase additional Fifth Third Stock, canceling the Plan’s ESOP option, or disclosing the inside information so that the market would adjust its valuation of Fifth Third stock (resulting in the ESOP no longer “overpaying” for the stock). The plaintiffs claimed the defendants failed to take any of these actions, resulting in the significant reduction of the plaintiffs’ retirement savings when the Fifth Third stock price fell.
The district court dismissed the complaint for failure to state a claim, finding that ESOP fiduciaries are entitled to a presumption that their decision to remain invested in employer securities is reasonable, and concluding that the complaint’s allegations were insufficient to overcome that presumption. The Court of Appeals for the Sixth Court reversed, ruling that while a special presumption does exist, this presumption is evidentiary only and does not apply at the pleading stage.
The Supreme Court vacated and remanded the Sixth Circuit’s decision, holding that ESOP fiduciaries are not entitled to a special presumption of prudence. The Court first noted that while ERISA imposes a duty of prudence on pension plan fiduciaries, Congress recognized that ESOPs are designed to invest primarily in the stock of the participants’ employer, meaning that their investments are not intended to be diversified. Accordingly, ESOP fiduciaries are not obliged to diversify the investments of the plan so as to minimize the risk of large losses or act with the care, skill, prudence, and diligence of a prudent person insofar as that duty requires diversification. Nonetheless, the Court held that ERISA does not create a special presumption favoring ESOP fiduciaries. Rather, because the duty of prudence applies to all ERISA fiduciaries and the specific provisions regarding ESOPs make no reference to a special presumption, ESOP fiduciaries are subject to the same duty of prudence as other ERISA fiduciaries.
In holding that ESOP fiduciaries are not entitled to a special presumption of prudence, the Court found that the special purpose of an ESOP—investing participants’ savings in the stock of their employer— does not warrant relaxing the duty of prudence. Further, the Court held that the common law is inapplicable, and that trust documents cannot excuse trustees from their duties under ERISA. The Court also rejected defendants’ contention that subjecting ESOP fiduciaries to a duty of prudence without the protection of a special presumption would lead to conflicts with insider training laws. Finally, the Court dismissed defendants’ argument that a special presumption is necessary to stave off costly duty-of-prudence lawsuits and incentivize companies to offer ESOPs to their employees. The Court found that a special presumption is an inappropriate way to deal with meritless lawsuits.
The Court concluded that where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and insufficient to state a claim. Moreover, to state a claim for breach of the duty of prudence, a complaint must plausibly allege an alternative action that the defendant could have taken, that would have been legal, and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the plan than to help it.
Dudenhoeffer makes it even more important that plan sponsors and fiduciaries adhere to administration and participant communication best practices and plan design strategies, as advised by counsel. If you sponsor an ESOP and would like to discuss this ruling further, please reach out to one of our Labor and Employment or Employee Benefits and Executive Compensation attorneys listed below.